Yesterday I took a look at the trading account I started tracking on Covestor in August 2007. What is being tracked is a combination of a couple of IRAs which total about $70,500 at inception -- not a huge amount, but was using it to test some strategies and start creating an online track record. Now starting in about the middle of 2008 I didn't put as much emphasis on this account; one, there weren't that many opportunities to be long stocks during period, and two, there was so much turmoil going on in the markets from July forward, I was spending every second I could on my core trading account. That account has significantly more funds in it and involves going both long and short, while I can only go long in the IRA.
I took a closer look today at this account, because I noticed that my stated rate of return for the tracking on this account as -30% (-22% annualized). I haven't checked it, but it sounds close enough given the calculation methodology. But what is interesting about this situation is that I actually have a positive return on this account. I didn't calculate the exact internal rate of return, but I started with $70,500, made a withdrawal (excess contribution) of about $7,000 in October 2008, and my current balance is about $69,200 (no other deposits or withdrawals). So a quick estimate of the return for the year and five month period is in the neighborhood of 7 percent. Not hall of fame material, but also not particularly bad for an account that traded long only during one of the worst periods in recent history.
Why the seeming discrepancy? Given interest rates, we know that interest on cash wasn't a factor. The main reason is that the traditional investing measures such as Covestor will track the rate of return assuming you are fully invested, ignoring cash balances (which makes sense, because these funds are expected to be fully invested since they are competing with the market indices in general). Whereas being a short-term systems trader, my methods depend much more on the money management and timing aspects -- I am in cash quite a bit, trading less of the account when I have less of an edge, and am scaling into more positions with more of the account when I have more of an edge. So when bad days occur, I am less invested than when good days occur.
This review was also a good reminder for me also that having the cash on hand to be able to scale in to opportune situations is very important to my trading style.
tmantrader
Tuesday, March 3, 2009
Wednesday, December 31, 2008
2008 - Lessons Learned In Pursuit of the Holy Grail of Trading
2008 was a year I'll remember vividly in my trading career, and certainly NOT because I made lots of money in the markets.
It is human nature to look for the holy grail, and traders -- professional or amateur -- are no exception. We all deep down would love to find that one indicator or system that will open the coffers to a lifetime of easy profits. Well, I didn't find the grail, and I probably never will, but that doesn't mean I didn't learn some valuable lessons; moreover, I am absolutely convinced will make my trading and future pursuit of the grail more profitable from what I learned -- much of it through mistakes and the adversity that comes along with those mistakes.
Here are some of the lessons I learned in 2008:
1. The ability to go both long and short has the potential to make you more effective as a trader. It makes your equity curve much smoother. Unfortunately, I didn't implement my short systems until February of 2008 (which makes January that much more painful to think about), but once I did results were remarkably better.
2. Position size matters so much more than you could imagine. Keeping your size small allows you to not worry about specific risk such as corporate or sector risk. Smaller size allows you the flexibility to add to positions as your edge increases. With small positions (1% or less), you also have no need to worry about stops for money management, which increases your edge. And by definition, smaller size gives you more cash. The key is to exploit your edge over thousands of trades as opposed to looking for a home run.
3. Knowing your edge and how you it relate that edge to your overall exposure is not trivial. Why enter trades and expose your account when there is little or no edge to be had? Just because you had room in your portfolio? The market doesn't give setups according to your schedule. And during what situation do you want to have more invested (in terms of bigger positions or more positions), when your edge is higher, or when it is lower?
4. Cash is king. Although you may be concerned you are missing an opportunity on the sidelines, having cash on hand can be absolutely liberating, especially if you think of it in relation to your edge. Cash also helps to reinforce your the mental edge (see 5.) that you will always have be able to pursue an opportunity when it should arise. In my system testing, I have found the very best results seem to come from systems that have less exposure than I would have thought -- this comes from not having to reject good trades when you are fully invested.
Think about how one felt during September and October if he or she had cash to take advantage of the fear going on, versus someone who was trading on margin at the beginning of the period and watched their accounts go down hard, powerless to do anything about it (I speak from experience here).
5. Who cares what the crowd is doing? My very worst decisions come inevitably when I listen to the pundits, read newspapers, watch financial television, and then allow that to impact the game plan I have formed -- especially when my plan has much of its success involves doing things counter to the crowd. Your mind cannot be right if you are paying too much attention to the crowd. Which leads me to the last lesson....
6. Having your mind right is what makes all the other stuff work. If your mind is not right, none of the other stuff matters. You can have the best game plan in the world and it crumbles without the ability to execute during the most intense moments of fear and greed. If your psyche is not right to execute your plan, you should not be involved in the markets. Overexposure, overtrading, thinking you have the ability to predict the markets, listening to the herd, hubris, making execution mistakes -- any of these attributes have the ability to derail a great plan.
It is human nature to look for the holy grail, and traders -- professional or amateur -- are no exception. We all deep down would love to find that one indicator or system that will open the coffers to a lifetime of easy profits. Well, I didn't find the grail, and I probably never will, but that doesn't mean I didn't learn some valuable lessons; moreover, I am absolutely convinced will make my trading and future pursuit of the grail more profitable from what I learned -- much of it through mistakes and the adversity that comes along with those mistakes.
Here are some of the lessons I learned in 2008:
1. The ability to go both long and short has the potential to make you more effective as a trader. It makes your equity curve much smoother. Unfortunately, I didn't implement my short systems until February of 2008 (which makes January that much more painful to think about), but once I did results were remarkably better.
2. Position size matters so much more than you could imagine. Keeping your size small allows you to not worry about specific risk such as corporate or sector risk. Smaller size allows you the flexibility to add to positions as your edge increases. With small positions (1% or less), you also have no need to worry about stops for money management, which increases your edge. And by definition, smaller size gives you more cash. The key is to exploit your edge over thousands of trades as opposed to looking for a home run.
3. Knowing your edge and how you it relate that edge to your overall exposure is not trivial. Why enter trades and expose your account when there is little or no edge to be had? Just because you had room in your portfolio? The market doesn't give setups according to your schedule. And during what situation do you want to have more invested (in terms of bigger positions or more positions), when your edge is higher, or when it is lower?
