Sunday, December 20, 2009

Larry Connors Short Term Trading Strategies That Work Review

Short Term Trading Strategies That Work by Larry Connors and Cesar Alvarez belongs on your shelf if you are interested in swing trading and I'll tell you why.

Larry Connors is very well known in the field of investing. He managed a hedge fund and has created many books on trading techniques all based on quantified research. I have read many of his books and I think this particular book is probably his best.

The foundations for this book really started with the book that was published a year before this one called How Markets Work. In that book Connors and his researcher Alvarez put forth quantified research that showed a clear edge for investors who buy pullbacks and sell rallies for those using a short term horizon measured in days. They demonstrated through their market research that buying a very oversold stock or etf outperformed the market on a short time horizon and buying an overbought stock or etf underperformed the market on a short time horizon. On a longer term horizon buying those oversold breakouts may in fact work but within the shorter term context he clearly demonstrates the edge lies with buying what everyone currently hates, and selling when everyone loves. You can see how the development of the specific strategies Connors proposes in Short Term Trading Strategies That Work really began. Though I do recommend How Markets Work, I think of it as the foundation for Connors later work and an optional read ,not essential, as it does not contain the specific strategies developed in Short Term Trading Strategies that Work.

Now that we have discussed the background of the book let's take a look at what's in it. The book itself is rather short and concise but don't let that fool you. The first 7 chapters focus on some general trading rules that are really the foundation for the strategies that come later in the book. One of the rules for example is to go long stocks or etfs above the 200 day moving average and to short stocks or etfs below the 200 day moving average. Sounds simple right? Many mutual funds follow this rule but how many people out there have been seriously burned trying to "catch a falling knife", or pick a top in a market that keeps going up? This rule alone could have saved investors a lot of money during the market crash we experienced. . Connors gives you the stats to back this up and should make you think twice about going against the long term trend. There are several other market observations that talk about the vix, intra-day pullbacks, holding positions overnight, and a very clear and surprising opinion about stops. All of this comes with quantified research to back up the findings.

Now for the strategies. Overall the strategies are incredibly simple. Surprisingly simple. Many of you might look at them and say that's it? Where is the complexity? Connors would say he is very wary of strategies that have too many rules. I can tell you from my experience as well, that trying to take into account too many market variables will hurt your performance over the long term. You will freeze or wait too long for the perfect set ups. Just identify a strategy that has an edge and execute it.

One of my favorite strategies in the book, and one that I use is the 2 period RSI. This is a unique application of the RSI indicator and it does in fact work as the book suggests. I can verified this through my own back testing. The testing done by Connors and Alvarez is complete but anyone who is going to trade a strategy should do their own extensive testing and I think you will find these strategies do give you an edge as Connors and Alvarez propose.

All of the strategies, though different, work on the premise discussed above. Buy markets that are extremely oversold and sell markets that are overbought. The strategies vary by the methods used to identify overbought and oversold conditions.

One complaint that I read about this book before I bought it was that the wins were rather small. This may be true but depends on your point of view. The wins do tend to be small percentages (1-3 percent perhaps), but the winning percentage is quite high. It can be as high as 75-85 percent, and if you scale into the position the potential winning percentage is even higher. It would require a decent sized account, however, to take advantage of the small percentage returns per trade. If you are looking for larger gains per trade then these strategies are not for you.

Even though you won't get many "home run" trades,  I think this is great for newer traders who are beginning. You want to get some wins under your belt and develop some consistency. These strategies provide you with that possibility. Don't think that you can't fail with these strategies because you can. Taking these trades is very tough to do. Why might you ask? Because you are buying when everything looks terrible. You are going long a stock when everyone thinks the market is heading down. Trust me, if you pay attention to the financial news and are using these strategies, you are going to hesitate and put yourself at a disadvantage. Don't listen to the news! This is where the new trader can get off the mark and start second guessing. Everything around you in the news is going to tell you not to take the trade, but the statistics of the system should give you confidence to take them. You do have to develop that mental toughness that all traders need to develop or you won't succeed with it. Hey those analysts might be right on a longer time frame but that's not what these strategies are about.

Even if you decide that these methods are not for you I still think this book is worth the investment. You will be getting some robust strategies, and a little better understanding of the workings of big money in the markets.