The Trading Digest

In this article by Ambrose Evans-Pritchard it is noted that

“The share of foreign buyers (”indirect bidders”) plummeted to 5.8pc, from an average 25pc over the last eight weeks.”

Having not followed the longer term statistics related to foreign purchases in the debt market it is hard for me to quantify the actual change this implies, but clearly there was a big move by foreign buyers away from our debt in the short term. I will be curious to see whether this snowballs or tends to plateau, if and when the credit issues level out because this is the linchpin that has allowed our crazy national spending spree.

Have a Great Day!

Dave Johnson

Nicely done if I do say so myself (pat pat). System goes back to cash and waits for the next pop back below 20 on the T2108.

I also include a chart of interest for breakout players.

Those ETF’s I threw out yesterday that were part of the whole T2108 trade I designed, really popped up yesterday.

IAI was up from the open 2.3%. (profit target at 40.92)
PGJ hit the 3% profit target during the afternoon surge.

The t2108 indicator jumped all the way into the 30’s so we won’t be buying anything this morning based upon this system.

Have a Great Day!

Dave Johnson

Those are some big ass bars to work with huh?

Dave

I wanted to present another system that presents an opportunity to buy fear in a weak market. This particular system has quite a good track record and thought I would mention it because it could trigger on tomorrows close. The system is quite simple. It first requires 4 consecutive red candles. Meaning four consecutive days where the close is lower that the open.

I ran some tests on the SP500 tracking ETF to give you an idea how powerful this setup is. Your job as a trader, based upon the data I present would be to “frame” the trade. Maybe you like the historical data - maybe not. But if you decide to take the trade you must use proper risk management. What percentage of your portfolio do you allocate? That would have to based on many factors I can not see for anyone but myself. Each trader needs to do his/her own analysis.
Ok, so here is what you looking for if you decide to watch/trade this. We have had 3 consecutive red candle days - and tomorrow would need to close below the open. Oh yes and the close needs to be a down day as well. Keep in mind we will most likely gap down based off the CSCO news and we would need to close below that open. If we do you’ll need to buy the closing price of the SPY.

The exit is quite simple:

• a 3% profit target
• holding for 7 days

Whichever triggers first. That is it. Simple.

Now I shall present the data of this setup since the beginning of the SPY in 1988. It is actually quite good. Many systems of this nature tend to have good win percentages but it is at the expense of having losers a bit larger that winners. That is not the case with this system over the past 25 years. I have included a link to a spreadsheet showing all the trades below. And a graphic showing some visual stats.

spreadsheet-of-all-trades.xls

Basically we have seen 71% winners - with winners averaging about 2.27% and losers about 1.24%. Quite impressive. Maybe a red candle is not always such a bad thing.

Have a Great Night!

Dave Johnson

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

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

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

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

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

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

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

So we have ridden down fairly far and I have noticed some of the sentiment gauges starting to lean a bit bullish which always tends to make me leery of that case. But after such a strong down thrust statistically being up versus down in the short term is the high probability play. I am curious in the the very very short term where the readers think we will finish on Friday versus yesterdays close (Tuesday). We closed at 1428.23 on the SP-500 cash index. So after the next 3 days - where do we land? Positive or Negative. And take a stab at the value if you wish too. Just leave your guesses in the comments. Feel free to leave your analysis as well. I think it may be helpful for other readers to hear comments from posters. Here are a couple charts for some perspective.

Daily Chart

Weekly Chart

Have a Great Day!

Dave Johnson

Earlier today before the release of the Fed Minutes at 2:00 EST I had made a rare intraday post to point to an oddity that had occurred on my 500 tick SP Futures chart (the ES). I like this chart because it makes turning points and flag edges quite clear to me on a longer term basis in order for me to time my entries on the shorter timeframes.

Anyway, this printed a pretty double “tent stake” - so named for their sharp bottoms and broad tops, an inverse of their brethren the “church steeple” top (hammers more appropriately). We had a decent rally off those and then after the Fed Minutes we printed more of these long wicks on the candles. Now if you trade intraday and especially on emotional big down days, any break of these long wick candles can spell trouble. Your typical breakout play that can certainly gather steam.