4. Cash is king. Although you may be concerned you are missing an opportunity on the sidelines, having cash on hand can be absolutely liberating, especially if you think of it in relation to your edge. Cash also helps to reinforce your the mental edge (see 5.) that you will always have be able to pursue an opportunity when it should arise. In my system testing, I have found the very best results seem to come from systems that have less exposure than I would have thought -- this comes from not having to reject good trades when you are fully invested.
Think about how one felt during September and October if he or she had cash to take advantage of the fear going on, versus someone who was trading on margin at the beginning of the period and watched their accounts go down hard, powerless to do anything about it (I speak from experience here).
5. Who cares what the crowd is doing? My very worst decisions come inevitably when I listen to the pundits, read newspapers, watch financial television, and then allow that to impact the game plan I have formed -- especially when my plan has much of its success involves doing things counter to the crowd. Your mind cannot be right if you are paying too much attention to the crowd. Which leads me to the last lesson....
6. Having your mind right is what makes all the other stuff work. If your mind is not right, none of the other stuff matters. You can have the best game plan in the world and it crumbles without the ability to execute during the most intense moments of fear and greed. If your psyche is not right to execute your plan, you should not be involved in the markets. Overexposure, overtrading, thinking you have the ability to predict the markets, listening to the herd, hubris, making execution mistakes -- any of these attributes have the ability to derail a great plan.
Wednesday, October 1, 2008
October 2008: Learning from Adversity in the Markets
The week of October 6 was the worst trading week of my life and at the time I thought it might have been one of the worst weeks of my life period. I experienced first hand what was possible in the market during a bad time.
A recently as week earlier, I had hit new equity highs in all my accounts. I had actually come all the way back from the November 2007/January 2008 periods by implementing and sticking to a set of strong and steady trading systems. I was even starting to use some discretion because things were working so well (who says you can't predict the markets?). Life seemed pretty good, my confidence was high, although I admit some of the headlines were starting to bother me.
My account was starting to fill with positions, and my systems were calling me to scale into more positions. What happens next? The market after some fakes up, can't seem to hold any gains. I had seen this before, right? While it was happening I was scaling into even more positions and at points even bought into the market indices more broadly -- even to the point of using margin, much more than my own methods would allow for (instead of perhaps hedging the positions I already had given I was getting into so many). I had seen this before -- it was clear to me that the market was obviously coming back once everybody panicked and sold all they wanted to sell, right?
Well, we all saw what happened next -- this market goes on to post the worst week in history. In a span of five days, I lost over 22% of my accounts and everything I had worked so hard during the year to make and then some just vanished...and I still had exposure going into the weekend.
I was scared and sick to my stomach. I had feelings of guilt, despair, and emptiness -- you name the negative emotion, and I was experiencing it. I had reached the so called uncle point, that next Monday I started to divest myself of most of my positions.
Of course, within a couple of days, things start to come back with a vengeance, and I missed it out on it. I was even on the wrong side of the comeback on a few trades as I sold into the strength. You can imagine the thoughts that went through my mind -- I couldn't print them.
It was obviously time to regroup. There were times during the next week where I considered stopping, but after thinking it all the way through, I was determined to come back better for it. During the next week I calmed down, and started to replay everything -- review my trades, run my backtests to see if what I would have expected to happen actually happened.
One of the things I found during my review was had I followed my system without the massive overexposure, I would have experienced a drawdown of over 10%, but within a week or two I would have actually been at a new high again! Instead, since my emotions got the better of me, I abandoned what I knew was appropriate at exactly the wrong time. My whole strategy revolves around patience -- buying into fear and selling into greed -- and I was forced into doing just the opposite because of my own hubris.
The question going forward was: could I use this experience to learn from my mistakes?
A recently as week earlier, I had hit new equity highs in all my accounts. I had actually come all the way back from the November 2007/January 2008 periods by implementing and sticking to a set of strong and steady trading systems. I was even starting to use some discretion because things were working so well (who says you can't predict the markets?). Life seemed pretty good, my confidence was high, although I admit some of the headlines were starting to bother me.
My account was starting to fill with positions, and my systems were calling me to scale into more positions. What happens next? The market after some fakes up, can't seem to hold any gains. I had seen this before, right? While it was happening I was scaling into even more positions and at points even bought into the market indices more broadly -- even to the point of using margin, much more than my own methods would allow for (instead of perhaps hedging the positions I already had given I was getting into so many). I had seen this before -- it was clear to me that the market was obviously coming back once everybody panicked and sold all they wanted to sell, right?
Well, we all saw what happened next -- this market goes on to post the worst week in history. In a span of five days, I lost over 22% of my accounts and everything I had worked so hard during the year to make and then some just vanished...and I still had exposure going into the weekend.
I was scared and sick to my stomach. I had feelings of guilt, despair, and emptiness -- you name the negative emotion, and I was experiencing it. I had reached the so called uncle point, that next Monday I started to divest myself of most of my positions.
Of course, within a couple of days, things start to come back with a vengeance, and I missed it out on it. I was even on the wrong side of the comeback on a few trades as I sold into the strength. You can imagine the thoughts that went through my mind -- I couldn't print them.
It was obviously time to regroup. There were times during the next week where I considered stopping, but after thinking it all the way through, I was determined to come back better for it. During the next week I calmed down, and started to replay everything -- review my trades, run my backtests to see if what I would have expected to happen actually happened.
One of the things I found during my review was had I followed my system without the massive overexposure, I would have experienced a drawdown of over 10%, but within a week or two I would have actually been at a new high again! Instead, since my emotions got the better of me, I abandoned what I knew was appropriate at exactly the wrong time. My whole strategy revolves around patience -- buying into fear and selling into greed -- and I was forced into doing just the opposite because of my own hubris.
The question going forward was: could I use this experience to learn from my mistakes?
Tuesday, July 1, 2008
Stock Selection - Using the Wisdom of the Market Masters
How do you go about selecting stocks?
That always seems to be the million dollar question. "Do you use a stock picking strategy for your longer term holdings? You do? Why bother? You do know that nobody beats the market, right. Do you know that 80% of fund investors do not beat the S&P? Why wouldn't you buy a low fee index fund and get out of the way?"
Fair enough. Who can argue with that? We always know what investing in the S&P 500 would have gotten us, versus investing with a mutual fund manager. Plus you get a lot of popular stocks and a lot of the big names you hear in the media: Apple, Citigroup, Exxon/Mobil, GE, IBM, Microsoft. Seems like the way to go, right?
