ConnorsResearchTradingStrategySeries

TradingStocksand
Optionswith
MovingAverages
AQuantified
Approach
By

ConnorsResearch,LLC

LaurenceConnors

MattRadtke
 P a g e |2

Copyright 2013, Connors Research, LLC.

ALL RIGHTS RESERVED. No part of this publication may be reproduced, stored in a

retrieval system, or transmitted, in any form or by any means, electronic, mechanical,
photocopying, recording, or otherwise, without the prior written permission of the
publisher and the author.

This publication is designed to provide accurate and authoritative information in regard

to the subject matter covered. It is sold with the understanding that the author and the
publisher are not engaged in rendering legal, accounting, or other professional service.

Authorization to photocopy items for internal or personal use, or in the internal or

personal use of specific clients, is granted by Connors Research, LLC, provided that the
U.S. $7.00 per page fee is paid directly to Connors Research, LLC, 1-973-494-7333.

ISBN 978-0-9886931-7-3

Printed in the United States of America.

 P a g e |3

Disclaimer
By distributing this publication, Connors Research, LLC, Laurence A. Connors and Matt Radtke
(collectively referred to as Company") are neither providing investment advisory services nor acting as
registered investment advisors or broker-dealers; they also do not purport to tell or suggest which
securities or currencies customers should buy or sell for themselves. The analysts and employees or
affiliates of Company may hold positions in the stocks, currencies or industries discussed here. You
understand and acknowledge that there is a very high degree of risk involved in trading securities and/or
currencies. The Company, the authors, the publisher, and all affiliates of Company assume no
responsibility or liability for your trading and investment results. Factual statements on the Company's
website, or in its publications, are made as of the date stated and are subject to change without notice.

It should not be assumed that the methods, techniques, or indicators presented in these products will be
profitable or that they will not result in losses. Past results of any individual trader or trading system
published by Company are not indicative of future returns by that trader or system, and are not indicative
of future returns which be realized by you. In addition, the indicators, strategies, columns, articles and all
other features of Company's products (collectively, the "Information") are provided for informational and
educational purposes only and should not be construed as investment advice. Examples presented on
Company's website are for educational purposes only. Such set-ups are not solicitations of any order to
buy or sell. Accordingly, you should not rely solely on the Information in making any investment. Rather,
you should use the Information only as a starting point for doing additional independent research in order
to allow you to form your own opinion regarding investments.

You should always check with your licensed financial advisor and tax advisor to determine the suitability
of any investment.

HYPOTHETICAL OR SIMULATED PERFORMANCE RESULTS HAVE CERTAIN INHERENT

LIMITATIONS. UNLIKE AN ACTUAL PERFORMANCE RECORD, SIMULATED RESULTS DO NOT
REPRESENT ACTUAL TRADING AND MAY NOT BE IMPACTED BY BROKERAGE AND OTHER
SLIPPAGE FEES. ALSO, SINCE THE TRADES HAVE NOT ACTUALLY BEEN EXECUTED, THE
RESULTS MAY HAVE UNDER- OR OVER-COMPENSATED FOR THE IMPACT, IF ANY, OF CERTAIN
MARKET FACTORS, SUCH AS LACK OF LIQUIDITY. SIMULATED TRADING PROGRAMS IN
GENERAL ARE ALSO SUBJECT TO THE FACT THAT THEYARE DESIGNEDWITH THE BENEFIT OF
HINDSIGHT. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO
ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE SHOWN.

Connors Research
10 Exchange Place
Suite 1800
Jersey City, NJ 07302

 P a g e |4

Table of Contents
Section1Introduction.............................................................................5
Section2StrategyRules...........................................................................8
Section3TestResults............................................................................15
Section4SelectingStrategyParameters...............................................21
Section5UsingOptions.........................................................................25
Section6AdditionalThoughts...............................................................29
Appendix:TheConnorsRSIIndicatorandHistoricalVolatility..............31

 P a g e |5

Section1

Introduction

 P a g e |6

Indicatorsarenotalwayswhattheyappeartobe.Movingaveragesarewidelyusedasatrendfollowing
tool.Inmanyofthetradingstrategiesthatwehavedevelopedovertheyears,the200daymoving
average(MA)isusedtoidentifythedirectionofthetrend.Wehavefoundthattakingbuysignalsonly
whenthepriceisabovethe200dayMAcanimproveprofitabilityinmanysystems.

Recently,wecompletedresearchthatshowsmovingaveragescanalsobeusedaspartofastrategyto
findshortterm,meanreversiontradingopportunities.Thismaybesurprisingtosometradersbecauseit
mightseemoddtouseatrendfollowingindicatorlikeMAsinashortterm,meanreversionstrategy.

WhileMAsareusedinthisstrategy,theMAisnotbeingappliedinitstraditionalway.Aswehighlighted
inthe2004bookHowMarketsReallyWork,itisimportanttodevelopuniqueinsightsintothebehavior
ofprices.

InHowMarketsReallyWork,wetestedcommonknowledgeanddiscovereditwasnotalwaysbestto
followwidelyacceptedmarkettruths.Wefoundthatitwasbesttobuyshorttermweakness,for
example,andresearchshowedthatselectivebuyingwhenmarketbreadthwaspoorwasmore
profitablethanbuyingwhenmarketbreadthindicatorswereuniformlypositive.Wealsodiscoveredthat
changesinvolumewereirrelevanttomakingbuyandselldecisionsdespitethewidespreadbelief
amongtradersthatvolumeisneededtoconfirmanuptrend.

Wehavecontinuedthattypeofresearchandwealwayslookatdataratherthanwidelyacceptedtruths.
Indoingso,wefoundthatmovingaverages(MAs)canbeusedasshorttermtimingtools.

Traditionally,MAsareusuallyusedastrendfollowingtools.Buysignalsaregivenwhenpricesclose
abovetheMAandsellsignalsresultfromclosesbelowtheMA.Whiletheycanbeusedprofitablyinthis
way,therearealsoanumberofproblemsassociatedwithMAs.

Whenamarketisrangebound,whichismostofthetime,tradersexperienceanumberofwhipsaw
tradeswhilewaitingforthenexttrendtoemerge.Whipsawtradesareentriesthatarequicklyreversed.
Commissionsandothertradingcostscanbesubstantialwhenpriceswhipbackandfortharoundthe
movingaverageandthosecostsdecreaseprofits.

SignalsbasedonMAswillalsoalwaysbelate.ThisisbydesignsinceMAstrailthemarket.However,
thesedelayscanleadtomissinglargepricemoves.ThepriceofSPDRS&P500ETF(NYSE:SPY)increased
morethan30%afterbottominginMarch2009,forexample,beforelongtermMAsgavebuysignals.

SystemsbasedonMAsgenerallyhavelowwinratesandamajorityofthesystemprofitscomefromonly
afewofthetrades.Mosttradesendinonlysmallgainsorlossesthatresultfromwhipsaws.

TheseproblemsmakeMAsdifficulttotrade.Inbacktestingoverlongperiods,theyseemtobe
profitablebutinrealtime,thedelayedsignalsandlargenumberoflosingtradesleadmanytradersto
abandonthesystem.

WeviewedtheproblemsofMAsasanopportunitytodevelopatradingsystembasedonmean
reversion.

