What sort of technicals do you look for when choosing a good stock to RTM trade? I've found the ones the work best have an average daily volume around 1 million or so. Too much volume is not good since RTM strategies exploit inefficiency and high volume instruments tend to be more efficient so there's less opportunity there. Too little volume seems to result in too much randomness to trade on an intra-day scale. What do you think?
I thank you for this pearl of wisdom. I will just end my day here. It couldn't possibly get any better.
Volume is loosely correlated to mean regression properties. Beside, I don't agree with you when you say RTM strategies exploit inefficiencies. Ninna
What inefficiencies? Such things last less than 1 ms in the markets nowadays. There are none around for retail. RTM startegies exploit an assumption about price behavior. As such, they have a failure rate when the assumption does not hold.
Perhaps inefficiency is the wrong term. What I mean is prices get out-of-whack due to forces unrelated to actual supply and demand whether it's a bunch of market-on-open orders from naive retail investors or some felonious rumor. The theory is the price will revert to the equilibrium between supply and demand. The exchanges want to maximize their profit on the spread so it is in their interest to set the bid/ask at the level where there's an equal amount of volume on either side. A low volume instrument can get out-of whack and just hang there because there's no data for the exchanges to base their best guess as to where the optimum bid/ask level should be.
Yes, that is not an inefficiency though. It is irrational investing. Why do you think there are irrational investors? I don't think there are any. There are only wrong or correct trading decisions. The market can go in any direction for longer than your RTM startegy can stay solvent. If you want to make money in the markets follow the trend.
Who cares what the market does? My long RTM strategy has a correlation to the market of only 11%, and that's in live trading for over 2 years. And why not do both, RTM and trend following? That's what I do. They both work. To the OP, I won't say how I identify RTM stocks, but I will say that Larry Connors has done some pretty good work in this area.
Why should anyone expect otherwise? The market has been going straight up for the last two years. Looking at its correlation with RTM strategies is meaningless. I knew several guys who traded the good years based on pairs and RTM. I am talking professionals managing large funds. They are all out of the market. When these methods break down they leave no room for recovery. Most lost several years of profits in a few months. If you are leveraged more than 2:1 the risk of ruin is very high. I knew someone very mathematically oriented (PhD statistics) who was hit by a 60% DD in about a month's time with leverage 5:1. You got to use some good stops there but I never figure out how to determine stops with RTM strategies so I do not use them. Maybe you know how to do that.
There is more than one way to trade reversion to the mean. What I am doing doesn't require margin and it hasn't broken down in the past 4 years of live trading or 10 years of backtests. Then again it is not scalable to the fund level either.