It's definitely well known (and true) that the decision to be in the market is definitely the majority of the battle, and explains a good portion of returns for those who are successful. But I also believe there is a lot of wisdom out there that makes a strong case for having a stock selection strategy other simply buying the market itself -- a couple of extra percentage points on your return over a period of many years can make the difference between being good and being rich.
Whether you like it or not, investing in a market index like the S&P500 is a strategy. That strategy is: Buy the 500 largest capitalization stocks in the market, make the size of each position proportional to the stock's market capitalization... and then reinvest and rebalance over time as the situation changes.
There are lots of other strategies put forth by a lot of the some of the greatest investors of our time ( the "market masters") that when backtested, seem to have done significantly better over long periods of time than buying the S&P 500 index, at least when you test these strategies back over the last 50 years or so. Why not take the advice of these gurus when picking stocks?
If I am going to buy a stock for an investment (that is, something I plan on holding for more than a week), I am certainly going to attempt to use those strategies that have proven some success. Whether or not that success continues, I do not know. But I certainly plan on using what I know.
How do I tap into the thinking of the market masters? You can start by reading books by them and/or about them....here are some books to start with.
Some Investing Books from the Market Masters
Super Stocks, and The Only Three Questions That Count, by Kenneth Fisher. Fisher manages over $50 billion, was the pioneer of the price to sales ratio as a criterion for picking stocks. He does not think with the herd and debunks all kinds of commonly accepted thinking in his books. For example, buying stocks while P/E ratios are low must be better than buying them high, right? Read the book to debunk this myth and others.
Security Analysis, and The Intelligent Investor, by Benjamin Graham. Two classics. Security Analysis is the bible for value investors. Graham is ultraconservative; in fact, he is so conservative it is tough to find stocks these days that meet his criteria (maybe that should tell us something about today;s market!)
The Little Book That Beats The Market, by Joel Greenblatt. Short, simply written read by one of the country's most successful hedge fund manager (Greenblatt averaged over 40% a year in his hedge fund picking undervalued stocks). A great, simple system for picking value stocks while spending very little time doing it.
John Neff on Investing, by John Neff. Neff managed the Vanguard Windsor Fund for years, a pure value investor who shares his thinking into how to find those really undervalued, beaten down opportunities.
How to Make Money in Stocks, by William O'Neil. A classic for momentum investors from the creator of the CANSLIM system and founder of Investors Business Daily; timeless rules on how to make (and not to lose) money in the stock market. O'Neil's track record is incredible.
What Works on Wall Street, by James O'Shaughnessy. O'Shaughnessy has done a fantastic job on research going back to 1950 (through 1996), backtesting every strategy you can think of, in most cases debunking a lot of the ones that get the most press. He has proven out stock picking strategies that are a great combination of growth and value, and outperform over the long run. I love the approach because it is backed up by good, solid data.
One Up on Wall Street and Beating The Street, by Peter Lynch. Over his 13 year tenure as the manager of Fidelity Magellan Fund, he was the top-ranked fund manager (and probably the most famous). In Beating The Street, Lynch takes the reader step by step through his process of selecting stocks for the Barron's roundtable in which he participated in.
Winning on Wall Street, by Martin Zweig. Zweig was an academic and a very successful fund manager. The insights he provides are tremendous. Very rigorous methods for finding growth at a reasonable price (as an aside, if you look at the past 10 years worth of performance data on the Zweig stock screen on the AAII site, the results are jawdropping). Also has some solid thinking on how to take macroeconomic variables into consideration when investing (economy, inflation, interest rates, fed policy, etc).
AAII. I cannot say enough good things about AAII (American Association of Individual Investors). I got an AAII lifetime membership for $360 and it is the best money I have ever spent. The website has stock screens for most all of the strategies of the market masters above which alone is worth the price, and the AAII Journal and Computerized Investing publications are great resources that give practical advice (not hype) to the individual investor for making money in stocks. http://www.aaii.com/
Magic Formula Investing. The companion to The Little Book that Beats the Market. This site has the database with the top 100 picks using the magic formula from the book at any point in time. And it is FREE, all you have to do is register. http://www.magicformulainvesting.com/
Value Line. I subscribe to Value Line -- it is expensive ($299/yr), but worth it. Value Line comes with a weekly publication that ranks its database of 3,500+ stocks -- uses a scale from 1 to 5 in three areas: Timeliness, Safety, and Technical. It has all kinds of historical data on earnings, balance sheet, multiples, ratios, etc.....and the website has a very powerful screening tool which allows you to access and export the data. http://www.valueline.com/
That always seems to be the million dollar question. "Do you use a stock picking strategy for your longer term holdings? You do? Why bother? You do know that nobody beats the market, right. Do you know that 80% of fund investors do not beat the S&P? Why wouldn't you buy a low fee index fund and get out of the way?"
Fair enough. Who can argue with that? We always know what investing in the S&P 500 would have gotten us, versus investing with a mutual fund manager. Plus you get a lot of popular stocks and a lot of the big names you hear in the media: Apple, Citigroup, Exxon/Mobil, GE, IBM, Microsoft. Seems like the way to go, right?
It's definitely well known (and true) that the decision to be in the market is definitely the majority of the battle, and explains a good portion of returns for those who are successful. But I also believe there is a lot of wisdom out there that makes a strong case for having a stock selection strategy other simply buying the market itself -- a couple of extra percentage points on your return over a period of many years can make the difference between being good and being rich.
Whether you like it or not, investing in a market index like the S&P500 is a strategy. That strategy is: Buy the 500 largest capitalization stocks in the market, make the size of each position proportional to the stock's market capitalization... and then reinvest and rebalance over time as the situation changes.
There are lots of other strategies put forth by a lot of the some of the greatest investors of our time ( the "market masters") that when backtested, seem to have done significantly better over long periods of time than buying the S&P 500 index, at least when you test these strategies back over the last 50 years or so. Why not take the advice of these gurus when picking stocks?
If I am going to buy a stock for an investment (that is, something I plan on holding for more than a week), I am certainly going to attempt to use those strategies that have proven some success. Whether or not that success continues, I do not know. But I certainly plan on using what I know.
