Something is brewing

Check out the huge volume coming in to UUP several days ago. Looks like the dollar is double bottoming while the S&P could be double topping. Check out $USD also.

As a side note my automated trading systems are forward testing perfectly. I would be trading them today if my broker wasn't being a pain in the neck about not giving me a pattern day trading account. But I'm pursuing some other interests and shooting a video of an idea I have to pitch to a local company. So that's my life in a nutshell.

Choppiness Index vs. ADX

I just wanted to mention that in my testing I have found Bill Dreiss's Choppiness Index to be far superior to ADX. ADX is supposed to measure the strength of a trend, but the CI does more by telling you how orderly price is moving using fractal geometry. I just started live trading small positions this month with an automated strategy. Hopefully the volatility will start to pick up a bit as traders come back from vacation.

Volatility Based Position Sizing

I just finished coding a volatility based position sizing algorithm and the results are pretty dramatic. My hypothesis was that it would transform my system's equity curve into more of a straight line and that's exactly what it did, smoothing the results over time. When conditions are more volatile a wider stop is used and less shares are purchased. Less volatile means a tighter stop and more shares, so smaller moves are capitalized on.

If anybody is interested in seeing the code I can post it with the disclaimer that it hasn't been tested in live trading.

Before Position Sizing with Static Stops

After Position Sizing with Dynamic Stops

New direction for this blog

For those who may have been following this blog for a while, I want to let you know that this blog will be taking a different direction. If you are mainly interested in seeing examples of discretionary trading, than there are several excellent traders that I link to over at the left column. I was discretionary trading for the last year and a half to get familiar with the markets. I am now embarking on the second phase of my trading career. Discretionary trading taught me a lot about myself. If you don't think you are emotional, try trading for a while. I had some good months, but I realize that the biggest obstacle to my success is myself. I believe that to really become a good trader you must enjoy the challenge of trading and have extreme mental toughness. Watch Tiger Woods play golf and you will see that he is intensely competitive and always believes that he is able to win, even after some bad shots. As a trader you have to be able to shake off some bad trades and not get into a negative feedback loop. It is difficult to "keep the faith" after a drawdown period no matter how many psychology books you have read. My advice to those looking to discretionary trade is make sure you love what you're doing.

If you're still reading than you probably have an interest in automated trading. I've been using Tradestation for about a week and have already developed some simple algorithms that outperform my own trading record, so the results are encouraging. I don't think I will be sharing the specifics of my strategies out of fear that Golman Sachs reads my blog and starts frontrunning my orders :) My approach to developing automated strategies is to keep it simple and general. I think if you get too specific, you end up with something that works great for a short period of time and then stops working. If I look at the trades my systems make, I can see examples of how people trade, like that's a narrow range bar at the ORH, or that's a pullback to a 50% fibonacci retracement. But I'm not searching for those setups specifically. If you keep your strategies general, you cast a wider net. There is always the temptation to overoptimize. If my algorithms start performing at an 80% win rate, I get suspicious. I look for a profit factor around 2.0 and a win rate around 60-70%. Anything higher seems suspect. I backtest over several years but weigh the last two more highly. I test on SPY mainly, but I may be getting into currency trading as a backup market. Right now there is too much correlation though, so the benefit of diversification really isn't there.

MOT - ascending triangle breakout

I'm actually in this long term. Thought it wouldn't hurt to talk up my book. If all my readers buy MOT right now it could move the stock up .001 cents. The market's been a real snooze--not much to comment on.

Thursday trade - SU

I was seeing a lot of good setups today--it was hard to choose. I couldn't resist these two really negative candles (almost a tweezer top) at the PDL on high volume in SU. One negative was that there was a lot of congestion between 30 and 30.5 so I was expecting it to stall at the ORL at 30.4. It did stall there but on fairly low volume, but I didn't like how much relative strength SU and USO were showing. I tightened my stop to BE plus a little extra for my efforts and got stopped out for a small .46R winner.

Setup: 65

Wednesday missed trade - MS

While the rest of the market was rallying in the morning, financials were going sideways and XLF printed a series of negative candlesticks. This trade was more instinctive, I just had a feeling that if MS broke 29, it would go down for a while. I waited for a break of 29 and then entered a limit order at 29. If I put the order at 28.98, I would have been filled...

