Emotionally it's a lot easier to buy on strength than to buy into weakness. Buying into a falling market feels unnatural. Your instincts warn that price may continue to fall resulting in lost capital. On the other hand buying when the market makes new highs feels more natural. Price is moving in your direction and the sky is the limit!
However, what feels natural or easy is often the opposite of what you should be doing. In this post I'm going to compare these two different trading strategies on the S&P E-mini futures market and see which one produces better results.
I created two simple trading systems in EasyLanguage. Both systems will go long only. Both systems will utilize a 200-day simple moving average (SMA) for an environment filter. Long trades will only be opened if the closing price is above the 200-day SMA. All open positions are closed at the end of the 5th day. No commissions or slippage will be deducted for these tests. The tests were all executed on the S&P E-mini futures market between September 1997 and September 2011.
BUY NEW HIGHS
First let's create a system that goes long if price creates a new three day high. In other words, when price creates a short term breakout on the up side, we will open our long position. This will represent our buying into strength test. Below is the equity curve.
The system is profitable, but we have an ugly looking equity curve with deep drawdown.
BUY PULLBACKS
Instead of going long on a new three day high, we are going to go long after three consecutive lower closes. This system will represent our buying into weakness test. The equity curve below depicts this system.
What a difference! This equity graph looks great all the way until the recent market volatility that hit during the summer of 2011. Our last trade produced a large loss at the very end of our equity curve. Remember, both of these trading systems have no stops.
The point is clear. Buying into weakness outperforms buying into strength for the S&P.