Improving The Double Seven Strategy

In this article I want to take a look at a reader’s recommendation on improving the Double Sevenstrategy. If you recall, the Double Seven strategy is a long-only strategy for the the broad U.S. indexes. It was created by Larry Connors and was covered in a previous article, “Double Seven Strategy”. Recently a reader pointed out a possible improvement to the system which appeared in the “Letters to the Editor” section of Stocks & Commodities Magazine, V. 27:3 (8-9). In short, the recommendation modified the entry and exit signals in an attempt to capture more profit. Changes included the following:  Market entry would become a buy stop entry and the exit would become a trailing stop. To be honest, I found the description of the changes not 100% clear and my testing was not promising. However, the concept of a buy stop and trailing stop are worth looking into. First, let’s provide a quick review of the Double Seven strategy.

The Original Rules

As a reminder, here are the original rules for taking long trades which are executed on a daily chart:

• The instrument must be above its 200 day moving average
• If the instrument closes at a seven-day low then buy at market
• If a long position is open and the instrument closes at a seven-day high then sell at market 

Testing Environment

I coded the above rules in EasyLanguage and tested it on the S&P cash market going back to 1983. Before getting into the details of the results let me say this: all the tests within this article are going to use the following assumptions:

• Starting account size of $100,000.
• Dates tested are from 1983 through June 30, 2014.
• The number of shares traded will be based on volatility estimation and risking no more than $2,000 per trade.
• Volatility is estimated with a five times 10-day ATR calculation. This is done to normalize the amount of risk per trade.
• The P&L is not accumulated to the starting equity.
• There are no deductions for commissions and slippage.
• There are no stops. Please note we are not adding our profits to our trading account! We are always trading a small percentage of our starting capital. Thus, the results demonstrated here are very conservative and it would be easy to generate much higher returns. Here is the position sizing formula used:

Shares = $2,000 per trade / 5 * ATR(10) For an example of what the trades will look like on a daily chart, below is an image of a couple of trades. As the market makes a seven-day low, a long trade is entered. Open trades are then closed at the next seven-day high.

Double Seven Strategy

Equity Curve line

Modification of Entry Signal

The recommendation within Stocks & Commodities Magazine recommended…

“Set a sell-stop 0.1 below the close of the seven-day high, and keep moving it below the close each day until you are sold out.” I modified this a bit. In essence, we have a classic trailing stop and it makes a lot of sense given we are attempting to capture as much profit as possible when the market recovers from a pull-back in an overall bullish regime. Presumably during a strong market we can expect price to occasionally go beyond our traditional seven-day high exit. A trailing stop may very well capture more profit. Of course some of the trades will “give back” some of the profit as price must fall to hit our seven-day stop, but the handful of runners should provide us with more P&L to offset these setbacks. The only way to really see if this will work is to test it. For my test I used the seven-day low instead of the close.  Below are the results with our new modified seven-day low trailing exit.

Improving Double Seven Strategy

We can see we make slightly more net profit but it comes at a price. Our profit factor falls as does the percentage of winning trades. We decrease our consecutive winners while increasing the number of consecutive losing trades. We do have a slightly larger average profit per trade, but we obtain this with less efficiency as seen by our profit factor. Viewing the equity curve you can clearly see the choppiness of this system. Sure it makes more money, but it’s not a clean looking equity curve when compared to our standard Double Seven Strategy. Why would this be? By introducing our trailing stop we are causing a number of trades to get stopped out that ultimately turn in our favor. This leads to more trades when compared to the original rules as well. Recall the original rules have no hard stop – only dynamic exit at a new seven-day high. By adding our trailing stop we immediately place a hard stop at the low of the past seven-days. Introducing this stop ‘hurts’ our system. Can we try something else? Maybe what we can try is only introducing the trailing stop when… 1. a new seven-day occurs; and 2. we have positive P&L. This will delay adding the trailing stop.

Price will be free to meander or make new lows instead of taking us out at a nearby stop level. If price happens to move lower before we add our trailing stop then makes a new seven-day high and our open position P&L is negative, we’ll call this a losing trade and simply exit at the market. However, if we have positive open position P&L at a seven-day high, we’ll activate our tailing stop. Below are the results.

Improving Double Seven Strategy

This looks a lot better. We are making significantly more profit and doing it will decent efficiency based upon the profit factor value. We do take some significant heat based upon the drawdown value. Overall, the equity curve looks decent as we make more profit per trade.

Modification of Entry Signal

The recommendation within Stocks & Commodities Magazine recommended…

“Set a buy-stop 0.1 above the close of the seven-day low, and keep moving the buy-stop down above each day’s close until you are bought in.” The idea is we can often enter at a lower price if the market continues to fall dramatically over the next day. I tested this with not much promise. To me, setting a buy-stop at a level .01 above the close of the bar does not make a lot of sense. Often when setting a buy stop to enter the market you set it above a recent significant high. What comes to mind is the daily high. So, that’s what I did next. When the market markets a new seven-day low, I then place a buy-stop at the high of the bar. Price must then hit that high in order for a new position to be opened, confirming some strength on the bullish side. Please note, we are adding these new entry rules but keeping our original exit. This is because I want to see how these new rules changes the system without the interference of our new exit

This significantly reduced profitability. Clearly, buying into the weakness is better than waiting for bullish confirmation. While it may “feel better” to wait for bullish confirmation before opening a long trade, the performance metrics clearly state you should be buying into weakness. In short, the original rules produce much better results.

Conclusion

This experiment was not really a test based upon the rules provided by the Stocks & Commodities Magazine reader. However, it was inspired by it. Thus, it’s possible the reader’s solution may be better than what I’ve come up with here. I really don’t know. However, I think we can see some basic tenants of trading the S&P during a bull market that many readers of this website will be familiar with.

1. Buy into weakness with a market order.

2. Hold a trade to gain more profit.

These are well known tenants of the S&P and this strategy test just highlighted them once again. Other things that could be tested include buying with limit orders and exiting into strength based upon a different indicator such as a 2-period RSI. In closing, we found that our best results were realized by only modifying our exit rule to include a trailing stop.