Wednesday trade - POT

I traded this as a bullish pennant. The setup was nice and the breakout occured on pretty strong volume. I was really on the wrong side of the market though. After entering the trade I looked at the market internals, which were awful, so I tightened my stop aggressively to 104 and got stopped out for a .45R loss. We're entering summer trade, so I'm trying to be more selective and only trade stocks that are in play.

Setup:65

Friday trade - DRYS

DRYS was showing a lot of relative weakness today compared to the market and DSX and EGLE. It was bouncing off of 8.3 on very low volume midday. I shorted on the break of 8.3. The breakout bar was a nice WRB with high volume. I was holding out for 7.5 and kept tightening my stop. It ended up bouncing off of 7.6 with no real indication it was about to turn around so I got stopped out at 7.85 for a 1.9R trade. Lately I have been getting faked out by something I see on the tape so I didn't tape read today and I had a more relaxed state of mind.

Setup:65

Monday trade - ACAS

I was planning to trade this as an OR breakout. My broker won't let me place stop orders within 10 cents of the ask price, so on low priced stocks I have to use limit orders and enter manually. I jumped the gun on this one when I saw some strength in the tape and entered early. It ended up breaking 4.25 in the afternoon after I had scratched the trade for a small .33R loss. Today's action felt very fishy as financials were the primary mover. There was a noticeable lack of herding. But I was on the right side of the market, in the right sector so I'm patting myself on the back for going with the flow and not trying to stubbornly short today.

Setup:60

TLT breakdown

The most interesting thing that happened today was TLT broke below 100. Either we've already entered slow summer trading mode or everybody is waiting on the FOMC annoucement tomorrow, but it's been like watching paint dry.

Discretionary vs. Automated Trading

I've been neglecting this blog lately because I have started the transition to automating my trading. My long term goal has always been to develop automated trading strategies. First I needed to become familiar with the markets so I could discover firsthand what works and doesn't work. I do believe that the best automated trading will underperform the best discretionary trader in terms of win/loss ratio and expectancy. However, there is expectancy and opportunity as Van Tharp explains. If I am only able to find one or two excellent trades per day manually, and an automated system finds 10 decent trades per day, the results can be equivalent in terms of P&L. For example, 2 discretionary trades with an expectancy of 2.0 will result in 4R profit. Ten automated trades with an expectancy of .4 will also result in 4R profit. The one drawback is that the 10 trades incur a greater transaction cost in terms of commissions and slippage.

The transition to automated trading won't occur overnight. This is going to be a lengthy process that begins with translating all of my favorite setups to code so an alert will be triggered every time something sets up. I think this alone should improve my trading because the criteria will have to be clearly defined (should reduce some impulsive trades that don't completley fit my criteria) and the universe of stocks that a scanner can monitor will be much larger than my small watchlist and unusual volume scans. I have been coding in Metatrader MQL4 and will eventually port over to Tradestation's Easy Language.

Note to self - stop fighting market

This rally seems to be getting a little out of hand. Almost like we need a downtick rule to keep irrational exuberance in check. Speculators are profiting from stocks going up! I keep trying to stubbornly short though and am missing some of the upside moves out there. Solar stocks were on fire today. TSL and FSLR had some very nice volume. So what if it's insane, there is money to be made from extreme emotions.

Warning: as soon as I come around to going long that usually means the market is about to nosedive.

Friday trade - FWLT

This is the first time I've traded an h pattern. Jamie and Anarco swear by them, so I was pretty confident when I saw this pattern set up in FWLT. The target of the pattern was about 18.2, the optimistic target was 18, filling the March 23rd gap down. The breakout bar was nice but lacked volume. The move slowed during the Bernanke speech at noon, but it wasn't seeing any volume and was weak relative to the market so I held on. I exited (early in hindsight) for the following reasons for a 2.6R win:

Extreme TICK reading

Quadruple OPEX day, didn't want to push it

S&P was approaching 775 support level

Sharp move down felt like a possible knee jerk Bernanke speech over reaction

Capitulation volume at S2

Setup: 75

Wednesday skipped trade - KBH

I skipped this cup and handle because this was FOMC day and the market was very choppy.

Setup: 75

Friday missed trade - KBH

I was looking at homebuilders on Friday because they had a very weak opening 15 minute bar. KBH had a nice run up into resistance at 11 on declining volume on the daily chart. It bounced off of 11.20 and put in a tweezer reversal on the 5 and 10 minute charts and a hanging man on the 15. Even if I had got the order in at the break of 11, KBH moved from 11 to 10.9 in about two seconds so I might not have been filled.

