The Trading Digest

Teenie weenie though

Oh wait we have to like give the whole trade. Phooey.

Ok faithful readers. Do we buy this? How? What trade size? Do we set a stop? Are we adding to a portfolio full of holdings? or maybe one bursting with cash? Does that affect our decision process?

Have a Great Night!

Dave Johnson

No trigger but maybe you can be ready next time we get it.

I wanted to make a quick clarification of the 4 Red Candle System I mentioned last night. The 4 red candles all need to be a down days. Meaning each candle’s close is lower than the previous close. So although you can have a red candle on an up day (close lower than open but close higher than previous close), that would not fit the criteria for this system.

Happy Trading!

Dave Johnson

Here’s my amazing stat of the week.  I ran test where the first day of each month I buy the S&P 500 and wait for the end of a month where the close is higher than my purchase price before selling.  I only hold one position at a time.  Obviously, 99% of the trades are profitable (since I won’t exit until it’s profitable).  What’s interesting though, is to look at the periods where the holding time was the longest (ie the longest time the S&P 500 had between taking out a previous month’s open price.

Going back to 1963, the three longest holding times are 90 months, 79 months and 42 months.   The 90 and 42 are both from the horrible bear market of the late 60’s and 70’s.  The 79 month was from 10/2000 -> 5/2007.   The S&P opened 10/2000 at ~1441, today it’s at 1326.  7.5 years and a loss of 5%+.  It’s hard to find many periods of S&P performance worse than that.

- John

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

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

- John

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

“i feel your pain.

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

my realized losses came up to nearly 30k.

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

so we learn …”

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

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

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

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

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

- John

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

Please be careful out there.

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

- John

Here

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

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

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

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

Dave Johnson

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

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

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

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

- John

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

I had a nice intraday trade today also, but from a different perspective. Going into today, I was 100% long in my swing portfolio and own a few NQ’s from another system I run. I was late getting into work today because I had some errands to run. I got in about an hour into the trading day and saw everything up huge. Since we’re in a volatile environment and these morning rallies are prone to failing and we were near a “whoosh” point, I saw an opportunity to hedge a little of my profits. Therefore, I went short the S&P 500 (shown on chart). This was not a 10 minute trade, it was designed to protect some of my morning profits. With these type of trades, I hope they’re losers. I hope everything keeps going up and I cover it at a loss. I intentionally hedge for far less than I am long and of a less volatile instrument so if it turns into a +3% day, I’ll still be up 80% of that.

After a few hours when things did start to fall apart, I saw that same double tent stakes that Dave did and covered. Notice that I was nowhere near the low nor was I trying to be. The only way these hedge trades are profitable is to actually cover them at a profit. After my cover, we went lower and then rebounded strong in the afternoon leading to unrealized gains in my long positions as well as a realized gain in my short position.

I apologize for having to steal Dave’s chart, but mine are messed up from missing the first hour.

- John

We just printed a double bottom with a pattern I really like. See those hammers or “tent stakes” as I call them? Very solid pattern going into the Fed Minutes release. I have a long off of it. We’ll see how much support it provides for the rest of the day.

Brigbox was correct in choosing the last date we had a 1% up day with volume higher than the previous 22 days. It happened on November 4th, 2004. That is right 2004. Quite an oddity considering the frequency at which they have shown up in the past.

In the comments from the last post you can see what other readers chose as well.

Congrats Brigbox and thanks everyone for playing along.

Have a Great Day!

Dave Johnson

I’m sure some of you have noticed I haven’t been posting as much recently, the primary reason is I haven’t really had anything to say.  Take today for example, it was your pretty typical large down day.  Both Dave and I have made posts alluding to the impending volatility (Stormy Seas,  Bank Index Drop).  We’ve also mentioned time and time again of managing your overall exposure, by using strength to sell into so when there is weakness, you have the opportunity of having capital to deploy.