 P a g e |7

WhipsawsarecausedbythebinarynatureoftheMAsystem.Itisalwayseitherinoroutofthemarket,
orisalwayslongorshort,basedontheinteractionoftheMAwithprices.Wecanreducethisproblem
bydefiningrulesthatonlytakehighprobabilitytrades.Manymarketsareuntradeablethemajorityof
thetimeandrulescanbedesignedtorecognizewhenthemarketisatanextremeandtradeonlyunder
therightconditions.

AnotherweaknessofMAsystemsisthattheygivebacklargeamountsofprofitsafterthetrendreverses
beforetheyexitortheyrequiredelaysthatmisslargeprofitsbeforeenteringtrades.Thisiscausedby
thefactthatpricesmovesignificantlyawayfromtheMAwhenmarketsaretrending.Sometraders
addressthisproblembyclosingtradeswhenpricesdeviatetoofarfromanMA,whichleadstoanother
problembecausestrongtrendswillbemissedandtheprofitabilityofthesystemwillbereduced.We
addresstheproblemofbyusingtwoMAswhichminimizesthedelaysatturningpoints.

Allofthestrategyrulesarefullydetailedinthenextsection.ThisisapowerfulnewwaytouseMAsthat
candeliverprofitsinanymarket.

 P a g e |8

Section2

StrategyRules

This document cannot be reproduced without the expressed written permission of Connors Research, LLC.

 P a g e |9

Movingaveragesaregenerallyusedtofollowthetrends.SometraderswilluseMAstohelpidentify
overboughtoroversoldmarkets.Thisapproachusuallyinvolvesidentifyingwhenthepricehasmoved
toofarfromtheMA.TodeterminewhenpricesaretoofarfromanMA,channels,basedon
percentagesorstandarddeviations,areoftenaddedtotheMA.Channelsfailtoidentifystrengthand
areinvariablywrongduringthemarketslargestadvancesordeclines.

TheQuantifiedMovingAverageStrategyusestwomovingaveragestoreducetheprobabilityofbeing
wrongatmajormarketturns.Bothmovingaverageswillmovealongwithpricesandtherelationship
betweenthetwoaverageswillhighlightoversoldmarketextremes.

ThisstrategyexecutestradesusingasimplethreestepprocessconsistingofSetup,EntryandExit.The
rulesforeachofthesestepsaredetailedbelow.

AQuantifiedMovingAverageStrategySetupoccurswhenallofthefollowingconditionsaretrue:

1. Thestockspricemustbeabove$5.
2. Thestocksaveragedailyvolumeoverthepast21tradingdays(approximatelyonemonth)
mustbeatleast250,000shares.
3. Thehistoricalvolatilityoverthepast100days,orHV(100),mustbegreaterthan30.(Seethe
Appendixforadefinitionofhistoricalvolatility).
4. Todaysclosemustbeabovethe200daymovingaverage,orMA(200).
5. ThefastMAisatleastY%belowtheslowMAwhereY=2.5,5.0,7.5,or10.0%.The
followingMAscenarioswillbetested:

Scenario Fast MA Slow MA

1 MA(C,5) MA(C,10)
2 MA(C,5) MA(C,20)
3 MA(C,5) MA(C,50)
4 MA(C,10) MA(C,20)
5 MA(C,10) MA(C,50)

IfthepreviousdaywasaSetup,thenweEnteratradeby:

6. SubmittingalimitordertobuythestockatapriceX%belowyesterdaysclose,
whereXis2,4,6,8or10%.

Afterweveenteredthetrade,weExitusingoneofthefollowingmethods,selectedinadvance:

7a. Theclosingpriceofthestockishigherthanthepreviousdaysclose.Wetypicallyreferto
thisexitastheFirstUpClose.
7b.ThestockcloseswithaConnorsRSIvaluegreaterthan50.
7c. ThestockcloseswithaConnorsRSIvaluegreaterthan70.
7d. Theclosingpriceofthestockisgreaterthanthe3daymovingaverage,orMA(3).
7e. Theclosingpriceofthestockisgreaterthanthe5daymovingaverage,orMA(5).

This document cannot be reproduced without the expressed written permission of Connors Research, LLC.

 P a g e |10

Letslookateachruleinalittlemoredepth,andexplainwhyitsincludedinthestrategy.

Rules1&2assurethatwereinhighlyliquidstockswhichcanbereadilyboughtandsoldwithtight
bid/askspreadsthatreducetradingcosts.

Rule3assuresthatthestockhasenoughvolatilitytoallowforlargemoves.

Rule4identifiesthedirectionofthelongtermtrend.Byrequiringtheclosetobeabovethe200day
MA,wearefindingstocksthatareoversoldbutremaininalongtermuptrend.

Rule5identifiesshorttermoversoldextremes.

Rule6allowsustoenterthetradeatanoptimalprice.TheSetuprulesidentifyanoversoldstockand
theentryrulewaitsforittobecomeevenmoreoversoldonanintradaybasis.

Rule7providesawelldefinedexitmethod.Fewstrategieshavequantified,structured,anddisciplined
exitrules.Rule7givesyoutheexactparameterstoexitthetrade,backedbyover12.75yearsof
historicaltestresults.Aswithallotherstrategyparameters,weselectinadvancethetypeofexitthat
wewilluse,andapplythatruleconsistentlyinourtrading.

Rules7band7cuseConnorsRSItodefinetheexit.Inthepast,manyofourstrategiesuseda2dayRSI,
orRSI(2)toidentifyoverboughtandoversoldconditions.OurrecentresearchhasshownConnorsRSIto
beamoreeffectiveindicator.IfyourenotfamiliarwithConnorsRSI,detailscanbefoundinthe
Appendix.

InourtestingweclosedalltradesatthecloseoftradingonthedaythattheExitsignaloccurred.Ifthisis
notanoptionforyou,ourresearchhasgenerallyshownthatsimilarresultsareachievedifyouexityour
positionsatorneartheopenthenextmorning.

Nowletsseehowatypicaltradelooksonachart.

Fortheexamplebelow,welluseastrategyvariationthatrequiresthe5dayMAtobemorethan10%
belowthe20dayMAontheSetupday.Thelimitorderwillbeplaced6%belowtheSetupdaysclosing
price.WewillexitwhentheConnorsRSIisgreaterthan70,theexitmethoddefinedbyRule7c.

This document cannot be reproduced without the expressed written permission of Connors Research, LLC.

 P a g e |11

ChartcreatedinTradingView.ReprintedcourtesyofTradingVew.com.

Figure1:Smith&WessonCorp.(SWHC)Trade

ThechartaboveisforSmith&WessonHoldingCorp.whosesymbolisSWHC.Inthechart,thetoppane
showsthepricebarsinblack,the5dayMAorMA(5)inblueandthe20dayMAorMA(20)ingreen.The
greenarrowshowswhenthetradewasenteredandtheredarrowhighlightsthedaytheExitruleis
triggered.

Rule1issatisfiedbecausethestocksclosingpriceis$7.96onAugust22,2012,wellabovetheminimum
valueof$5.

Rule2ismetbecausetheaveragedailyvolumeonthedaytheSetupiscompletedismorethan1.9
million,abovetheminimumof250,000.

