A Long-Term Stock Index Trading Strategy

Zig Zag Indicator

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In this article I describe a long-term stock index trading strategy. I then show how the strategy performed on the S&P 500 index.

The strategy was inspired by the Zig-Zag indicator and is based on the closing daily price.

The Zig-Zag Indicator

2014-10-27 S&P500 Index

The Zig-Zag indicator looks great on a chart. In the image here it picks out the highs and lows as the S&P500 advances in 2009-2013.

It can be calibrated to make it more or less sensitive. If the indicator is set to 10%, it will only change when the price has moved at least 10% in the opposite direction to the existing trend.

However, for most traders the Zig-Zag indicator is not very useful. This is because it can only be calculated by looking at past data. Each turning point can only be shown once the underlying market has retraced by the percentage deviation. The indicator is useful for people looking at market wave theories but it is not possible to trade the moves shown on the image above.

The Stock Index Trading Stratey

I wanted to look at what an actual trading strategy would look like if it used the same principles as the Zig-Zag indicator. This trading strategy should be long-term and it should ignore small moves in the opposite direction.

Trading Strategy Rules

  • If Long and the closing price retraces more than a variable percentage, then close the Long position and open a Short position.
  • If Short and the closing price retraces more than a variable percentage, then close the Short position and open a Long position.

Trading Strategy Results

Excel Backtest Model

I analysed the results of the strategy using my Long-Short Backtest Model. If you are interested in using Excel to backtest trading strategies you can read more about it in my article Why Use Excel to Backtest Trading Strategies.

The Backtest

The strategy was tested on the S&P 500 index from 2000-2014. The strategy started off with $100,000 of capital and used no leverage. The strategy was tested using 10% deviation.

Gross Winning Trades $121,757
Gross Losing Trades $-41,490
Net Profit $80,267
Profit Factor2.93
Winning Trade10
Losing Trades16
Win Percentage38%
Largest Winning Trade $34,229
Largest Losing Trade $-8,885
Max Drawdown16%

The charts below show how the strategy performed relative to the underlying index.

2014-20-27 Trading Strategy
2014-20-27 SP500


It can be seen from the charts that the strategy comfortably outperformed the underlying market. The strategy was more profitable and had smaller drawdowns.

Video

In the video below I provide some more information about the trading strategy and highlight how changing variables can affect the profitability of the strategy.

More Trading Strategies

Check out my Trading Strategies page for more trading ideas.