All you can do during these times is cut back on any margin and keep following your systems.  As expected, my personal account and our swing portfolio are both in similar drawdowns.  However, you’ll notice that our swing account is up ~18% versus less than 5% for the same time frame of the S&P 500.  That is by all accounts an excellent year.

Could the market go down more tomorrow?  Absolutely.  Could it go down the rest of the year causing our swing portfolio to end the year with a loss (albeit most likely far less than the market), sure it could.  Am I worried about either of these scenarios?  Not at all.  Dave and I have spent thousands of hours testing and refining our systems and are extremely confident in their long term ability to outperform the market.  A 10%, 15%, or even 25-30% drawdown is not going change that.  The key is these systems work long term. Long term is not daily, weekly, or even monthly.

- John

Found the link to this paper in this weeks issue of The Economist.  Fascinating paper describing the unusual returns experienced by long/short equity hedge funds.  A must read.

- John

In the spirit of my post last week, here’s my updated portfolio:

Symbol             % Gain Loss                  System

AMZN                +0.37                                Swing
EWA                    +10.91                            Trend Following
EWH                    +14.51                            Trend Following
EWZ                    +12.96                            Trend Following
FXI                      +36.09                           Trend Following
GLD                     +12.36                           Trend Following
GNTX                  -5.79                              Swing
SCHW                 -4.87                               Swing
SRCL                   -4.42                              Swing
WFMI                 -7.51                               Swing

Only at about 60% invested now, but that will change tomorrow morning with the new buys from the swing system.  As you’ll notice, the longer swing positions hang around, the worse they’re usually doing since winners are quickly sold.  ADCT and FSLR from last week were sold for nice gains.  VRTX is a different story :).

- John

I recently signed up for a StockTickr account.  For those of you not familiar with it, it’s a very robust tool where you can import all your trades directly from your brokerage statement (assuming you use one of the brokers they support) and then view statistics on your trades.  Furthermore, you can “tag” trades for different systems.  I wanted to use it so I can see the performance I’m getting from my swing stuff versus my trend following versus my intraday trades.

After I loaded up all my trades (took about 15 minutes for YTD from IB),  I started playing with the commission calculator which is designed to let you plug in different commission structures and see if you would have saved money versus what you current pay.

For stock trades only (no futures or options), I have incurred $972.86 in commissions at IB year to date.  If I was paying $6.95-$9.95 per trade (current going rates at the aforementioned brokers) I would have paid between $5,831.05 and $8,348.05 in commissions.  This means I have saved between $5,000 and $7,000 by using IB.

If any of you reading this are still using Fidelity, Ameritrade, Schwab, Etrade or anyone else charging $6.95+, please do not make another trade until you’ve moved your account to a more reasonably priced broker.  This is especially true if you’re a subscriber to our collective2.com system as the amount you’ll save over the course of a few months will more than pay for the entire years subscription fees.

- John

http://www.bloomberg.com/apps/news?pid=20601087&sid=aAAJdNHgnKUw&refer=home

Ultimately this will be the greatest drag on the US economy. Not in the way that most might see it though. Certainly the Government will face its own fiscal challenges. But the economy which is driven by consumer spending will be hurt by boomer spenders spending just a touch less than they used to. The ramifications of that reality will have reverberations throughout the economy unlike boomers have ever seen in their lifetimes. Less goods produced and consumed means less jobs which means…….Not good. But that is a little ways off for now.

Enjoy the ride while you can.

My wife said I have to work this video into a post for her……..Ummmm…… Boomer Money…..Lick it Up (while you can)

I should note this is my own opinion and is not necessarily that of John’s (we don’t do macro stuff anyway).

Have a Great Night!

Dave Johnson

I’m afraid my previous post was not as clear as it could have been.  The results of my scan found a long only system that was a consistent loser over a 20 day time period.  A system like that is very rare because almost any long only scan you run on the QQQQs is a winner due to the extreme upward bias since the QQQQ’s inception.

