Finding consistent entry and exit points is the challenge in trading the world of stock markets. Most traders are unable to distinguish between short-term noise and long-term trends and therefore often make noise-driven rather than data-driven decisions, miss their calls, or enter too early or too late. This is even more so the case for traders that specialize in exchange-traded funds (ETFs), which tend to reflect larger market moves and have a tendency to mask real pullbacks and simply noise.
In Chapter Six of Larry Connors’ High Probability ETF Trading, there is a strategy known as the “Multiple Days Up (MDU) and Multiple Days Down (MDD)”. It systematically allows for potential market reversals based on recent price action. The strategy bought those ETFs where the price has declined for several consecutive days in hopes of capturing mean-reverting price movements. The basic idea is simple: after a few down days, a market is owed and due for a short-term rebound. This strategy supports trading on such a tendency through a set of clear entry and exit rules.
This article takes the MDU and MDD strategy out with the stops, looking at the fine print behind the rules, results of backtests on various ETFs, and what we can learn by applying these principles. By the end you will know how to apply these principles yourself and look to save returns while mitigating risk.
What is the MDU and MDD Strategy?
The MDU and MDD strategy is basically a momentum-based ETF trading strategy based around the concept of mean reversion probability following an extended trend. In this, it basically tries to ascertain when an ETF has had a series of down days and, hence, presents as an area for reversal as the price might revert to the mean, which often takes the form of a price bounce or reversal.
The Key Idea Behind MDU and MDD:
Multiple Days Down (MDD): The strategy looks for ETFs that have declined for four of the last five trading days. This is identified as a “weak” market, which might be because of bounce back or flat period.
Multiple Days Up (MDU): If an ETF has gone up a lot for several consecutive days, the strategy may interpret this as an area that pulls back or experiences a short-term reversal; hence, sell.
Trading Rules of MDU and MDD Strategy
The rules governing the MDU and MDD strategy are straightforward yet successful when executed accordingly:
Entry Conditions (Buy):
Price Above 200-Day Moving Average: The ETF should be in an overall uptrend.
Price Below 5-Day Moving Average: The ETF must be in a short-term downtrend.
At Least Four Down Days in the Last Five: This is the key entry signal. The strategy requires that the ETF has fallen for at least four out of the past five trading days.
Enter on Close: Only at the end of all conditions, the strategy instructs to buy when closing the running trading day.
Exit Conditions (Sell):
Close above 5-day Moving Average : The position is sold when the ETF closes above the 5-day moving average.
No Stop Loss: Interestingly, the strategy does not take advantage of the stop loss. It goes purely on the action of prices and the moving averages for the determination of exit.
Backtesting the MDU and MDD Strategy
We backtested this strategy on various stock market ETFs from the year 2000 up to the present. The goal of the backtesting was to gauge its performance and see how it fared in relation to a simple buy-and-hold strategy.
Backtest Results on Individual ETFs
We first ran the MDU and MDD strategy across 20 different stock market ETFs in our initial backtests. Results: The results were very moderate, capturing some profitable moves into the strategy, though overall returns were not spectacular at all. A notable observation in this strategy is very little time spent in the market, which can limit the aggregate return. Performance of the performance varied significantly; some of the ETFs gave a positive return while the others underperformed significantly even using a simple buy-and-hold strategy.
Portfolio Application Strategy
We then put the strategy through a portfolio of five ETFs, with 20% to each position, holding up to five ETF at any given time. The results from the back-test show that the equity curve was much steadier while the annual returns were relatively low. This means that while MDU and MDD catch some short-term reversals, it is not quite enough as a standalone strategy for sustained high returns.
Refining the Strategy with QQQ and SPY:
We further refined the strategy by applying it to the two most prominent ETFs, QQQ, which tracks the NASDAQ-100, and SPY, which is the proxy for the S and P 500. Results were more stable but could not deliver consistent high returns. In this round, the strategy had more erratically moving equity curves, and the returns were far from being impressive enough to warrant trading by MDU and MDD approach alone.
Understanding Performance: Why This Strategy Has Been Losing
The MDU and MDD strategy tends not to work well always because of its dependence on mean reversion in short time frames. Price often tends to revert toward the mean over some period, but this does not always occur within the short time span that this strategy pays attention to. In addition, the missing stop loss allows large steady downtrends to cause damage to performance, especially during market crashes or long-lasting bear markets.
Enhance the MDU and MDD Strategy
For improvement of this strategy, there are a few amendments that can be made:
Combination with Other Indicators: Using other indicators such as the RSI or MACD can be used to prove the validity of the trade signal. In preventing false signals, this may be very effective.
Add a Stop-Loss: Adding a stop loss can help just restrain the possible losses faced due to the long period in the bear market or other financial crises.
Include long-term charts: A program that looks for stronger periods of consolidation and reversals should be employed. The MDU and MDD strategy shall work effectively on longer duration charts, such as weekly and monthly charts rather than moving only daily.
Conclusion: Do You Apply the MDU and MDD Strategy?
The MDU and MDD strategy is an intriguing way of identifying market reversals based on recent price action. However, backtesting fails to turn it into a risk-free way of making money. It is likely to run into a difficult time in some market conditions such as when the time in the market is low or on prolonged trends. In short, this strategy is very good at catching those short-term pullbacks and subsequent rebounds. It really fits well within a larger, more diversified trading approach.
I would recommend, for anyone using this strategy, combine it with other technical indicators along with some risk management techniques such as stop-loss orders to improve their performance, and most importantly, before you deploy them in actual trading, always make sure to backtest your changes should you have made some or refined your strategy.
The MDU and MDD strategy gives proper grounds for the understanding of market reversals but, like any trading strategy, needs its expectations adjusted along with sound risk management.