How do I tap into the thinking of the market masters? You can start by reading books by them and/or about them....here are some books to start with.
Some Investing Books from the Market Masters
Super Stocks, and The Only Three Questions That Count, by Kenneth Fisher. Fisher manages over $50 billion, was the pioneer of the price to sales ratio as a criterion for picking stocks. He does not think with the herd and debunks all kinds of commonly accepted thinking in his books. For example, buying stocks while P/E ratios are low must be better than buying them high, right? Read the book to debunk this myth and others.
Security Analysis, and The Intelligent Investor, by Benjamin Graham. Two classics. Security Analysis is the bible for value investors. Graham is ultraconservative; in fact, he is so conservative it is tough to find stocks these days that meet his criteria (maybe that should tell us something about today;s market!)
The Little Book That Beats The Market, by Joel Greenblatt. Short, simply written read by one of the country's most successful hedge fund manager (Greenblatt averaged over 40% a year in his hedge fund picking undervalued stocks). A great, simple system for picking value stocks while spending very little time doing it.
John Neff on Investing, by John Neff. Neff managed the Vanguard Windsor Fund for years, a pure value investor who shares his thinking into how to find those really undervalued, beaten down opportunities.
How to Make Money in Stocks, by William O'Neil. A classic for momentum investors from the creator of the CANSLIM system and founder of Investors Business Daily; timeless rules on how to make (and not to lose) money in the stock market. O'Neil's track record is incredible.
What Works on Wall Street, by James O'Shaughnessy. O'Shaughnessy has done a fantastic job on research going back to 1950 (through 1996), backtesting every strategy you can think of, in most cases debunking a lot of the ones that get the most press. He has proven out stock picking strategies that are a great combination of growth and value, and outperform over the long run. I love the approach because it is backed up by good, solid data.
One Up on Wall Street and Beating The Street, by Peter Lynch. Over his 13 year tenure as the manager of Fidelity Magellan Fund, he was the top-ranked fund manager (and probably the most famous). In Beating The Street, Lynch takes the reader step by step through his process of selecting stocks for the Barron's roundtable in which he participated in.
Winning on Wall Street, by Martin Zweig. Zweig was an academic and a very successful fund manager. The insights he provides are tremendous. Very rigorous methods for finding growth at a reasonable price (as an aside, if you look at the past 10 years worth of performance data on the Zweig stock screen on the AAII site, the results are jawdropping). Also has some solid thinking on how to take macroeconomic variables into consideration when investing (economy, inflation, interest rates, fed policy, etc).
Data Sources
Where do I get the data in order to pick stocks which meet the guru's criteria? Everything you need is on the internet. Here are some sources I use.AAII. I cannot say enough good things about AAII (American Association of Individual Investors). I got an AAII lifetime membership for $360 and it is the best money I have ever spent. The website has stock screens for most all of the strategies of the market masters above which alone is worth the price, and the AAII Journal and Computerized Investing publications are great resources that give practical advice (not hype) to the individual investor for making money in stocks. http://www.aaii.com/
Magic Formula Investing. The companion to The Little Book that Beats the Market. This site has the database with the top 100 picks using the magic formula from the book at any point in time. And it is FREE, all you have to do is register. http://www.magicformulainvesting.com/
Value Line. I subscribe to Value Line -- it is expensive ($299/yr), but worth it. Value Line comes with a weekly publication that ranks its database of 3,500+ stocks -- uses a scale from 1 to 5 in three areas: Timeliness, Safety, and Technical. It has all kinds of historical data on earnings, balance sheet, multiples, ratios, etc.....and the website has a very powerful screening tool which allows you to access and export the data. http://www.valueline.com/
Validea.com. This is a pretty cool site. For $299 / yr, you can access a database of all stocks and see how they do using some of the screens of the market masters. validea.com grades each stock on how it does against the formula. The founder of the site wrote a very interesting book about Market Gurus. http://www.validea.com/
wsj.com Online version of the Wall Street Journal. You have to be a subscriber to the Journal to get access to this, but it is well worth it (I love reading the paper as well). http://www.wsj.com/
Yahoo! Finance. Best source of free data on the internet for stock data...news, quotes, charts, research, analyst data. finance.yahoo.com . Their free data is better than most of the sites you have to pay for. Enough said.Sunday, June 15, 2008
Active Traders -- Resources to Get You Started
As I got started into active trading and started to develop my trading style and specific strategies, I spent hundreds of hours and read dozens of books on the subject. Here are two traders that have some great resources out there in the form of books and websites.
How Markets Really Work: A Quantitative Guide to Stock Market Behavior, by Larry Connors.
All traders wonder if the setups they use actually make you money...breakouts, momentum, trend, counter-trend, sentiment, volatility, high volume days....how well do these setups really work and do they lead to better trades? Connors takes years of data, and debunks lots of the investing myths and backs it up with years worth of data and backtesting.
Connors also co-founded TradingMarkets.com, which has great active trading resources -- articles on new research and ideas, some very good subscription services for trading indicators and data which provide short-term edges, and some very good trading courses and books.
Trade Like a Hedge Fund, by James Altucher. Altucher is a contributor to TheStreet.com, managing partner for Formula Capital (a fund of hedge funds), writes a weekly column for the Financial Times , and runs the website stockpickr.com (which is part of the The Street.com network).
In this book he shows 20 different, non-correlated trading strategies -- and he backtests these ideas on the Wealth-Lab Pro platform. Altucher also picks strategies that go against the conventional wisdom and they are backed by data and testing.
On stockpickr.com there are lots of ideas for picking winning trades. In particular I like the Active Trader section of the website. It has signals for each of the systems they trade, historical results, and even the Wealth-Lab pro code. Good stuff....
How Markets Really Work: A Quantitative Guide to Stock Market Behavior, by Larry Connors.
All traders wonder if the setups they use actually make you money...breakouts, momentum, trend, counter-trend, sentiment, volatility, high volume days....how well do these setups really work and do they lead to better trades? Connors takes years of data, and debunks lots of the investing myths and backs it up with years worth of data and backtesting.
Connors also co-founded TradingMarkets.com, which has great active trading resources -- articles on new research and ideas, some very good subscription services for trading indicators and data which provide short-term edges, and some very good trading courses and books.