But if that emotional level is punctured and very quickly pops back up trapping those that played the breakout the fuel for a quick pop and potentially more is in place. That is exactly what we had happen today. The support of the long wicks were broken and the very quickly reversed. But the clincher was the volume in that reversal.

I drew in the emotional break down line. You can see that red candle (key bar) that punctures below the lows and closes below the obvious support level (naked close). This brought in massive trade size and which now sets me to watching the top of that bar as well as the emotional line. Remember breakout players played short below that level. As what typically happens when the breakout fails a quick snapback occurs with some follow through that takes out the emotional level as well as the key bars high (reversal).
So we have printed tons of reversals and ultimately print the clincher naked close reversal. Now what happens after the pop? We begin to trail back lower. But look at that volume as she rolls back. Nada. Shorts/Sellers flat out ran out of gas. I especially like these Naked Close Reversals to be on big volume and in key support and resistance areas. The volume should be the tell if it is.

In this case the ensuing rally pounced upon the lack of sellers and found a key support area for a very large advance into the close.

One more trading day until Turkey Time. If I don’t post before then….Have a Great Night and a Glorious Holiday!

Dave Johnson

In my post 2 weeks ago about the large drop in the banking sector I had made a few comments as to what I thought this drop might mean going forward. I had used a hypothetical holding period of 10 days to see what sort of forward results we could see. I also think it shows quite succinctly the power of backtesting.

Here is what I said 2 weeks ago:

Over the next 2 weeks I expect to see what our small snippet of history has shown us.

• Massive volatility in the market and banking in particular
• A tendency towards a upward reaction after a panic low is put in
• I would expect the range in the Bank Index to have a range of >7% low to high over the next 2 weeks

All of these “predictions” were not based on opinion or my personal bias, but were based on what the market had done on average in the past when this condition triggered.

Here is the chart showing that post 2 week period. The blue dot shows the trigger day and the bands denote the high to low range after that period:

Let us review each of the statements.

“Massive volatility in the market and banking in particular” - although most would have thought this statement to be an obvious one it actually was not. If you look at high volatility periods in general these spikes tend to see a lessening in ATR (Average True Range) in periods that follow. Yet we saw an increase in the 10 day ATR for the SP-500 jump 24% and in the BIX.X a 41% increase.

“A tendency towards a upward reaction after a panic low is put in” - on November 7th we had a 6.8% drop in the BIX.X, the largest one day drop in the sector since the selloff began in February and the 8% upward reaction after that massive down day within 4 days.

“I would expect the range in the Bank Index to have a range of >7% low to high over the next 2 weeks” again this was pointing to volatility but also zeroed in on just how volatile. The average for the periods I tested was for post trigger range of over 10% and so I tried to be a bit conservative yet still give an idea of the magnitude of the potential 10 day range. We ended up with an 11.73% range - right on in terms of the historical norm.

This little example gives us a snapshot of the power of backtesting data. It not only gives me trade ideas and how I can frame them but also can give a broader view of what the context of the broader market might be. I would highly recommend you find some way to test and analyze past market data in order to make educated guesses at forward looking market analysis.

Have a Great Week! A shortened one at that!

Dave Johnson

I received some questions today if todays big up move confirms the long entry in the SP-500. It does not. Remember the entry is an up day with volume greater than the previous 21 days. We had an up day but volume was not even close.

Could be tough in the short term to overcome that big volume bar from 4 days ago. But hey who knows.

Have a Great Night!

Dave Johnson

In doing some research to show that not all high volume reversals are the same (one’s after fear are better) I came across a stat that just blew me away. I scanned for days with volume being greater than the previous 22 trading days and the day was up greater than 1% from the previous days close in the SP-500.

Since 1966 we have had at least 160 days that this happened or about 8 times per year. A fairly common event. As a matter of fact we have had at least one happen every year since 1966 without any years skipped. Well not every year. As a matter of fact we have not had one happen in a while.

Here is my challenge to you. Can you find that day for me? The last trigger in the SP-500? Put it in the comments if you find it. If I do not get an answer today I will post the stunning answer tonight. The first to get it correct gets my copy of “There Must Be A Pony In Here Somewhere” by Kara Swisher about the AOL - Time Warner debacle.

Have a Great Day!

