Archive for the 'Education' Category
Couple important notes and our first exit.
Crox will be an exit for tomorrow from our “shorts are longs?” portfolio. It’s closing price today is above the high of the previous 2 days. That’s all that’s needed to trigger the exit, and we will exit at the open tomorrow. For my new long entry we’ll use CAH which I picked up from a post over at the Slope of Hope.
Also in the trading room today it was insane. Too many stragglers, strangers, freaks, nuts and freakazoids you could imagine. It will now be password protected. Regardless of the interruptions I had another great day.
Email me at dayvejohnson@gmail.com if you would like the password.
Have a Great Night!
Dave Johnson
Anyway I had some good personal submissions for todays short candidate. I saw a couple that had market caps the were a bit small. The one I have settled on is HSY. Man that chart is worse than a chocolate bar on a hot sunny day. Awesome. It will be added to the long portfolio. Remember the exit……
You guys have got to get me links from other sites. User submitted short ideas are good but having hard links is even better for posterity stake.
I received some emails saying this exercise is a sign of bull market mania. Nothing could be further than the truth. I want to show you a system, with specific exit and entry rules. I have tested this system over many many years. It works in bear markets quite well too. The only variable that I am unsure is how the grabbing of others shorting ideas will impact the system. I suspect the performance will be quite good. Maybe we’ll actually outperform the major indexes. This is going to be fun regardless. The exit is one that is so simple, but it is one John and I have found to be extremely powerful when buying those long red bars downward. The component that I want you to watch is exposure. Watch how the system lessens exposure as the market has the inevitable pop up days. Especially when it has 4-5 holdings. As in backtesting you have to choose how much money to allocate and how many holdings this will encompass. 5 holdings in this live test is quite aggressive. But this is purely an educational fun exercise. Let’s see what this little monster does. Get me those links!
Have a Great Day!
Dave Johnson
A Fun New Idea…(I need your help though)
I have for a long time debated with readers, colleagues, and peers over the use of shorting. I at one time I had an open invitation to anyone to give me the parameters or rules of a shorting system for individual stocks that held in the swing timeframe (1-10 days) - that resulted to anything close to solid results. Anyway I have yet to see one.
This led me to an idea. I would like you the readers to send me links from other blogs and mainstream websites that list potential shorting candidates. I will then take these stocks that are setting up as potential shorts and play them to the long side. I will run a little 5 position portfolio just like I did on the old blog. I am working on getting a stocktickr.com portfolio setup so you can follow along.
I think ultimately the concepts that I may prove are a consistent exit is very powerful and the negative pessimism adds potential fuel to the upside. On all of these trades I will use the exit that I have mentioned here frequently - the close above the high of the previous 2 days. For the purposes of this little fun experiment I will focus on stocks with higher market caps. Lets just say Russell 1000 type material for now. I do not want to make this work for me so please this is just for fun with no disrespect to the originator of the shorting idea. Ultimately the trade may work in their favor.
I will need your help. Please Please help me find candidates that are out there. If I don’t have short ideas coming in from you that you see out there I will never be able to keep up with the number of holdings we need. The worse the chart pattern the better. The one rule I will likely add is that I will want a down day before I enter at the market open the following day.
So get out there and get me some really really bad ideas - I mean it c’mon the worst!. Maybe we can have a trade for tomorrow. Just leave a comment on one of the posts or email me directly at dayvejohnson@gmail.com
Have a Great Night!
Dave Johnson
In this post I am going to try and convey to you a concept that is so critical to system traders but so thoroughly misunderstood by many active traders. The problem that I continually face when I engage in conversation with other traders is that what they call a system is invariably an entry mechanism. Many of these are when some moving average, Fibonacci, overbought or oversold condition has been reached. These are obviously only a few of the many many more conditions that that this “trader” has seen on his charts that look so obviously profitable.
But are they profitable? As a backtester I can test concepts and see what in very general terms seems to “work”. But what of those people that don’t test? Do they know what “works”? Trust me I get emails from and this week met in my chatroom people that are doing things that I know do not work. As a matter of fact virtually all of the commonly held axioms of trading are dead wrong. How do I know? I’ve tested it. John who also writes for this blog has amazing programming skill which have allowed us to test more complex theory’s then I would have ever thought imaginable. So I know when I hear a “system” that does not work. But again they almost invariably mention the entry. Which leaves me shaking my head because having tested hundreds of thousands of concepts across millions of bars of data, entry is of no value when testing a system without exit logic.
When creating a system I need exit rules that will be applied across all of the data - entirely mechanical. I can give you a good example of something that happened in the chatroom of Thursday afternoon. The chatroom is mine and I have made it my goal to destroy the illusions of what works and try to reprogram people to look at the market in ways that do work. In a systematic type fashion. The reason most active traders under-perform the major indexes is because they are invariably doing things that don’t work. Anyway this visitor walked into the chatroom on Friday and said “
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yellow area denotes Al’s magic area
So basically thats the conversation. Can you guys understand how useless what he stated was? It was not really “tested” because there is absolutely no exit logic. So what happened? Well we hit 49.68 late in the day on Friday. Now what? Is the trade closed end of day Friday? Is it stopped out because he said the beauty of the system is that it takes “small losses”? Did it already take a few cent profit? It could possibly be a fantastic system. But what is the system? What I am trying to convey here is I hear this baloney all the time. It is of zero value to me - ZERO. This sort of nonsense is rampant on message boards, chatrooms, and blogs.
