The Trading Digest

Any thoughts?

From out original list of ETF’s that triggered 6 days ago another one has triggered an exit. The difference with this one is that it is exiting on the Ultimate Oscillator crossing 50. Remember the exit was one of two scenarios. Whichever triggered first. In this case it was the Ultimate Oscillator crossing 50 before nailing the 3% profit target like the first few exits. It is presently up  1.67% and would be sold at tomorrows open.

Have a Great Night!

Dave Johnson

We can now add VNQ to the list of ETF’s that hit the 3% profit target.

Having taken some profits in any portion of a system trade is an advantage. As to what will happen with the others I do not even venture to guess. I just trade em’ and leave the guessing to the pundits.

Dave Johnson

It has been 4 days since I mentioned a simple trade setup using the T2108 and the Ultimate Oscillator. I wanted to show you what that list of ETF’s have done since then with a screenshot:

(click to enlarge)

As you can see from the original 7 symbols mentioned 2 have hit their profit target of 3% (FXI and HHH) and of remaining 5 we have a spattering of small moves and one down 3.47%. Of course that is one of the ones I randomly picked to mention to you for this example. A big part of trading is accepting responsibility for you trades and in this case I will clearly pass the buck to my wife. You see when I wish to randomize my entry signals with no bias I usually yell from the office to my wife “honey pick 2 of the these…VTV EWS EWJ VNQ XLY HHH FXI” , well she picked EWS and VNQ. So this lag is clearly her fault and I wipe my hands clean of all responsibility. But seriously I suspect these exits to begin to trigger over the next few days and weeks.

I hope all the readers have a great holiday and maybe in some small way this blog has helped you to look at the markets in a slightly different way. And ultimately that may help you and I in our quest for positive returns.

Have a Great Holiday!

Dave Johnson

Just a quick follow up on my post last night about the T2108 and Ultimate Oscillator System. The T2108 indicator popped back above the 20 level so we will not have any new entries tomorrow. As I noted last night the entries were to be EWS and VNQ at the open this morning.

EWS was entered at $13.84 with a 3% profit target at $14.25

VNQ was entered at $61.87 with a 3% profit target at $63.73

also if the Ultimate Oscillator were to close above a reading of 50  this would also trigger an exit.

Walking the readers through an example like this zeros in on the critical component of exposure. Before the trade we determined the number of entries the system can hold and how many can enter per day. If the market were to have a big up day tomorrow and trigger the 3% profit target my exposure would have only been 2 out of 8 potential holdings, or 25% exposure. Yet if I had taken all of the entries that triggered I could have 7 holdings as that was the number of buy signals we created yesterday. In portfolio level backtesting this component is so important to define. If you use the same entry criteria at all times your exposure could soar on some waves and on others it will be light. That is reality- real trading. You can’t just keep buying beyond your levels of equity or comfort. Yet if you are too conservative you may end up always having to little exposure. The key is through backtesting finding a happy medium.

Yet if I were not to explain this component and just throw out signals, and they happen to all win….what did that tell you? How much did the system move up? Without knowing how many positions the system can hold there is absolutely no way to say. Next time you see a trade thrown out by another market commentator make sure you know how much of the particular systems equity it represents and how much equity that system makes up of the total portfolio. Otherwise the value of such advice is quite limited.

Have a Great Night!

Dave Johnson

In a previous post of mine, I talked about how the compensation structure of the average hedge fund could lead to unnecessary risk taking. The ironic thing is that the same structure can lead to avoid prudent risks.

For example, today is 12/17/2007, there are ~10 trading days left in the year. My account has performed well and I am well ahead of S&P 500. Now, I had a signal this morning from my long only NQ system. This system has multiple entry signals and while extremely profitable, can often have big drawdowns as it buys at times of high volatility. In the last wave down (one that started late Oct), the first entry was down ~230 NQ points (like I said, very volatile).

Now this system has a 70% winrate and a profit factor of ~2, so obviously quite a big edge of random entry. As I prepared to take the trade today, I thought about what I would do if I was managing other people’s money. Knowing I already had a good year with 10 days left, do I take a large risk trade and risk significantly reducing not only my end of year numbers but also my compensation (assuming I’m paid a percentage of yearly profits)?  Probably not.

However, I’m trading my own money and am in this to make maximize my profits over the long term.  Whether my account has  3% drawdown on the last trading day of December or the first trading day of January is not important to me.  The signal has a definite edge so I’m taking it.  BTW, the second entry triggered for this morning.

- John

John and I have in the past showed you how the T2108 indicator can be used to pinpoint extreme pessimism and with that a potential for a snap back upward in the swing timeframe on daily bars. The T2108 indicator is part of the Worden Telecharts package and plats the percentage of stocks below the 40 day moving average. I have used it in various systems that I have developed to filter the fear/pessimism environments.

One of the systems I recently tested was stumbled upon the last time the T2108 crossed below the level of 20 in mid November. This also coincided with a period that I was testing the Ultimate Oscillator as another tool to trigger oversold conditions in ETF’s and individual stocks. The knowledge of edges in each of these indicators allowed me to combine them into a system for trading stocks and ETF’s.

Seeing a chart with the 2108 indicator on it during bull and bear markets may help you visualize what these periods look like. In both these charts I used the SPY to represent the SP-500 and noted a period in the last bear market as well as the most recent bullish period we have just gone through. The blue buy dots you see are only showing a period when the indicator went to single digits which we discussed back in August. I circled the clusters of days where the indicator was below 20.