Dave Johnson

With the recent protracted slide in the financial sector many market observers have noted how this could be a sign of worse things to come for the limping market. In last weeks post I noted how a slide on the magnitude of 16% in the course of only 20 days pointed to a wild ride ahead.

The sector has slid more this week and I wanted to update the stats and present you with a trade that I think is setting up. We now have that same S&P Banking Index down 18% in 24 days as of the close on Wednesday. This has only happened on only 6 other occasions since 1983. Truly a noteworthy occurrence. As I reviewed the charts of the periods that triggered this condition I noticed that at times the SP-500 was in sync with the weakness in the Banking Index and at times only mildly so. One thing that generally happened fairly soon after this big drop in the Bank Index was a high volume reversal in the SP-500. I defined the high volume as the highest volume in the previous month and happening on a positive closing day.

If I were to test this condition (highest volume up day) on its own the resulting pop tends to be quite unimpressive but if this high volume pop up is preceded by the large banking drop the results are huge.

As I had mentioned an 18% drop in 24 days has only occurred on 6 separate dates that I have listed below.

The dates listed are the day after a close below the 18% level. If after this date we begin to look at the SP-500 chart and look for a reversal as defined by an up day on volume greater than all days in the previous month (21 days we’ll use) we would look to go long the next day at the market on the SP-500. We are going to look for a target in the 4-5% range.

Below you will find all of the charts of the SP-500 with the trigger date listed, the reversal day noted, and the profit target area were looking to hit. In each of these cases the target was hit very quickly even after entering after the large up move. The second entry date listed in 1998 actually happened while waiting for the earlier date to trigger a buy so we will only see 1 historical chart below for the 1998 entry.

This chart above of the 1998 entry shows our exit hitting in less than 2 weeks.

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Again the entry in 1999 above hits our target in only 11 trading days.

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The 2001 trade above hit out target in just over a week.

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In this the first of two 2002 entries our target is attained in only 2-3 days.

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In this second entry of 2002 we again hit our target area in just a few days.

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On average we see the large volume reversal entry day within 12 days after the large drop condition triggers. 1999 was the one that took much longer. All the others happened very quickly.

On average, our target area is hit in about 5-6 trading days. Think about that a 4-5% upside move in the SP-500 in 5 days.

Based upon this analysis I will be on the lookout for the high volume upward punch that will catch the shorts covering and those with limited equity exposure trying to catch the ride. As for me it is a trade. Nothing more. After my exit the markets can tank all they want. All I am doing here is trying to frame a trade. In terms of a stop - based on this historical snapshot I’d say a stop in the 7% area should allow enough room for the trade to work.

Keep your eyes peeled because if we get it. I won’t miss it.

Have a Great Weekend!

Dave Johnson

All week on financial television and media I have heard how volatile the market has been. All I can do is pull from SenatorLloyd Benson’s famous quote and say “Nasdaq today you are no Nasdaq of yesteryear”

I am in no way implying about future movement but those were spectacular moves. That you had to have been through to truly have a concept of massive moves.

Also this weekend I will be doing a follow up on my Bank index post from last week. And pointing to a specific trade that could provide a huge opportunity in the near future.

Have a Great Weekend!

Dave Johnson

The SP Bank (BIX–X) index has dropped 16% in the last 20 trading days and I wanted to test what sort of market action has happened after this magnitude of a decline. Since 1993 this has happened on 7 occasions.

In my test I bought the bank index the first open following the 16% drop in 20 days and sold in 10 days. Simple. On average that index has shown random 10 day holding periods to change in price on average about +0.39% . After this condition has triggered the average 10 day move has been about +5.07%. Wow massive. The volatility coming into this period tends to continue. If you look in the last 2 columns in the spreadsheet within the graphic you can see MAE% and MFE%. These represent Max Favorable Excursion and Max Adverse Excursion. This shows us how high (favorable) and low (adverse) price deviated within the 10 day holding period.

August 28, 1998 had the largest adverse excursion of 13.1% and ultimately finished 5% negative after the 10 day period. These periods are very volatile periods for the market as a whole and point to underlying concerns with growth and interest rate direction.

Over the next 2 weeks I expect to see what our small snippet of history has shown us.

• Massive volatility in the market and banking in particular
• A tendency towards a upward reaction after a panic low is put in
• I would expect the range in the Bank Index to have a range of >7% low to high over the next 2 weeks

Have a Great Night (and next couple weeks)!