Friday trade - AMAT

I traded this as a speculative double bottom. If you buy at a strong support level that is likely to hold, then the worst case is you break even (in theory). Trader Stewie often makes these trades in choppy conditions. AMAT has strong support at 8.5 on the daily chart. This stock tends to move in fifty cent increments. After 25 minutes of AMAT barely moving, I exited at break even. I'm trying to be quicker to fold a trade that isn't working right away. The TICK never broke 100 and it seemed like many traders took a half day. I also didn't like how it wasn't moving in conjunction with USO. It's a bit tricky right now trying to buy support and sell resistance since the levels in the indexes aren't clear yet. I was assuming that 6500 on the Dow would serve as psychological support to some degree. Fortunately we didn't close at the low of the day in the S&P: 666.

Setup: 75

Thursday trade - QQQQ

After my HNT trade this morning not following the market, I opted to trade the Qs this afternoon. I traded what looked like a perfect inverse H&S pattern that turned out to be a headfake. I don't usually trade these so if somebody can critique any problems with the pattern, I'm open to input. Looking back I shouldn't have been expecting much buying before tomorrow's jobs report, but I try to trust these technical patterns.

Setup: 70

Thursday trade - HNT

One of the most annoying trades is where you are right about market direction and timing but the stock you selected does not move with the market. I had one of those trades today and I think you can see what the missing ingredient was. The setup looked pretty good on 10 minute charts with a couple narrow range bars at the base of the open range but there was hardly any volume on the first bar. When a stock doesn't have unusual or at least normal volume it increases the likelihood that it will just drift and not follow the market.

Setup: 55

Wednesday trade - JOYG

I traded JOYG as an open range breakout. I liked the unusual volume (earnings) and the high base that met resistance at 18. I entered on a pullback to 18.05 after seeing the heavy volume on the breakout bar. It started to stall out so I moved my stop to breakeven. I wanted to see more volume come in and I didn't like how choppy the overall market was looking.

Setup: 65

Monday trade - HNT

This is my first day back making actual trades after paper trading some new ideas last month. Of course once I started developing a system for choppy, directionless markets--wouldn't you know it, the market started showing some direction and we had an unusually high number of trending days last month! But now I have another tool in my toolchest and I'm sure it will come in handy.

Starting out this morning it looked like we were in for a slow bleed down to 700. HNT looks like it's in freefall on the daily chart at least until it gets to support at 11. XLV was setting up an h pattern. I shorted HNT at 12.50 with my stop at 12.73. It was very slow to breakdown, but eventually accelerated. Half of me just wanted to cover when the S&P hit 700 but I couldn't ignore what looked like capitulation volume. This was a 1.95R trade. That could have been 4R with more patience but it's nice to start the month with a winner.

Setup:65

GDX - Rising Wedge

That huge volume looks like distribution to me ahead of the strong resistance around 38. Looks like a good place to take some profits off the table if you've been long gold for a while. Just my two cents.

Testing new setups

This month I'm paper trading a couple of simple setups designed to work better in a choppy market. One is fading an extended move to a major support or resistance point and the other is a speculative double top at an important level. It is not the most comfortable way of trading as it feels like you're stepping in front of a bus sometimes, but it seems to have a high win rate. I'm using tape reading to filter out stocks with very high momentum.

Here is an example of the double top setup:

40 is a significant level and the 200 DMA was at 40 on the daily chart. I look for a bearish candlestick in the morning and expect price to get rejected at the same level as long as I don't see too much momentum on the tape. I like to see the tape slow and a mix of red and green (trades being executed at bid and ask).

Market evolution

I've been thinking a lot lately about how dramatically the market has changed over the last year. The overall behavior of markets is a synthesis or average of the behavior of each individual decision maker participating in the market. Those with more capital have a greater influence of course. I think that market participants can be broken down into four categories: hedge funds, mutual funds, retail investors and retail traders. I'm going to ignore the effect of market makers, as their influence has probably remained relatively stable and doesn't apply to Nasdaq stocks.

From 2003-2007, hedge funds were a growing segment. When hedge funds were at their peak, they could produce strong, trending moves as more and more money was poured into the hot sector of the moment (i.e. oil). Today there are far fewer hedge funds left standing after the crash in 2008 and they have less money to manage. I have read that many hedge funds have resorted to intraday trading. According to Hedge Fund Research, the assets under management have declined from a peak of 1.9 trillion in 2008 to 1.4 trillion due to losses and investor withdrawals. This is a significant change.