Also, when I mentioned establishing positions this morning, what I meant was that even though this scan showed potential trouble ahead for the overall market, no scan would keep me from taking every signal of our swing trading system.  The key to system success is taking EVERY signal, whether you like it or not.  The 3 positions we established this morning were FSLR, AMZN and GNTX.   Both AMZN and FSLR were up over 3% while GNTX was down 1.5% for a nice gain on today’s new positions.

Here is what my current portfolio looks like

Symbol             % Gain Loss                  System

ADCT                  + 0.55                          Swing
AMZN                 +3.81                           Swing
EWA                    +16.87                         Trend Following
EWH                    +19.47                         Trend Following
EWZ                     +17.93                         Trend Following
FSLR                   +3.37                            Swing
FXI                      +38.62                         Trend Following
GLD                     +10.27                         Trend Following
GNTX                  -1.53                            Swing
SCHW                   +0.20                         Swing
VRTX                   -6.83                           Swing
WFMI                   +1.50                         Swing

All these positions are long and overall I’m 85% invested with 15% in cash.

- John

The QQQQ had a high volume reversal today. After gapping up, it climbed to a > 0.5% gain from yesterday before sharply reversing and closing down over 1% on high volume. I was curious how often a pattern like this had occurred before and what usually happened next.

I scanned the QQQQ’s for all cases where they opened higher, had a high greater than 0.5% above the previous day’s close and then closed down over 0.5% on volume at least 50% greater than the day before. The system would buy on the next open after this occurred and exit after 20 days (approximately one month).

Going back to 1990 this has occurred only 23 times and has an average 20 day loss of 0.77%. What’s most amazing about this pattern is that it is almost impossible to find any entry that will generate a loss on the QQQQ’s on a time based exit over this time period as the QQQQ’s have increased over 10x since 1990.

Now why this means that there may be trouble ahead for the market, that does not mean that our long only swing system on collective won’t be buying tomorrow. Remember, each system has it’s own time frame and money management strategy so it is very possible to have long systems being profitable at the same time a short system is also active.

- John

Recently, a guy I know has been extremely cranky because the stock of the company has been in a nose dive, so much so that it was even down yesterday (best S&P day in 4 years). As someone who has worked at multiple public companies with the full gamut of stock options, employee stock purchase programs and company stock available in the 401k plan, I wanted to spend a minute going over how the proper way to deal with these issues as I’ve seen far too many coworkers and friends get burned.

1. 401k - NEVER, NEVER, NEVER put your 401k money in company stock. I don’t care how great the company is doing and what it’s prospects are. Your 401k money is for your retirement and needs to be diversified. The number of people I’ve met who had their entire 401k in company stock is just frightening. Furthermore in the case that your company does blow up (Enron, WorldCom, CountryWide, etc), not only have you lost most of your 401k money, but you are also likely out of a job now also.

2. Employee Stock Purchase Plan - Some companies have the option to use a % of your salary (say 5-10%) to purchase employee stock on a quarterly/semi-annual basis. This is only worthwhile if you’re able to purchase the stock at a discount. For example, when I was at Microsoft, you could sign up in Dec. to participate in the Jan-Jun stock purchase program. They would take 5% of your salary out each paycheck and then on June 30th, the money would be used to purchase MSFT stock at the lowest price between Jan 1st and June 30th - 10%. Obviously this was a great deal. Not only did you get the lowest price, you got a discount also. Remember this was 10+years ago, so I’m sure the program is different now (backdating scandal?). However, these type of programs are only worth it if you get some type of discount or lowest price of the time frame.

