The Trading Digest

On this blog and my old I have tried to show you that in the short term swing timeframe buying dips can over the long term exhibit an edge over buy and hold of the major indices. I now want to show you the other side of that coin. My dip buying system for individual equities stays trading even during bear markets. This is because in backtesting just when you think you have a mechanical time to turn it off, it ends up severely impeding long term performance. Systems are mechanical and as it stands is the best incarnation. Yet it weak markets it will have a drawdown much like any mutual fund because it is just a fully invested portfolio that mimics the markets with a small edge. But as I tried to explain in my last post you must learn to properly position size risk with each system.

The opposite of dip buying is trend following. In my testing trend following on daily bars does seem to have a slight edge and that edge tends to play out in weaker markets when it hides in cash. I wanted to show the readers the types of ETF’s this system has triggered a buy in and when those buys were triggered. With all the new ETF’s I obviously would not take all signals but build a logical trend portfolio. This graphic shows the holding that are presently triggered by John’s system called Fuzzy MA. Wonderful system. It has you typical stats of any trend type system. Large winners and smaller losers with winners being about 45% of trades. Anyway look at the progression of the graphic:

Look at the bars held column. Notice the progression? Bonds in July. Metals in September. Euro kicks in the same time as dollar falls. Then all the Ultra Short ETF’s. Way way back I had given away how I structure my portfolio on my old blog. I still follows the same plan and I even incorporate concepts inside concepts to diversify systems even further than that simple formula.

So basically the swing system stays turned on at all times and the trend equity related turned off back in October and November protecting precious capital all the while Bonds, Metals, and anti Dollar plays turned on. My IBD breakout stuff again kept precious capital in cash following basic rules I have developed based mainly upon the works of Weinstein and O’neil. The best part is that as the market begins to fall the VIX begins to rise and ultimately the daily bars start to get longer. As an intraday E-mini trader it is a dream come true to have added volatility and range, allowing me to capture some decent intraday ranges as much of the overall portfolio is in cash.

It all goes back to my original post about multiple systems over multiple timeframes each with their own statistical edge proved by intensive backtesting. It is important to develop systems that counter each other in a positive way. Having systems that all do the same thing and that have equity curves that move in unison is really only one system. My advice? Spread risk across multiple uncorrelated systems. It’s really not hard to develop systems that do this. Best of luck and I am here to help.
Have a Great Night!

Dave Johnson

Is there a more thankless job that the one Ben Bernanke has right now? First the Fed begins cut rates slowly, in an orderly fashion. Critics complain that the US is slipping into the recession and the fed has already blown it by moving to slow. Then after Monday’s plunge, the Fed immediately cuts 75 basis points. Then the news about the rogue trader surfaces and suddenly the Fed is accused of acting too quickly and being a chicken little.

Which is it? Are they too slow or too fast?

- John

Now that the T2108 UO system has gone all to cash after the exit of IEO I can review the trades for you. Here is a graphic showing entries and exits. I also included a graphic showing the T2108 plunges below 20 where we were looking to go long with ETF’s that crossed below 30 on the Ultimate Oscillator.

Remember from the very first day we defined the parameters of the setup. This included:

• entry condition (T2108 under 20 and UO crossed below 3o)
• exit condition (3% Profit Target or UO crossing 50)
• number of holding the system will take (8 in this example)

So in an 8 position portfolio a 3% gain contributes 0.38% to the whole system performance (3.0 /8). The next component that would be up to the individual trader would be how much of your overall equity would this particular system represent? That would be entirely based on how aggressive you may be. I would not be incredibly aggressive but 25% sounds about right to me. Based upon this information the system returned 0.55% and if the system were only 25% of the total portfolio then you would divide that by 4.

This may seem small but remember the market fell over 10% since that first trade was triggered. We had 6 trades and 5 were winners. The larger loser EWS was larger than what backtesting showed but that was more raw luck of selection versus what we saw if we looked at every symbol that triggered. Overall this is a great way for you to see how you can begin to piece systems together. The trading blogospere is littered with recent blow ups that occured because people want to bet rather than trade. Here is the secret…..Position size is critical. Using leverage can cause large losses. And large gains. That is the allure. But the betters that risk their precious capital on a single concept rarely win in the long run. Preservation of capital is critical.

