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  CONNORS ONADVANCEDTRADINGSTRATEGIES
Laurence A. Connors
4. GORDON PUBLISHING GROUPMalibu, CaliforniaCONTENTS
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INTRODUCTIONCHAPTER 1 THE BASESECTIONONE S&P AND STOCK MARKET TIMINGCHAPTER 2 CONNORS VIX REVERSALSCHAPTER3 TRIN THRUSTSCHAPTER4 PERCENT ADVANCE/DECLINE INDICATOR (PADDSECTIONTWO VOLATILITYCHAPTER5 =MODIFYING TRADE SIZE AND STOP PLACEMENTBASED ON VOLATILITY MEASUREMENTCHAPTER6& = TRADING WHERE THE ACTION ISCHAPTER 7 — ADDITIONAL VOLATILITY RESEARCH
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viii Contents
SECTIONTHREE
CHAPTER 8CHAPTER 9CHAPTER 10
SECTIONFOUR
CHAPTER 11
CHAPTER 12CHAPTER 13CHAPTER 14
CHAPTER 15
SECTIONFIVE
CHAPTER 16CHAPTER 17
CHAPTER 18CHAPTER 19
NEW PATTERNS
1-2-3-4THE 8-DAY HIGH/LOW REVERSAL METHODSPENT MARKET TRADING PATTERN (SMTP)
EQUITY TRADING
THE CRASH, BURN, AND PROFIT
TRADING STRATEGY (CBP)
WHEN THEY'RE LATE, THEY’RE PROBABLY DEADDOUBLE VOLUME MARKET TOP METHOD
TRADING EQUITIES WITH THECONNORS VIX REVERSAL
TORPEDOES
OPTIONS STRATEGIES
TRADING VOLATILITY WITH OPTIONS
TRADING OPTIONS WITH THECONNORS VIX REVERSAL
OPTIONS ON STOCK SPLITS
EXPLOITING OVERPRICEDSTOCK SECTOR OPTIONS
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Contents ix
 
 
SECTION
sIx DAY TRADINGCHAPTER 20 15-MINUTE ADX BREAKOUT METHOD 147CHAPTER 21 10% OOPS 167CHAPTER 22 REVERSALS OFF THE MORNING CALL 171CHAPTER 23. WIDE RANGE EXHAUSTION GAP REVERSALS 175
SECTION MORE ADVANCED TRADING
SEVEN STRATEGIES AND CONCEPTS
CHAPTER 24 TRADING RUNAWAY MOVES 183CHAPTER 25  GIPSONS 193CHAPTER 26 MAXIMIZING PROFITS IN SHORT-TERM
MARKET DECLINES 205CHAPTER 27 LARGE-RANGE DAYS 215CHAPTER 28 TWO-FOR-ONE MONEY MANAGEMENT 219CHAPTER 29 MORE THOUGHTS 227CHAPTER 30 HOW SUPERIOR INDIVIDUALS BECOME 233CHAPTER 31 FINAL THOUGHTS 235APPENDIX : 237
Historical Volatility Calculations, 237Trade Summaries, 238Other Publications Offered by M. Gordon Publishing Group, 256
ABOUT THE AUTHOR 259
 INTRODUCTION
This book was written with the me of 10 years ago in mind. My goal hasbeen to produce the book I wish I had a decade ago when I made afull-time commitment to my trading.
Over the years I have read hundreds of books on investing and trading.The ones I learned the most from were written by individuals who re-moved their egos from their writing. Their books were written simply,and without the need to show the reader how smart the authors were. Ihope to do the same here. I suspect, if I tried, I could bore you with 12-letter words, run-on sentences, and I could quote Nietzsche and Plutarchto show you how intelligent I am. I could drop names of some of thefinancial market celebrities I barely know, and I could fill the back of thebook with a huge bibliography. But I will not, for as I mentioned earlier, Iam writing the book as I would have wanted it myself, and I suspect myneed to keep things simple and to the point are also yours.
This book is a compilation of two years of my monthly newsletter, theProfessional Traders Journal. I have taken the best strategies and updatedthem for you. I have also added new strategies, concepts, and thoughts tohopefully bring the research to a new level.
The majority of the strategies presented were originally created by myresearch firm, Oceanview Financial Research. I have attempted to givereference and credit to those individuals from whom other strategieswere derived. If I missed anyone, I give you my strongest apologies.
  