Rule3requiresthehistoricalvolatilityoverthepast100days,orHV(100),tobegreaterthan30onthe
daytheSetupiscompleted.TheactualvalueofHV(100)onthatdaywas67.64.

This document cannot be reproduced without the expr

 P a g e |12

Rule4issatisfiedbecauseSWHCclosedat$7.96,abovethe200dayMAwhichwas$6.43onthatday.

Rule5requiresthefastMAisatleastY%belowtheslowMAwhereY=2.5,5.0,7.5,or10.0%.Weare
using5daysforthefastMAand20daysfortheslowMAwithY=10.0%.

The5dayMAwas$8.09andthe20dayMAwas$9.24onAugust22.Inthiscase,thefastMAwasmore
than12%belowtheslowMA.TherelationshipbetweenthetwoMAscanbefoundwiththefollowing
formula:

Percentabove/below =((FastMA/SlowMA)1)*100
=(($8.09/$9.24)1)*100
=((0.8756)1)*100=12.44%

IfthefastMAisabovetheslowMA,thisvaluewouldbepositive.

SinceallfiveSetupruleshavebeensatisfied,weenteralimitorderforthenexttradingday,whichis
August23rd.Ourselectedstrategyvariationtellsustousealimit6%belowtheSetupdaysclosingprice
(Rule6),sowewouldusealimitpriceof:

LimitPrice =Closex(1Limit%)
=$7.96x0.94=$7.48

OnAugust23rdthepriceofSWHCdroppedaslowas$7.40,soourlimitordergetsfilledandwebuythe
stockatthelimitpriceof$7.48.

Onthenexttradingday,August24th,thepriceofSWHCclosedat$8.05.TheConnorsRSImovedupto
72.22.Thisisabove70,triggeringourExit(Rule7c).Wecloseourpositionatorneartheclosingpriceof
$8.05,whichgivesusaprofitonthetradeof7.6%beforecommissionsandfees:

Profit =Gain(orLoss)/CostBasis

=($8.05$7.48)/$7.48

=$0.57/$7.48=7.6%

Letslookatanotherexampleusingslightlydifferenttradeparameters.Inthisexample,wewillrequire
the5dayMAtobemorethan5%belowthe20dayMAontheSetupday.Thelimitorderwillbeplaced
8%belowtheSetupdaysclosingprice.Wewillexitwhenthepriceclosesabovethe5dayMA,theexit
methoddefinedbyRule7e.

ThechartbelowisforSpreadtrumCommunications(SPRD),andusesthesameconventionsasthe
previouschart.

This document cannot be reproduced without the expressed written permission of Connors Research, LLC.

 P a g e |13

ChartcreatedinTradingView.ReprintedcourtesyofTradingVew.com.

Figure2:SpreadtrumCommunicationsInc.(SPRD)Trade

TheSetupdayforthistradewasDecember13,2011.AsperRule1,theclosingpriceisabove$5at
$20.74.Rule2ismetbecausetheaveragedailyvolumeonthedaytheSetupiscompletedisabove1.9
millionshares,abovetheminimumof250,000.Rule3issatisfiedbecausetheHV(100)is77.60.Rule4is
takencareofwhenSPRDclosedat$20.74,aboveits200dayMAof$19.50.

Rule5requiresthefastMAisatleastY%belowtheslowMAwhereY=2.5,5.0,7.5,or10.0%.Weare
using5daysforthefastMAand20daysfortheslowMAwithY=5.0%.

The5dayMAwas$21.82andthe20dayMAwas$24.39onDecember13th.Inthiscase,thefastMA
wasnearly11%belowtheslowMA.TherelationshipbetweenthetwoMAscanbefoundwiththe
followingformula:

Percentabove/below =((FastMA/SlowMA)1)*100
=(($21.82/$24.39)1)*100
=((0.8946)1)*100=10.54%

WithallofourSetupconditionsmet,wearereadytoplacealimitorderforthenextday.SinceSPRD
closedat$20.74,thelimitorderwillbeplacedat$19.08($20.74*0.92)asperRule6.

This document cannot be reproduced without the expr

 P a g e |14

OnDecember14th,thepriceofSPRDhitanintradaylowof$17.51,whichisbelowourlimitprice,soour
ordergetsfilledandweenterthetrade.

TheExitistriggeredonDecember20,whenSPRDclosedat$21.38,aboveits5dayMAforthefirsttime
sincethetradewasentered.

Thistradewouldhavegeneratedaprofitofapproximately12.1%beforecommissionsandfees.

Nowthatyouhaveagoodunderstandingofthetrademechanics,welllookatthehistoricaltestresults
fordifferentvariationsofthestrategy.

This document cannot be reproduced without the expressed written permission of Connors Research, LLC.

 P a g e |15

Section3

TestResults

This document cannot be reproduced without the expressed written permission of Connors Research, LLC.

 P a g e |16

Wecanneverknowforsurehowatradingstrategywillperforminthefuture.However,forafully
quantifiedstrategysuchastheonedescribedinthisGuidebook,wecanatleastevaluatehowthe
strategyhasperformedinthepast.Thisprocessisknownasbacktesting.

Toexecuteabacktest,wefirstselectagroupofsecurities(sometimescalledawatchlist)thatwewant
totestthestrategyon.Inourcase,thewatchlistconsistsofnonleveragedstocks.

Nextwechooseatimeframeoverwhichtotest.Thelongerthetimeframe,themoresignificantand
informativethebacktestingresultswillbe.ThebacktestsforthisGuidebookstartinJanuary2001and
gothroughtheendofSeptember2013,thelatestdateforwhichwehavedataasofthiswriting.

Finally,weapplyourentryandexitrulestoeachstockinthewatchlistfortheentiretestperiod,
recordingdataforeachtradethatwouldhavebeenentered,andaggregatingalltradedataacrossa
specificstrategyvariation.

OneofthekeystatisticsthatwecangleanfromthebacktestedresultsistheAverage%Profit/Loss,also
knownastheAverageGainperTrade.Sometradersrefertothisastheedge.TheAverage%P/Listhe
sumofallthegains(expressedasapercentage)andallthelosses(alsoasapercentage)dividedbythe
totalnumberoftrades.Considerthefollowingtentrades:

TradeNo. %GainorLoss
1 1.7%
2 2.1%
3 4.0%
4 0.6%
5 1.2%
6 3.8%
7 1.9%
8 0.4%
9 3.7%
10 2.6%

TheAverage%P/Lwouldbecalculatedas:

Average%P/L=(1.7%+2.1%4.0%+0.6%1.2%+3.8%+1.9%0.4%+3.7%+2.6%)/10
Average%P/L=1.08%

Average%P/Listheaveragegainbasedoninvestedcapital,i.e.theamountofmoneythatweactually
spenttoentereachtrade.

Forshorttermtradeslastingthreetotentradingdays,mosttraderslookforanAverage%P/Lof0.5%
to2.5%acrossalltrades.Allotherthingsbeingequal,thelargertheAverage%P/L,themoreyour
accountwillgrowovertime.Ofcourse,allotherthingsareneverequal!Inparticular,itsimportantto
considertheNumberofTradesmetricincombinationwithAverage%P/L.Ifyouuseapproximatelythe

This document cannot be reproduced without the expressed written permission of Connors Research, LLC.

