Friday, March 03, 2006

Strategy Session: Sequence Analysis

Dr. Brett Steenbarger explores the difference between mechanical system traders and historical pattern traders in recent posts and as usual, comes up with insightful conclusions. Mechanical traders trade a model. Historical pattern traders conduct ongoing modeling as a dynamic process. For example, if you know what the market did yesterday and you see how the market opens today, can you make reliable forecasts to assist you in your trading? Will you know if you are swimming against the current or with it? Historical pattern traders use signposts to confirm if they are on the side of history - or against it.

An example of historical pattern trading is something Dr. Steenbarger calls Sequence Analysis. Here is Brett's explanation:

"I examine every historical trade identified in my analyses and then walk them forward to identify the normal sequences of profits and losses. I'm specifically looking for key events that separate the winning trades from the losers, so that these could serve as rational exit points. To give but one simple example, if I find that 85% of all winning 10-day trades started out by being profitable in the first two days, I might not want to hold a loser after two days." (Note: emphasis added)

In sequence analysis, you always update forecasts with the most recently available data. That's where Trade-Ideas comes in. Use Trade-Ideas to find the rational exit points OR use it to scan for the key events that indicate the higher probability of winning trades.

The Strategy: Sequence Analysis - Down Day Followed by Strong Open: Bullish

You can read Brett's full description here. In this example of Sequence Analysis the key event question is: What has happened historically when a down day has been followed by a strongly up open? The short answer is: a strong open following a weak day affects the market's short-term trajectory. Let's see it configured.

How Its Modeled

The set-up includes these filtering conditions:

The alerts we select as triggers within this filtered universe are stocks that: increase by more than 3% in price from the opening OR cross daily highs OR running up with momentum.

Who Can Benefit

Dr. Brett Steenbarger:

"This is an example of how updating forecasts with real time data can greatly aid trading. Traders need not wait for real time events to occur, however, to conduct these analyses. They can prepare for real time possibilities by conducting "what-if" scenarios with the historical data. Such sequence analysis would look at all historical occasions of market declines . . . and then investigate what happened when the following day opened strong."

For extra credit you could design the opposite of this strategy (i.e., Down Day followed by a weak open) for use in more bear markets. Read the Online Help definitions to get started.


  • Dr. Brett Steenbarger's blog here.
  • Configure this strategy for your own use here.
  • Link to other Strategy Sessions here.
  • Remember that these set-ups are sketches meant to give you an idea how to model your own trading plan. Use this 'as is' or modify it to your own liking as many others do. Know, however, that and all individuals affiliated with this site assume no responsibilities for your trading and investment results. The indicators, alerts and all other features are for research purposes only and should not be construed as investment advice.
  • June Seminar Footnote - To gain a full understanding of how this strategy and others can help you in your trading plan, we suggest you attend our training seminar in June. There we will focus on all the advanced aspects of our software needed to give you an edge against larger, more capitalized participants. We just opened the sign up page so that you can officially pay for and reserve your spot (conference limited to 100 existing subscribers).

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