I view the influence of mutual funds as more random. At the end of the month, they rebalance their portfolios which shows up as sector rotation. When they want to invest in a particular equity or sector I think they basically use programs or bots to buy in over time and I don't believe they pay much attention to technical analysis. Mutual funds control vast quantities of cash so their effect is important in the long term, but I'm not sure if their presence is predictable in the short term. The effect of mutual funds has probably decreased slightly since 2008 as the quantity of cash under their management is less vast. I'm sure that many seniors close to retirement have moved their money to less risky investments and that money will unlikely reenter the market.

If you define a retail investor as someone who invests in the long term and holds for a period of months or years, then I think you would agree that the number of retail investors has declined since 2008.

That leaves the retail trader. From what I've read, this is a fast growing segment. Brokers are gaining customers at a rapid pace. Many believe that buy and hold is dead and that our markets could be rangebound for several years, or even a decade as seen in Japan. The number of traders seeking to gain from intraday price moves has arguably grown considerably over the last year or two as holding anything overnight has become a very risky strategy.

To summarize, the effect of hedge funds is decreasing as there are fewer around and they have less cash under management. Large, trending price moves will likely be a thing of the past in the near future. I've noticed that the average intraday setup is now more likely to only extend to .382 or .500 (for the Fibonacci lovers). Less money at work means less extension. The influence of mutual funds has decreased. More retail investors are evolving into retail traders. Swing traders are becoming intraday traders. The intraday trader who used to hold for two hours is now holding for one. The scalper going for 5 ticks is going for 2. The retail trader segment is becoming very crowded. In the past I think that this segment could be safely ignored as most retail traders were riding on the coattails of the hedge funds. But I think today they (or we) have reached a level where they are starting to shape price movement as all other influences in the marketplace are contracting.

Hopefully this little essay has sparked some reflection on how the market has changed and how we can adapt our strategies to conform to the current market conditions. I think it was possible to trade using the same basic strategy from 2003-2007 but I doubt that there are many traders using the same strategy today as they were using during that period. As traders we must evolve along with the market.

Further reading on Hedge Funds:
http://marc.brightonhouseassociates.com/wordpress/2009/02/demand-increases-for-short-term-highly-liquid-trading-oriented-hedge-fund-strategies/

January Review

I'm done trading for January. My performance has declined over the last few months. I haven't been seeing many good setups and even the ones that look good don't fully extend. And of course when there aren't good setups there is always that temptation to trade less than stellar setups. I overtraded at the beginning of the month because I had too much of a preconceived idea about January's. One would expect an increase in volume and for certain sectors to start pulling ahead of the crowd. This is usually the month when new money goes to work, but that hasn't been the case. Over the last few months I've been trading less and trying to wait it out until conditions improve but now I have to assume that this is how conditions may be for the next few years. I need to find a way to trade low volume, choppy, directionless markets--the achilles heel of any trending system.

I reviewed my trades during a successful period last year. What I noticed was that not many entries were that great, but most trades at least went my way for a little while and I was quick to bale out of trades that weren't doing much. Lately, I've been "going down with the ship" too often and stubbornly staying in trades that I know aren't working in the back of my head. I'm considering using time stops. For example, I will start a stopwatch at the beginning of a trade and move my stop to the point where I would only lose .25R after 10 minutes. Then I would move to break even after commissions after 30 minutes. I'm going to be paper trading some new ideas in February so I might not be posting much...

Weekly SPX chart - disturbing symmetrical triangle

I don't focus much on the long term but I noticed this symmetrical triangle on the weekly SPX chart. If this resolves to the downside, we could see the S&P at 500. It's not too unrealistic if you consider several of the financials/banks could be nationalized like AIG and approach zero.

Having too much directional bias

Am I the only one who has trouble going long? I'm like Paul Giamatti in Sideways, "I am NOT drinking any Merlot!" but substitute drinking any Merlot with going long. That was a stretch, I know. I've heard that a lot of new traders have trouble shorting, but I have the opposite problem. The majority of my trades are shorts. I like how fast stocks can go down. When a stock goes up it pauses retraces, goes up some more, pauses. With a good short you are often in and out on one bar. I don't have any long overnight holdings (except for Motorola, don't ask) so that I can be market neutral, but I'm thinking about actually going long a token amount just so I can even out my bias. Short covering or not, if the market's making a move I should be in on it no matter which way it's going.