People want 200% gains with minimal drawdown. Yet to attain those gains consistently you would be constantly putting the overall portfolio in the risk of ruin position over and over. I am sure you have seen people that advertise tremendous returns with options strategies. But if that strategy returned 250% annually (unlikely) could you use your whole portfolio to trade that system? or would maybe 5% seem more reasonable based upon the obvious risk of losing 50-100% of total capital? Setting realistic goals is critical to not only your success as an investor but in reality your long term staying power as a trader. People scoff at 20% annual returns but at that rate your money will double every 3.5 years approximately. Meaning that a $50,000 account would grow like this:

In 3.5 years 100k

In 7 years 200k

in 10.5 years 400k

in 14 years 800k

in 17.5 years 1.6 mil

Preservation of capital and the application of small edges over the long term are what drive account values upward in the long term. Betting your account on the hopes that the market will bounce when you feel it should is an absolute recipe for disaster. If you click on the archive from mid December until now you can follow all the posts related to this system.

Have Great Weekend!

Dave Johnson

The T2108 ETF system goes all cash tomorrow. The last exits of open positions are IEO which we entered at yesterdays open and exited today’s open as it hit the 3% profit target. EWS which was entered 12/18/07 has crossed above the 50 level on the Ultimate Oscillator and that signals an exit for tomorrows open. Once we know that closing price we can put together some stats and compare that to my backtest data this weekend.

I saw a comment on one of the recent posts that mentioned that their data showed the UO not below 30. Guys if your data source is off by a smidge on any open or close in the past couple weeks the corresponding indicator will be off. Do you really think it mattered if I bought DIA SPY EWY EWG IEO EWS …..BLAH BLAH BLAH. ……They are correlated. Look at the charts. You needed to increase equity exposure. I really didn’t care which one. You just had to have some exposure. Stop looking at the pine needles on the forest floor and THINK what just happened these past couple days (ie the forest). Do you really think it mattered if the UO was 28 or 32?

Dave Johnson

This recent foray below 20 was met with an extremely emotionally charged market action. We are above 20 again so the system waits for the next plunge below. Yesterday EWG (Germany) nailed the 3% profit target right away in the morning. The other holding IEO (US Oil and Gas) came withing 3 cents of our profit target but the Ultimate Oscillator crossed above 50 so it is an exit at today’s open. The other holding we are carrying from the last punch below 20 is EWS (Singapore) pushed right to the cusp of a 50 cross as well. My data shows no cross so we’ll see where it is after the close today.

I think (hope) that the past 2 days succinctly pointed to the need to develop some sort of strategy that will try to do something in these fear/panic market environment to the long side. Again and this is the key, remember position size. That is the piece of the puzzle that you must put together. Based on my risk how much of my portfolio would a system like this be allocated 20% 50% 10% ?? That is only a question you can answer. One thing we should note though is the this “system” never had more than 3 holdings in a 8 position portfolio. We played and set it up conservatively. I did that intentionally in order to try to highlight the fact as the trader/developer I test and design these things in ways I feel comfortable based on historical backtests taking into account that things in the past can always overwhelmed by a worse current situation. I wanted to show readers that although these trades seem aggressive it is really a matter of how much equity you allocate to the idea. I tried to show you it could be done in a very conservative way.

After the last position closes I will review all the trades and we’ll assess how we did and use this realtime trade information so that we can maybe apply some of that knowledge in the next poke through 20.

On a side note the 2 stocks I mentioned also hit the respective 5% profit targets that individual equities use.

Have a Great Day!

Dave Johnson

You can’t make this stuff up guys. EWG hits the 3% profit target right out of the box.

I will update tonight.

Have a Great Day!

Dave Johnson

Because we remain under 20 onn t2108 I scanned for ETF’s that crossed below the 30 level with the Ultimate Oscillator. Only one met my liquidity requirement but I will let the other one slide in because our exposure is so low for the system with only one holding.

I am going to select EWG and IEO be the new entries for tomorrow open.

This morning was absolute panic/fear and not many blogs or financial sites recommended a trade like I did today. I knew through testing that risk was actually less in those emotionally tense moments before the open. Contrary to what the trading community believes. Either way there are no guarantees in trading only probabilities and it’s understanding these probabilities that allows me to “frame” a trade into a set of rules that define entry and exit - unemotionally. Within a 15 minutes our first target was hit one the XLE and in another hour the DIA target was hit.

