Sunday, April 22, 2012

Fade Opening Gap SPY Trading Strategy

I mentioned in a previous post that fading the opening gap can be very profitable on certain indices and securities.  Here is one of the best examples - the SPY ETF.  Using a very basic strategy of buying or selling in the opposite direction of the opening gap and taking profit at previous close (or closing out at the end of day if the target has not been reached) shows this equity graph (using Yahoo! finance data and compounded returns)


As you can see, this is a very profitable almost every year especially post-2008.  Note there are many ways to improve upon this strategy (to reduce risk mostly) but the basic one works pretty well.  Note that this does not include any trading costs nor slippage which can occur at the open despite SPY being very liquid.  However, let's look at the risk of the strategy.  Here is a graph of the draw-downs from the equity high water mark.


The max draw-down was only 20% and that was in the depths of the 2008 crises which is not bad considering that the SPY dropped +50% during that period.  Post 2008, the draw-downs have barely made it pass 5%.  The Sharpe ratio of this strategy over this thirteen-year time period is about 1.19.

Edit (03/25/2013):  After looking at this further these numbers are mostly bunk based off bad high-lows from historical Yahoo! Finance data.  This strategy is still somewhat viable (you need to be more selective) but not nearly as profitable.

2 comments:

  1. Have you traded this strategy live, or just tested it? I believe the numbers are not so good in real life.... ?
    http://www.quantifiedstrategies.com/opening-gaps-in-spysp-500-part-1/

    ReplyDelete
    Replies
    1. Thank you for the first comment post!

      I have tested it only for a few days before I moved on to something else. After I added commissions/spread and slippage I expected about half the profit that I was seeing in the paper trading. I didn't really think that Yahoo would have bad quote data for SPY since it is so liquid and actively traded, but that is an interesting thought which would negatively affect the results. I guess I could try it with IB historical data too confirm the results.

      Delete