3. Stock Options - NEVER, NEVER, NEVER excercise your vested options unless to intend to sell them. Please don’t tell me about the tax benefits of exercising early and waiting a year to sell them to try to get the additional appreciation to be capital gains. Never have I seen more money lost trying to save a few bucks on taxes. What inevitably happens is that people excercise (thus triggering a huge tax bill) and don’t immediately sell. Now April rolls around and the stock is well below the excercise price so now you’re paying taxes on gains you’ve lost. It’s just idiotic. If you’re determined to excercise, you MUST either sell enough shares right then to cover ALL the taxes or try to get fancy and limit your downside by using options or something similar.

4. Don’t ever trust what management says. As investors we see it time and time again, a company says for months “No, we don’t have any issues with X, everything is fine” and then finally they do the mea culpa and send out a press release at 8pm admitting that “X” really was an issue and now they’re taking a charge, reducing guidance, etc. and the stock is down 10%. For some reason, people don’t have the same skepticism at “their” company. They receive these emails from management saying that everything is ok and they believe them. Do NOT believe senior management over your own instincts. If your stock is off 30% in 3 weeks over mortgage exposure concerns, I don’t care what the CEO says, there are some issues there, they just haven’t admitted them. Remember, senior management at public companies are always selling, selling the stock to investors, selling the prospects of the company to the employees, selling the current spin to each other. There are alot of smart people on Wall St. who understand many companies balance sheets better than most of the executives who work there and when they start voting against the stock with their own money, the stock is not a “screaming buy”.

- John

As some of you may have noticed, we’ve had some recent instances where the same person attempts to post multiple comments under different names about our post a few months ago relating to Timothy Sykes new book.  The nature of the comments make me doubt that the poster has even read Tim’s book.  I’ve already responded to the poster’s comments with a reply comment so I’m not going to waste my breath here.  Suffice to say, we will no longer be allowing comments from this IP as this is a blog dedicated to sharing information and ideas, not bickering and name calling.

- John

A few months ago in my first “Market Myths” post I talked about the dangers of trying to assign a “why” to market moves.

Barry over at Big Picture has a great example of this that’s a must read.

- John

Saw this blurb about the nice move in AAPL today:

NEW YORK — Apple Inc. shares jumped $7.26, or 5.72 percent, to $134.08 Wednesday on speculation          the company will introduce new models of its iPod music player in time for the Christmas holidays.

Goldman, Sachs & Co. analysts wrote in a note to clients that Apple’s announcement “is likely to include a       full line-up of revamped iPods” and “provides another reason to own Apple shares.”

This passes for “analysis” now days?  That Apple will likely update it’s most popular consumer electronics line (which hasn’t been updated for awhile) prior to the Christmas shopping season?  Who’d have ever thunk…

- John

That is the question. Can Dave and I, as typical retail investors actually succeed with an automated trading system? We’re about to find out. Using off the shelf tools (Amibroker and IB), I’ve automated one of our scalping ES systems we first tested live over a year ago. When testing it live, we found the spread on the ES (1 tick or $12.5 per contract), was too wide for the system to be viable and thus we shelved it.

Then a few weeks ago, I had a thought, what if we used the SPY instead of the ES? With the spread often being .01, the 500 shares required to replicate 1 ES contract only has a $5 spread. Standard bundled commissions are $5 round trip for the 500 shares while I think the ES is $4.80. So in a typical trade, I save $15 in spread and only pay .20 extra in commission. Obviously SPY does not have the same tax advantages as the ES, but my goal is always to make my tax bill as high as possible each year :).

In backtesting, the system does 84% winners w/ an average winner of $34.09 and an average loser of $82.75 for a Profit Factor of 2.18.

I just got the system working yesterday running in my IB Papertrading account and am going to post it’s ongoing stats to help me keep track of how close it follows the backtest as well let you guys follow along to see if this can actually work.

Here are the initial stats

8/21 - (Half day only) 8/8, $29.44 Avg Win.

- John

Dave and I both exited our T2108 trade into the close today for a profit of ~+50 ES points. What I wanted to do with this post was talk about how I handled this trade from start to finish.