Trade Like a Hedge Fund, by James Altucher. Altucher is a contributor to TheStreet.com, managing partner for Formula Capital (a fund of hedge funds), writes a weekly column for the Financial Times , and runs the website stockpickr.com (which is part of the The Street.com network).
In this book he shows 20 different, non-correlated trading strategies -- and he backtests these ideas on the Wealth-Lab Pro platform. Altucher also picks strategies that go against the conventional wisdom and they are backed by data and testing.
On stockpickr.com there are lots of ideas for picking winning trades. In particular I like the Active Trader section of the website. It has signals for each of the systems they trade, historical results, and even the Wealth-Lab pro code. Good stuff....
Friday, May 16, 2008
Beeks System -- Rules
Rules for the Beeks system (as of January 2008)
Beeks is a primarily a momentum system, which looks for stocks in an uptrend...but at the same time is a shorter term countertrend system, looking for stocks that have taken a quick breather, attempting to get back in as the stock gets its second wind and takes off on that next leg up.
Entry criteria:
- Stock must be behaving well; that is, RSI needs to be in "overbought" range at some point over the last month.
- The stock then needs to have slowed, as measured by 3 to 4 down (or very small up) closes.
- Volume condition: Average volume over last month must be over 100,000 shares, but the prior day's volume needs to be not more than 3 times the average volume over the past month.
- Volatility: this system takes higher volatility stocks as measured by the stock's average true range -- the range needs to be at least 2-2.5%.
Exit criteria:
Exit at some point the day following two consecutive up closes; or a break of the 5 day SMA. Do not hold for any longer than 5 days.
Position Sizing. There are no stops in this system; all risk management is done through position sizes -- so any one position should never be over 5% of your trading assets -- and preferably would be less.
Knish System -- Rules
Rules for the Knish system (as of December, 2007)
Knish is a mean reversion system, looking to capitalize on stocks ready for a quick rebound after being "overly stretched downward".
Entry. Knish uses two methods to determine potential trade entries:
1) A streak. You may enter the day after five consecutive down days, with the condition that the difference of yesterday's close (Bar) and the previous day's close (Bar - 1) is greater than the day before yesterday's close (Bar - 1) and the close of the day preceding (Bar - 2).
2) A band violation. A buy can be be executed if the price goes outside the difference of the highest high of the last 13 days less the lowest low of the last 13 days by at least 24% of that range (the "band").
Filters. Both entry conditions have additional prerequisites, or filters:
1) Oversold. The 11 period RSI must be "oversold" (I use an RSI value of 33 or less);
2) Trend Filter. The longer term trend must be up (Close > 200 day MA). Exception: except if the streak condition has reached seven or more down days, at which point entry is still allowed, if the streak condition in 1) is still met.
3) Band/Volatility filter. In order to make the trade worthwhile, the band needs to be at least 5/8 of 1% of the limit price (since it is the profit target).
Exits. Knish trades have multiple conditions for an exit.
1) Profit target hit. Price rises by 100% of the "band" that is calculated band violation condition in the entry criteria.
2) A two day up streak. Sell at market the following open after two up closes in a row.
3) Rate of change drops below average after 5 days held. If the trade has been held for at least 5 bars, and the one day rate of change is below the average (geometric average) rate of change for the last five days, then exit the trade.
4) Stop hit. The stop is a wide stop - 5 times the "band". It's not meant to be hit as much as it is to prevent a meltdown.
5) Time stop. A trade will not last more than 10 days.
Knish will then review candidates, favoring those with lower RSI, and stocks that that are less correlated to positions already in the portfolio. Only two positions in a security can be open at one time.
Knish is a mean reversion system, looking to capitalize on stocks ready for a quick rebound after being "overly stretched downward".
Entry. Knish uses two methods to determine potential trade entries:
1) A streak. You may enter the day after five consecutive down days, with the condition that the difference of yesterday's close (Bar) and the previous day's close (Bar - 1) is greater than the day before yesterday's close (Bar - 1) and the close of the day preceding (Bar - 2).
2) A band violation. A buy can be be executed if the price goes outside the difference of the highest high of the last 13 days less the lowest low of the last 13 days by at least 24% of that range (the "band").
Filters. Both entry conditions have additional prerequisites, or filters:
1) Oversold. The 11 period RSI must be "oversold" (I use an RSI value of 33 or less);
2) Trend Filter. The longer term trend must be up (Close > 200 day MA). Exception: except if the streak condition has reached seven or more down days, at which point entry is still allowed, if the streak condition in 1) is still met.
3) Band/Volatility filter. In order to make the trade worthwhile, the band needs to be at least 5/8 of 1% of the limit price (since it is the profit target).
Exits. Knish trades have multiple conditions for an exit.
1) Profit target hit. Price rises by 100% of the "band" that is calculated band violation condition in the entry criteria.
2) A two day up streak. Sell at market the following open after two up closes in a row.
3) Rate of change drops below average after 5 days held. If the trade has been held for at least 5 bars, and the one day rate of change is below the average (geometric average) rate of change for the last five days, then exit the trade.
4) Stop hit. The stop is a wide stop - 5 times the "band". It's not meant to be hit as much as it is to prevent a meltdown.
5) Time stop. A trade will not last more than 10 days.
Knish will then review candidates, favoring those with lower RSI, and stocks that that are less correlated to positions already in the portfolio. Only two positions in a security can be open at one time.
Thursday, May 15, 2008
My Active Trading Systems
I have done a lot of system testing over the last year. I use Wealth-Lab Pro as my testing platform. At this point I trade two systems which I have developed using ideas I have gained from trading books. I have even given these systems names!
My Active Trading Systems
Knish. This is a mean reversion system, that attempts to take weak, recently "oversold" stocks as measured by the 14 day RSI ( or relative strength index ) that have had a streak of one week's down closes, or the lowest low over a two week period and bets on a short term swing up. It takes profits via a profit target or after two up closes. It is looking to grind out small profits.
Beeks. This is also a mean reversion system; however, this system looks for stocks that are aggressively and efficiently trending higher, and that have had a pullback over the last three to four days, looking for that burst up shortly thereafter. This system is more volatile because it does not take a profit target and exits on two up closes, but is also looking to grind out lots of small profits over time.
