The Strategic Trader
Detailed Strategy Evaluation


Simple Profitable Strategy: Part 1 (Design)

In this article series we are going to take what we have learned from RSI, MACD, Bollinger Bands, and Aroon Oscillator to build a simple yet profitable strategy. For validation, the strategy testing period will exclude 1/1/2000-6/1/2001 and 1/1/2011 – present. This will allow us to perform sanity checks in later phases to avoid curve fitting.

The goal is to build a strategy that is still profitable after taking out both slippage and commissions. Since most of our articles to date have dealt with the 5 minute time frame on ES, we will continue using those parameters.

The Setup:

In order to build a strategy, we have to have a place to start. For this strategy, we will start by combining the best aspects of each of the trading methods we have tested thus far. Starting with the most recent Aroon Oscillator method.  We identified AroonOscillator(8) crossing below -80 as possessing a slight edge, so we will put a stick in the ground here.

Initial Results (Pre commission/Slippage):

Profit: +$54,987
PF: 1.20
Max DD: -$4,662
Sharp: .58
Trades: 6925
Win %: 58.51%
Average Trade: +$7.94


This is a good start, but far from profitable once commissions and slippage are applied.

Before we move on to filtering out trades or tweaking the exits we need to add more potential “entry conditions”. In this step we go back through all the indicators that showed a slight edge and see if an optimized parameter combination for it improves overall performance.

The main purpose of this phase is to get as many entries as possible while still remaining over our “statically significant” thresholds. Each individual entry criteria does not need to remain above the threshold, but as a whole when used in an if/or combination the strategy needs to at least exceed on percent profitable or pure profit.

  1. Additional Aroon Oscillator Parameter Combinations
    • No additional combinations improved results significantly. AroonOscillator(27) <-99 helped, but not enough to justify inclusion
  2. Cross below Bollinger Lower Band
    • Bollinger(2.5,7) was added to the strategy
  3. MACD cross below signal line
    • MACD(2,12,4) was added to the strategy
  4. RSI Hidden Divergence
    • RSI Hidden Divergence 29,10,4 was added to the strategy
  5. RSI Hidden Divergence
    • RSI Hidden Divergence 14,22,6 was added to the strategy
  6. RSI Hidden Divergence
    • RSI Hidden Divergence 18,6,2 was added to the strategy
  7. Aroon Hidden Divergence
    • Aroon Hidden Divergence 12,17,4 was added to the strategy


Profit: +$81,925
PF: 1.15
Max DD: -$4,700
Sharp: .59
Trades: 13600
Win %: 57.32%
Average Trade: +$6.02

trading strategy development


Several key metrics decreased from the initial entry condition, but this is to be expected. Now we have a basic set of entry conditions providing over 13,000 trades. In the next several articles we will look at different ways of filtering out the non-performing trades, and implement an exit that makes more sense than a static 5 bar exit.

Eventually we will incorporate advanced concepts such as data mining and neural networks to improve the final product.



RSI Part 9: Risk/Reward

Before temporarily moving away from RSI, I want to evaluate each method one more time using the risk/reward test discussed in this article: Risk/Reward Testing

Crossing Above a Threshold:
Surprisingly many parameter combinations performed very well. Unfortunately, no combinations were able to exceed our desired targets.

Crossing Below a Threshold:
This method performed horrible based on this metric. This is what I thought might happen, and the reason I wanted to perform this test. Buying when oversold is a high percentage play if your nimble. But from a risk/reward standpoint its a hard strategy to trade.

Normal Divergence:
This method still did not contain any tradeable edge. Performs very poorly.

Hidden Divergence:
No combination was able to exceed our lofty targets, however several combinations missed by only fractions of a percent. This further underscores the fact that RSI Hidden Divergence contains a tradeable edge.