(Pre Trade)

After that ugly, ugly close on Wed., Dave and I ran our usual nightly scans and saw that many of the “T” indicators (including our favorite T2108 - percent of NYSE stocks above their 40% MA) were at historic lows. Now I’d posted before what the stats look like when T2108 gets below <15, after the close Wed. it was below 10, 7.74 to be exact. Dave and I started going through the historical cases this had happened, 2002, 2001, 1998, etc.

We also kicked around scenarios of what type of news events could possible occur. What if a large mortgage company went bankrupt? What if Goldman had to close one of their hedge funds? What would the Fed do if things got uglier?

Based on historical precedent, we felt that in addition to the technical setup, there was a good chance that another large down day would cause more intervention from the Fed. I still remember the Fed surprise rate cuts in 2001 and we talked about how careful we’d need to be on any intraday shorts as a surprise rate cut can cause a huge instant move in the futures.

(Sizing)

Once I decided that this was a trade I wanted to do, I had to decide how much size to do it with. Keep in mind that prior to this, I’d never held any emini contracts overnight. The first thing I did was determine how much I was willing to risk on this scenario (remembering that if it was a loser all my swing stocks would be getting hammered also).

I decided I would risk ~8% of my portfolio on this emini trade. Since I had set a max loss of 6% that meant I needed emini exposure to be about 135% of my total portfolio value. So for every 100K, I’d buy 2 ES contracts. The combination of this and my 90% long I already had with my swing longs meant my total exposure would be 225% long. Prior to entering the trade, I calculated what I thought my account balance would be if we went straight down 6% (another 85 ES points). I actually spent a fair amount of time visualizing this number to make sure I was comfortable with it. I discovered I was so everything was set for the next morning.

Notice at no point did my calculations involve the margin requirements of an ES contract. I always do position sizing on the total value of the contract I’m buying, not the margin amount (which is irrelevant to me). In fact, I don’t even know what the overnight margin requirement is for an ES contract except that it’s ridiculously low.

(Entry)

Prior to open, Dave and I saw the futures gapping down big, which was the perfect setup for this trade. I received a phone call right at the open, so actually entered a few minutes later as ES was creeping up from the open.

(In trade)

After bouncing around the open, everything started dropping and I think at the lows of the trade was ~25 points against me, and of course swing stuff was down too. The total losses were nowhere near what I’d already visualized as my max loss, so I didn’t get too worried. About 2pm EST, I went to a birthday lunch for a coworker that lasted past the close, so I had no idea how things had done the last 2 hours.

Shortly after the close, Dave called and told me the futures were around 1420 so were up about 20+ ES points. This was obviously good news and we confirmed that the T2108 was still below 12, so no reason to worry about an exit the next day.

This morning I awoke to see futures down 14, since we already had a nice cushion, I wasn’t too concerned. On my way to work, Dave called to tell me the Fed had just cut rates and everything was gapping up huge. Nothing much happened during the day and near end of day we confirmed that T2108 was well above 12.

(Exit)

Although we had tested with exiting at the next open (easier to test that way), we had decided after the rate cut to look for an exit near end of day, assuming T2108 was still above 12. All I did was wait until about 3:58 and sell the contracts. Nothing fancy.

(Results)

This one trade added ~4% to my total portfolio value, a huge number. The most important thing, was not that the trade worked (that was good too), but how I spent way more time thinking about how I wanted to frame the trade (sizing, stop, how much could i lose, etc) than I actually did making the trade. This insured that even if the trade went horribly, horribly wrong, I would still be in a very good position to keep trading and not be looking at a huge drawdown.

Now if only opportunities like this came along more often :). But as our testing showed, we went 5 years between setups like this and will probably go another 5 before we see it again.

- John

My intraday data is showing we are above a reading of 12 on the T2108 and as of 3:33 PM EST we stand 50 SP points above yesterdays opening entry. That is our pre-planned exit strategy. That is a gain of a little over 3%. Hope you caught the ride. I am leaving for vacation on the Outer Banks, NC for a week of fun in the sun, so John will have to keep ya posted.