Friday trade - WYE

This was a pretty nice setup that didn't work out. I was sensing more choppiness today so I wanted to trade a gapper that was in play so it wasn't as affected by the overall market. WYE broke out but couldn't get past the open range low. I stayed with it because buyers weren't coming in even while the market was beginning a choppy rally. It got stuck in a tight range so I kept tightening my stop. I wasn't sure which way it would break but odds seemed to favor breaking down. It got stopped out before CNBC announced that the merger with PFE was more certain than initially reported in the WSJ, supposedly something will be done Monday. In retrospect I should have just closed out the trade so I could focus on stocks that were actually moving. I told myself I was being patient but I think I was truthfully being stubborn. This one trader always says treat your capital like it's your employees. You don't want your employees standing around doing nothing. I took a small .4R loss but it distracted me from better trades.

Setup:70

Thursday missed trade - DRYS

I have a bad habit of staring at the indexes instead of shuffling through the stocks on my watchlist. I simply missed this divergence between DRYS and QQQQ. You can see at 1:45 that DRYS fails to rally along with the overall market, and the other shippers: EGLE, DSX, and TBSI.

Friday trade - AXP

Going into trading this morning I wanted to be open to the possibility that yesterday was a key reversal day. There was some enthusiastic buying at the open but the TICK never exceeded 554. Financials continue to weigh down this market, so I started focusing on the credit card companies. JPM, MA, and AXP are all headed toward their November lows. There was a nice bear flag in V but I let it go and instead shorted AXP after a couple of narrow range bars with volume contraction. There is also a miniature C&H on the 5 minute chart. I exited as my 3R target was approaching. It looked pretty clear that the PDL would be tested, but I wasn't going to push it. A good trade is like a gift. If someone gave you a $20 gift certificate, would you tell them you were hoping for $40? I'm thankful for a 2.83R trade in this market.

Setup: 75

Wednesday trade - ACI

I traded this as a symmetrical triangle at the base of a wide ranging bar. It was slow to break out, stalling at the ORL, but then it accelerated at 10:30. That's when I remembered about the oil inventory report. I wouldn't normally trade ahead of that but it worked in my favor this time. It felt like a gift, so I exited pretty quick after the thrust down and big volume bars. This was a 1.43R trade. Today was nice because there was no question that I wanted to be short after the weak defense yesterday of the 850 area.

Setup: 65

Tuesday skipped trade - CI

This is a setup I was looking at but today was just insanely choppy and I try not to trade during lunch. Going forward, I'll be focusing on stocks that are "in play" in order to cope with the chop. As much as I like trading stocks on my watchlist that I'm familiar with, if they aren't getting unusual volume, they are going to be off limits.

Thursday skipped trade - CF

This is the trade I would have made if it wasn't such a chopfest today. Break of 53.50 with target of 55. CF was getting a lot more volume than POT and MOS today.

Wednesday chart of note - TIE

This setup is similar to the DRYS trade I made on November 10th. There is just a complete lack of buyers after the move down in the morning. There was probably one buyer showing a lot of size at 8.70 that finally decided to lift. You can see the bearish candlestick at the top of the range on high volume where the bulls threw in the towel. I passed on this one because the risk/reward just wasn't there as I wasn't expecting TIE to get below the strong support at 8.50.

Wednesday skipped trade - DAL

With the choppiness we've been seeing, I've been more hesitant to trade. This isn't really one of my normal setups, but you could see the lower highs and the symmetrical triangle. There is an NR7 on minuscule volume right before the breakout. The overall market was actually moving slightly higher at the time, so I passed.

Monday trade - AAPL

This was a good setup that just didn't work out. I did feel like the overall market was short term overbought at the time, but a couple narrow range bars with volume contraction at the top of the ORH is too good to pass up. I was looking at trading ACI from 19 to 20 (looked very good on the daily charts), but it didn't set up properly.

Setup:70

Fear vs. Greed

I'm feeling philosophical with the start of the new year. I've been thinking about the old axiom that stock prices are moved by fear and greed. But when you think about it, greed can really be thought of as another form of fear. There is the fear of losing money and the fear of missing out on an opportunity to make money. So before you put on a trade you have to accept the risk involved and realize that it is possible for you to lose money. But you also have to be relaxed and not be afraid of missing a big move. Like in surfing, there is always another wave coming right behind the current wave.