Think about that…an index moving 3% in such a short period of time- an index. In system design and backtesting I see this quality in a metric called “profit per bar”. Meaning as I evaluate all of the trades over the data set, they are the systems that tend to produce outsized gains in short time periods. Those types of trades tend to happen near emotionally charged and fast moving downward markets. It happens over and over and over. In every decade, yet I will implore readers or colleagues and friends to take the trade and they almost invariably prefer to “wait and see”. And of course they miss the trade. They fear open ended risk yet they allow their index funds in their retirement funds to be in stocks. If you can not clearly define risk then the trade must remain small - a very simple rule. But whatever you do don’t pass up the trade. The longer you follow this trading game the better you will be able to sense that panic opportunity yourself.

This morning the lemmings froze at the wrong time.

Have a Great Night!

Dave Johnson

Not bad having both our entries from this morning hit our 3% targets in short order. Excellent. I hope some of you profited from those trades.

Have a Great Day!

Dave Johnson

You MUST size your positions accordingly so that you do not need to use stops or worry about margin calls.  I’m sure most of you have heard/seen about High Probability Trader, and what can happen if you’re trading too large of size with this type of size.  As one of the commenters on his site relates:

“i feel your pain.

IB auto-closed my position of 8 NQs 1/2 point above limit down.

my realized losses came up to nearly 30k.

after the fed cut and bounce, i could not get back in to reduce losses as my excess liquidity was only enough to open 1 position.

so we learn …”

When Dave and I enter trades, we distinguish between the type of trade it is, the size and what the exit strategy is.  Do we sometimes use large amounts of margin?  Yes, but primarily in the intraday timeframe with tight stops.  For example, for ever 100K in my account, I might buy 5 ES contracts (approx 3:1 leverage) for an intraday trade with a stop  4 points away, for a fixed risk of $1000.   Those trades are mostly short term momentum based so they either work or don’t and you’re out with an hour or so.  In no circumstance would I add to that position if it went against me or move my stop.

But I would NEVER use that type of methodology in any of my dip buyers (ie our collective system) or my NQ system.  In fact, I’ve been long the NQ off and on since the first of the year including this past weekend.  I was actually at a casino with my wife over the weekend and heard that everything was going down big Sunday night.  Since I wasn’t over leveraged and all my systems are tested in volatile market conditions, I really wasn’t that worried about a 4-5% drop in the market at the open Tuesday morning.  I was actually more worried about if I should split 8’s against a dealer’s 9 at the $15 blackjack table we were at.  I wasn’t worried about my account going to 0.  I wasn’t worried about a margin call.  I wasn’t worried about IB auto liquidating my positions as I’m never anywhere close to using all possible margin overnight.

The vacation continued as usual and upon returning back home late Monday night, I fired up TWS for the first time since Friday and saw my NQ positions alone had my portfolio down about ~3%.  Pretty much par for the course.  I fully expect to see drawdowns in excess of 20% from time to time based on market conditions.  These are obviously the type of conditions that cause them.  The one thing I knew NOT to do was to either sell or try to go short near the open.  When you’ve looked at as many charts and run as many backtests as I have, you know that the biggest up days always follow the biggest drops.  With the S&P being down well over 10% in less than 3 weeks, the odds of a big bounce are high.

This is always the paradox of dip buying and why so many people blow up doing it.  The further down market goes, the higher the probability of a big bounce which is what makes it so tempting for people to keep adding at lower and lower levels until the eventually blow up.  Instead, what I do, is predetermine my max exposure and at what levels and stick to that.  I was already at max exposure last week, so regardless of how bounceable the open looked, I was not going to violate my money management rules and take a risk of getting into real trouble.  I’ll just let my current positions play out and take the exits as they come.

Remember, trading is supposed to be fun, or at least financially rewarding.  If I was ever in a position where I have to worry about what the futures are doing on a Sunday night versus playing blackjack with my wife while drinking some beers and watching a great NFC championship game, I’d close my account the next day and dump all my money into an index fund.

- John

Man that was a quick in and out on XLE. Maybe DIA will get the 3% as well?

Have a Great Day!

Dave Johnson

Things are never as good, or as bad as they seem.

Please be careful out there.

Also, make sure to check out this great post from Traderfeed about these type of markets.

