001,000K500K
FIGURE 16.3
AMAT on November 12, 2001.
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• Gerald Ford pardoned Richard Nixon (not as horrible as terrorism, obviously, but symptomatic of the complete distrust America had for itsleaders)—Day 1: –2.7 percent; two months later: +7.4 percent.• Pearl Harbor, December 7, 1941—Day 1: –4.2 percent; two monthslater: –5 percent (the market did not go higher than Pearl Harbor dayuntil October 8, 1942).• Cuban missile crisis, October 26, 1962—Day 1: –1.9 percent; twomonths later: +12 percent.• Destruction of the Twin Towers in New York City by terrorists, September 11, 2001—Day 1: –5.2 percent; two months later: +4 percent.In every case when it seemed like the world was falling apart it paid tobe a buyer of U.S. equities. Will this pattern continue forever into the future? We don’t know. However, buying panic has always to this point beena reliable method of making money in the markets and this pattern seemslikely to continue for some time. Another thing to note is that panic willnever go away—there will always be the latest negative employment report,murmurings of war, an earnings rumor, a merger and acquisitions deal thatgot squashed, and so on that will drive people into another selling frenzy.Frenzies are irrational and must be bought. If you are worried that “thistime things are different,” then keep your position sizes small (whichshould be done for all of these systems anyway).
RESULTS OF THE 5-MINUTEBOLLINGER BAND SYSTEM(Feb 2, 2002–June 30, 2003) See Table 16.1 for results of the 5-minuteBollinger band system applied to the following basket of stocks: AMAT,BRCM, CSCO, DELL, INTC, JDSU, MSFT, ORCL, QQQ, SEBL, and SUNW,for February 2, 2002 to June 30, 2003. These are the highest volume Nasdaq100 stocks. You can see that the average return is 2.77 percent per tradeacross 113 trades with 92 percent success.It is also worth examining the results of this system per stock to whichwe are applying this system. For instance, the results on MSFT from 1999 toJune 30, 2003, are shown in Table 16.2 and on ORCL in Table 16.3 (see page177).Raising the barrier so that we are looking for a stock to penetrate 2 percent lower than its 10,2 Bollinger band (10-day moving average, 2 standarddeviations) gives the result shown in Table 16.4 (see page 177) for ORCL.We can see that in this case the system increases the number of trades butlowers the average profit per trade.
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TABLE 16.1 5 Min BB System, 2/2/02–6/30/03All Trades
All TradesAverage Profit/Loss %Average Bars Held
1132.77%1.46
Winning TradesAverage Profit %Average Bars HeldMaximum Consecutive Winning Tables
104 (92.04%)3.22%1.1230
Losing TradesAverage Loss %Average Bars HeldMaximum Consecutive Losing Trades
9 (7.96%)–2.43%5.442
TABLE 16.2 5 Min BB (Just MSFT)All Trades
All TradesAverage Profit/Loss %Average Bars Held
171.99%1.71
Winning TradesAverage Profit %Average Bars HeldMaximum Consecutive Winning Tables
14 (82.35%)2.63%110
Losing TradesAverage Loss %Average Bars HeldMaximum Consecutive Losing Tables
3 (17.65%)–0.99%52
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TABLE 16.3 5 Min BB—ORCLAll Trades
All TradesAverage Profit/Loss %Average Bars HeldWinning TradesGross ProfitAverage Profit %Average Bars HeldMaximum Consecutive Winning TradesLosing TradesAverage Loss %Average Bars HeldMaximum Consecutive Losing Trades
492.12%1.5946 (93.88%)$106,970.122.34%1.37343 (6.12%)–1.20%51
TABLE 16.4 5 Min BB Variation—ORCLAll Trades
All TradesAverage Profit/Loss %Average Bars Held
1761.12%1.91
Winning TradesAverage Profit %Average Bars HeldMaximum Consecutive Winning Trades
155 (88.07%)1.52%1.526
Losing TradesAverage Loss %Average Bars HeldMaximum Consecutive Losing Trades
21 (11.93%)–1.84%52
CONCLUSIONEvery day in the market is actually extraordinarily volatile. The average 7percent return in the markets since 1950 does not really express the volatility of the journey. Every day is often up or down 2 percent, not just once butseveral times. To be able to get pieces of those 2 percent moves and havethose pieces add up is the mark of a successful trader. Gut feeling will notdo it in the long run, but thoroughly researched systems such as the one described in this technique will.