 P a g e |17

sameamountofcapitalforeachtradethatyouenter,youllmakealotmoremoneyontentradeswith
anaverageprofitof4%pertradethanyouwillononetradethatmakes10%.

AnotherimportantmetricistheWinningPercentageorWinRate.Thisissimplythenumberof
profitabletradesdividedbythetotalnumberoftrades.Inthetableabove,7ofthe10tradeswere
profitable,i.e.hadpositivereturns.Forthisexample,theWinningPercentageis7/10=70%.

WhydowecareaboutWinRate,aslongaswehaveasufficientlyhighAverage%P/L?Becausehigher
WinRatesgenerallyleadtolessvolatileportfoliogrowth.Losingtradeshaveawayofclumpingup,
andwhentheydothat,thevalueofyourportfoliodecreases.Thisisknownasdrawdown.Those
decreases,inturn,canmakeyoulosesleeporevenconsiderabandoningyourtradingaltogether.If
therearefewerlosers,i.e.ahigherWinningPercentage,thenlossesarelesslikelytoclump,andyour
portfoliovalueismorelikelytogrowsmoothlyupwardratherthanexperiencingviolentupanddown
swings.

***

This document cannot be reproduced without the expressed written permission of Connors Research, LLC.

 P a g e |18

LetsturnourattentiontothetestresultsforthedifferentvariationsoftheQuantifiedMovingAverage
Strategy.

Thetablebelowsortsthetestresultstoshowthe20variationsthatproducedthehighest
Average%P/L.Allvariationsthatgeneratedfewerthan100tradesignalsduringthe12+yeartesting
periodhavebeenfilteredouttoavoidskewingtheresults.

Top20VariationsBasedonAverageGain

Avg
# Avg Limit
Days Win% MAScenario MAStretch ExitMethod
Trades %P/L %
Held
160 5.51% 3.8 75.63% MA(5)/MA(10) 10.0 10 Close>MA(5)
166 5.14% 3.9 69.28% MA(10)/MA(20) 10.0 10 Close>MA(5)
236 4.99% 4.3 68.64% MA(10)/MA(20) 10.0 10 CRSI>70
980 4.78% 3.9 73.47% MA(5)/MA(10) 5.0 10 Close>MA(5)
591 4.76% 4.0 70.56% MA(5)/MA(20) 10.0 10 Close>MA(5)
712 4.52% 4.5 69.24% MA(5)/MA(20) 10.0 10 CRSI>70
360 4.51% 4.0 70.28% MA(5)/MA(10) 7.5 10 Close>MA(5)
246 4.50% 3.9 70.73% MA(5)/MA(10) 10.0 8 Close>MA(5)
175 4.49% 4.7 69.71% MA(5)/MA(10) 10.0 10 CRSI>70
379 4.48% 4.0 70.18% MA(10)/MA(20) 7.5 10 Close>MA(5)
525 4.40% 4.5 69.52% MA(10)/MA(20) 7.5 10 CRSI>70
617 4.26% 3.7 71.15% MA(5)/MA(10) 7.5 8 Close>MA(5)
267 4.24% 4.7 69.29% MA(5)/MA(10) 10.0 8 CRSI>70
1,125 4.23% 4.1 70.76% MA(5)/MA(20) 7.5 10 Close>MA(5)
273 4.17% 3.9 68.86% MA(10)/MA(20) 10.0 8 Close>MA(5)
1,074 4.16% 4.7 70.86% MA(5)/MA(10) 5.0 10 CRSI>70
874 4.10% 2.4 72.20% MA(5)/MA(10) 5.0 10 Close>MA(3)
395 4.08% 4.4 69.87% MA(10)/MA(20) 10.0 8 CRSI>70
1,731 4.04% 3.8 73.43% MA(5)/MA(10) 5.0 8 Close>MA(5)
394 3.93% 4.5 68.27% MA(5)/MA(10) 7.5 10 CRSI>70

Belowisanexplanationofeachcolumn.

#TradesisthenumberoftimesthisvariationtriggeredfromJanuary1,2001September30,2013.

Avg%P/Listheaveragepercentageprofitorlossforalltrades,includingthelosingtrades,basedon
investedcapital.Thetop20variationsshowgainsrangingfrom3.93%to5.51%overthe12+yeartesting
period.

AvgDaysHeldistheaveragetradedurationexpressedasanumberofdays.Therangeforthevariations
aboveisrelativelysmall,averagingjustover4days.
This document cannot be reproduced without the expressed written permission of Connors Research, LLC.

 P a g e |19

Win%isthepercentageofsimulatedtradeswhichclosedoutataprofit.Mostofthetop20variations
havewinratesinthelow70s.Thisisahighpercentageofprofitabletradesinaworldwheremany
tradersareaimingfor5060%.

MAScenariodefinesthetwomovingaveragesusedinthetest.ThiscorrespondstoRule5andshows
thevaluesforthefastandslowMAs.ThefollowingMAscenariosweretested:

Scenario Fast MA Slow MA

1 MA(C,5) MA(C,10)
2 MA(C,5) MA(C,20)
3 MA(C,5) MA(C,50)
4 MA(C,10) MA(C,20)
5 MA(C,10) MA(C,50)

MAstretchcorrespondstothevalueofYinRule5ofthestrategy.ThiscolumnshowsthevalueofYfor
therulewhichsays,thefastMAisatleastY%belowtheslowMAwhereY=2.5,5.0,7.5,or10.0%.

Limit%isrelatedtoRule6ofthestrategyanddeterminesthelimitpricethatwillbeusedtoenterthe
trade.Wetestedlimitsof2,4,6,8or10%belowtheSetupdaysclose.

ExitMethodistherulethatwasusedtoexittradesinthisstrategyvariation,asdescribedinRule7.

Next,letslookatthestrategyvariationsthathavehistoricallyhadthehighestfrequencyofprofitable
tradesorWinRate.

Top20VariationsBasedonHighestWinRate

Avg
# Avg Limit
Days Win% MAScenario MAStretch ExitMethod
Trades %P/L %
Held
160 5.51% 3.8 75.63% MA(5)/MA(10) 10.0 10 Close>MA(5)
980 4.78% 3.9 73.47% MA(5)/MA(10) 5.0 10 Close>MA(5)
1,731 4.04% 3.8 73.43% MA(5)/MA(10) 5.0 8 Close>MA(5)
2,956 3.09% 3.6 73.04% MA(5)/MA(10) 5.0 6 Close>MA(5)
2,012 3.60% 3.9 72.47% MA(5)/MA(20) 7.5 8 Close>MA(5)
874 4.10% 2.4 72.20% MA(5)/MA(10) 5.0 10 Close>MA(3)
1,763 3.24% 3.6 71.75% MA(5)/MA(20) 10.0 6 Close>MA(5)
318 3.88% 2.3 71.70% MA(5)/MA(10) 7.5 10 Close>MA(3)
3,673 3.09% 4.0 71.47% MA(5)/MA(20) 5.0 8 Close>MA(5)
1,558 3.57% 2.3 71.44% MA(5)/MA(10) 5.0 8 Close>MA(3)
1,502 3.14% 1.6 71.17% MA(5)/MA(10) 5.0 8 FirstUpClose
617 4.26% 3.7 71.15% MA(5)/MA(10) 7.5 8 Close>MA(5)
3,517 2.80% 3.7 71.14% MA(5)/MA(20) 7.5 6 Close>MA(5)

This document cannot be reproduced without the expressed written permission of Connors Research, LLC.

