The Trading Tips Newsletter July 2005 issue documented Larry Pesavento's Opening Price Principle.  The article showed favorable results for 10 stocks for one month of examination.  However, I felt the need for further research to answer questions, such as whether the 0.618 retracement distance was the optimal retracement percentage to use.  Also, should the stop be based on 50% of yesterday's range or some other percentage?  This follow-up article will attempt to find answers to questions like these.

Larry suggested a list of 40 stocks for this research project.   Ten stocks were picked for each of these 4 general categories:  Low Beta, $30 to $60 price, $60 to $90 price, and over $90 price.  The following list attempts to have a varied representation of stocks for our research.  

The project used Ensign Windows and its custom programming language called ESPL to implement the trade rules and tally the results.   The results show the simple accumulation of profit or loss for a stock, based on 1 share.  If a stock was bought at $25.00 and sold at $25.62, then the trade is counted as a Win and the Net accumulates 62 cents.   No slippage or commission has been factored into the results.   This simplicity is acceptable because we are seeking to find which parameters result in an improvement or degradation of the Opening Price Principle system. 

The system rules for the research project were these:

• Evaluate 40 stocks over a 5 week period from July 18th through August 19th.
• Attempt a Long position if the price 1 hour into the session is above the opening price.
• Attempt a Short position if the price 1 hour into the session is below the opening price.
• Evaluate entry at different retracement percentages of the first hour's range.
• Evaluate different protective stops based on yesterday's daily range.
• Do not initiate a trade in the last 2 hours of the day.
• Exit the trade on the close if it has not been stopped out.

Trade detail generated by this project could fill a book.  So, only a sample of the detail is shown here to illustrate the results.  The following example of trade detail is for the Low Beta stock list, using 0.618 for the retracement percentage for the entry price objective, and a stop size of 50% of yesterday's range.

For the SBUX symbol, the results for 25 days show that 10 winning trades accumulated a gain of $2.40 and 5 losing trades accumulated a loss of $1.06.   Two of the 5 losing trades were from being stopped out.  The Net for this symbol is a positive $1.34.   No trades were made on 10 of the days because the market never retraced to the desired entry price level before the time cutoff at two hours before the market close, or the 1st hour price was unchanged from the opening price (no bias).

Retracement Percentage:

For the balance of the article, only a summary of the trade detail is given for the sake of comparing different parameters.  The first parameter to examine was the retracement percentage of the 1st hour range which affects the entry price objective.  For a retracement of zero, then every Long and every Short would be executed on the open price of the next bar.  The only No Trade days for a zero retrace are those days where the 1st hour price is unchanged from the opening price (i.e. 12 in the following table for the 0.000 Retrace row).

A protective stop was calculated to be 50% of Yesterday's Range offset from the Entry Price.  Occasionally, the 1st hour price was already more favorable than the Entry Price level, in which case the trade is initiated at a more favorable price.

The following table shows the trade summary for 5 different retracement percentages from 0% to 100%.  The 100% retracement means the Long entry price would be the Low of the 1st hour range, and a Short entry price would be the High of the 1st hour range.

The results suggest that a retracement of 0.786 is the most favorable percentage to use of those tested.  Positions are initiated nearly 50% of the time.   Half of the trades were winners and half were losers.  The Net of only $43.61 from 475 trades is a concern because the average gain per trade per share is only 9 cents, and that is before slippage and commissions are factored in.

Stop Percentage:

Each column in the following table is for a different Stop size.  The Stop size is calculated using a percentage of Yesterday's Range.  This size is then offset from the Entry Price to be the trade's protective Stop.  Each row is a different retrace percentage for entry price.  The summary values shown are Nets.  The 0.500 column shows the same Net results from the previous table which used a stop size of 50% of yesterday's range.
 

