Tuesday saw QQQ drop somewhat heavily, and for the third day in a row. These three drops took us back to mid-August levels, blowing through a ton of support levels… My mean reversion senses are tingling!
So, let’s take a look at what happens in these situations by formulating a simple rule to capture them, that will then exit after the mean reversion has (hopefully) happened:
- If QQQ is down at least 3 days in a row, and it closes below the 10-day intraday low, go long.
- Close the position one day after QQQ closes above its 5-day SMA.
A simple rule, designed to capture big drops in hope for a bounce. The usual issues associated with catching falling knives come up.
Sometimes it works great…
And others not so much…
But over time there is remarkable consistency:
Here are the stats:
Downside skew is never nice of course, is there something we can do to soften the biggest losses? As it happens in most cases with swing systems, adding a stop loss is generally a bad idea. Indeed adding a simple 3% stop loss would decrease returns, lead to a much more uneven equity curve, and also result in deeper and longer drawdowns. Getting fancier and adding various special rules to the stop (such as a period after getting stopped out during which trading is not allowed) does not significantly improve the results. The solution here is simply proper position sizing so that you can take the losses you have to take and still be comfortable.
Finally, is this just an accidental feature of the NASDAQ 100, or could we use it in other markets as well? Let’s have a look at a broad array of equity index ETFs:
Well, there you have it…
Disclosure: Net long U.S., U.K., Singaporean equities.