 P a g e |20

1,926 3.60% 4.6 71.13% MA(5)/MA(10) 5.0 8 CRSI>70

880 3.56% 1.9 71.02% MA(5)/MA(10) 5.0 10 CRSI>50
1,035 3.88% 3.8 71.01% MA(5)/MA(20) 10.0 8 Close>MA(5)
2,792 2.28% 3.4 70.99% MA(5)/MA(20) 10.0 4 Close>MA(5)
4,792 2.06% 3.5 70.97% MA(5)/MA(10) 5.0 4 Close>MA(5)
1,572 3.12% 1.8 70.87% MA(5)/MA(10) 5.0 8 CRSI>50
1,074 4.16% 4.7 70.86% MA(5)/MA(10) 5.0 10 CRSI>70

All20ofthetopvariationshavehistoricallyproducedaprofitonatleast70%oftheidentifiedtrades!
Noticethatthereisagooddealofoverlapbetweenthislistandtheonepresentedintheprevious
sectiononAverage%P/L.Thisoverlapindicateswehavemultiplestrategyvariationsthathave
historicallywonconsistentlywhileproducingexcellentedges.

This document cannot be reproduced without the expressed written permission of Connors Research, LLC.

 P a g e |21

Section4

SelectingStrategy
Parameters

This document cannot be reproduced without the expressed written permission of Connors Research, LLC.

 P a g e |22

Inpreviouschapterswevedescribedthedifferentvaluestestedforstrategyparameterssuchasthe
movingaveragesweuse,thedistancethefastMAfallsbelowtheshorterMA,entrylimit%andexit
method.Inthissectionwelldiscusssomeadditionalfactorstoconsiderasyoudecidewhichvariation(s)
touseinyourtrading.

Letstalkconceptuallyaboutentriesandexitsforamoment.Bothentryandexitrulescanbethoughtof
intermsofhowstricttheyare,i.e.howeasyordifficulttheyaretoachieve.Youmightalsosaythat
strictnessisameasureofhowfrequentlyorinfrequentlytheruleconditionsoccur.Foroscillatorssuch
asConnorsRSI,valuesthatareclosertotheextremes(0and100)aremorestrict(lesslikelytooccur)
thanvaluesinthemiddleoftherange.

Stricterentryruleswillbesatisfiedlessfrequentlythanmoreleniententryrules,andthusastrategy
thatreliesonthestricterruleswillgenerallygeneratefewertradesthanastrategywhoseentryrulesare
moreeasilysatisfied.Witharobuststrategy,therewardforfewertradesisusuallyahighergainper
trade,onaverage.Ifyoubuyaslightlyoversoldstock,itsmostlikelytoprovideamoderategain.Butif
youwaitforthestocktobecomeextremelyoversold,thechancesaremuchhigherthatitwill
experienceasignificantpriceincreaseandresultinabiggerprofit.

Incontrasttoentryrules,thestrictnessofexitruleshaslittleeffectonthenumberoftradesgenerated
bythestrategy.However,justliketheentryrules,stricterexitrulestypicallyresultinhigheraverage
profits.Why?Becausestricterexitrulestendtokeepyouinyourtradesforalongertime,givingthe
stockmoretimetoexperiencethemeanreversionbehaviorthatwereattemptingtoexploitwitha
strategylikethisquantifiedapproachtoTradingStocksandOptionswithMovingAverages.Thus,for
entriesthetradeoffisbetweenmoretradesandhighergainspertrade,whileforexitsthetradeoffis
betweenshortertradedurationsandhighergainspertrade.

***

This document cannot be reproduced without the expressed written permission of Connors Research, LLC.

 P a g e |23

NowletsturnourattentionbacktothestrategydescribedinthisGuidebook.Inthetablebelow,we
comparefourvariationsofthestrategythatallusethesamemovingaveragescenario(5daysforthe
fastMAand10daysfortheslowMA),thesamelimitentry(6%)andthesameexitmethod(ConnorsRSI
>70).OnlythevalueoftheMAStretchfortheentrythresholddiffersbetweenthevariationsshown
below.

TheEffectofMAStretchEntryThresholdforQuantifiedMAStrategy

Avg
# Avg Limit
Days Win% MAScenario MAStretch ExitMethod
Trades %P/L %
Held
10,059 1.98% 4.6 68.76% MA(5)/MA(10) 2.5 6 CRSI>70
3,360 2.83% 4.6 70.30% MA(5)/MA(10) 5.0 6 CRSI>70
1,106 3.11% 4.7 68.44% MA(5)/MA(10) 7.5 6 CRSI>70
407 3.51% 5.0 66.34% MA(5)/MA(10) 10.0 6 CRSI>70

Noticethatthemostleniententryinthetable,thefirstlinewithanMAStretchof2.5%,generatedthe
mosttradesignalsandthelowestgainpertrade.Astheentryrulebecomesstricter,i.e.theMAStretch
thresholdrises,weseefewerandfewertradesignalsbuthigherandhigheraveragegainspertrade.The
variationwithanentrythresholdof10%increasestheAverage%P/Lbyabout75%comparedtothe
firstvariation,butalsohaslessthan1/20ththenumberoftrades.

Itshouldcomeasnosurprisethatthepatternemergesagainwhenweholdallparametersconstant
excepttheLimit%usedtodeterminethelimitentryprice.IfwekeeptheSetupconditionsconstant,
thentherewillobviouslybemorestocksthatexperienceapullbackof2%orgreaterthenextdaythan
therewillbethosethatpullbackbyatleast10%.

VariationswithDifferentLimit%EntriesforQuantifiedMAStrategy

Avg
# Avg Limit
Days Win% MAScenario MAStretch ExitMethod
Trades %P/L %
Held
8,317 1.34% 4.4 65.88% MA(5)/MA(10) 5.0 2 CRSI>70
5,509 1.97% 4.5 67.83% MA(5)/MA(10) 5.0 4 CRSI>70
3,360 2.83% 4.6 70.30% MA(5)/MA(10) 5.0 6 CRSI>70
1,926 3.60% 4.6 71.13% MA(5)/MA(10) 5.0 8 CRSI>70
1,074 4.16% 4.7 70.86% MA(5)/MA(10) 5.0 10 CRSI>70

Wehaveconfirmedthatstricterentryrulesresultinfewertradesbuthigheraveragegains.Nowlets
lookattheexits.HereweholdtheSetupandentrycriteriaconstant,butvarytheexitmethods:

This document cannot be reproduced without the expressed written permission of Connors Research, LLC.

