Extreme price movements, both upward and downward, are associated with high volatility and are usually short-lived. This mean reversion strategy tries to capitalize on this by taking advantage of the moment when the movement loses momentum and returns to its average. The Red Dog Reversal strategy looks for stocks which are currently in such a price extreme. Once we have identified such stocks an exact entry point is set with a clear stoploss. The strategy is initially intended as a pure day trading play, as we should not lose sight of the fact that we are acting against the current trend. Depending on how the trade evolves during the trading session you can however decide to leave (part of) the position open and speculate on a multi-day countermove.
Warning! A word of warning in advance for those who wish to hold positions overnight. The stops used in this day trading strategy are short to sometimes very short. This means that if the movement continues over several days, the profits could mount up nicely. But that also applies to the possible loss! An open long position where the initial stoploss was only 20 cents and where the price suddenly opens $1 lower the next day can have serious consequences for your portfolio!
An easy visual way is to view the stock in relation to a moving average, for example the SMA20.
Sudden violent rises or declines cause a noticeable gap to appear between the price and the SMA20.
Oscillators such as the Stochastics and the RSI also indicate well where price extremes occur on the chart and when oversold and overbought levels occur. These indicators converge well with the earlier visual method using the SMA20.
Now that we know how to objectively define a price extreme, it's time for the actual strategy.
Since we are talking about a mean reversion strategy we are going to look for a reversal signal where we take a position which is opposite to the existing trend.
Conditions for a buysetup:
The actual setup
In this example the long position has never been in any danger. The price closed at the end of the trading day with a profit which was more than 2.5 times the initial risk.
Below the chart as of the date this article was written (2021/12/10):
Those who held some of the long position were able to profit from the continued rise. The SMA20, for example, was a nice target point for this setup.
Example of a short setup
The next trading day we will be looking first and foremost for an opening price that opens below the high of this last candle. Below, the 5m chart of CWK.
The actual setup
Here too this turned out to be a perfect entry. The potential profit was up to four times the risk for those who closed the position before the end of the trading day.
Below is the chart at the date of writing this article (2021/12/10):
[This screen](https://www.chartmill.com/stock/stock-screener?f=p_pg5,stoch_b_20,sl_pt_X_0,s_nl10,v1_50b500,exch_us&v=3&s=se&bc=1&cf=(cu%3C%3D(sm20v*0.91))&months=3&o1=3&op1=20,14205462&i2=55&ip2=14&cpl=3) (to be used before the market opens) shows all US stocks listed more than 9% lower than the SMA20 and with a Slow Stochastic indicator lower than 20. These stocks can be used to screen for a potential intraday reversal upwards.
[Link](https://www.chartmill.com/stock/stock-screener?f=p_pg5,stoch_b_20,sl_pt_X_0,s_nl10,v1_50b300,exch_ca&v=3&s=se&bc=1&cf=(cu%3C%3D(sm20v*0.91))&months=3&o1=3&op1=20,14205462&i2=55&ip2=14&cpl=3) > Canada only
[Link](https://www.chartmill.com/stock/stock-screener?f=p_pg5,stoch_b_20,sl_pt_X_0,s_nl10,v1_50b200,exch_eu&v=3&s=se&bc=1&cf=(cu%3C%3D(sm20v*0.91))&months=3&o1=3&op1=20,14205462&i2=55&ip2=14&cpl=3) > Europe only
[This screen](https://www.chartmill.com/stock/stock-screener?v=3&bc=1&s=se&f=p_pg5,v1_50b500,stoch_a_80,s_nh10,sl_pt_0_X,exch_us&cf=(cu%3E%3D(sm20v*1.09))&cpl=3&months=4&o1=3&op1=20,14205462) shows stocks listed more than 9% higher than the SMA20 and with a Slow Stochastics Indicator higher than 80. These stocks can be used to screen for a potential intraday reversal downwards.
[Link](https://www.chartmill.com/stock/stock-screener?v=3&bc=1&s=se&f=p_pg5,stoch_a_80,s_nh10,sl_pt_0_X,v1_50b200,exch_ca&cf=(cu%3E%3D(sm20v*1.09))&cpl=3&months=4&o1=3&op1=20,14205462) > Canada only
[Link](https://www.chartmill.com/stock/stock-screener?v=3&bc=1&s=se&f=p_pg5,stoch_a_80,s_nh10,sl_pt_0_X,v1_50b200,exch_eu&cf=(cu%3E%3D(sm20v*1.09))&cpl=3&months=4&o1=3&op1=20,14205462) > Europe only
These screen filters are very suitable as a basic selection which can then be filtered manually.Keep the best candidates in a watchlist and transfer the setups to your actual trading platform before the market opens.
With our stockscreener you can use the complete Red Dog Reversal pattern as a filter, with a distinction between the Red Dog Reversal Up and Red Dog Reversal Down pattern. This filter adjusts intraday but keep in mind that prices are delayed at least 15 minutes.
Select the ‘Indicator’ menu in the Stock Screener:
Link > Canada only
Link > Europe only
This screen shows all US stocks where the Red Dog Reversal Down pattern has been completed after the price has risen at least 5% in one week.
Link > Canada only
Link > Europe only
As with other strategies mainly based on price action, it comes down to finding as many converging elements as possible to support your setup. A price extreme where the price is at the same level as a support or resistance level or where a double bottom or top is formed, for example, are additional elements which can increase the chance of success.
For those who want to hold positions overnight by means of this strategy we repeat the warning that the intraday risk in that case should absolutely be reduced if you do not want to be confronted with unpleasant surprises when the price suddenly opens much lower (in case of a long position) or much higher (in case of a short position) than your set stoploss.