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RSI Part 8 – Short Strategies

In previous articles we have identified two methods that provide an edge on the long side (Bullish Hidden Divergence and Buying on oversold conditions). Before reading this article, its recommended you read the following two articles:

1. Buying on “Bullish Hidden Divergence
2. Buying when oversold

For this article we tested the same two concepts to see if they also had an edge when traded from the short side. The first method we looked at was “Bearish Hidden Divergence”. The testing strategy was very similar to the one used in “Bullish Hidden Divergence”. It was immediately apparent that this strategy had a significant edge just like its bullish counterpart.

Several combinations easily exceeded our target values when predicting 3 bars into the future. However, when predicting 5 bars into the future the results were not quite as clear. Several strategies came extremely close, but failed to exceed our targets. In some cases missing by fractions. Because this strategy easily blew past our targets for 3 bars into the future, we know the general concept has an edge. Its likely the edge degrades fast when trading short though. When we explore exit strategies in a future article we will need to take this into account. Here is a screenshot from one of the 3 bar combinations:

Next we tested selling short when RSI crosses above a given threshold (overbought). This strategy also clearly contains a statistical edge. Many combinations for both 3 and 5 bars into the future were profitable. Here is an example of one such combination:

The next step will be to create a “combination” strategy using several parameter combinations each exhibiting a statistical edge to see if the combined edge is maintained.

Source Code:

Download Divergence Source

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RSI Part 7 – Bullish Regular Divergence

In this article we will be testing Bullish Regular Divergence using RSI.

Bullish Regular Divergence
Price: Lower Low
RSI: Higher Low

Using Bullish Hidden Divergence we were able to significantly exceed our targets and prove that there exists a statistical edge when using that method. However, the same can not be said for regular divergence. The strategy produced several combinations which were profitable, but all of the returns were well below our targets. Therefore we can not rule out random chance accounting for those results. Here is a P/L chart from the best combination:

Notice how “random” and volatile the results appear? When compared to the chart produced from the Hidden Divergence article, you can clearly see the difference.  Here is a P&L chart from the Hidden Divergence article.

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RSI Part 6 – Bullish Hidden Divergence

A common technique for trading oscillators such as RSI is to use divergence. There are two types of divergence, regular and hidden. Regular divergence is commonly used to signal trend changes, and hidden divergence is used to signal trend continuation.

Bullish Regular Divergence
Price: Lower Low
RSI: Higher Low

Bearish Regular Divergence
Price: Higher High
RSI: Lower High

Bullish Hidden Divergence
Price: Higher Low
RSI: Lower Low

Bearish Hidden Divergence
Price: Lower High
RSI: Higher High

In this article we will be testing Bullish Hidden Divergence. This method is commonly used when a stock is in an uptrend and pulls back to test support. To find divergence we need to look at the lows of both RSI and price. Since RSI moves smoother than price, I used it as a way of finding lows. Once a low has been identified in RSI, I start looking for another potential low. If one is found I compare the price of the stock at the time of the first RSI low to the value of the stock now. I then compare the first RSI low with the new potential low. If RSI has made a lower low and price has made  a higher low I continue. Next, I check to see how many bars have passed since the first RSI low. This is to help ensure that enough distance has been created between the two valleys.

I optimized the strategy on 3 parameters:

1. RSI Period
2. Number of bars to look back when calculating a low
3. Number of bars to pass between lows

Initial (5 bar) results were decent. Most optimized pairs performed very well. However, only one combination was able to exceed our target value on both percent and profit. The strategy used a 9 bar RSI, 3 bar look-back, and required at least 9 bars between low points.

The (3 bar) results also did well. The same combination that exceeded our targets for 5 bars also exceeded for 3 bars. Here it the PL screenshot.

Further Enhancements:
Commonly Bullish Hidden Divergence is used to continue an uptrend. Therefore, I tried to only take trades when the stock was in a confirmed uptrend such as above a moving average etc. This method did not result in any performance gain. As we explore more indicators and determine which are ideal for identifying trend we can revisit this strategy.

Source Code:

Download Source

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