I have challenged people in the room this week based on a variety of criteria they believe make a viable system. I can prove they are not. I am going to continue to do that. My lesson here is a system is not entry logic alone. Start to test those exits not based on when you think you would get out of the trade but based on a solid consistent set of rules. While in the trade whole bouquets of emotions can and do affect trading decisions
On my old blog I posted the signals for a swing trade system that I had tested in various market conditions over a variety of years. I posted these before the market opened with simple at the open market orders. In the year that I posted these we made 40%. Not bad. But the beauty of this is that before the test was started I posted what the average winner, average loser, and average holding period would be. At the end of the year those numbers were right on the nose. Amazing? How did I know? Because I had seen in backtesting over 250,000 trades and what they looked like through all trade conditions. Nothing magical but just basic standard deviation in price of the holding period I would be holding based on historical precedence. This is powerful stuff.
After dispelling many of these hokey “systems” I usually get asked “So what does work?” For now I will keep that part simple. The goal of this blog is to start covering the varying concepts that do work in very basic form. But what works is the opposite of conventional wisdom. I know thats so hard to grasp because it hits the core of many active traders belief systems. But it is without question why the vast majority of active traders underperform the major equity indexes.
So please feel free to stop in my chatroom. I have been posting my intraday trades for a particular system that is making major reversal calls. This system generally triggers about 2 signals per day. I trade this on both the SP futures as well as the Dow futures. This system is somewhat different than in the live videos I post but uses similar techniques as those. We had a great week trading and in the end I think many that were there have learned a bit having been there. So feel free to stop in but please leave your market myths at home. (the permanent link is the upper left hand part of the page)
Have a Great Night!
Dave Johnson
Follow up on ETFC Trade and Some Thoughts
Last week I had thrown out to you a swing trade that had triggered in my swing trading system. This system is throughly backtested and has clear entry and exit rules. The trade in ETFC is a good example of some key trading concepts that cannot be stressed enough when system trading as well as discretionary trading.
As you can see noted with the red arrow we are presently below that entry price. The exit for this trade is Thursday’s open. No ifs, ands, or buts. An exit in system trading is an exit. PERIOD. Most traders do not seem to grasp the concept of closing a position before it goes profitable. What you must understand is that I have hundreds of thousands of trade examples in my backtest data and I certainly am not able to assimilate all of this information on a trade by trade basis by eye. In the end 65-70% of all trades close profitably. The data speaks for itself. The exit I have passed along to you for this trade is quite simple. Exit when price closes above the high of the previous 2 bars. Keep an eye on those in any timeframe you may monitor.
Another broad concept I want to convey that maybe you had missed. This trade had occurred during weakness in both the major market indexes as well the stock itself, ETFC in this example. These are even higher probability swing plays when looking for the when and what to swing trade. I know this flies in the face of conventional swing trading wisdom - but again I can prove it outperforms those conventional methods by far based on my extensive backtesing in all of the various market conditions.
So in the end I passed along a trade that had about a 85% chance of winning. But dang if it didn’t (well maybe it will gap up tomorrow). Which leads me to the last lesson. No matter how much data, backtesting, and confidence you have in a trade - it is NOT a sure thing. Based on this knowledge you must spread your trades and risk across various systems and market positions. This is absolutely critical to have enough ammunition for the next fight.
In that same post I had also posted the SP500 chart noting its consolidating pattern , where you had a confluence of a few patterns of a bullish and possibly bearish look. What ultimately happened was what I thought was the most likely occurrence. A run through the previous wave low and taking out stops of the players looking for a high risk/reward trade. Classic. (Compare chart to previous post)
Let’s see if that upper trend line and a general resistance area slow things down this week and next.
And for those who have asked when my live futures trades are coming again all I can say is soon 
Have a Great Night!
Dave Johnson
ETFC has been coming up on my mean reversion scan. The system itself is a swing trading system in that it has a full set of definable entries and exit rules and holds from 1-10 days. The exit for this trade will be a close above the highs of the previous 2 bars. A stop loss will not be used so this trade would need to be part of an overall portfolio - not 100% of the portfolio.
With an obvious double top/head and shoulders and a potential stop harvesting low below us on the SP500 - this should be an interesting week. Oh yes throw in FED stuff this week. Very interesting indeed. Wait if we go up from here is that an inverted head and shoulders
Have a Great Day!
Dave Johnson
An Essential List for any Trader
Globetrader in one of his earlier posts had posted a spreadsheet for testing your risk of ruin based on some basic trading statistics. A fantastic tool from a fantastic blog.
Also Murray Ruggerio’s excellent article on cross market analysis and prediction (pdf)
From Linda Bradford Radke, lot’s of her market wisdom with these articles (a plethora)
Eventually this market will go down. Learn basic stage analysis to get an idea when that may happen. Weinstein has always been a favorite of mine in all trading timeframes.
Maybe stage analysis does not do it for you. Years ago I scanned a page from Yale Hirsh’s “Don’t Sell Stocks on Monday” in which he referenced a market timing system that had an amazing record at the time. With rising yields some of these factors could eventually come into place.
Now that you have the basic tools you need just head over to Dr. Brett’s site to get your head screwed on straight - so you can actually follow your rules.
Have a Great Night!
Dave Johnson
Official Exit on T2106 Trade - Some Stats
I just wanted to give you the official update on the SP-500 swing long trade. McClellan (T2106) closed above the zero reading. This was the exit I was looking for. The exit is Mondays open. 40+ SP points as of todays close.
Let’s look at how backtesting can give you an edge.