I will write up summaries of the rules of these in later posts.
My Active Trading Systems
Knish. This is a mean reversion system, that attempts to take weak, recently "oversold" stocks as measured by the 14 day RSI ( or relative strength index ) that have had a streak of one week's down closes, or the lowest low over a two week period and bets on a short term swing up. It takes profits via a profit target or after two up closes. It is looking to grind out small profits.
Beeks. This is also a mean reversion system; however, this system looks for stocks that are aggressively and efficiently trending higher, and that have had a pullback over the last three to four days, looking for that burst up shortly thereafter. This system is more volatile because it does not take a profit target and exits on two up closes, but is also looking to grind out lots of small profits over time.
I will write up summaries of the rules of these in later posts.
Thursday, May 1, 2008
Why Consider Active Trading?
Good question. You hear about traders -- there are "rags to riches" stories; there also stories about those who mortgaged the house, only to lose it in a day trading account?
What are my beliefs about active trading, versus buy and hold?
Consider the following scenario?
So in this example, risking 10% of our portfolio, our total return has gone from 3% to 7.5%!! And we were 90% in T-bills.
What are my beliefs about active trading, versus buy and hold?
Consider the following scenario?
- You have been given a balance of 100,000 to invest. Let's also assume you can earn a "risk-free" rate of return (U.S. treasury bills) of around 3% (let's ignore the ravages of inflation for now because that hits any investment denominated in US Dollars). If you do nothing else, you will earn this 3% per year.
- You have been convinced by a friend to start actively trading a small piece of your account. You've told your friend that you are willing make one trade at a time, but you are limited to investing 10% of your portfolio (using the balance at the beginning of the year for this calculation). The other 90% you are going to keep in the T-bills.
- In this friend's "system", you will have streaks of winners and losers, but on average throughout the year you will earn on average of 1% return per trade (after commissions). Each trade will on average last a week, or five trading days.
For simplicity's sake, let's assume there are 240 trading days in a year.
Let's calculate the rate of return on your portfolio with hypothetical system assuming our returns are "smooth" -- that is, we earn the average on every trade, have no taxes involved (what a world!) and occur exactly as planned.
- 240 days/5 days per trade = 48 trades per year.
- 10% of the portfolio is in active trading...assuming a rate of 0.5% average return per trade over 48 trades = 1.0% x 48 x 10% = 4.8%
- 90% continues to be in the risk free investment, so 90% times 3% = 2.7%
- 4.8% for 10% of portfolio + 2.7% for 90% = 7.5%
So in this example, risking 10% of our portfolio, our total return has gone from 3% to 7.5%!! And we were 90% in T-bills.
Now, you say, c'mon, tman, get real...you couldn't really achieve returns like you discuss in your example. Let's discuss the concerns.
These types of returns don't occur uniformly each year -- there are some major ups and downs, just as in long-term investing. This is most certainly true -- we would have to endure some major swings with that 10%. But if over long periods of time, if we could achieve these types of returns, and our drawdowns weren't any higher than they would be being "buy and hold" investors (and let's be honest, there are some big drawdowns in "buy and hold" stock investing), we could probably live with that concern. Remember in our hypothetical account we were also holding 90% T-bills - which give us some cushion for the other 10%.
What makes you think there are systems that can achieve that rate of return? Good question. The only thing is I can say is that I have seen these types of systems and have developed and tested some of them myself. And some of them have opportunities to make even more money than 1.0% per trade.
So, this might give some insight as to why I am at least interested in pursuing the benefits of active trading. I might be willing and able with a piece of my portfolio to increase my returns and reduce my risk. If I am willing to swing for the fences, I even increase the amount I put into it. Who can resist the thought? I, for one, cannot.
Tuesday, April 1, 2008
Hedge Funds as an Alternative Investment
There is a lot of talk in the media about hedge funds -- lots of it hype, lots of attention to the ones that go bust.
Hedge funds in general can be a great place to put money. By U.S. law, one has to be an "accredited investor" in order to have access to a hedge fund. Hedge funds are not subject to as many rules and regulations as mutual funds so there is a lot more flexibility involved in the strategies they can employ. On the other hand, that flexibility can sometimes involved risk, so it is more important that one does a lot of due diligence when choosing this as an investment.
Many hedge funds strive for zero correlation with other asset classes, while still creating positive return above and beyond the market, or alpha. Obviously a non-correlated, high performing asset class is incredibly handy for leveling out the "dips" in your equity curve if you own more traditional assets such as stocks and bonds.
Hedge funds apply a variety of strategies with attractive returns that are independent of traditional stock and bond investments: these include merger/arbitrage, long/short (they can sell stock they don't own), relative value investing, and trend following strategies. They can buy commodities, mortgages (even sub-prime mortgages!), collectibles, real estate -- and anything you can think of.
Hedge funds may or may not be risky -- much of that depends on how much leverage they use; by that do they invest using borrowed money, or margin (controlling a larger amount of the asset with a small amount of money put down). Beware of those that use margin -- it is a double edges sword; on the other hand hedge funds that don't use margin may be less risky in many cases than their mutual fund competitors.
Hedge funds in general can be a great place to put money. By U.S. law, one has to be an "accredited investor" in order to have access to a hedge fund. Hedge funds are not subject to as many rules and regulations as mutual funds so there is a lot more flexibility involved in the strategies they can employ. On the other hand, that flexibility can sometimes involved risk, so it is more important that one does a lot of due diligence when choosing this as an investment.
Many hedge funds strive for zero correlation with other asset classes, while still creating positive return above and beyond the market, or alpha. Obviously a non-correlated, high performing asset class is incredibly handy for leveling out the "dips" in your equity curve if you own more traditional assets such as stocks and bonds.
Hedge funds apply a variety of strategies with attractive returns that are independent of traditional stock and bond investments: these include merger/arbitrage, long/short (they can sell stock they don't own), relative value investing, and trend following strategies. They can buy commodities, mortgages (even sub-prime mortgages!), collectibles, real estate -- and anything you can think of.
Hedge funds may or may not be risky -- much of that depends on how much leverage they use; by that do they invest using borrowed money, or margin (controlling a larger amount of the asset with a small amount of money put down). Beware of those that use margin -- it is a double edges sword; on the other hand hedge funds that don't use margin may be less risky in many cases than their mutual fund competitors.