The results suggest that the profitability of the system is dependant more on the Retracement percentage than it is on the percentage used to calculate the protective stop.  There is more variation in the result going vertically in the table, than there is in going horizontally in the table.   Some of the rows have their best results using the 0.500 percentage of yesterday's range, and others do better using a more generous stop.  I think this table confirms that the 0.500 percentage is an appropriate parameter to use.

Money Management:

May I suggest additional ideas to investigate, some of which are:

• Once a position is profitable, move the stop to break-even.
• Once a position has achieved a profit objective, remove a portion of the position, and move the stop to break-even.
• Put on half of the position at the retracement percentage, and the balance of the position upon breaking through the upper range level for Long positions, and the lower range level for Short positions.
• Use a trailing stop, such as a Parabolic Stop after the position is initiated.
• Vary the time for the Opening Price range.  Perhaps 30 minutes or 45 minutes into the session would have better results than using the price 60 minutes after the open.
• Base the protective stop distance on a percentage of the opening period's range instead of upon yesterday's daily range.

Larry received the following e-mail from another trader who conducted independent research of the Opening Price Principle.

"Just wanted to let you know about some testing I did on the OPP strategy.  I bought the book at the NYC trader's expo and have coded a simple program to use it on my TradeStation platform.  I've historically tested it with about ten stocks or so and just started using it on one, RYL.  The system does the following:

• Buy or sell short after a few 4-minute bars (usually 3-6) based on current price vs. opening price of the regular session.
• Set stop loss based on stock price, like 1/2 point for TASR but 2 points for SPY.
• Sell or cover 1/3 of position at a gain similar to loss threshold then set breakeven stop loss for remaining shares.
• Sell or cover remaining shares near close.

Amazingly, any symbol I've back tested has more winning that losing trades.  Maybe it's indicative of the market, but shorting is much more successful than going long.  In fact, on TASR the system wins over 70% of the time and the annual return is over 100%.  Unfortunately, my broker can't find TASR shares to short.  It has pretty good results on GOOG and RIMM also.

It's important to mention that the system is only optimized for which bar to enter so curve fitting is minimal.  I make a visual assessment of a stop loss point when I set up the system but that could be optimized too.  All my results are for 100 days of back testing.

Obviously picking those stocks with good intraday volatility and small tails on a daily candlestick chart makes the best candidates.  If you have any in mind you want me to check, let me know.  Thanks for the lead on this system.

[If Howard wants to publish my e-mail] That's fine with me, but it's not exactly the same system Howard coded.  I'm putting [a large account] to work every morning on OPP and wouldn't be doing it if it didn't work."  -- Bob (Bubba in chat) Marsh
 

"Have been test driving the new tool (Opening Price Principle) on Ensign.  Larry & Howard deserve a medal for your work together on this in my opinion.  Do you use the principle on longer time frames, i.e. Weekly, Monthly or even quarterly charts?  As price structures form on all time frames I am assuming the same basic formula could be used on longer time frames.  Your thoughts would be welcome."  -P. Biggs  07-29-2005

Reply:  "I only use the Opening Price Principle for intraday --- it was never tested on a longer term --- the folks at Ensign should get a medal --- but still most people will be too lazy to work it out."  -Larry Pesavento  07-29-2005

Summary:

The Opening Price Principle is a strategy with merit.  However, it is not the Holy Grail of trading.   As with any system, there are portions of the strategy that can be adjusted and research needs to be done to determine appropriate 'in the ballpark' parameters.   As pointed out by the feedback from Mr. Marsh, the application of money management principles can improve on the system results.  Unfortunately, I have not had time to investigate the strategies used by Bob Marsh.  His feedback is presented as additional ideas for investigation.

What have these articles on the Opening Price Principle accomplished?   Larry presented the basic strategy.  I and others have used our abilities to back test the basic strategy and variations of it as we mutually seek to understand the impact of adjusting parameters, determining which type of stocks the system seems better suited for, and how results might be improved upon through the use of money management skills.  Our efforts are not the final authoritative answer.  Please continue the investigative process by doing research of your own.