An Example of an S&P 500 Trading System using a technical analysis based on the SBV Oscillator

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June 20, 2008

+8% (104 points) in two months

This week's SBV chart example is a continuation of the example of June 13, 2008. In this week's example, we show two trading systems:

Trading System #1

Chart 1. Relationship between the SBV oscillator and index reversal points. S&P 500 index. 60-day view. 1 bar = 1 hour. SBV(20)

It's Simple and profitable

In our trading example, we applied the following simple system which is based on our SBV indicator:

1. Once the SBV indicator has declined below minus 33% (the indicator will now show red), we will enter a short position (if we are not already short).
2.  Once the SBV indicator has advanced above minus 33% (after having been below that level), we will enter a long position (the indicator still shows red).
3.  Once the SBV indicator has rallied above plus 33% (the indicator will now show green), we will enter a long position (if we are not already long).
4.  Once the SBV indicator has declined below plus 33% (after having been above that level), we will enter a short position (the indicator still shows green).
5.  Additional Stop Loss Rule - If the SBV had fallen into negative territory and has begun to rise, but has not hit the signal line, close the short position when the SBV is back in positive territory, and stay in cash until a new buy signal appears. Do the opposite for a long position.
6.  Additional Trailing Stop Rule - If you are in long position and the SBV has declined by more than 10%, close the long position and stay in cash until a new signal appears. If you have a short position and the SBV has advanced by more than 10%, close the short position and stay in cash until a new signal appears.

Table 1: Trades based on the   5-rule (additional stop-loss rule) system.

In last week's example, we explained the use of the trailing signal that will help to prevent the SBV oscillator from moving too close to the signal line and causing it to generate a signal.

This example illustrates this rule in practice when, on June 16, 2008, the SBV oscillator did not reach a 33% signal line and began to decline.

Trailing Signal Line Example:

To generate a "Long" signal - Once the SBV indicator has begun to advance after having been below minus 30%, we will enter a long position when the SBV advances by 10% from its most recent lowest negative level. If the SBV has declined below minus 20% and has begun to advance, but has not crossed minus 30%, we will enter a long position when it advances above minus 20%.

To generate a "Short" signal - Once the SBV indicator has begun to decline after having been above plus 30%, we will enter a short position when it declines by 10% from its most recent highest positive level. If the SBV has advanced above plus 20% and begun to decline without having crossed plus 30%, we will enter a short position when it falls below minus 20%.

The simplified version of the rules above could be a strategy of using multiple fixed signals levels:

Signal Level 1: If the SBV rises above plus 20% or drops below minus 20% and reverses its trend without hitting 33%, use 20% as the signal line;

Signal Level 2: If the SBV rises above plus 33% or drops below minus 33%, use 33% as the signal line.
In a similar fashion, the signal levels could be built further.

How to modify a trading system depends entirely on the trading style and risk tolerance of a trader. For instance, one trader may select a conservative trading system (with a fixed 33% signal level), which would be in a "Cash" position now. On the other hand, another trader may prefer to use a riskier system (with multiple fixed signal levels), which would be in a profitable "Short" position now. While the conservative system may miss some of the trends, the riskier system would catch all of the trends, but would generate more negative trades.

Trading System #2

Chart 2. Relationship between the SBV oscillator and index reversal points. S&P 500 index. 60-day view. 1 bar = 1 hour. SBV(20)

Signal Level 1:

Signal Level 1: If the SBV rises above plus 20% or drops below minus 20% and reverses its trend without reaching 33%, use 20% as the signal line.

Signal Level 2: If the SBV rises above plus 33% or drops below minus 33%, use 33% as the signal line.

1.  Once the SBV indicator has declined below a negative signal level (the indicator will now show red), we will enter a short position (if we are not already short);
2.  Once the SBV indicator has advanced above a negative signal level (after having been below that level), we will enter a long position (the indicator still shows red);
3.  Once the SBV indicator has rallied above a positive signal level (the indicator will now show green), we will enter a long position (if we are not already long);
4.  Once the SBV indicator has declined below a positive signal level (after having been above that level), we will enter a short position (the indicator still shows green);
5.  Additional Stop Loss Rule - If the SBV had fallen into negative territory and has begun to rise without having hit the signal line, close the short position when the SBV is back in positive territory and stay in cash until a new buy signal appears. Do the opposite for a long position.

Table 2: Trades based on the   5-rule (additional stop-loss rule) system.

As you can see, there is no significant difference in returns between system #1 and system #2. However, we believe that using additional technical indicators may help to eliminate negative trades and substantially improve system #2.

Note: The 20% level for the SBV indicator was determined in relation to the prevailing market conditions at the time that the trading examples were selected. In order to establish the optimal critical levels for the SBV indicator, traders should consider the current market situation and review the history of prior volume surges, including their magnitude (i.e., the level that the SBV indicator reached).

Our charts are unique in that they give traders the opportunity to choose the specific chart settings that best fit their personal trading styles and risk tolerances. Traders can thus develop and test their own trading systems. On our charts, you can scroll back in history to test any system that you have created.

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