Saturday, December 15, 2007
Establishing a Track Record
Part of this process is to establish an audited track record. I am beginning that process by using covestor.com .
Covestor is a 2007 startup that allows members to create audited track records of their trades, allowing them to gain recognition (and in the future earn fees from their recommendations). The site allows members to track others' performance and follow the trades that they make. Membership to Covestor is free.
You can record your trades on the site manually after you make them, or you can "auto-confirm" trades via a download from your brokerage (extremely cool), which will then update the Covestor site about 15 minutes after you trade (they work with most of the major brokerages). The connection to your brokerage is secure; Covestor works with Yodlee (a major provider of data aggregation technology) to create a "one-way" view of your data.
Your identity and individual data can remain private; also, Covestor 'normalizes' your investments so that people are seeing scaled trades instead of actual amounts (they do label your account as a 'small', 'medium', or 'large' account however for purposes of tracking). You can also choose whether to allow your picks to be accessed by anyone on the web, or by members only. Good stuff.
More about Covestor: http://www.covestor.com/about/news
To start my track record, I am starting with a couple of small IRAs: my IRA and my wife's IRA. This is an active trader account -- trades held anywhere between 2 to 10 days. The represents about 10% of active trading assets. You see the Covestor widget on the right hand side of the blog -- click to see my performance. This account is very aggressive and has wild fluctuations in account equity -- it is not representative of my investment results (whether it is doing well or not).
I plan to add my more traditional investment accounts and larger accounts later. But I needed to start somewhere.
My track record for my IRA trading account: My Track Record
Covestor is a 2007 startup that allows members to create audited track records of their trades, allowing them to gain recognition (and in the future earn fees from their recommendations). The site allows members to track others' performance and follow the trades that they make. Membership to Covestor is free.
You can record your trades on the site manually after you make them, or you can "auto-confirm" trades via a download from your brokerage (extremely cool), which will then update the Covestor site about 15 minutes after you trade (they work with most of the major brokerages). The connection to your brokerage is secure; Covestor works with Yodlee (a major provider of data aggregation technology) to create a "one-way" view of your data.
Your identity and individual data can remain private; also, Covestor 'normalizes' your investments so that people are seeing scaled trades instead of actual amounts (they do label your account as a 'small', 'medium', or 'large' account however for purposes of tracking). You can also choose whether to allow your picks to be accessed by anyone on the web, or by members only. Good stuff.
More about Covestor: http://www.covestor.com/about/news
To start my track record, I am starting with a couple of small IRAs: my IRA and my wife's IRA. This is an active trader account -- trades held anywhere between 2 to 10 days. The represents about 10% of active trading assets. You see the Covestor widget on the right hand side of the blog -- click to see my performance. This account is very aggressive and has wild fluctuations in account equity -- it is not representative of my investment results (whether it is doing well or not).
I plan to add my more traditional investment accounts and larger accounts later. But I needed to start somewhere.
My track record for my IRA trading account: My Track Record
Saturday, December 1, 2007
Why This Blog?
As I strive to become a better investor, trader, and financial expert, I anticipate several needs that this blog may be able to help address:
- A need to journal my trades. If I am going to become a better trader, I need to write down my trades and my rationale. That way I am accountable and I am forced to reflect on my learnings and mistakes. Creating this blog is the beginning of that process -- it provides a very convenient vehicle for creating a journal by day, and to do it in a more public way (the accountability part!).
- A need to crystallize my ideas and thoughts. As I read and experiment, I find that have all kinds of ideas that I need to get down in writing -- what looks interesting, what I might give a try, what ideas might I need to test further, where the resources are that might help me....many times I find if I don't get them down, some of them just vanish into thin air (especially the older I get).
- A potential way to build credibility. I don't know where this journey will take me -- I am hopeful I will continue to become more effective in managing my own investments well, but there is the possibility of going beyond that -- if I ever am going to take a more "public" path -- perhaps become a financial planner, investment adviser, or financial writer, I will need to be able to effectively and lucidly express my strategies in order to establish credibility with others.
- Giving others ideas. I have spent a lot of time reading and researching ideas to make outsized rates of return. I would like for others to get the benefits of my own insights -- especially those who are newer and might be following along (empathy!!!) -- maybe I can suggest strategies, investments, reading material, websites, and/or other resources to help others get an edge.
Next: another thing I have a high degree of urgency around is establishing an audited track record. I'll talk more about that in the next entry.
Thursday, November 1, 2007
Leaving the Rat Race to Trade
You want to do WHAT?
In 2006, the time had come. After nearly 20 years in my industry, at the age of 42 -- I was seriously considering leaving my job in corporate America in what was one of the more challenging decisions I have ever made. A month later, after careful consideration, it was done: I would retire and leave the rat race in the middle of the year. No more working for "the man".
There were a lot of reactions from the people I told -- many reacted in amazement, some thought I must have a secret job lined up (can we join you?), some thought I must have been fired (management layoff, scandal perhaps?), maybe I'd just gone off the deep end (like I hadn't heard that before). After all, over the last 18 years, I had rapidly worked my way through the ranks, became a partner in the business....and through the rapid growth of the company and my own advancement, I found myself managing the second largest regional office of a Fortune 1000 company -- and the world's largest human resources consulting and outsourcing firms. I was the operations head of a group of over 2,000 employees.
Then as I explained what I was thinking to others, the conversation got into: "Don't be ridiculous. Why in the *** would you give up your job -- who leaves a job like that? What are you thinking--have you really thought it through? Do you have enough money? What does your wife and your family think? Do you really know what you are doing? You realize you've been in management a long time -- do you have any real world skills? What if you change your mind? Are you really going to leave behind us and the people you work with?" I will admit these were darned good questions...I was not really sure the answers to all of them, and I was certainly dazed and confused.
What I was sure of....was that I was mentally and emotionally tired. Tired of the long hours and the pressure. Tired of answering to corporate on minutiae and spending time on "administrivia" that did not benefit my clients. Tired of having to 'reorganize' and 'downsize' to squeeze out as much money as possible for short-term thinkers. As much autonomy as I had (after all I was the boss!), I felt trapped, not intellectually stimulated.