- gave me an idea of historical after entry drawdown
- gave me an idea of the average holding period
- gave me an idea of the types of return to expect
Let’s look at the graphic I posted last week with the original trade recommendation:
Let’s see what this trade looks like:
+2.83% Return
6 Bars Held
MAE = -0.22
Kind of an average trade eh? THAT is the power of backtesting in a crystal clear example. A historical edge was demonstrated with a clear and concise picture of past trades. This time it worked out in my favor. I hope it did for you too. Let me know how you played the trade.
Have a Great Night!
Dave Johnson
McClellan (T2106) Exit at hand
As a follow up to my post on the -200 reading on the T2106 indicator and the backtest I ran, it looks like we’ll be adding another winning trade to the list of past winners. The indicator more than likely will have a closing value above zero at the close today which was the exit we used in the backtest. Intraday it is above that value. We nailed that bottom perfectly and are up 44 SP points. Nice.
For some reason this particular buy signal seemed to really rub some people the other way. I received quite a few emails/IM’s that said I was stupid/crazy/perma bull - all I can say is making statistically probable trades is rarely easy. It’s always during some crisis. This time it was surging bond yields. My point is it was not the time to be short based upon our historical backtest. For those that were - my brokerage account thanks you.
I will do a follow up tonight to make sure we get the zero cross for a closing value.
Have a Great Day!
Dave Johnson
Market Myth #3 - Drawdowns are Avoidable
You’ve read Market Myth #1 and #2. You are no longer tweaking settings constantly or trying to figure out “why” the market does what it does. You have taken a zen like approach and watched the market, studied data, run hundreds of hours of backtests until finally you have found a profitable system. Like many profitable systems, it is long only, trades US equities and buys stocks on dips. The so called “dip-buyers” are quite prolific in the wealth-lab code library.
You go live with your system on 5/1/2007 and things are great, each day you buy a few stocks and they immediately bounce back. By the end of the month your starting account of $100,000 is up to over $105,000, a nice return of over 5% in it’s first month! Then on 6/5/2007, the market dips a bit, your system adds some positions, on 6/6/2007 it goes down some more and of course your systems adds more. You are 80% long going into 6/8/2007 and within the first couple hours you buy enough positions to use up all your available cash, however the market continues to decline. When the smoke clears at the end of the day, you’re account balance stands at $99,500. Down $500 from the start of 5/1/2007 and down over 5% from your peak.
You can’t help but be a bit disappointed to give back all those gains in only 3 days, 3 lousy days. If only I’d sat out this dip, if only I’d reduced the position size, if only I’d waited longer to buy, if only, if only. However, the real if only is if only I’d leave everything alone and keep trading the system as is.
Drawdowns are a fact of life, for any trader and especially a system trader. They are to be expected and even welcome as often a drawdown come before a period of outperformance. In this case, the drawdown was not even 6%, a tiny wiggle on that beautiful 5 year equity chart generated from baacktesting, but somehow looms much larger when you watch your gains wither away so quickly before your eyes.  The absolute worst thing you can do is try to avoid drawdowns, since by constantly changing strategies or systems to avoid the most recent drawdown, you virtually insure that your system will not be prepared for the next one and you will fail to outperform in up markets.  I’ve never seen a good system that did not have drawdowns of at least 10%+ and the system made famous by the Turtles often experienced drawdowns in the 30-50%+ range. The difference between a successful and unsuccessful system trader is often the ability to stick with the system through the unavoidable drawdowns…
- John
What does a -200 McClellan cross mean? BUY!
I had noted that the T2106 (McClellan) indicator in my Worden Telecharts package had crossed below the -200 level. This reading indicates an extremely short term oversold condition. I ran a backtest in Wealth-Lab that tested a trade with these parameters:
- Tested on the SP-500 back to September 1986 when my McClellan data began
- I entered the day following a close below the -200 reading - at the market and at the open
- My exit was when the indicator closed above the zero reading - again at the market and at the open the following day
The results are quite good. 13 trades - all winners. The average holding period was about 7 days. I have included a graphic with the test results and a list of the individual trades. The September 11th related period had the largest Max Adverse Excursion while in the trade.
I took a snapshot of a recent period when a couple entries occured.
And here is what todays chart looks like……….
Clearly we are entering a period of volatility but based on historical tendencies being long here is the trade.
Have a Great Night!
Dave Johnson
Market Myth #2 - Tweaking Settings
Tweaking settings. This Market Myth is the carrot that keeps the guru chasing, holy grail seeking, pie in the sky, almost breakeven traders going. All it will take is a bit of tweaking of my indicators and I’ll have the secret to the temple. Unfortuntely what usually follows the carrot is the stick and the lost trader moves on to new settings and new ideas.
Having had the opportunity to intereact with many of the readers of this blog and my former swing trade blog I can attest to the quest for the magic settings. I am here to tell you that tweaking your indicators is not going to make you become the trader you envision. What will work is consistently applying a trading strategy that has a historical and live traded edge.
Basing your trades on buying at the X period moving average versus the Y is not going to be the revelation you think it is. Having backtested virtually hundreds of thousands of variations of the main trading concepts (trend following, mean reversion) I can tell you that the “tweaking” of common trading concepts is not the answer. And it most certainly does not flow from some guru without a historical track record over varying market conditions. ALL systems have their blindspots. The key is to know those blindspots and have other systems that can pick up the slack in that sort of market condition.
So instead of chasing the magic setting I would recommend chasing broad concepts that do work. Find what has worked - not based on what your were told but what you can PROVE with your own research.
Have a Great Day,
Dave Johnson
SMH trade closes profitably this morning
The long setup I had proposed for Tuesdays open in the SMH would be an exit today. I ask you. Would you have been stopped out of this trade? Maybe we can get into Market Myth 2- STOPS - maybe this weekend.
