If you are using any kind of a system based on technical analysis, you need to own and read this book as well as the earlier work by the same authors (Larry Connors and Cesar Alvarez), Short-Term Trading Strategies That Work. Both books are clear and understandable, and both lay out approaches that really do work.
The difference between the work of Connors and Alvarez and almost everyone else is that they show you exactly how to APPLY commonly available statistical tools. Everyone who has spent a couple of hours watching CNBC knows what the VIX is, for example, but it is just noise to the vast majority of people. Connors and Alvarez provide explicit instructions that enable the application of this number to buying and selling decision making..
Take the 200 day moving average, for example. A fine number, easily available from a number of sources, but specifically how should it affect your trading strategy? Connors and Alvarez use this measure very simply and directly. If the target security is above the 200 day moving average, only consider long moves. If it is below that average, only consider short moves.
This is simple and measurably effective. You can test any of the strategies in any of their books with and without this rule, and the difference is clear. The strategies work when this rule is included; they don’t when it is not.
This book introduces their approach to short selling and money management tactics. The short selling tactics are a logical extension of their long strategies, but the money management is a new wrinkle. Like most of their presentation, it’s not fancy but it does offer a quantified approach for averaging into a position. The best aspect of everything that these books offer is a solid foundation for quantification because without that foundation, experimentation is useless and progress is uncertain.
The only quibble that I have with either book is over the definition of the word “strategy’. As they say more than once in this book, it’s all about selling into overbought conditions and buying oversold securities. One strategy for which they present several effective tactics. I’m not knocking this. It’s a good strategy, and they make it better when they only buy in healthy markets and sell in overall weak markets.
They present a lot of useful statistics about a wide variety of indicators, but they are only looking for indications of overbought or oversold markets. The indicators they suggest are pretty reliable and work effectively when used as they suggest, but they are not different strategies. For example, you could not diversify by using several of their different strategies because they all tend to lead you into the same trades. That is, security A is overbought or oversold. Several indicators may reveal this, but that does not mean that there are several different opportunities.
A really good book makes you ask questions. For example: Which indicator is the best? Is there a combination of these indicators that is more effective than any single indicator on its own?
Connors and Alvarez also present a variety of indicators to tell you when to get out of a position. Each of these indicators point to the market no longer being oversold or overbought. Notice that the strategies are not looking to profit further in that direction. The end-of-day aspect of the exit rules may be trying to catch a little of that over-bounce. They make a point of saying that you shouldn’t get out during the day if you hit the target for that day. I suspect they are right, but that is one of the few assertions that they do not back up with statistics.
Engineering is all about gathering and evaluating measurements, then putting those measurements to work. This book, like its predecessor, provides a good hands-on introduction to the basics of financial engineering.