Have a Great Week !

Dave Johnson

Have been greatly exaggerated..

Just read from Clueless Q that he thought we were shutting down, nothing could be further from the truth.  With recent volatility, we’ve been busy, busy trading and making money.  Last week I mentioned that the T2108 trade triggered again.  Here are the results for this trade:

This was a great trade, a + 2.23% on the SPY, or the equivalent of about 32 emini points.  As you can see, during the past two weeks even with the huge down days, a disciplined long only system can still be profitable.  The same is evident in our swing equity system which hit a new equity high today.  Yes, you read that right, market down big from July highs, yet our long only system hit a new equity high.  It is possible to make money on the long side in a downward market.

If you’d been wondering we we’ve been, the truth is that yes, we were a little frustrated from the chat room.  So many people thinking that trading is a get rich quick scheme that requires minimal work.  Just turn on the computer in the morning and watch the money roll in.  Nothing could be further from the truth.  The most aggravating thing was how many questions we would get that are answered on our blog.  People not even willing to put in the work of reading through our blog archive, which is 100% free and very valuable.  Go through the archives, see specific trades mentioned at time of entry and see how many were profitable.  I know the 2 T2108 trades were both profitable.  See what type of setups we use, run tests to see how much you could allocate to each trade and be comfortable with the drawdown.  Watch these setups live and trade with small size to get a feel for how the trades go.  Read books on trading systems, spent days testing ideas, learn what a curve fitted system looks like, learn how different styles of trades impact an equity curve, monitor different systems on collective2.com and see how many of them blow up.  These are the types of activities that _will_ make you a better trader.  Whining about a losing trade, trading too much size, having a strong bias without statistical backing and not having a solid money management plan will _not_ make you a better trader…

- John

In my post last weekend, I mentioned how the T2108 was < 15 and provide results of a system that bought at market the day after that signal and sold three days later.

Here is the result of the trade that triggered from last Fri. (7/27)

As you can see, it was a small winner, .57 % or about 8 S&P points.  What’s interesting is that the volatility during this trade was actually less than the average for this type of scenario.  The average winner and average loser are both larger than either the MAE/MFE was for this trade.  What that says, is that this week was below average volatility for a market so oversold.

Notice that the same trade triggered again for this coming Monday so I’ll follow that one also and expect to see increased volatility.

- John

With the recent news of another large hedge fund failure, the usual talking heads start their annual calls for “greater regulation” and talk about the “outsized risks” these funds take as reasons for the failure. While there may be some validity to these claims, they are not the real reason that hedge funds often fail in spectacular fashion. The real reason is that the hedge fund system encourages managers to roll the dice.

Think about it, your a manager of a $1 billion hedge fund. The 2% management fee is a mere $20 million a year and most of that is eaten up by overhead costs. The real money is in the 20% performance fee. Therefore, you decide to leverage the fund 10:1 in S&P futures. Now each 1% increase in the S&P is a 10% move for your fund. Lets also assume that if your fund is up 30% for the year you’ll stop trading for the year and just collect your additional $60 million (you personally will pocket $25million of that) while if your fund is down 30%, the investors will demand their money back and the fund will be shut down.

Now we’re in a coin flip situation, pick a random day to start from and see if the S&P moves up 3% before it moves down 3%. The odds are close to 50/50 on a given day. Now lets look at the consequences for you the manager.

1. S&P goes up 3%, you’re a hedge fund golden boy, and earned over $25 million in a single year, plus your recent performance has increased your profile and now your fund has double to $2 billion meaning that the management fee is now $40 million, guaranteeing an extremely generous salary for you even if the fund does not outperform the next year.

2. S&P goes down 3% and your investors all demand their money back. You still made a good salary for the year, and since you’re an “experienced hedge fund manager”, you’ll have no trouble being backed to start another fund where you can flip the coin again.