 P a g e |24

VariationswithDifferentExitMethodsforQuantifiedMAStrategy

Avg
# Avg Limit
Days Win% MAScenario MAStretch ExitMethod
Trades %P/L %
Held
420 2.19% 1.9 65.95% MA(10)/MA(20) 7.5 10 FirstUpClose
403 2.98% 2.6 68.24% MA(10)/MA(20) 7.5 10 Close>MA(3)
379 4.48% 4.0 70.18% MA(10)/MA(20) 7.5 10 Close>MA(5)
430 2.49% 2.0 67.67% MA(10)/MA(20) 7.5 10 CRSI>50
525 4.40% 4.5 69.52% MA(10)/MA(20) 7.5 10 CRSI>70

Allfivevariationsgeneratedaverysimilarnumberoftradesignals.Therangeisfrom379tradesto525
trades.However,thevariationthatusesthemostlenientexitmethod(coveringthepositiononthefirst
daythatthestockpriceclosesup)generatesanaveragegainthatisabouthalfofthestrictestexit
methods.Wecanalsoseethatstricterexitsincreasetheaveragegainandwinratesbycomparingthe
twodifferentMAandConnorsRSIexits.MA(3)isalessstringentexitrequirementthanMA(5)andMA(3)
islessprofitableonaveragethanMA(5)althoughtherearemoretradeswiththelessstringentrule.The
sameistruewhenusingConnorsRSItotriggertheexitrule.

Armedwiththisinformation,youwillnowbeabletoselectstrategyparametersthataremostlikelyto
producethenumberoftradesignals,averagegains,andtradedurationthatbestcomplementyour
overalltradingplan.

This document cannot be reproduced without the expressed written permission of Connors Research, LLC.

 P a g e |25

Section5

UsingOptions

This document cannot be reproduced without the expressed written permission of Connors Research, LLC.

 P a g e |26

Optionstradinghasbeenamajorgrowthindustryoverthepastseveralyearsinthemarkets.Thisis
becausespreadshavetightened,liquidityhasincreased,andtheabilitytoeasilytradecomplexoptions
hasneverbeensimpler.

Wellnowfocusonapplyingoptionstradingtotheshorttermmarketmoveswehavejustlearned.Like
everythingelseinthisGuidebook,therearedefinitiverulesastohowtoexecuteanoptionstradewhen
astrategysignaltriggers.

Beforewegoon,itwillbehelpfultoreviewafewtermsandconceptsrelatedtooptions.

Theownerofacalloptionhastheright,butnottheobligation,topurchasetheunderlyingsecurity
(stockorstock)atthestrikepriceonorbeforetheexpirationdateoftheoptioncontract.Thevalueofa
calloptiongenerallyrisesasthepriceoftheunderlyingsecurityrises.Acalloptionisconsideredtobe
InTheMoney(ITM)whenitsstrikepriceisbelowthepriceoftheunderlyingsecurity,andOutofThe
Money(OTM)whenitsstrikepriceisabovethepriceoftheunderlyingsecurity.Forexample,ifthe
incrementbetweenstrikepricesforSPYoptionsis$1andthepriceofSPYiscurrently$162.35,thenthe
first(closest)ITMcalloptionistheonewithastrikepriceof$162.ThefirstOTMcalloptionisthe$163
strike.

Theownerofaputoptionhastheright,butnottheobligation,toselltheunderlyingsecurity(stockor
stock)atthestrikepriceonorbeforetheexpirationdate.Thevalueofaputoptionusuallyrisesasthe
priceoftheunderlyingsecurityfalls.AputoptionisconsideredtobeInTheMoney(ITM)whenits
strikepriceisabovethepriceoftheunderlyingsecurity,andOutofTheMoney(OTM)whenitsstrike
priceisbelowthepriceoftheunderlyingsecurity.IfthepriceofSPYiscurrently$166.55,thenthefirst
(closest)ITMputoptionisthe$167strike,andthefirstOTMputoptionisthe$166strike.

Thestrategydescribedinthisguidebookistobuystocksthatareoversoldbasedonquantifiedmoving
averagerules.Toimplementthatstrategywithoptions,callswouldbeused.Putoptionswouldbeused
toimplementstrategiesdescribedinotherGuidebooksthattakeshortpositions.

Mostoptioncontractscontrol100sharesoftheunderlyingstockorstock.However,thepricequotedby
mosttradingplatformsisthepricepershare.Therefore,thecostofpurchasingtheoptioncontractis
typically100timesthepershareprice,pluscommissions.Thus,ifaSPYcalloptionhasaquotedpriceof
$1.27,thenitwillcostyou$127.00pluscommissionstopurchasethecalloptioncontract.Sometimes
youwillhearthepriceofanoptionreferredtoastheoptionspremium.

Alloptioncontractshaveanexpirationdate,afterwhichthecontractisnolongervalid.Thethreemost
commontypesofoptionexpirationsare:

Weekly:Contractexpiresonthelasttradingdayoftheweek,typicallyaFriday.
Monthly:ContractexpiresontheSaturdayfollowingthethirdFridayofthemonth,whichmeans
thatthelastdayfortradingtheoptionisthethirdFriday.
Quarterly:Contractexpiresonthelasttradingdayofthecalendarquarter.

This document cannot be reproduced without the expressed written permission of Connors Research, LLC.

 P a g e |27

InthisGuidebook,wewillbefocusedentirelyonoptioncontractswithmonthlyexpirations.The
monthlycontractwiththenearestexpirationdateisknownasthefrontmonth.Forexample,iftodayis
June10th,thenthefrontmonthcontractistheonewhichexpiresinthethirdweekofJune.Thenext
availableexpiration(inthiscaseJuly),isknownasthesecondmonth.ThedayafterJuneexpiration,July
wouldbecomethefrontmonthandAugustwouldbecomethesecondmonth.

StrategiesintheGuidebookgenerallyfollowcertainpatterns:

1.Themajorityofthemovesfromentrytoexithavebeenheldaveryshortperiodoftime(212
tradingdays).

2.Theaveragegainspertradehavebeenlargewellbeyondthenormaldistributionofprices
overthatshortperiodoftime.

3.Ahighpercentageofthemoveshavebeendirectionallycorrect.

Whenwelookatthistypeofbehavior,itcanleadtomanystrategiesbutonestrategystandsout(and
thishasbeenconfirmedbyprofessionaltraders).Thestrategyistobuythefrontmonth,inthemoney
calloption.

Whyfrontmonth,inthemoneylongoptions?Becausetheywillmovemostcloselytothestockitself.
Andthecloseranoptionmoveswiththestock,thegreaterthegainwillbeonapercentagebasiswhen
themoveiscorrect.

Herearetherules.

1.Asignaltriggers.

2.Buythefrontmonthinthemoneycall.Ifyouwouldnormallytrade500sharesofthestock
buy5callcontracts(every100sharesshouldequalonecalloptioncontract).

3.Exittheoptionswhenthesignaltriggersanexitonthestock.

Letsgofurther:

1.Whatdoesinthemoneyexactlymeanhere?

Inthiscaseitsdefinedasonetotwostrikepricesinthemoney.Thiswillbebelowthecurrentmarket
priceforacalloption.Ifthepriceofthestockis$48andtheintervalbetweenoptioncontractsis$5,
thenbuya$45or$40call.

2.Whatdoesfrontmonthmeanhere?

Becausetheholdingperiodissoshort,youwanttotradetheoptionswhosemonthlyexpirationisthe
closest.Iftheclosestmonthiseighttradingdaysorlessfromthefrontmonthsoptionexpirationdate
(meaningthesecondWednesdaybeforeorcloser)usethefollowingmonthastheonetotrade.

 P a g e |28

3.WhathappensifIminthepositionanditexpires,yetthesignalforthestockisstillvalid?