Bear Chart (click to enlarge)

Bull Chart (click to enlarge)

The system I created will only begin to trigger buys when T2108 is below 20, which closed at 19.93 today after the selloff into the close. Now that the condition is turned “on” I can now look for the trigger with the individual stock or ETF. With ETF’s I want the Ultimate Oscillator to close below a reading of 30 and on individual stocks a close under 25. Today 7 ETF’s closed below 30 from my list of about 100 very liquid ETF’s. They are:

EWJ
EWS
FXI
HHH
VNQ
VTV
XLY

With this system any of these would be considered a buy. But as with any system we need to determine how much capital to deploy and how to enter the positions based on past drops. My testing has shown using a 8-10 position portfolio where on each day no more that 2-3 entries is triggered is about the best. So lets say we are going to use 8 holdings and we can add 2 new holdings on any one day while older positions are open. So if tomorrow is still below 20 on the T2108 we will look and see if any ETF’s are still below 30 on the Ultimate Oscillator. The exit for the system is like any system and is hard coded. It is either a 3% profit target or a cross above 50 on the Ultimate Oscillator indicator- which ever comes first. The 3% target can trigger intraday. A time out exit also comes into play beyond a 40 day holding period. That is it. Really quite simple,

For my portfolio I will be buying EWS and VNQ. Tomorrow we’ll see what other setups are brought to us. Oh yes the entry is at the open the day following the condition triggering. So my entry will be at tomorrows open. Here are those charts:

This system is truly a standout in terms of winning percentage, drawdown, and profit factor. In the last 8 years a total of 116 buys have triggered and 88% of them were winners. The average winner was 3% and the average loser was about 2.3%. I have tested beyond this period but I don’t want to go too deep into the past for now because we would have to confront some backtesting challenges and I want tokeep it simple for the blog. Needless to say the period beyond 8 years is just as good and provides validity to the most recent data.

Each wave that dips into these areas are unique and it would not be unusual to see a foray into these areas that are not profitable so as always allocate a reasonable percentage of the portfolio to a system like this and follow it to the letter.

Oh yes I mentioned the individual stocks portion of the system. Today from the Nasdaq 100 I have only SBUX triggering. So I will keep an eye on that one as well.

Have a Great Night!

Dave Johnson

Thought this was an interesting chart showing 5 week Average Percentage move for S&P.  Notice past few months have reached levels not seen since 2003…

It was Joseph Pulitzer who once said

“Newspapers should have no friends”

In reading my Investors Business Daily this morning I happened to catch the photo on the front page showing the Republican hopefuls before the Iowa debate Wednesday night. Then on page 13 they ran a IBD/TIPP poll showing the appeal/unappealing rating of the various presidential hopefuls. Pretty neat stuff. Only thing is Ron Paul the guy on their front page is not even in the poll. Neither is Duncan Hunter who is also in the picture. Does IBD have friends?

(Click Photo for Full size)

Now the obvious response to this is the line has to be drawn somewhere. Good point. Yet how is Mike Bloomberg in the poll? Mike Bloomberg?!? Below are snapshots from presidentspolls2008.com showing the most recent ABC News national poll and the CNN New Hampshire Polls.

Do you see Mike Bloomberg anywhere? I mean Paul is even leading Fred Thompson in New Hampshire. Yet he is not in the poll.

Investors Business Daily has never hidden their strong Republican bias in their editorials or stories. Which is perfectly fine because it plays into their support of smaller government, lower taxes, pro business. But now they seem to want to guide their readers away from Republican candidates that would not meet their presidential qualities. Which is fine. As long as they are recognized for that bias.

As Ben Hecht once said:

“Trying to determine what is going on in the world by reading newspapers is like trying to tell the time by watching the second hand of a clock”

Have a Great Day!

Dave Johnson

Trading is very different from “normal life” which is why so few people are good at it. In “normal life”, everyone says, “Don’t sweat the small stuff”, which basically translates to “If you keep showing up at work, taking care of your family and saving a bit of money, you’ll probably end up ok”, which is pretty much true.

Where people go wrong in trading is they try to apply the same top down strategy which usually involves forming an opinion on the overall market and then allowing that bias to influence all their trades. The problem with this is that predicting overall market directions over the next few hours, days, or weeks is completely irrelevant to being profitable in the market.

To be profitable, you must sweat the small stuff. I can consistently make money without CNBC, without news, without streaming quotes, without fancy charts. How do I do it? By sweating the small stuff. Dave and I have spent thousands of hours evaluating and analyzing numerous types of automated systems across all types of market environments using all different types of stocks with various position sizes. Either of us can pretty much look at the rules of an equity system and tell you what the long term statistics will look like, without ever running a backtest.

That knowledge was required to develop a system with a consistent edge. Once we had that (the easy part), the hard part begins. That part is executing the system consistently and properly EVERY SINGLE DAY and trying to keep commissions/slippage to a minimum. Each night, I religiously update all my quotes, run all my scans, enter all my orders, regardless of what the futures or doing, or what Cramer is saying, or what time of the year it is, or what the fed is doing, or what the $ is doing, or if I’m in a drawdown or if I’m feeling bearish. Those are all irrelevant. The important thing is to follow the system. Experimentation should be limited to order execution trying to get better prices (I’ve tried almost every order type IB has).

If you do all of the above, then you can stop worrying about the headline numbers and whether you’re bullish or bearish and just focus on executing your system and being a profitable trader.

- John

What would our founding fathers think of this?

While they’re at it, can they go ahead and reset the prices of some of the stocks I’ve bought in the past year?

- John