In bull markets, investors often buy stocks after price dips in anticipation the broader uptrend will resume and push stocks higher. Despite their simplicity, pullbacks rank among the most consistent patterns in the stock market over the past few decades, the 2008 financial crisis notwithstanding. The data shows stocks tend to bounce back quickly after sharp declines.

The pullback pattern analyzed here couldn’ t be much simpler: a series of lower daily lows accompanied by an uptick in volatility. The setup was tested on daily price data from May 2000 to May 2009 in four U.S. index exchange-traded funds (ETFs): S&P 500 (SPY), Nasdaq 100 (QQQQ), Dow Jones Industrial Average (DIA), and Russell 2000 (IWM). The rules were then reversed — i.e., selling short after three higher daily highs and lower volatility — and compared to the long-only pullback pattern.

The results are interesting, but the strategy uncovers some of the same pitfalls addressed in the Active Trader system design series.