Remember, it only takes being right once to be financially set for live and Wall St. is the land of second chances. Don’t believe me? Anyone remember Brian Hunter?

- John

One indicator I look at to view the relatively level of oversold is the T2108 included in Worden’s Telechart product.  The T2108 indicator shows the % of NYSE symbols that are above their 40 day MA.  On friday, it had a value of 14.86, it’s lowest reading since May of 2004.

Curious as to how these days play out.  I did a quick screen to buy at open the day after the T2108 value is < 15 and then sell 3 days later on the SPY since 1988.
Here are the statistics:

As you can see, 78% of the trades are winners, with an average profit of 1.47% of the next 3 days.  Interestingly enough, the largest loser was not from 9/11, but from 1998 when the credit markets experienced extreme turbulence.  Here’s the chart showing buys and sells from that period and just how steep that 1998 decline was.

- John

One of the hardest things for new traders to deal with is drawdowns.  Even traders that have a system with a backtested positive edge have trouble stomaching drawdowns well within the parameters of “normal”.  To use an example from real life, look at our system on Collective2.com.  We tell everyone to expect maximum drawdowns in the 25-30% range.  Everyone nods and their head and says “no problem”.  Now fastfoward to today.  Based on recent market action, the portfolio was 100% invested (as it should be), just last week it touched an all time equity high, just short of 112,000 and up 12% from it’s inception in late Feb.  Now after a week of rough market activity it’s down to ~$107,000 (and with NTRI’s afterhours performance, probably down a few grand more).  We’ll guesstimate ~$105,000 is it’s current value.   Over half the gains YTD gone in one week.

Is the system  broken?  Did we do something wrong?  Should we have been less  invested today?  The answer to all these  questions are NO.  Remember in the first paragraph where I said to anticipate max drawdowns inthe 25-30%range?  This drawdown is only 6.25%.   Miniscule compared to historical drawdowns.   A 25% drawdown (similar to one seen in Dave’s blog’s portfolio in 2006) would take our 112,000 portfolio down to $84,000.  Will we experience a drawdown like that on our collective portfolio?  Absolutely.  Is this the beginning of that drawdown?  I have absolutely no idea and neither does anyone else.

If this size drawdown makes you uncomfortable, it’s going to be difficult for you to beat the market by a significant percentage.  The fact is that to outperform you have to have exposure and with exposure comes risk.  The ratio between avg return and max avg drawdown is alot closer to 1.5:1 than most people would like to believe.  It is simply not practical to think you’ll be able to get avg 60% returns with max 5% drawdowns.  To average 60% returns, expect to see potential 40%+ drawdowns.  Remember, any positive system can give you 60% returns with enough leverage, it’s just a matter of how much the drawdown will be and if you’ll run out of money first.

- John

People ask Dave and I all the time if they can “have” our trading systems.  Some want the swing system, some the intraday stuff, some the trending stuff, but the answer is always the same.  No. I wanted to make this post to answer the question once and for all so I can just link to it whenever we’re asked.

What people don’t understand is that Dave and I have literally spent thousands of hours and thousands of dollars developing these systems. The time was used testing, retesting and testing again. The money has gone to software, data sources and money used to experiment with different concepts in live trading.

We’ve proven time and time again these systems work in real time.  For examples of the swing system, look at Dave’s old blog.  He ran the swing system for a year live, giving every signal before the open.  Here are the results, up over 40% in 12 months.   Also, anyone who’s been in the chatroom these last 2 weeks has seen Dave make over 10K on live trades with predefined entries and profit targets.   I’ve read alot of different stock blogs and have yet to see one where people are as bold as Dave and put out real trades w/ real position sizes and real tickers and real exits and real profits or losses.  If anyone knows of some, please send them, we’d like to read them.