Dave Johnson
Market Myth #1 - Why
This is the first in what will hopefully be a series of posts dispelling common market myths that only reduce your ability to succeed at trading.
The first I want to talk about is the common mistake of trying to assign a “why” to every market move. Let me start first with an example. Everyone remembers the huge down day we had on 2/28 which was preceded by a large down move in the Chinese market. After that day, the financial press as well as many traders quickly determined that the China sell off was the “why” the Dow lost ~500 points. Fast forward to yesterday when China experienced a similar sell off overnight, the US markets gapped down a sizeable amount and any trader who beleived that a China sell-off equaled huge down day in the US markets could not wait to get short. Of course the large amount of traders leaning to the short side most likely contributed to the nice upday the US markets ended up with. Why did this happen? Why did a huge selloff in China in Feb lead the Dow’s biggest loss in years while the same thing yesterday led to record highs?
The answer is (and this is the hardest part) that there is not an answer. The market is not an equation to be solved, you can not simply take the same inputs multiple times and expect the same results. Remember the market is made up of numerous participants, all of which have have different emotions, positions and goals every single day. This is one reason why the economic reports are so hard to trade ahead of, even if you knew what the # was going to be, attempting to predict the response is extremely difficult since everything is based on perception of expectations. Therefore you end up in a “the market is expecting a good #, even though the # is good, is it good enough to overcome the expecations and did the participants who anticipated a good number already take their positions, thus driving up prices prior to entry, etc”. It becomes a very circular logic trail which I’m not capable of decoding.
The same applies for any indicator or market internal. Many people view breadth or volume as predictive. It’s not, it’s just a measurement of where things are at a specific time. Don’t let people tell you that a decent size up or down day did not matter because breadth or volume did not confirm. All the matters is that the market is moving in one direction or the other and your positions are either gaining or losing money. If I’m long equities and my portfolio is down 1% for the day, it’s of little consolation that it was “low volume” or “non-confirming breadth”. Remember, when you sell a position at a profit and deposit the money into your bank, the dollars are not tagged with a “these $$$ were made on a low volume rally” post-it that reduces their value.
Making money is the goal, not trying to predict the future. Once you stop worrying about why things are happening and just focus on what is happening, you will find you have much less of a bias and are in a much better position to react to unusual events. As I often tell people when they ask me “how do you think the market will do the rest of the year?”, I can see the Dow ending the year at 15,000+ as well as the ending at < 10,000. There are scenarios that could easily lead to either of those of numerous others. What’s important is not where I think the market will go or why, but that I am positioned to trade my account profitably in any of those scenarios.
- John
I would be looking to enter the SMH (semiconductor ETF) Monday with an exit being a close above the high of 2 days prior. That is at the close of subsequent days, look back at the high of 2 days prior. If your higher - exit next day at the market. It’s an exit that is used quite frequently in our backtested systems and is also very simple to see visually.
A pop up in the semis would most likely be in conjunction with the market as a whole - so it’s possible the recent weakness in the Semis point to a upward pop in the market.
Does anyone have a clue as to what the entry criteria is for the QQQQ KISS trading system John had posted last week? Look at the number of entries. Look at the returns. Remember it can take 8 potential entries - so each entry is 1/8 th of portfolio size and the exit is as I descibed above (wait did he reveal that yet?). No one has guessed it yet and I am so surprised. At least guess!
Anyway think about it. It’s really so simple as to blow the mind.
Have a Great Rest of your Holiday!
Dave Johnson
A classic intraday trade example
Today I figured I would tell the story of a weakening market with photos instead of video. So while CNBC and their cohorts were lauding the strong market all day they were caught by surprise by the strong late day reversal. I will say I missed this trade because I had to leave the trading desk during this setup at 3:00 PM EST but it played out as I had a notion it would.
During the strong upward phase of the morning move in all the major indexes the higher beta ones such as the Semis (SMH) - Nasdaq (QQQQ/NQ) - Russell 2000 (IWM/ER2) were moving powerfully upward and leading the way higher by outpacing the lower beta SP500 and Dow 30. But as this was happening the Accumulation/Distribution indicator that I apply to the SPY (SP-500 ETF) continued to make lower highs and lows. I have come to rely on that indicator and chart as a pretty good indication of underlying strength and weakness in conjunction with my other forms of potential evidence.
As you can see Accumulation/ Distribution was having nothing to do with the strong advance up to the lunch time period. I was noting this thinking I might be able to look for a large topping pattern to look for a possible short in the afternoon for a longer term hold versus a short term scalp. Just something to keep in mind because remember these trade entries require a weight of evidence on my side.
The next thing that I noted was that the high beta stuff (SMH- NAZ) was starting to lag as the Dow went to new highs at about 2:50 EST.
SMH
(arrow noted the point before waterfall drop)
Naz Futures
(many were noting the inverse head and shoulders as a sign we were going back to high of day)
Dow Futures (YM) Look at that high of day not confirmed by the previous charts.
So by having a heads up and a plan, a trader could have been ready for the 3:00 drop.
As a final clincher look how prior to the drop AMEX Tick busted a trend line on the 2:58-2:59 bars while having the ergodic indicator cross on that chart.
So while chasing the market in most instances is a poor strategy there are times when having a bias based on a weight of evidence can lead to very strong entries that can give a level of confidence in scaling into a position as long as the conditions your noting remain the same.
If you are trying to use discretion such as this analysis in your trading I can pass along some pointers unrelated to your analysis and trade parameters that I find critical in my trading.
