Every industry has a set of rules which need to be followed before making a decision. The stock market rules can include a series of indicators which highlight the turning point in the trade.
For this particular test, we intend to use the ETF SPY as a vehicle. SPY is the symbol for an SPDR S&P 500 exchange-traded fund which trades on several exchanges. The abbreviation SPDR stands for the Standard & Poor’s Depositary Receipts, which was the former name of the ETF. The logic here can be used for both the ETF market and the Emini futures market.
We will also use the popular indicator ADX, which was created by Welles Wilder in the 70’s along with a 10 day low and an IBS. An IBS is an oscillating indicator which measures the relative position of the close price with respect to the low to high range. The acronym IBS stands for “Internal Bar Strength” and can be calculated as follows: (close – low) / (high – low).
These rules have been utilized to correctly predict the direction of the market 89% of the time since 1998. In fact, they have done a very good job of identifying the times SPY have been pulled back and are due to rally. The high level test results for the edge and the equity graph are displayed below. The edge can be further tested, analyzed and improved using different exits.