xii
Introduction
Good work must be acknowledged and only I am to blame for any over-sights.
I would like to thank Mark Boucher, Fernando Diz, Jeff Cooper andDerek Gipson for their contributions. They have helped make a goodpublication better. I would also like to thank my editor Bill Masciarelli,Bob Pisani, Danilo Torres, Irene Golden, Judy Brown, David Landry, JoeCalandro, and Jeff Cox for their invaluable contributions in helping createthis book.
Finally, I would like to thank my wife Karen for again lovingly puttingup with my nonsense while writing a book. ‘Thanks also to my daughterBrittany, who is now the only ten year old, who knows how to createhistorical volatility charts from a Bloomberg terminal, and my daughterAlexandra, who is, as far as I know, the first five-year-old to help collatea financial markets trading book. I marvel at both of you and can onlywonder in amazement what the future will bring. 
CHAPTER 1
THE BASE
This first chapter is more important than the trading strategies chapters. Itwill provide you with a basis for understanding why a small handful ofplayers make extraordinary money trading while the majority do not. Thischapter will create the foundation you must have to maximize the effective-ness of the strategies which are the heart of the book.
I have traded the markets directly or indirectly since I was in collegemore than twenty years ago. I began, as most traders do, by searching forthe perfect trading system. If I told you that I have outgrown this pie inthe sky pursuit, I would be lying. I still wake up in the middle of thenight and go to my home Bloomberg terminal to test something that Ibelieve will change the course of trading history. I suspect that if I amstill alive 50 years from now, I will be doing the same.
As I have grown older, I have learned to lessen my expectations. I havecome to realize that it is good to think big, but success in trading is notdependent on finding the holy grail trading system. It is much more de-pendent upon having a trading method that meets the following threecriteria:
1. The method must be conceptually correct.
2. ‘It must provide you with a small “edge.”
3. Most importantly, the method must be able to manage the “bad tail.”
Let’s look at each component in further depth. 
2
Chapter 1
COMPONENT 1—THE STRATEGY MUSTBE CONCEPTUALLY CORRECT
If a strategy is not based upon inherently correct market principles, it isprobably useless. I suspect that if I looked at the schedule of every MajorLeague Baseball team over the past decade, I could find some sort ofpattern that predicted market behavior. An example would be when theSeattle Mariners win by two runs or more on Tuesday night, and RandyJohnson doesn’t pitch the game, soybeans rise 72 percent of the time thefollowing day. You may laugh at this example (don’t trade it), but I haveseen methodologies and strategies sold to traders that make as muchsense as the one above.
Markets have built-in characteristics. For example, strongly trending mar-kets will pause, pullback, and then continue their original move; in bearmarkets, sessions tend to close below their opening; low volatility is pre-ceded by high volatility, etc. Any middle level student of the game hascome to know these and similar truths. When you read the upcomingchapters, you will see that the inherent market features I have just listedand others like them are the basis of my strategies.
I strongly believe that in order to improve upon your trading you mustonly trade strategies that exploit inherent market characteristics.
COMPONENT 2—THE EDGE
Over the past 100 years, which industry has been one of the most consis-tently profitable? The insurance industry. Why? Because insurance com-panies have a built-in “edge.” They can statistically show that based on anormal distribution of events—mortality rates, average life span, etc.—they will profit in the long run. Casinos and bookmakers work from andprofit from the same long-term statistical probabilities.
In sports betting, there is a 4.5 percent edge to the house. It is evenhigher on parlays, teasers, etc. Last year an acquaintance of mine usedthis edge to earn more than $12 million from his offshore sports bettingestablishment. Even though it is a bit more complicated than this, thisgentleman needs only to match-up both sides of a game and he is as-sured a profit. The same type edge holds truc for the casinos in craps,roulette, and any other game of chance. A well-know casino executivewasn't kidding when he said, “When a sheep is on the way to theslaughter, he may kill the butcher . . . but we always bet on the butcher!”
  