Our combination of systems is not something we just threw together one night and started trading, it’s the result of lots of work that called on Dave’s 10+ years of trading experience and my 10+ years of software development. The combined result is our intellectual property and is not something we’re willing to just “give” away anymore than one of you would “give” away something you’ve worked on for years that has tremendous value to you.

Which brings me to why we even have this site and our systems on collective. When we were learning to build systems, we did find many good resources online and now that we’ve learned to do it, we want to help other people do the same just as people helped us. We also want to keep people from being scammed by people out there trying to sell systems or services for thousands of dollars that don’t even work. Some people think these type of sites generate lots of money but nothing could be further from the truth. The revenue from our website has yet to pay for the hosting costs and all the money we’ve made from collective won’t even buy Dave a plane ticket to fly down to Austin so we can drink some beers. We’re not asking for money, the cost of hosting this site is trivial and if the ads cover it, so be it and if they don’t it doesn’t really matter.

We want to help traders by sharing some of our knowledge, but we very much believe in the “give a man to fish and he eats for a day, teach a man to fish and he eats for a lifetime”.   I am more than happy to help readers with questions on systems, debugging, suggestions etc. but only if you have actually taken the time and effort to acquire some backtesting software, load up data and at least attempt to write a system to do what you want.  I’m not interested in doing backtesting for people who are unwilling to take even these small steps.  But if you do have a real system your working on and want some honest feedback or help, feel free to click the “Email Us” link in the top left corner and I’ll be happy to help out.

If you feel that backtesting in any form is beyond your ability or you do not have the time to dedicate to it, you can always subscribe to our two collective systems the stock swing portfolio and the futures swing portfolio.   If you think $40 per month is too much for a stock swing system, I’ll point out that I pay $30 a month just for the data I use to generate the signals so even if I did give you the system, you’d still be spending $30 a month to run it properly.

Anyway, this post turned out longer than I anticipated, but it needed to be said.  Being a successful systems trader is hard work and if you’re not willing to put in the time then either subscribe to a system you trust and follow it religiously or save yourself a lot of money and frustration and just go with these guys.   Because I know from my days at working at active trader brokerages that  90% of active traders won’t beat their returns in the next 12 months.

-John

I just finished reading an advance copy of Timothy Sykes’ (more on the author here), “An American Hedge Fund”, which is an autobiography that reads more like a modern day Horatio Alger novel. The book is a very easy read as Sykes leads the reader through his whirlwind rise from high school junior to manager of his own hedge fun in just a few years.

Unlike most books on this subject, Sykes is not shy about sharing his emotional ups and downs on his journey. He details real trades, with real ticker symbols and real dollar amounts. The goal is not to educate the reader on how to trade, but to provide the reader insight into his experiences and what he learned from them.

Since this book is more of a story than a reference I don’t want to give too much more away as knowing the details of how it ends detracts from the story. I will say that I thoroughly enjoyed the book and think Tim was right on when he said that this book targeted a niche not currently covered, I can’t think of another book like it.  The book will be available October 1st.

- John (& Dave)

1.  Assuming an “average year in the markets”, how much would you expect your trading account to be up on a percentage basis?

2.  Assuming the above, what would you expect your max drawdown in that year to be?

Please either respond via comments or if you’d like to remain anonymous, click the “Email Us” link in the upper left corner of the main page and I’ll summarize the anonymous results.

- John

In a previous post I had made reference to a piece on the www.swing-trade-stocks.com site that made a point I was trying to convey. In that post I said to disregard the rest of the site in a very offhanded dismissive manner. Craig from that site left me a comment that made me look a bit deeper at his site. I was wrong in summarily dismissing the content of the rest of the site. Craig my apologies. I thought, based upon the hyphenation in the URL, the audio presentation on the front page, and the tone of some of the testimonies that your site was another of the spammy type of trading catch-all sites. It’s not, as a matter of fact your work is to be commended. My bad.

If you do get a chance to check out the site it has some really useful information in relation to swing trading.

Dave Johnson