Dave Johnson

All the gory details…

http://www.bloomberg.com/apps/news?pid=20601109&sid=aouTzYS5mCCY&

- John

The massive runup from the extreme oversold lows of Mid-August gave me an idea to test. Let’s test a rate of change that just occurred from the lows on the Nasdaq 100 37 days ago. As of Fridays close we were greater than 12% higher than price 37 days ago. A big big move.

So if we screen for that condition and enter the next day at the open. (noted in blue dot)

And code an exit logic that looks like this:

We exit no matter what after 22 days (about 1 month) at the following open

or

We hit a 10% profit target

We do this on the Nasdaq 100 Index going back to Feb 1988 (beginning of data)

This condition triggered on 62 occasions - 69.35% were profitable - with an average profit of 2.65% - the dollar profits and drawdown are based on $15,000

Thats massive. As a matter of fact the average return over any 22 day period would be +1.22% yet we are seeing +2.65% average return.

The 10% profit target probably was only hit once or twice right? Wrong. Out of the 62 trades 16 hit the 10% target before the 22 day timeout exit. That is about 25% of the time. I put a link below where you can download a PDF showing all the trades.

Here is a PDF with all those trades listed

I am not here to expouse a particular bullish or bearish view. I can only show you what I am seeing in this test. I have no bias and I will not make any particular trade based upon this test. This data is very similar to a test I ran on the old blog that everyone dismissed at the time (here and here). Also some of the newer readers may benefit from a post on the old blog that talked about my portfiolio construction. That has changed only slightly from when I wrote that and has done very well for me. But that is another post for another day.

Have a Great Day!

Dave Johnson

On Monday morning I posted a headline that caught my eye. Remember last weekend? What were we worried about? Growth Fears. Thats right. Time to go short right?

Here we are on Friday. Dow had the best week since April I believe. BEST.

What can we learn from this? A week where people flail their ams shouting how horrible forward performance will be, yet it ends up being the best week in 5 months. Stick to YOUR plan. And don’t be diverted by the headlines.

This is by no means a bullish rant. The chart is clearly at a crossroads but I implore you to always be extremely wary of the “obvious” trade. It is never ever that easy.

People in the blogospere who understand this “it is what it is” concept are few and far between..

The best blogs out there in my opinion are:

Stephen Vita - original and daring but willing to ride a trend

Bob’s advice for stocks- Bob is not only a gentleman but a market maven when researching IBD type growth stocks

Dr. Brett’s site - as a trader if you have not been here you haven’t been anywhere - best of breed

Technically Speaking with Ron Sen- a must read who makes being a contrarian almost anti-contrarian. A trader with an eye most closely aligned with my own.

HeadlineCharts - a new one for me but one I enjoy reading and find to be unemotional and extremely helpful inside the big picture

In my blogroll you will find others I find either enjoyable to read or helpful in trading. All come highly recommended in my opinion.

One thing these guys all have in common is that they post regularly. John and I tend to post rather infrequently and a bit irregularly. My only excuse is that I try to avoid the mundane and hop on the most salient points I see developing in the markets. Obviously these tend to trigger at extremes. My hat is doubly off to those that I have highlighted above, who gracefully weave frequent quality commentary with highly enjoyable reading. Hats off Gents.

Have a Great Weekend!

Dave Johnson

Well that sure makes trading this week easy. Go short at Mondays open. Because “stocks are expected to extend their losses next week”. Man you can’t make this stuff up. Ok I am not saying they won’t be right but I’d put the probability at just around the levels of a coin flip. Certainly headlines such as these encourage average investors to make emotional decisions after having seen an erosion in their 401k values since mid July - but create opportunities for astute swing traders with an eye on statistical probabilities.

As always look for clues of potential intermediate turning points in emotional “guaranteed” markets that can catch the crowd leaning the other way - such as:

• those sharp up turns that leave extreme high volume footprints behind
• solid and wide reversal patterns such as inverted head and shoulders
• diamond bottoms
• double bottoms  - (support)
  
• triple bottoms  - (more support)

you get the picture.