Inthiscase,rolltothenextmonth.Youretradingthestocksignalssoyouwanttohaveexposuretothat
signal.

4.Whataboutliquidityandspreads?

Theressomediscretionhere.Thereisnohardandfastruleastowhatexactlyliquiditymeansin
options.Manytraderslookforminimumvolumeand/oropeninteresttodetermineliquidity.

Assumingthereisactivevolumeintheoptions,lookatthespreads.Iftheoptionistrading$3.00bid/
$3.30offer,thespreadis10%.Canyoureallyovercomea10%spread?Notlikely.Nowcomparethisto
anoptionthatstradingat$3.25bid/$3.30offer.Thisisfarmoreacceptableandtradable.

5.Whataretheadvantagesofbuyingcalloptionsinsteadofthestock?

Assumingthespreadsandliquidityarethere,theadvantagesarelarge:

1. GreaterpotentialROIoncapitalinvested.

2. Lessmoneytiedup.

3. Lesspointsatrisk.Thismeansifyoubuyastockat$50,thepricecantheoreticallyfallto
zeroandyoucouldloseup$50ashare.Theoptionscanonlyloseuptothepremiumyou
paid.So,ifyouboughtthe$45callfor$5.50,theriskisonlythepremiumof$5.50.

4. Theresgreaterflexibility.Forexample,letssaythestocktriggeredabuysignalat$50and
youpaid$5.50forthe$45calls.Ifthestockimmediatelymovesup(letssayto$56),you
havechoices.Youcanexit,oryoucanrollintothe$55callgettingmostofyourmoneyout
andnowturningthisintoanearlyfreetradeifyoubelievethatpriceswillcontinuetorise.

Therearenumerousexampleslikethisandyoucanfindthesetypesofstrategyopportunitiesinmost
optionsbooks.ButtradinganythingexoticordifferentthansimplybuyingITMcallsisagainsttheadvice
ofthemanyprofessionalsweposedthisquestionto.

Inconclusion,optionsprovidetraderswithagoodalternativetoowningthestockoutright.The
structuredmethodologyforourstrategiesis:frontmonth,inthemoney,withequivalentsizing(1
optionper100shares),andexitingwhenthestocksignalsanexit.

Theaboveoptionsstrategy,inmanyexpertsopinion,isthebestandmostefficientstrategybasedupon
thehistoricaldatafromthesesignals.

 P a g e |29

Section6

AdditionalThoughts

 P a g e |30

1.AsyouhaveseenthroughoutthisGuidebook,theQuantifiedMovingAverageStrategyhashadlarge
quantifiededgeswhenappliedinasystematicmanner.

2.Thereareliterallyhundredsofpotentialvariationsforyoutouse.Byadjustingtheinputvariables
describedintherules,youcancustomizehowthestrategywillperformforyou.Wantmoretrades?
LookatvariationswithfastermovingaveragesorsmallerMAstretchvaluesfortheentryrules.Bigger
averagereturns?Checkoutthevariationsthathavethestrictestentrycriteria(highMAStretchvalues
andhighLimit%entryrules)andlongestdurations(ConnorsRSI70exitmethod).Wanttogetinandout
oftradesmorequicklytoreduceovernightriskandfreeupyourcapitalforothertrades?Trythe
variationsthatutilizetheFirstUpCloseexitmethod.

3.Whataboutstops(andweincludetheanswertothisinallourStrategyGuidebooks)?

WehavepublishedresearchonstopsinotherpublicationsincludinginourbookShortTermTrading
StrategiesThatWork.

Whatwehavefoundisthatstopstendtolessenperformanceandinmanycasestheycompletely
removeedges.Yes,itfeelsgoodwhenastockkeepsmovinglowerandlowerandastopgotyouout.On
theotherside,theresearchwhichisbackedbyuptotwodecadesoftestresultsonmanyshortterm
tradingstrategiessuggeststhatstopsgethitoftenandaccumulatemany,manylosses.Fewtrading
strategiescanovercometheseaggregatedlosses.

Formanytradersstopsareamust.Psychologicallyitallowsthemtotaketrades,especiallydifficult
trades.Whetheryouusethemornotisapersonalchoice.Onthewholethough,theedgesyouseein
thisstrategyandmanyothershorttermstrategiesarelowerwhenstopsareappliedtothem.Againthis
isapersonalchoiceonlyyoucanmakeforyourself.Weknowsuccessfultradersinbothcamps.

4.Slippageandcommissionwerenotusedinthetesting.Factorthemintoyourtrading(theentriesare
atlimitpricessoslippageisnotanissue)andmakesureyouretradingatthelowestpossiblecosts.
Mostfirmsarenowallowingtraderstotradeforunder1centashare,soshopyourbusiness,especially
ifyouareanactivetrader.Theonlinebrokeragefirmswantyourbusiness.

WehopeyouenjoyedthisadditiontotheConnorsResearchTradingStrategySeries.Ifyouhaveany
questionsaboutthisstrategypleasefeelfreetoemailusatinfo@connorsresearch.com

 P a g e |31

Appendix:

TheConnorsRSI
IndicatorandHistorical
Volatility

 P a g e |32

ConnorsRSI

LarryConnorsandConnorsResearchhavebeendeveloping,testing,andpublishingquantifiedtrading
strategiessincethemid1990s.Duringthattime,wehavehadtheopportunitytoevaluateagreat
numberofdifferenttechnicalindicatorsandtoassesstheireffectivenessinpredictingfutureprice
action.Nowwevetakenthenextstepandcreatedanindicatorofourown:ConnorsRSI.Inthischapter
wewilldescribetheindicatorandprovidedetailsonitscalculation.

ConnorsRSIisacompositeindicatorconsistingofthreecomponents.Twoofthethreecomponents
utilizetheRelativeStrengthIndex(RSI)calculationsdevelopedbyWellesWilderinthe1970s,andthe
thirdcomponentranksthemostrecentpricechangeonascaleof0to100.Takentogether,thesethree
factorsformamomentumoscillator,i.e.anindicatorthatfluctuatesbetween0and100toindicatethe
leveltowhichasecurityisoverbought(highvalues)oroversold(lowvalues).

BeforewediscusshowtocalculateConnorsRSI,letsreviewWildersRSI.RSIisaveryusefulandpopular
momentumoscillatorthatcomparesthemagnitudeofastock'sgainstothemagnitudeofitslossesover
somelookbackperiod.Wilderhimselfbelievedthat14periodswastheideallookback.Weoftenuse
theshorthandnotationRSI(14)forthe14periodRSI.TheformulabelowcomputesRSI(14)foraseriesof
pricechanges:

IfwewantedtocomputeRSIforadifferentnumberofperiods(N),thenwewouldreplace14inthe
formulaabovewithN,andreplace13withN1.Regardlessofthenumberofperiodsusedinthe
calculation,theresultwillalwaysbeanumberbetween0and100.TraderswhouseRSI(14)typically
lookforvaluesgreaterthan70toidentifyoverboughtconditions,andvalueslessthan30toindicate
oversoldconditions.