In trading, the edge immediately goes to players like the market makerswho buy on the bid and sell on the offer. One does not need to be agenius to figure out that the guy who buys at 46 and can immediatelysell it at 46 1/2 has the edge over guys like me who have to buy at 461/2 and can only immediately sell it at 46.
Your strategies must provide you with some sort of edge. It does nothave to be big! The casino’s edge is usually only a few percentage pointsand the edge for the market maker in the previous example is less than1.5 percent. This small edge is enough to make one rich if the opportu-nity arises enough times and if you can conquer the third componentwhich is...
COMPONENT 3—-YOU MUST MANAGE THE BAD TAIL!
This is the single most important and critical point I willmake in the book. It must be burned into your memory. Anyone canmake money when things work out as they normally should. The majorityof traders who blow-out, do so when they succumb to the “it-will-never-happen-to-me” syndrome.
Let's look at a bell curve to understand this further.
 
As you can see, normal events occur around 67 percent of the time. Inmarket terms, this means that prices will fall within one standard devia-tion of their mean (average) 67 percent of the time within a specific timeframe. When this happens, (approximately two-thirds of the days are likethis) one’s methodology makes some money and loses some money. Aswe move further and further away from the mean we get into the areaswhere the large profits or substantial losses occur. This is when our nor-
 
The Base 
Chapter 1
mal $200/trade edge makes $5,000 or loses $5,000. When our methodol-ogy makes $5,000, we are geniuses, and when it loses $5,000 it hurtsbadly, but usually not enough to wipe us out. It is when a trade occurson the “very edge” of the tails that the rumor mill gets cranked up. Whenthe trade lands on the “good tail,” it becomes the story of the trader whoturns $10,000 into over $3 million in one option trade (a true event told tome by a friend who handled the trade) and on the other end of the spec-trum, it is the well-known money manager who recently sold thousandsof naked puts into a severe market decline and turned his client’s moneyinto dust after a decade of stellar performance (the bad tail”).
My main concem for you (and for me) is how to manage the bad tail.The risk of ruin can never be eliminated but it can be greatly lessenedwhen the bad tail occurs. It is mostly done with protective stops, it isdone with spreads on options (instead of a naked position), and it is donewith adjusting your trade size to reflect current volatility (see Chapter 5).As you will see, trading 1000 shares of a stock that has a current volatilityof 10 percent is vastly different than trading the same stock when itsvolatility rises to 40 percent.
There are many unsuccessful traders who grind themselves to death be-cause they do not have an edge. There are more traders, though, who diebecause of one reason: they did not manage the bad tail!
One more point: when creating market strategies, you must realize thatmarket generalities are useless, A “market generality” is different from aconceptually correct market characteristic. For example, most traders be-lieve that sustained TRIN readings under one are bearish and sustainedTRIN readings above one are bullish. I have yet to see a money managertake this information and consistently make money from it. Other exam-ples that you have heard include fade the morning move, buy the marketafter lunch, go long heating oil in the fall, buy the breakout-fade the test,etc. We can all name many more generalities, but I suspect you get thepoint.
Before you trade “market lore,” ask yourself, “Why isn’t everyone rich ifsomething so simple is true?” In order to gain an edge over some of thesmartest people in the world, you cannot trade generalities. You muststep outside the box and think differently. This is easier said than done,but as you will see from the strategies in the upcoming chapters, the bestones were conceived by looking at things from a perspective that is de-cidedly different.
  