But most likely these reversals happen after punching through an obvious area everyone is watching such as recent support or a important trendline. Be especially vigilant after gaps through these key areas. You can see a couple obvious ones as we head into this week.

So instead of fearing periods like these. Relish them because invariable one side of the boat just gets a bit too crowded. You must stay vigilant and strike when the odds (not the headlines) are in your favor and the lemmings decide they are on the wrong side of the boat.

Have a Great Night!

Dave Johnson

Let’s see IBD confirmed rally and a double/triple 9 to 1 rally.

Clearly a bullish bias going forward. Multi-Day Pullbacks should be bought in my opinion.

Have a Great Day!

Dave Johnson

This chart of the SP500 futures says it all. Today is going to be fun.

Have a Great Day and Long Weekend!

Dave Johnson

I thought you might find the following links interesting about some very large options positions being put on.

Large mystery trader looking for large down move?

And this thread trying to discern the ramifications of that information.

For those non-system traders out there, do you let information like this affect your decision making process? How do you frame the trade? As for me I just follow my systems and let the chips fall where they may.

Also I am back from the North Carolina beaches after a week of fun and sun. Had a blast down there.

I also see John mentioned the intraday SPY system he’s working on. I will be curious to see how the walk forward testing goes over the next few weeks.

Have a Great Night!

Dave Johnson

The compelling trade I noted last night ended up positive on the day and will not trigger an exit until T2108 crosses the value of 12 - were at 10.79 as you see below.

Have a Great Night!

Dave Johnson

With todays market selloff I was looking forward to the close to see if the T2108 indicator (% stocks under 40 day moving average) had closed in single digits. And lo and behold it had - it actually closed at a value of 8.24 today. Very low indeed. I ran a backtest to see what a close below 10 implied and how I might be able to frame a trade to the long side.

Here are the parameters of that trade.

• a close below 10 on T2108
• buy the open following the close below a 10 reading
• exit when T2108 closes above a value of 12 - (a small improvement)
• a stop-loss based upon historical deviations will be at 6%

I ran on data back to 1990 on the SP-500

It has triggered on only 6 occasions -  1990 (twice), 1994, 1998, 2001, 2002 and of course today.

Here are the results of that scan:

So the average winner is a whopping 5.7%! with only a 6 day holding period. Any other 6 day holding period would have an average change of about 0.15%. Truly volatile as John has shown in the previous two T2108 trades. Max adverse excursion on these trades was in the 5% area. So it has at times taken some adverse movement before the advance pushed through.

Here are charts of each of those signals (click to enlarge) :

The two signals close together in 1990

the 1994 setup

the 1998 setup

the 2001 setup

the 2002 setup

and where we stand today…….

And remember this would be a trade. That’s all. Well, I have framed the trade. Who’s taking it?

Have a Great Night!

Dave Johnson

I watched the market today, like I do everyday and saw we had some mixed trading in the morning and a little bit of selling in the afternoon. Nothing dramatic, no panic selling, nothing to get excited about all in all a very “normal” day. All my systems performed well within their parameters and I stayed ahead of the market by being down less than the market and adding some exposure on the way down.

What always surprises me about days like this is the amount of reaction they cause. I see a headline on Yahoo - Stocks plummet on soaring bond yields. CNNfn goes with Bears come roaring back. I also saw threads on elitetrader.com saying the market was “falling apart”, “how far down”, etc.

The reality is that 1% drop in the S&P is not that uncommon. A quick scan shows that since 1/1/2004 it has happened 64 times out fo 852 trading days or 7.5% which would be about 1 in every 14 days or once every 3 trading weeks. Think about that, once ever 3 weeks we get a day like this. 1% down days are 25% more common than option expiration weeks. They’re 4 times more common than emini futures rollovers. Yet neither creates near the reaction.

You’ll notice that Dave and I rarely do daily market “commentary”, the reason being that 99% of the days are pretty much the same. Market goes up, market goes down, market stays about flat. Every now and then (i.e. 2/27/2007) we get a day that is exciting, but otherwise it’s just more of the same. My plan for tonight is the same as every night: run my system scans every night, enter the orders, drink a beer, then sit back and let the market do it’s thing tomorrow.  The most difficult decision I’ll have made in the past 24 hours is which type of beer to drink tonight.  This is the beauty of system trading.

- John

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

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

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