1) Sit back in your chair (keep your nose off your screen)
2) Relax your shoulders
3) Be aware of your breathing pattern - slow and even
4) Allow the chart to “give” you the trades
5) Keep playing out scenarios and how you might react - act when one plays out
I will try to get some more videos up this week. I just hate having to take a mediocre trade for the sake of the video. So if I see some interesting setups I’ll try to pass them along.
Also guys, give John some feedback on the previous post. What do you think he is using as an entry criteria? Something simple….. Yet seems to have quite remarkable performance with very little market exposure. And….It worked in the bear market. (Damian got the exit
Have a Great Night!
Dave Johnson
The importance of multiple systems
One of the things I’ve learned since I’ve gotten serious about trading, is that even if you have a great system you’re happy with (Dave and I’s swing system), it still makes sense to trade it in conjunction with other, possibly less profitable systems.
Let me try to explain what I mean. The swing system (and it’s multiple variations we run) has by far the highest $ return per bar as well as the highest return based on the amount risked. However, those numbers can be misleading on a portfolio level as it is simply not possible (or advisable) to keep a constant exposure to take advantage of times the market goes straight up (ie last fall or this April).
Also, the swing system can underperform when the gains are concentrated in the very largest stocks (like the current Dow led rally) since most of the swing holdings are higher beta names. This is one of the reasons I worked on the ETF trend following script and the reason that Dave uses his “Modified IBD” system. Both of these are longer term holds - weeks to months instead of days and will obviously have higher drawdown to return ratios and lower profit per bar #s. However, in times where there aren’t any good opportunities to add swing trades or times when high beta is lagging, having a percentage of your portfolio in a system like that helps you keep up with a strong bull market.
Today is a great example, my portfolio is 30% ETFs and 70% Swing Trades, yet my 30% ETFs made more dollars for me today than my swing trades. Dave had a similar situation with one of his recent IBD type entries that was up over 3% today.
-John
Click To Play
Remember the video from yesterday? Well that same exact pattern occured today. Check it out.
Live Trade Educational Video 05/14/07
Click To Play
Figured I’d do a bit of training involving longer and wider patterns.
Trend following and a swing trade.
John’s last post about USO was great. Look at all those European ETF’s that just rocked from his initial entry. I personally know that John worked quite hard on that trend following system. Developing a system that matches you personality as well as having reasonable performance expectations is so critical when designing any system. John at the time of developing this system was looking for an element of his portfolio that would have higher market exposure when things were moving upward. Our swing trading system will tend to have lower exposure as the market has strong upward pushes such as we had recently. His adjustment of adding the trending component to his overall portfolio really allowed him to fire on all cylinders on this strong market advance. Way to go John.
Our swing trade system will be wanting to add some serious exposure after yesterdays selloff. ADCT being one of those.
I’d look to exit that one once we get a close above the high of 2 days prior. Otherwise a 10 day timed exit will occur.
On another note I am sorry guys I did not get a video recorded yesterday. Unfortunately I did not see a trade in the morning that I thought would be a good trade example for you. In the afternoon I ended up having to pick my sister-in-law up at the train station. I will give it another whirl today.
Have a Great Day!
Dave Johnson
Live Trades and the Collective2 system
I have received loads of positive feedback about the Live E-mini Trade videos. I appreciate that. One of the downsides of getting this whole video series together is that it has slowed my other posts. I know many of you like the backtesting and system testing research that John and I have posted. Now that I have my screen recording system down pat and have settled on a good video host I think I will be able to get back to my normal posting routine. Thanks for bearing with me.
Some of you may have missed the post on the swing trading system so I will post it again. On my old blog I ran a very successful swing trading portfolio that many readers had asked if I would be doing again on this blog. Part of the problem with tracking that system was recording all the exits and entries and making sure they were correct. The solution was Collective2.com - they for a fee will track your system and even allow subscribers to your system. I have been tracking the swing system for about 2 months now and the numbers have been very impressive. You can even get a 30 day trial to the signals if you wanted to see the types of trades it triggers.
I am working on a post where I will analyze some of the public systems for many of the parameters I feel are important to a “good” system. Obviously risk per trade and realism are key components to that. I even started noting some of the systems that trade stocks that have a high realism factor, high Sharpe Ratio, and at least a bit of a track record. In my post will get into how I analyze a system. If you think you have a system that you think would do well I encourage you to post it for all the world to see.
Today’s ISM numbers should provide some more clarity on the economy and the Fed. Briefing.com’s Patrick O’hare has a good preview of this mornings ISM data and how a low reading in the past has tended to coincided with Fed Easing.
Have a Great Day!
Dave Johnson
Live Trade Training 04/24/07
Today I am going to do a bit of training in the video. You have been asking for details - so tonight I will bring you a small sample of some of the things I look for when entering a trade.
Click To Play
Have a Great Night!
Dave Johnson
Limit orders and Wealth-Lab
For any Wealth-Lab users out there who test or work with limit order systems, make sure to read this thread about how much difference actual time based priority versus random priority can have on a limit order system. As many of you know, I do trade a limit entry based swing system. I have never used the product mentioned in the thread (or any intraday data), but instead have a system that generates a relatively small number of limit orders and by working with position sizes make sure in my simulations that I am taking every trade. The result of this is that my actual trading results have matched the Wealth-Lab simulator results almost exactly.
You must be extremely wary of any limit system that generates hundreds of limit orders each day with very small (< 1%) average profit per trade as testing those system on EOD data is not an accurate representation of what trading them will be like. As always, if you have any questions, feel free to email me.
- John
Can I make money doing X?