SECTION ONE
S&P AND STOCKMARKET TIMING
The strategies in this section identify when the stock market is at psy-chological extremes and likely to reverse. The strategies, “Connors VIXReversal I, 0, and Ii,” “TRIN Thrusts,” and the “Percent Advance/De-cline Indicator” are among my favorites for trading the stock market andstocks. They identify times when fear or greed are at maximums andmarket reversals are likely to follow.
James Cramer, who is one of the best traders on Wall Street and overseesa terrific web site, TheStreet.com, is a master at instinctively identifyingthese periods. In a recent article he was quoted as saying “I’m neitherbull nor bear. I try to take advantage of emotional swings in stocks thatare probably unjustified by fundamentals.” Though I do not personallyknow Cramer, based upon his track record, I suspect his abilities to iden-tify market extremes—to smell the fear and punish the greed— are asgood as they come.
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6
Section One
I do not possess Cramer‘s magic touch. I need to rely on some sort ofstatistical evidence to confirm my instincts at these extremes. The follow-ing strategies are among my best and are the ones I use to “smell the fearand punish the greed.” Before trading these strategies, you should beaware of the risks involved in trying to identify large market reversals.You are many times using your face to stop a runaway train and whenyou are wrong, you will be punished. Your largest profits, though, willcome when you are correct. Therefore, I strongly recommend using sometype of money management strategy combined with these signals.
One final note: The testing in the following chapters show the results using $500per contract point on the S&P’s. Due to a recent split, the value is now $250 percontract point. Also, even though I am publishing mechanical results, none ofmy methods are intended to be mechanical systems, nor do I trade them as me-chanical systems, | use them ortly to help me identify a potential directional biasin upcoming days. 
CHAPTER 2
CONNORS VIXREVERSALS
In 1994, when Blake Hayward and I wrote Investment Secrets of a Hedge FundManager, we included a chapter entitled, “New Markets, New Indicators.”Among the strategies mentioned in that chapter was one which incorporatedthe VIX indicator. I mentioned that up to that point markets made veryshort-term tops when the VIX dropped under 11 percent and very short-termbottoms when the VIX traded above 15 percent. Because the indicator was sonew, I felt it was too soon to blindly fix upon those levels, but the conceptcertainly had promise.
Since that time, and especially after 1995, the normal daily trading rangefor the VIX has greatly increased. In this chapter, I will show you how Ihave adjusted the parameters of the indicator to identify one- to three-day market tops and bottoms. I have also included more than four yearsof test results. We will also look at how to apply the readings to trade theS&P’s and the stock market.
CONNORS VIX REVERSAL I
The VIX (CBOE, OEX, Volatility Index) reflects a market consensus esti-mate of future volatility based on “at-the-money” quotes of OEX indexoptions. Periods of low volatility (a low VIX reading) basically reflect aquiet, rising market, whereas periods of high volatility (a high VIX read-ing) are associated with sharp market sell-offs.
  
Chapter 2
The VIX is used as a contrary indicator. The higher its reading (and hencethe more fear in the market), the more likely the market is reaching ashort-term bottom, and the lower the reading, the more likely the marketis reaching a short-term top. In my opinion, due to the increasinglyspeculative role that OEX options have assumed, the significance and thereliability of the VIX as a market timing indicator have greatly increased overthe past few years. :Until now, most traders have used predetermined static bands (as I did in1994) to identify what is a “high” reading and what is a “low” reading.Although this works, one never knows if those bands are truly reflectiveof today’s market or if they really only reflect how markets reacted in thepast. I endeavored to create a way to look at the VIX only within thecontext of its very recent price action and settled on the relative VIX ac-tion of the previous fifteen trading days. I then addressed the matter ofthe indicator reaching an overbought or oversold condition but continu-ing to become even more overbought or oversold. Finally, I added a fea-ture that identifies when market sentiment has reversed intraday from anextreme reading. From these pieces comes the “Connors VIX Reversal I.”
Here are the rules:
FOR BUYS
1. Today the VIX must make a 15-day high.
2. Today, the close of the VIX must be below the open.
3. If Rules 1 and 2 are met, buy the S&P’s (or the market) on the closeof today. This will have to be done at the same time Rule 2 is metand in the last few minutes of trading.
4. Hold the position at least one to three days.
FOR SELLS
1. Today the VIX must make a 15-day low.
2. Today the close of the VIX must be above the open.
3. If Rules 1 and 2 are met, sell the S&P’s (or the market) on the closeof today. This will have to be done at the same time Rule 2 is metand in the last few minutes of trading.
4. Hold the position at jeast one to three days.
  