What's interesting is that I had remembered reading a book during the late 90's about a former Peat Marwick audit partner that had done "bare bones" retirement at age 35 -- he and his wife decided to downsize and travel the world. While I wasn't quite in the same financial conundrum, I did find a lot of parallels as I went back and re-read it (if you're interested : Cashing In on The American Dream , by Paul Terhorst). It was very motivating because it validated for me that I could leave a "good" job in order to pursue what I really wanted to do.
In my current job I had a strong group of successors in place and a good candidate to take my job, so I could rest assured the company was in good hands and I wasn't in danger of destroying what I had worked hard to help build (that was important to me), and I had provided enough notice not to leave the company in a short-term lurch.
My wife and kids were extremely supportive (granted, I'm not sure the kids really knew what it meant, other than I wouldn't be going to my office any more -- but maybe Daddy wouldn't be as "stressed out"!). From a financial standpoint, I was very fortunate in that I had the financial wherewithal to leave; our company had recently gone public and had done reasonably well over the past five years. I wouldn't describe my status as "wealthy", but I could say we will have enough if I can manage our affairs appropriately -- but if I don't, heck, I can always go back to work for "the man" if I need to, right :-)
So I shut my eyes, held my nose, and made the jump -- and left my company. Time to figure out what I wanted to do with my life again. Refreshing in some ways, but a very lonely feeling.
On the other hand, I was free -- I had more time to spend with my family, to travel, to read the classics (!), build that beach house I had always talked about, start learning new skills again, to recharge my batteries. That part was awesome. I found the biggest challenge was the social contact -- the people I worked with were very important to me -- that is what I missed, not the job.....at some point, I may blog more about my exit and underlying reasons and emotions....but that's not what this is about. (Very therapeutic for me, however!!!)
Now, what are you going to do?
Even while working, my biggest "hobby" has always been managing my investments -- I love the investment world -- anything having to do with personal finance, investing, trading, wealth/tax/estate management. What you do with your money after you get it. Lots of people are good at making money, but far fewer are adept in the art of how you keep it, protect it, and grow it.
In 2006, the time had come. After nearly 20 years in my industry, at the age of 42 -- I was seriously considering leaving my job in corporate America in what was one of the more challenging decisions I have ever made. A month later, after careful consideration, it was done: I would retire and leave the rat race in the middle of the year. No more working for "the man".
There were a lot of reactions from the people I told -- many reacted in amazement, some thought I must have a secret job lined up (can we join you?), some thought I must have been fired (management layoff, scandal perhaps?), maybe I'd just gone off the deep end (like I hadn't heard that before). After all, over the last 18 years, I had rapidly worked my way through the ranks, became a partner in the business....and through the rapid growth of the company and my own advancement, I found myself managing the second largest regional office of a Fortune 1000 company -- and the world's largest human resources consulting and outsourcing firms. I was the operations head of a group of over 2,000 employees.
Then as I explained what I was thinking to others, the conversation got into: "Don't be ridiculous. Why in the *** would you give up your job -- who leaves a job like that? What are you thinking--have you really thought it through? Do you have enough money? What does your wife and your family think? Do you really know what you are doing? You realize you've been in management a long time -- do you have any real world skills? What if you change your mind? Are you really going to leave behind us and the people you work with?" I will admit these were darned good questions...I was not really sure the answers to all of them, and I was certainly dazed and confused.
What I was sure of....was that I was mentally and emotionally tired. Tired of the long hours and the pressure. Tired of answering to corporate on minutiae and spending time on "administrivia" that did not benefit my clients. Tired of having to 'reorganize' and 'downsize' to squeeze out as much money as possible for short-term thinkers. As much autonomy as I had (after all I was the boss!), I felt trapped, not intellectually stimulated.
What's interesting is that I had remembered reading a book during the late 90's about a former Peat Marwick audit partner that had done "bare bones" retirement at age 35 -- he and his wife decided to downsize and travel the world. While I wasn't quite in the same financial conundrum, I did find a lot of parallels as I went back and re-read it (if you're interested : Cashing In on The American Dream , by Paul Terhorst). It was very motivating because it validated for me that I could leave a "good" job in order to pursue what I really wanted to do.
In my current job I had a strong group of successors in place and a good candidate to take my job, so I could rest assured the company was in good hands and I wasn't in danger of destroying what I had worked hard to help build (that was important to me), and I had provided enough notice not to leave the company in a short-term lurch.
My wife and kids were extremely supportive (granted, I'm not sure the kids really knew what it meant, other than I wouldn't be going to my office any more -- but maybe Daddy wouldn't be as "stressed out"!). From a financial standpoint, I was very fortunate in that I had the financial wherewithal to leave; our company had recently gone public and had done reasonably well over the past five years. I wouldn't describe my status as "wealthy", but I could say we will have enough if I can manage our affairs appropriately -- but if I don't, heck, I can always go back to work for "the man" if I need to, right :-)
So I shut my eyes, held my nose, and made the jump -- and left my company. Time to figure out what I wanted to do with my life again. Refreshing in some ways, but a very lonely feeling.
On the other hand, I was free -- I had more time to spend with my family, to travel, to read the classics (!), build that beach house I had always talked about, start learning new skills again, to recharge my batteries. That part was awesome. I found the biggest challenge was the social contact -- the people I worked with were very important to me -- that is what I missed, not the job.....at some point, I may blog more about my exit and underlying reasons and emotions....but that's not what this is about. (Very therapeutic for me, however!!!)
Now, what are you going to do?
Even while working, my biggest "hobby" has always been managing my investments -- I love the investment world -- anything having to do with personal finance, investing, trading, wealth/tax/estate management. What you do with your money after you get it. Lots of people are good at making money, but far fewer are adept in the art of how you keep it, protect it, and grow it.
Over the last couple of years prior to leaving my job, I started reading every book on investments I could get my hands on. I had a quantitative background -- math, statistics, systems -- and in my old job, I came up through the ranks as an actuary and pension administration consultant who specialized in developing and testing systems. (This background I would find very beneficial in the next year as I develop and test systems for trading.)
I then started trading much more actively, making mistakes, reading more, making more trades, more mistakes, going back to the drawing board, making more mistakes....and so on....and after a while, I was officially started into the wild world of trading, and have been doing it for about a year now.And that's where we're going to start with this blog.
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