OurpreviousresearchhasshownthatusingshorterlookbackperiodsmakesRSImoreeffectivein
predictingshorttermpricemovements.WehavepublishedmanystrategiesthatutilizeRSI(2),aswellas

 P a g e |33

severalthatuseRSI(3)andRSI(4).ChangingthenumberofperiodsalsohasaneffectontheRSIlevels
thatbestidentifyoverboughtandoversoldconditions.Forexample,anRSI(2)valueoflessthan10is
usuallyareliableindicatorofanoversoldcondition,whileanRSI(2)valueover90isagoodbenchmark
foranoverboughtcondition.

NowletsturnourattentionbacktoConnorsRSI.Asmentionedpreviously,ConnorsRSIcombinesthree
components,andasyoumightguess,theyareallelementsthatourresearchhasrepeatedlyshownto
havesignificantpredictiveability:

PriceMomentum:Aswejustdiscussed,RSIisanexcellentwaytomeasurepricemomentum,
i.e.overboughtandoversoldconditions.Bydefault,ConnorsRSIappliesa3periodRSI
calculationtothedailyclosingpricesofasecurity.WewillrefertothisvalueasRSI(Close,3).

DurationofUp/DownTrend:Whentheclosingpriceofasecurityislowertodaythanitwas
yesterday,wesaythatithascloseddown.Ifyesterdaysclosingpricewaslowerthanthe
previousdaysclose,thenwehaveastreakoftwodownclosedays.Ourresearchhasshown
thatthelongerthedurationofadownstreak,themorethestockpriceislikelytobouncewhen
itrevertstothemean.Likewise,longerdurationupstreaksresultinlargermovesdownwhen
thestockmeanreverts.Ineffect,thestreakdurationisanothertypeofoverbought/oversold
indicator.

Theproblemis,thenumberofdaysinastreakistheoreticallyunbounded,thoughwecould
probablyplacesomepracticallimitsonitbasedonpastexperience.Forexample,wemight
observethattherehavebeenveryfewinstancesofeitheranupstreakoradownstreaklasting
formorethan20days,butthatstilldoesntgetustoatypicaloscillatortypevaluethatvaries
between0and100.

Thesolutionistwofold.First,whenwecountthenumberofdaysinastreak,wewilluse
positivenumbersforanupstreak,andnegativenumbersforadownstreak.Aquickexample
willhelptoillustratethis:

Day ClosingPrice StreakDuration

1 $20.00
2 $20.50 1
3 $20.75 2
4 $19.75 1
5 $19.50 2
6 $19.35 3
7 $19.35 0
8 $19.40 1

TheclosingpriceonDay2ishigherthanonDay1,sowehaveaonedayupstreak.OnDay3,
thepricecloseshigheragain,sowehaveatwodayupstreak,i.e.theStreakDurationvalueis2.
OnDay4,theclosingpricefalls,givingusaonedaydownstreak.TheStreakDurationvalueis

 P a g e |34

negative(1)becausethepricemovementisdown,notup.Thedownwardtrendcontinueson
Days5and6,whichourStreakDurationreflectswithvaluesof2and3.OnDay7theclosing
priceisunchanged,sotheStreakDurationissetto0indicatingneitheranupclosenoradown
close.Finally,onDay8theclosingpricerisesagain,bringingtheStreakDurationbackto1.

ThesecondaspectofthesolutionistoapplytheRSIcalculationtothesetofStreakDuration
values.Bydefault,ConnorsRSIusesa2periodRSIforthispartofthecalculation,whichwe
denoteasRSI(Streak,2).Theresultisthatthelongeranupstreakcontinues,thecloserthe
RSI(Streak,2)valuewillbeto100.Conversely,thelongerthatadownstreakcontinues,the
closertheRSI(Streak,2)valuewillbeto0.Thus,wenowhavetwocomponentsRSI(Close,3)
andRSI(Streak,2)thatbothusethesame0100scaletoprovideaperspectiveonthe
overbought/oversoldstatusofthesecuritywereevaluating.

RelativeMagnitudeofPriceChange:ThefinalcomponentofConnorsRSIlooksatthesizeof
todayspricechangeinrelationtopreviouspricechanges.WedothisbyusingaPercentRank
calculation,whichmayalsobereferredtoasapercentile.Basically,thePercentRankvalue
tellsusthepercentageofvaluesinthelookbackperiodthatarelessthanthecurrentvalue.

Forthiscalculation,wemeasurepricechangenotindollarsandcents,butasapercentageof
thepreviousdaysprice.Thispercentagegainorlossistypicallyreferredtoastheoneday
return.Soifyesterdaysclosingpricewas$80.00,andtodayspriceis$81.60,theonedayreturn
is($81.60$80.00)/$80.00=0.02=2.0%.

TodeterminethePercentRank,weneedtoestablishalookbackperiod.ThePercentRank
valueisthenthenumberofvaluesinthelookbackperiodthatarelessthanthecurrentvalue,
dividedbythetotalnumberofvalues.Forexample,ifthelookbackperiodis20days,thenwe
wouldcomparetodays2.0%returntotheonedayreturnsfromeachoftheprevious20days.
Letsassumethatthreeofthosevaluesarelessthan2.0%.WewouldcalculatePercentRankas:

PercentRank=3/20=0.15=15%

ThedefaultPercentRanklookbackperiodusedforConnorsRSIis100,orPercentRank(100).We
arecomparingtodaysreturntotheprevious100returns,orabout5monthsofpricehistory.To
reiterate,largepositivereturnswillhaveaPercentRankcloserto100.Largenegativereturns
willhaveaPercentRankcloserto0.

ThefinalConnorsRSIcalculationsimplydeterminestheaverageofthethreecomponentvalues.Thus,
usingthedefaultinputparameterswouldgiveustheequation:

ConnorsRSI(3,2,100)=[RSI(Close,3)+RSI(Streak,2)+PercentRank(100)]/3

Theresultisaveryrobustindicatorthatismoreeffectivethananyofthethreecomponentsused
individually,andinmostcases,alsomoreeffectivethancombiningthethreecomponents
independently.

 P a g e |35

Historical Volatility

Thehistoricalvolatilityisdefinedasthestandarddeviationofthelogarithmicpricechangesmeasuredat
regularintervalsoftime.Sincesettlementpricesareusuallyconsideredthemostreliable,themost
commonmethodofcomputingvolatilityinvolvesusingsettlementtosettlementpricechanges.We
definedeachpricechange,xi,as:

xi =ln(Pi /Pi 1)

wherePi isthepriceoftheunderlyingcontractattheendoftheith timeinterval.

Pi/Pi 1 issometimesreferredtoasthepricerelative.

Wefirstcalculatethestandarddeviationofthelogarithmicpricechanges:

standarddeviation 0.05778/9

0.000642

.025338

Wethencalculatetheannualvolatilitybymultiplyingthestandarddeviationbythesquarerootofthe
timeintervalbetweenpricechanges.Sincewelookedatpricechangeseveryweek,thetimeintervalis
365/7:

annualizedvolatility .025338 365/7

 P a g e |36

.02533852.14

.0253387.22

.1829(18.29%)

Reprinted from: Nathanberg, Sheldon. Option Volatility & Pricing, Advanced Trading Strategies and Techniques, 2d ed., (Chicago:
Probus Publishing, 1994), Appendix B.

 P a g e |37

ReceiveConnorsRSIReadingsforFreefromtheTradingMarketsScreener