One of the most common questions I see asked by new traders in blog comments and on message boards is “Can I make money doing X?”, where X is a style of trading. Do any of these sound familiar?
Can I make money scalping the ES?
Can I make money buying breakouts?
Can I make money buying pullbacks?
Can I make money trading earnings releases?
Can I make money trading afterhours?
Can I make money selling options?
Can I make money buying options?
Can I make money using fundamental analysis?
Can I make money using technical analysis?
Can I make money with an automated trading system?
Can I make money trading discretionary?
The answer to all these question (and any others I’ve left off) is yes. New traders often underestimate how large and diverse the financial markets actually are. For each type of trading strategy, there are thousands of people who use it successfully and thousands more who use it unsuccessfully. There is no such thing as the “best” strategy, they are all different, but potentially viable. What is more important is finding a style that fits your personality and your situation. By situation, I mean your time and capital restraints, as well as personality. Obviously if you have a $10,000 account, then a trendfollowing system designed to work across 20 different commodity markets would not work for you. Likewise, if you work a full time job, then scalping the emini’s intraday would not be the best pick.
The important thing is to pick a strategy that fits with your situation and devote yourself to it. The worst thing you can do is constantly jump around from strategy to strategy every time you experience a drawdown. Not only will you be unprofitable, but you will never spend enough time on any single strategy to learn its nuances and how best to trade it. I see this all too often on blogs, a trader starts swing trading stocks, then has a bad month or two and switches to day trading stocks. After another rough patch they decide maybe they should try futures, etc. etc. All the while looking for the “perfect” strategy they often overlook opportunities to learn from and refine whatever their previous strategy was.
- John
Let me tell what they have to do with trading. During the trading day we have a chatroom for a select few traders that has become a good source of camaraderie and interaction during the trading day. One of the fun side notes during the day is our donkey challenge. The what you say?
The donkey challenge stemmed from a comment one day that mentioned my neighbors donkey had gotten loose and was running through my yard. So when we wanted to give away a prize for our market challenge we chose a donkey. Originally we would all guess what the SP-500 futures would close at . Then the closest would win the donkey - a truly high and prestigious honor in our room. It was something that helped us pass a sometimes slow and boring trading day.
Recently we changed the game a bit. It actually mimics exactly what I do with my live SP-500 trades - Each trader gets to choose one setup during the day and give the entry and exit. Much as I do with my live screen recording. No second chances, no take overs. One shot. Each person in the room must make an official call at anytime during the day. Could be a half point scalp. Could be going for a big winner. Either way the trade must be closed by end of day.
This leads to various strategies but one thing has become abundantly clear to me both through my once of day recorded videos as well as the donkey competition. When using such restraint by only selecting one trade per day the results from the room have been phenomenal. As an example from the previous week we had 22 trades and 18 winners. For a net of 14 points from the five traders. Mostly scalp type trades but occasionally we had guys that play for the bigger move. The results from this past week were not an aberration but what we have normally seen for the past few weeks since we started this.
So from a traders perspective I cannot stress how important waiting patiently for that one setup can be. No trades because your bored. No marginal setups. No over trading. No trades because your nose is pushed up against the screen. One setup. That’s it. As you have seen from my live trade videos I am only grabbing about 2.5 SP-500 E-Mini points per week per contract based on one setup per day. I say only because thats what I continually hear from readers and other traders. Can you do 2.5 SP points by the end of this week? For most beginning traders the ability to do that on a consistent basis is virtually nil. I am here to tell you doing just that can be quite rewarding but most “traders” do not have the discipline needed to achieve this.
Let’s see just how inconsequential this is:
2.5 points X $50 per point = $125.00 / contract
Now it’s just a matter of determining what your trading minimums are.
Let’s say you have a $100,000 allocated to you e-mini trading And you want to use just this one simple strategy.
We do not want to risk more that 1% per trade. So that is $1000.00
Using some of my historical averages my average stop is about 1.5 points or $75.00 on this setup.
1000 / 75 = 13.33 contracts
So we can trade 13 contracts. Now lets do the math with our new trading size.
2.5 points per week X $50 per point = $ 125.00 X 13 contracts =Â $1625.00 - commissions (around $300.00)
My being able to make that 2.5 points per week is a mammoth success. Even netting one point is winning and that can be parlayed into quite a successful little business. So if your just starting out or have struggled with trading in the past my advice is to focus on what has worked. Distill that down and take the best setup each day. If over a period of time you have found that you are doing this profitably then maybe you could add a second setup. As you exclusively focus on this one potential setup you will see many potential trades pass without being in them. This will help you evaluate without the emotions of being in the trade and accrue the much needed screentime all traders need.
So when your at your screen think of that donkey - how your going to win todays donkey - how your going to take that one shot - your best shot.
Have a Great Night!
Dave Johnson
Shorting 8 Straight up Days?
In my post from yesterday on buying a condition where 8 consecutive down days have occurred, you’ll notice some thoughtful comments from Damian. Damian thought that testing the opposite condition - 8 straight up days and shorting would be a good idea. Exit criteria are exactly the same only reversed - making a close that is less than previous 2 days lows. Review that previous post for the other conditions of that test. I tested with exactly the same conditions and on the same SP-500 with 10 portfolio slots. Here are the results of that system.
As you can see our performance was pretty poor. As a matter of fact our long only system way outperformed the short only system in the bear market. Now I know where this conversation is going to go next, adding filters such as being under the 200 day moving average. I have been through this before on the old blog. I won’t try to interpret the why this is the way it is. I will just let it stand on it’s own.
Have a Great Day!
