Two Simple Rules to Trade PowerRatings

By Larry Connors

PowerRatings are the single most popular tool we have at TradingMarkets. In this article, we will show you how you can potentially improve your trading edge even further with PowerRatings . All it requires is the addition of two rules .

When we first published PowerRatings beginning in 2005, the simulated results were based upon a holding period of five days. If a stock had a PowerRating of 9, its simulated returns were based upon buying a stock on the opening and exiting the stock five trading days later. But, as we will teach you here, one can dramatically improve the simulated edges in PowerRatings  further by adding two simple trading rules to them.

Here are the rules:

  1. Only buy a high PowerRating stock (7 or higher) on a limit order below yesterday's close.
     
  2. Instead of using a static exit and waiting for five days, use a dynamic price exit by exiting the trade when the stock closes above its 5-day simple moving average (SMA).

By adding these two simple rules, the simulated returns rise substantially and expand the edges even more.

Here are the PowerRatings simulated returns from January 1995 to December 2010 using a standard five day exit.

PowerRating
Average % Gain
% Correct
No. of Trades
7
+0.7%
54%
224,7445
8
+1.3%
56%
148,7000
9
+2.0%
58%
25,475
10
+2.9%
62%
5,2831
Totals 1.0% 55% 404,472

Now let's add the two rules mentioned above. We'll only buy the higher PowerRatings stocks (7 or higher) on a limit order below yesterdays close, and we'll exit on the opening the day following a close above the 5-day SMA. Here are the results when we add these two rules.

The first table shows what has happened by entering a high PowerRating stock on a limit order 3% below yesterdays close and exiting on the open the day following a close above the 5-day SMA. As you can see, not only does the average gain improve in all cases, but the % correct improves substantially too.

3% Limit, 5-day SMA Exit

PowerRating
Average % Gain
% Correct
No. of Trades
7
+1.9%
68%
62,232
8
+3.1%
71%
48,650
9
+4.3%
75%
8,853
10
+5.9%
75%
1,974
Totals 2.6% 70% 121,709

Here are the results for using a 5% limit and using the 5-day SMA exit.

5% Limit, 5-day SMA Exit

PowerRating
Average % Gain
% Correct
No. of Trades
7
+3.0%
70%
30,376
8
+3.93%
72%
26,215
9
+6.1%
77%
5,019
10
+7.8%
77%
1,185
Totals 4.0% 72% 62,795

Again we improve in all cases, and we now see the % correct rise to 72% and more going all the way back to 1995 on over 62,000  trades .

Here are the results for using a 7% limit with the 5-day SMA exit.

7% Limit, 5-day SMA Exit

PowerRating
Average % Gain
% Correct
No. of Trades
7
4.4%
71%
16,262
8
6.3%
74%
15,0758
9
7.9%
79%
2,962
10
10%
78%
778
Totals 5.6% 73% 35.077

Even though the number of trades drops, the % correct rises to 72%, and the average gain per trade jumps to 5.08% per trade. The edges on the 9's and 10's are even more extreme, with more than three out of every four signals being profitable and returns rising to 10% per trade for those stocks which had a top PowerRating of 10.

One caveat to the above is that most days, PowerRatings are viewed by thousands of traders. Too many people entering or exiting at a fixed price, or on the open, will potentially have an impact on price behavior (and likely make at least a few specialists and market makers wealthier). Also, in low volatility environments, fewer stocks trade to the 4-7% levels than in high volatility environments. Therefore, if you apply PowerRatings to your investing and trading, please be cognizant of these facts when entering and exiting positions.

We hope this information is helpful to you. For a free PowerRatings trial, click here. If you have any questions on the research or the strategy please feel free to email us at editor@tradingmarkets.com or call 213-955-5858 ext 1.

Larry Connors is CEO and Founder of TradingMarkets.com and Connors Research.