Some Short Term Trading Strategies That Really Work

In a recent blog post, we highlighted the potential benefits of using short term trading strategies. One advantage of trading frequently can be the fact that it allows a trader to rapidly compound gains. Through that process, wealth can accumulate quicker.

Our post drew a variety of responses. Some readers asked for specific examples of short term trading strategies. There are many resources available on this topic. But, most of the best strategies will require a great deal of effort or software that may be expensive.

Some of the most popular strategies among short term traders include those developed by Larry Connors at TradingMarkets.com. That site is no longer regularly updated but still contains a wealth of information about short term trading.

Many of the strategies Connors developed use the Relative Strength Index (RSI). However, he advocated changing the calculation period from 14 days or weeks to as little as 2 periods. His results show that this can be more effective.

A Strategy Using One Indicator, and a Moving Average

Among the strategies detailed in one of his books, High Probability ETF Trading: 7 Professional Strategies to Improve Your ETF Trading, is a system known as RSI25. This strategy is typical of the work Connors published. It has a high win rate and small average gain with a short holding period.

  • 3 Penny Stocks to Explode in America's Hottest Sector
    As U.S. Defense spending hurtles towards $6.7 TRILLION, one small subset of stocks will soar... For the first time in 18 years, we're on the brink of a situation that could turn every $1,000 into $491,000. It's an historic situation, one that hasn't appeared in nearly two decades. And there are THREE penny stocks that stand to absolutely soar as this situation hits critical mass. Click here to get the ticker symbols.

In the book, back tested results are presented. This is another characteristic of Connors’ work. Data is always presented to support the conclusions. Back testing RSI25 on 20 of the most liquid ETFs for as long as the ETF had been traded, a period of up to 15 years at the time of publication, showed a win rate of 77%.

The average trade delivered a gain of 1.06%. The average trade accounts for the gains and losses of all trades and is the result assuming all trades were taken. For this strategy, the average holding period was a little more than six days.

If it were possible to find a trade like this every six days, you would find 42 trades in an average year assuming 252 trading days in a year. Compounding the 1.06% gain over those trades would result in nearly doubling your money with $1,000 growing to $1,917 in one year. That demonstrates the potential power of short term trading.

For RSI25, trades are entered when the 4-period RSI, or RSI4, is under 25 and the closing price of the ETF is above the 200 day moving average (MA). This strategy is designed to but short term pullbacks in long term up trends. This strategy is explained in a YouTube video.

RSI4 is used to identify the short term pullback. When it is under 25, the ETF is considered oversold. The 200 day MA is used to define the long term up trend.

After a position is opened, trades were closed when RSI4 ended the day above 55. Other exit strategies could be used to improve the trading performance. This strategy does not use a stop loss because stops tend to hurt performance of short term systems traders.

The chart below shows the equity curve for this system using the stocks in the S&P 500. Notice that is relatively smooth, avoiding large losses even in bear markets.

A Second High Probability Short Term Strategy

Another strategy developed by Connors is detailed at TradingView.com. This strategy uses a 2 period RSI or RSI(2). For this strategy, the average holding period of a trade is just over 2 days. This strategy is also designed to buy short term pullbacks in long term up trends.

The buy rules are similar to the RSI25 strategy:

  • Buy when RSI(2) is below 10 AND
  • The close is greater than the 200 day MA AND
  • The close is less than the 5 day MA

This strategy also finds short trades. To go short, look for stocks below their 200 day MA, above their 5 day MA and enter when RSI(2) is greater than 90. Trades can be entered at the close on the day all conditions are met or on the open the day after the conditions are met.

To exit a long trade, sell when the stock closes above its 5 day MA. For short trades, exit on a close below the 5 day MA. There are no stop loss or other exit rules.

Back test results enter trades at the open on the day after the signals are given. The system consistently generated win rates of about 65% and delivered steady profits in bull and bear markets. The system was even profitable in testing on foreign exchange markets.

The chart below once again shows the results on the individual stocks in the S&P 500, taking signals for buys only. Short trades were ignored because shorting carries high costs and high risks and is not suitable for small traders. This strategy also produces a smooth equity curve.

Putting It All Together

Many short term traders use multiple strategies. The reason for this is because there are few opportunities in any given strategy. Using multiple strategies presents more trading opportunities.

There are many other short term trading strategies for you to consider. For example, videos are available to explain the TradingMarkets’ R3 Long Strategy and TradingMarkets’ 3 Day High Low Trading Strategy. However, all of them will require some degree of commitment to implement.

To begin with, there will most likely not be a free web site that identifies trades every day. Strategies like this usually require some kind of software or a subscription service to obtain the data and trading signals. Each of these strategies is relatively easy to code in any of the popular software packages.

Strategies and results like this also require a commitment of time. The strategy will need to be run every day. This will require steps such as obtaining data and searching for signals. All trade signals need to be accepted by system traders since there is no way to know in advance which of the trades will be winners.

As an alternative, it is possible to follow a few stocks or ETFs at a free web site like TradingView.com. They offer the ability to customize the RSI indicator and obtain charts with RSI(2) or the 4 period RSI. An example is shown below.

While RSI(2) is above 90, this is not a short signal. Remember, the sell short signal would only be generated if the ETF, in this case, was below its 200 day MA.

Reviewing charts on a daily basis would be one way to become a short term trader. As assets grow, an investment in the tools similar to those used by professionals could become affordable. However, short term trading generally requires more commitment, of both time and resources, when compared to long term investing.

Whether you start with a manual review of charts or with software that is programmed to identify trades, it will be important to review a number of stocks or ETFs for trading opportunities. The list of trade candidates should be diversified by sector, industry and even country.

The high probability trading signals these strategies tend to be infrequent. By search for trades in a variety of sectors, there should be more opportunities. The same could be true for country ETFs. For example, there could be a trade in European stocks when US stocks are in a trading range.

With effort, and commitment, short term trading can lead to success. But, there will be drawdowns and periods of time with no activity. Remember that success requires following your strategies with discipline in good times and bad.