Dave Johnson
8 Down Days in a Row - Buy?
On one of the swing trading/mean reversion systems that I trade it had LLTC came up as a potential buy candidate. When I looked at the chart I noted that it had been down 8 consecutive days.
Gosh I love when that happens. In order to show you what a simple system based on this concept might do I created a script that I could backtest in Wealth-Lab.
The system parameters are as follows:
- Buy the open the day after 8 consecutive down days
- Exit when the price close is above the bar 2 bars ago
- No stop loss
That’s it. Now I know most people would consider this system lunacy based upon the lack of stop and buying such obviously weak positions. I ran this system on the present components of the SP-500 to see what sort of results we see. The system has some very promising aspects.
The parameters of the portfolio simulation where as follows:
- 10 position portfolio
- tested on the last 7 years of data
- $200,000 starting portfolio
- if there are more signals than available slots in the portfolio the system randomly selects enough positions needed to fill the portfolio
- .02 cents commission per share on buys and sells
The obvious backtest caveats should apply.
The system had 70% winners with the average winners being 3.45% and loser 4.17%
The system returned 17.96% annually with only 29% exposure.
The equity curve looks like this:
Drawdowns like this:
Annualized performance since 2003 has diminished as the level of volatility has subsided. Possibly this is a system that would do best in a rising ATR environment, such as we have experienced recently.
The list of stocks that would qualify today are…..
AMGN
FLR
HBAN
LLTC
PAYX
SOV
STI
Have a Great Day!
Dave Johnson
Dip buying. Those dirty little words.
Buying dips. It’s almost a dirty word in investing circles. As many of you know on my previous blog I wrote extensively on that subject and tracked a real-time portfolio of swing trades (1-10 day holding period) that were always entered at the open of the next trading day. The system itself was part of dip buying strategy that had tested very well on baskets of stocks during virtually any market condition I tested it against. This portfolio had done extremely well in the year that I tracked it in real-time for you on on that blog. The archives of that blog are full of trades for your review.
The base elements of that system were the ability to recognize stocks that were volatile, had some previous strength, plenty of liquidity, previous volume bulge, and most recently strong directional weakness. But the absolute key elements of trading a system like this is to trade with a portfolio that can expand and contract it’s number of holdings based on the waves of strength and weakness in the market.
In other words your exposure level. If buying dips is the secret to success in swing trading the market then exposure is the holy grail. If the market as a whole is at a 6 day RSI of 80 and I have a 10 position portfolio, and I have 4 open slots available in that portfolio, should I add the 4 buy signals I have in todays scan? Essentially going to 100% exposure. If you were to test market performance a few days after a 80 RSI reading I can assure it is less than those of readings below that in a very broad general sense. So why pile in? If you are trading stocks that are of a recent volatile nature it will not be necessary to be fully invested to keep up with the market because your portfolio essentially is more volatile than the market as a whole. If the market were to selloff the next few days then you have some ammunition left to add positions as the market drops and look for the eventual strength to unwind positions. Having backtested literally thousands of variations of swing trading systems I can say unequivocally the secret is exposure. Always, always, always be aware of where the market is in its present wave and where your exposure level is in your swing portfolio in relation to that.
The other essential element of being able to survive the inevitable dip that becomes a full fledged big loss is to have enough portfolio slots that one bad trade does not ruin long term performance. On the blog I used a 5 position portfolio and in reality this was being quite aggressive. Something closer to 7-10 would be the minimum I would recommend. This will allow you the ability to expand and contract exposure effectively with the markets waves. If you browse the Wealth-Lab site you will see people mentioning dip buy disasters. There should be no disasters if each holding is only 1/10th of your portfolio. If a stock zooms down 30% in your holding period then this is “only” a 3% hit to the swing portfolio. Not too bad and you live to fight another day.
This now leads to the next inevitable question “why would you let a stock drop 30% ?” My answer to that is “where would you put your stop?” I am here to tell you from my extensive backtesting experience there is no stop level that does not adversely affect swing trading performance. None. I know that flies in the face of conventional wisdom. But I am entirely confident in that statement. John had written a bit about that last year. Ultimately the way to keep disasters from being disasters is to be properly diversified in your swing holdings. And wait for the eventual timeout or strength exit.
So although buying dip can be that dirty word I spoke of the key is to apply some of the principles I mentioned here to help you consistently outperform during most of the markets up and down waves. Not all of them but enough so that you have and edge. And an edge is all I am looking for.
Have a Great Weekend!
Dave Johnson
Emini’s, Risk and Leverage
As a followup to Dave’s explanation of how the emini contract works, I wanted to elaborate on the leverage and risk of the emini. One of the things that can be very confusing and intimidating to a new future trader is trying to figure out exactly how much leverage and risk they’re incurring by purchasing a future contract. In the case of the S&P 500 emini (ES), as Dave mentioned, the contract value is $50 per point, looking at my screen, the current Emini is trading at 1428, giving each contract has a value of $71,400.
Therefore, when you purchase one emini contract, what you’ve done is the equivalent of buying $71,400 worth of SPY or the proper amount of shares of each of the S&P 500 companies based on their index weighting to equal $71,400. Now how people get into trouble is when they fail to understand the magnitude of the difference between the actual contract value and the margin requirement at their broker. For example, I use Interactive Brokers and they only require $1750 per contract to hold it intraday. This means that on a single contract you are getting over 40x leverage, $71,400 / $1,750 = 40.1. Obviously this number bounces around as the price and value of the contract changes, but it’s safe to say the number is usually in the 35-45 range compared to the 4x allowed for intraday equity trades.