Connors VIX Reversals 9
FIGURE 2.1 CBOE OEX Volatility Index—-Here Is What a Setup Looks Like
en 010297(Clese>on 1271096
 
 
FIGURE 2.2 S&P 500 Futures
 
 
 SNS
10 Chapter 2
Before looking at the results, let’s look at the basis of the rules:
+ Rule 1 overcomes the weaknesses inherent in having a predeterminedVIX buy and sell zone. We now havea dynamic (as opposed to static)indicator which is truly reflective of current market conditions.
Rule 2 helps us avoid markets which become overbought/oversoldand then continue to move further in that direction. By waiting forthe VIX index to reverse intraday, we are identifying a definite changein market sentiment occurring at extreme levels.
Let’s look at the results:
 
CVR IE S&P 500 Index—CME—Daily—01/01/93-10/03/97
Performance Summary: All Trades
Total net profit $ 81,400.00 Open position P/L $ 0.00Gross profit $ 151,175.00 Gross loss $ -69,775.00Total number of trades 72 Percent profitable 65%Number winning trades 47 Number losing trades 25Largest winning trade $ 16,950.00 Largest losing trade $  -9,275.00Average winning trade $ 3,216.49 Average losing trade $ -2,79100Ratio average win /average loss 1.15 Average trade (win and loss) $ 1,130.56Maximum consecutive winners 7 Maximum consecutive losers 3Average number bars in winners 3 Average number bars in losers 3Maximum intraday drawdown $ -18,275.00Profit factor 217 Maximum number contracts held 1Account size required $ 18,275.00 Return on account 5%
Performance Summary: Long TradesTotal net profit $ 52425.00 Open position P/L $s 0.00‘Gross profit $ 110,175.00 Gross loss $ -57,750.00Total number of trades 50 Percent profitable 64%Number winning trades 32 Number losing trades 18Largest winning trade $ 16,950.00 Largest losing trade $ 9,275.00Average winning trade $ 344297 Average losing trade $ -3,20833Ratio average win/average loss 1.07 Average trade (win and loss) $  1,04850Maximum consecutive winners 6 Maximum consecutive losers 2Average number bars in winners 3 Average number bars in losers 3Maximum intraday drawdown $ -18,225.00Profit factor 1.91 Maximum number contracts held 1Account size required $ 18,225.00 Return on account 2BR%
 
 SSConnors VIX Reversals iW
Performance Summary: Short Trades
Total net profit $ 2897500 _ Open position P/L.Gross profit $ 41,000.00 Gross loss
Total number of trades 22 Percent profitableNumber winning trades 15 Number losing trades
Largest winning trade 12,200.00 Largest losing trade $ -3,675.00
Average winning trade 2,733.33 Average losing trade $ -1,71786Ratio average win/average loss 1.59 Average trade (win and loss) $ 1,317.05Maximum consecutive winners 5 Maximum consecutive losers
Average number bars in winners 3 Average number bars in losers
Maximum intraday drawdown
Profit factor Maximum number contracts heldAccount size required Return on account
 
 
As you can see, I went back more than four years, from January 1, 1993up through October 1, 1997. I did not include slippage and commission,as this is not a mechanical system, but $150 slippage and commission pertrade won't greatly affect the results. Finally, I used no stops in the test-ing. This led to a few good hits, yet in spite of this the results were solid.
The daily signals for the Connors VIX Reversal I can be found in theAppendix.
SUMMARY
The Connors VIX Reversal I does a solid job of identifying short-termmarket tops and bottoms. What is also significant is that in spite of thefact that we had been in a raging bull market during the test period, thesetup worked well to the short side.
Now, the question of how to trade the indicator. Obviously, if you are anS&P trader, you will trade the futures and implement some type of pro-tective stop to avoid the 18-point drop that occurred in 1996. You can alsouse this indicator to derive directional bias to complement your otherindicators. (If you trade stocks, and have a buy signal, it behooves you totake your profits in your short positions and reverse to the long side.)
I am not advocating using this as a mechanical system. | specifically use it tohelp identify short-term market tops and bottoms. Also, you may wish toadjust the look-back period and holding period to create more trades. Iwill many times look at less than 15-day highs/lows and if it is in confir-
 Om
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Chapter 2
mation with other indicators, I am quite likely to take the signal. Finally,to me, the most exciting and most profitable strategies for this indicatorare in the options markets. On the long side alone (selling puts) you havea directional bias combined with implied volatility collapsing! This willbe further discussed in the options section.
CONNORS VIX REVERSAL II
Here is another methodology that uses the VIX to measure overboughtand oversold conditions. The “Connors VIX Reversal II” (CVR Il) addsthe use of the Relative Strength Index (RSI) of the VIX to provide insightinto another way to time your entries more precisely.
“Common Wall Street wisdom” states that when the VIX is high, the mar-ket is likely to rise and when the VIX is low, the market is likely to drop.As far as I am aware, until the CVR I was introduced, no one could showwhere was the best high/low level to enter, and certainly no one hascombined it with an intraday reversal. The CVR Il takes the same con-cepts of the CVR I and uses an even more efficient way to measure over-bought/oversold levels.
Here are the rules:1. Take a five-period RSI of the closing VIX.
2a. When the five-period RSI gets to 70 or above, it signifies the VIX isoverbought and the market is oversold.
2b. When the five-period RSI of the VIX gets to 30 or below, it signifiesthat the VIX is oversold and the market is overbought.
3. | When a daily RSI reading above 70 is followed by a downtick in RSI,buy the market that day on the close. When an RSI reading below 30is followed by an uptick in RSI, sell the market that day on the close.
4. — Exit five to eight trading days later (or use some type of trailingstop exit).
Here are the results using an eight-day exit for the period January 1, 1993through October 1, 1997. They are among the best of any strategy I havepresented (a trade-by-trade summary is in the Appendix).
 ihConnors VIX Reversals 13.
 