- John

Well as many of you have probably guessed I was waiting patiently for the market to reach the under 20 level on the T2108. For those who have not followed along in the past this indicator represents the percentage of stocks above their 40 day moving average. A reading below 20 has tended to mark the areas of extreme deviations than can lead to small or even large snap back rally’s.

The last time we crossed this level I described a simple system that would allow you to trade to the long side with a portion of your portfolio that may be in cash now. I set it up as a system that would only buy ETF’s that have crossed below the 30 level on the Ultimate Oscillator when T2108 is below 20.

The system can hold a maximum of 8 holding and can only add 2 holdings per day. Our last foray below T2108 we added VNQ which hit it’s 3% profit target and EWS which has not hit an exit yet. It is down about 11% from entry so the system is overall down about 1% since I highlighted the system, certainly way outperforming the market in this wretched time for long equities. Having met all the conditions on Friday I am going to add DIA and XLE on Mondays open. This will bring the portfolio to 3 out of a possible 8 holdings. Remember a system does not have to represent your whole portfolio. You could have a series of systems each with their own percentage of equity of the entire portfolio.

If we remain below 20 on the T2108 after Mondays close we will look to add more ETF exposure if we remain below that 20 level. I had also mentioned in the original post that you could use individual stocks with this method. A couple more liquid stocks that were below a reading of 25 on the Ultimate Oscillator now and may participate in any snapback are:

ADBE

GNTX

The exit is a cross of 50 on the UO or a 3% profit target on ETF’s and 5% on stocks. Whichever comes first. But for the sake of record keeping I will stick to tracking the ETF portfolio for you. Let’s hope futures gap down Monday and not up huge.

Have a Great Week!

Dave Johnson

Here

Funny Kid Isnt Sorry About Huge Party - Watch more free videos

It has been about 12 trading days since I first highlighted a system to trade extremely oversold conditions in the overall market using the T2108 indicator. Based on the last foray below the reading of 20 on that indicator we picked up 2 positions, VNQ and EWS. Remember we only add 2 positions per day and we only spent 1 day below that 20 level. VNQ had quickly hit it’s profit target of 3% and EWS stands -4.7% below it’s entry level. So our 8 position portfolio using this system has a return of -0.2% over the past 12 trading days. Not too bad considering the nature of the market since then. Basically it has sat in 75% cash waiting for another poke below the 20 level or have a current holding hit a profit target. Or cross above the 50 level on the Ultimate Oscillator as the other exit rule.

The current market weakness has now pushed T2108 to a reading of around 30.

So maybe with some bad market days we can get that sub 20 reading. If so maybe the system will have an opportunity to add some exposure.

Speaking of exposure, as I have mentioned in the past where do you think the trend component, on daily bars, of equity correlated stocks would be invested now? That is right. Cash. So in very negative type market environments it is a good idea to have opposing systems each with their own segment of the overall portfolio. In the ETF oversold type system it could potentially add a few positions. But would that system be 100% of the overall portfolio. No it represents a portion of a collection of systems. A collection of systems with positive expectancies can lead to less volatile returns as well avoiding large drawdowns. What do you think a trend system of non-equity type ETF’s based upon daily bars would be invested in now. That is right all that commodity based stuff that has been on a huge run. Look at the charts below. Blue dots are entries. Red are exits. John has discussed this trend following system in the past he named Fuzzy.

I want diversification of timeframe, investment class, and trading systems (good post explaining system diversification). With the whole portfolio being a proper balance of systems that best enhance and complement each other. This is in my opinion the most difficult part to piece together as it really takes some walk forward in real life to see how the systems react together. Having seen many of these market waves up and down in the 20 years I have followed the markets on a very close basis it has helped me to piece systems together that make logical fits. Over time these have evolved and will continue to evolve as I find new ideas and concepts that I believe may have a role in the overall living breathing portfolio.Have a Great Week!

Dave Johnson

Before Christmas, I mentioned one of my NQ systems had recently triggered both of it’s entries. Now that the trades are concluded, I wanted to post a chart showing the entries and exits.

As you can see below, both of these trades were profitable, the first NQ contract was +35 and the second one was +19 for an average of 27 points per contract.  Made for a nice Christmas gift from Mr. Market. Later this week, I’ll get into how I do position sizing with this type of system.