Now that we’re aware of the amount of leverage inherent in the contract we can determine how much leverage we want to use when actually trading. Suppose you are just getting started and ready to make your first emini trade and do not wish to use any leverage as you are still learning. All you need to do is allocate the full value of the contract (~$71,000) to your “emini trading” and trade only one contract. Don’t use any of that $71,000 for anything but your single emini contract and you will not be using any leverage. Your emini account will fluctuate by the exact same amount as if you were just buying the SPY (without margin) and you can get a good feel for how the eminis trade.
What I don’t recommend doing, especially for a new trader, is to use the margin requirement to determine your number of contracts. Assuming the same $71,000 allocated to emini trading, just using the margin requirement would allow you to buy 40 contracts, thus you’d be controlling the equivalent of ~$2.8 Million of SPY or S&P 500 stocks.
Here’s an example of what that type of leverage can do. Assume the $71,000 account is long 40 contracts and takes a 4 point loss (equivalent to ~0.3% and well under the daily ATR). That 4 point loss times $50 per point times 40 contracts is (4 * 50 * 40) $8,000. The account just lost over 10% of it’s value on a swing that probably took less then 15 minutes (less than 1 minute if there was big news). Assuming the same scenario with only trading a single contract, the account would have been down only $200 or ~0.3%, same as S&P 500.
In conclusion, the most important thing to remember is how much inherent leverage there is in each contract and that you must adjust your number of contracts traded based on the total value of the contracts, not the margin requirement supplied by your broker.
Feel free to comment or email (link in top left corner) with any questions.
- John
What are these E-mini things?
I wanted to take the opportunity to explain a little about what vehicle I am trading in my live videos. What is being traded is the SP-500 futures contract. It is the miniature version of the larger floor traded contract and is 1/5 th size. This E-mini contract is entirely electronic and it trades on the Globex system. Each point is equal to $50 in profit per contract. The price moves in 0.25 increments meanng each tick (minimum price movement) is equal to $12.50. You can find more information at the CME website.
I trade these contracts through Interactivebrokers for less than $5.00 per round turn. This contract is extremely liquid and is used by many large financial institutions for hedging, speculation, and a liquid trading vehicle. To give you an idea how deep this market is - in some 1 minute periods I will see 10,000 contracts change hands. Do the math. Thats 10,000 x $50.00 per contract x 1433.00 (index value)= over $716,000,000 of SP500 stock changing hands on a minute to minute basis.
I personally have traded the SP’s for over 10 years. I used to trade the floor traded contract and now I trade the e-mini version exclusively. I wanted to also explain that the simple method I am using in the videos requires some screen time. You cannot just trade every setup. It takes time to acquire that feel for when the best, low risk setups are happening. I personally have about 2 dozen setups I look for on an intraday basis but on any given day I may only take about 1 -6 trades. I suppose 3 is about average. I will go through periods of higher activity and then fall back to more quiet periods. When my other systems in the higher timeframes have high exposure my intraday trading tends to be smaller and less frequent., versus a period like now where equity trend stuff has exited and I am sitting on a high cash level.
Have a Great Trading day. Looks like the whole Iranian situation and Bernanke speaking will have the markets at their emotional best.
Have a Great Day!
Dave Johnson
Diversification is a catch-phrase that is often heard in relation to stock investments. The typical mantra is to diversify along market capitalization (small cap to large cap) as well as along the investment risk strata (value through growth). The typical Morningstar rating box when evaluating mutual funds will look something like this.
But look at this chart of Growth vs. Value.
Or this one of Small, Medium, and Large Cap
That is NOT diversification.
But are there other forms of diversification that might be able to not only reduce risk but also smooth the equity curve? I believe there are such possibilities. What about diversification of trading timeframe? For example intraday trading up through long term buy and hold. This group would contain:
daytrading (intraday holding period)
swing trading (1-10 day holding period)
position trading (can hold from months to years)
long term holdings (typically holds for years)
Now lets assume you could apply an edge in each of these timeframes. Would not this create a truly diversified portfolio? With the ability to ride out dry periods and weaknesses that might be exposed in individual categories in the short term but have persistence and over the longer term. Now let’s take this diversification theory a step further. Let’s diversify among asset classes that have limited correlation. This group would contain:
Equities (stocks and their derivatives such as mutual funds, ETF’s, individual stocks)
Fixed Income (debt securities from corporate to government, ETF’s)
Commodities (metals, softs, grains, cattle, energy, currencies, and ETF’s that track these)
As we open ourselves to these other asset classes and timeframes we can see how limited the conventional diversification theory is. ETF’s will be an excellent tool in this process of diversification. With the sheer amount and varying styles that will be hitting the market, the ability to track hedge fund type strategies will be in the hands of average investors.
Hedge funds employ these strategies but rarely is this much diversification applied by one manager. In reality each fund has their favorite strategies and applies them across the fund with an eye on performance versus diversification. The fund of fund concept will incorporate some of these disparate ideas into one portfolio and try to achieve true divesification of risk, by employing the techniques I have just laid out.
In my own portfolio I try to apply these concepts of true diversification by applying a series of systems that have a statistical edge and merging them into one solid system. You see although some may see each technique and strategy as disparate systems, I tend to see the “system†as the application of the ideas of diversification into one living breathing and adaptable portfolio. With the plethora of trading products available to the retail trader and commissions cost as low as they are there is no major obstruction to applying these techniques in the individual traders account.
Tomorrow I would like to address how to apply position sizing across various strategies down to individual trades and how I construct my portfolio presently and where I see changes in the future.
 Dave Johnson