 
CVR II S&P 500 Index—-CME—Daily—01/01/93-10/01/97Performance Summary: All TradesTotal net profit $ 179,100.00 Open position P/L $ 4500.00Gross profit $ 312,500.00 Gross loss $ -133,400.00Tota] number of trades 96 Percent profitable 61%Number winning trades 59 Number losing trades 37Largest winning trade $ 30,700.00 Largest losing trade $ -10,525.00Average winning trade $ 5,296.61 Average losing trade S$ -3,605.41Ratio average win/average loss 1.47 Average trade (win and loss) $1865.63Maximum consecutive winners 5 Maximum consecutive losers 6Average number bars in winners 7 Average number bars in losers 8Maximum intraday drawdown $ ~44,450.00Profit factor 234 Maximum number contracts held 1Account size required $ 44,450.00 Return on account 403%Performance Summary: Long TradesTotal net profit $ 161,725.00 Open position P/L. $ 0.00Gross profit $ 214,400.00 Gross loss $ -52,675.00Total number of trades 55. Percent profitable 67%Number winning trades 37 Number losing trades 18Largest winning trade $ 30,700.00 Largest losing trade $ -10,525.00Average winning trade $ 5,794.59 Average losing trade $ -292639Ratio average win/average loss 1.98 Average trade (win and loss) $ 2940.45Maximum consecutive winners 7 Maximum consecutive losers 4Average number bars in winners 8 Average number bars in losers 8Maximum intraday drawdown, $ -24,475.00Profit factor 4.07 Maximum number contracts held 1Account size required $ 24A75.00 Return on account 661%Performance Summary: Short TradesTotal net profit $ 17,375.00 Open position P/L $ ~4,500.00Gross profit $ 98,100.00 Gross loss $ 80,725.00‘Total number of trades a Percent profitable 54%Number winning trades 22 Number losing trades 9Largest winning trade $ 14,100.00 Largest losing trade $ -9,900.00Average winning trade $ 4,459.09 Average losing trade S$ 4248.68Ratio average win/average loss 1.05 Average trade (win and loss) 5 423,78Maximum consecutive winners 7 Maximunn consecutive losers 6Average number bars in winners 7 Average number bars in losers 9Maximum intraday drawdown $ -50,550.00
 
Profit factor 1.22 Maximum number contracts held 1Account size required $ 50,550.00 Return on account ww
 14
Chapter 2
SUMMARY
The most significant aspects of the test are the percent correct and thetotal net profits. Also, the average profit per trade is about as solid as Ihave seen in my research. Please note that the above results reflect a me-chanical system which used no stops. I, again, strongly recommend usingsome kind of protective stop with this methodology.
CONNORS VIX REVERSAL III
This is the third VIX Reversal strategy I follow. It was co-created by amember of my research staff, Dave Landry. Dave, who is also a CTA, is inmy opinion, a top researcher. More importantly, he very much under-stands underlying market principles.
As many of you are aware, volatility is mean reverting. This