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TECHNIQUE 17
All Good ThingsCome in Fours(“4” Is a MagicNumber)
am always very impressed with the people who draw upon chaos theory, quantum mechanics, digital signal processing, and other esotericfar-flung sciences in order to develop indicators to trade the markets. Ifyou are a chaos theoretician and have five degrees and various awards andthen develop a “chaotic indicator” to trade the markets, who isn’t going toinvest in your hedge fund? That said, I have yet to see one of those indicators actually work and more often than not there is more of a marketing element in these ideas than an actual trading idea.Sometimes simple is best, although even the simplest idea needs to bethoroughly tested before being exploited. For instance, many people like tobuy the market after four down days, and short the market after four updays. Both ideas make intuitive sense. In one case, it is pretty clear themarket is not going to zero, so how many down days in a row can we actually have? Similarly, markets cannot go straight up forever or we would beat Dow 30,000 already. So it is reasonable after four up days that we shouldbe able to short the market.That said, after four down days, many die-hard longs give up hope andget ready to pack it in for the new bear market. Let us see what the truth is.
I
FOUR DOWN DAYS• Buy the close of the SPY (ETF for the S&P) on the fourth consecutivedown close.• Sell one day later.179
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Example: SPY, 5/25/99 and 6/11/99Consider SPY in the spring of 1999 (Figure 17.1). In late May the ConsumerPrice Index data came out and showed a spike in inflation. It became prettyclear that the interest-rate party was over. Federal Reserve Chairman AlanGreenspan had kept things going after the Long Term Capital Managementdisaster in 1998, but now there was a serious threat of inflation and interestrates were going to have to rise. For the next year and a half Greenspanset steady increases until January 3, 2001.Meanwhile, once the market realized that rates were going to rise, themarket started to slide. First on May 25 we had the fourth consecutivedown close in a row. Buying on the close and selling the next day resultedin a 1.11 percent profit. Then two and a half weeks later, on June 11, 1999,we had four down days in a row again and a buy signal was triggered forSPY at 123.86, which sold at the close one day later at 123.99 for only a 0.10percent profit.The results are shown in Table 17.1, listing a 73 percent accuracy ratewith an average profit per trade of 0.66 percent.
TABLE 17.1 4 Down Days and Buy—1993–6/03All Trades
All TradesAverage Profit/Loss %Average Bars Held
800.66%1
Winning TradesAverage Profit %Average Bars HeldMaximum Consecutive Winning Trades
59 (73.75%)1.33%115
Losing TradesAverage Loss %Average Bars HeldMaximum Consecutive Losing Trades
21 (26.25%)–1.23%12
Example: QQQ, 4/24/99 to 6/30/03The same system but with QQQ from March 24, 1999 to June 30, 2003 hasthe result shown in Table 17.2 (see page 182), listing a 66 percent accuracywith an average profit per trade of 0.94 percent.So now the question is: Does this system work in reverse? The answeris: not really.
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181
129.50129.00128.50128.00127.50127.20127.00126.50126.00125.50125.00124.50124.00123.50123.00122.50122.00
Volume12.50M10.00M7.50M5.00M2.50M
FIGURE 17.1
SPY, May and June 1999.
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TABLE 17.2
4 Down Days and Buy—QQQAll Trades
All TradesAverage Profit/Loss %Average Bars Held
420.94%1
Winning TradesAverage Profit %Average Bars HeldMaximum Consecutive Winning Trades
28 (66.67%)3.14%16
Losing TradesAverage Loss %Average Bars HeldMaximum Consecutive Losing Trades
14 (33.33%)–3.46%11
FOUR UP DAYS AND SHORT(NOT A RECOMMENDED SYSTEM)• Short on the close of the fourth consecutive up close.• Cover one day later.The results of applying this system to SPY from 1993 to June 30, 2003,are shown in Table 17.3. There we can see a 0.06 percent average profit pertrade and only a 52 percent success rate. After commissions and slippage,
TABLE 17.3 4 Up Days and ShortAll Trades
All TradesAverage Profit/Loss %Average Bars Held
1480.06%1
Winning TradesAverage Profit %Average Bars HeldMaximum Consecutive Winning Trades
78 (52.70%)0.66%18
Losing TradesAverage Loss %Average Bars HeldMaximum Consecutive Losing Trades
70 (47.30%)–0.64%0.968
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you would be down. Again we see that irrational fear can be exploited withsuccess when people push the market down four days in a row, even in abear market. Irrational exuberance is not as easy to punish.However, all hope is not lost, as shown in the next system.
4 UP DAYS AND SHORT FOR 1 PERCENT• Short when there have been four up days in a row with the last up daybeing a 2 percent up move. Short on the close.• Cover either when the position is 1 percent profitable or at the close ofthe next day.
Example: QQQ, 8/25/99Square in the middle of the biggest bull run ever, the QQQs made four updays in a row toward the end of the summer of 1999 (see Figure 17.2). Thefinal day of that run was a 2.1 percent up move on August 25. Shorting at theend of that day and waiting for a 1 percent profit would have allowed us tocover at 60.88 the next day.The results are given in Table 17.4, showing an 86 percent accuracywith an average result of 0.92 percent per trade. Not bad for a one daytrade.
TABLE 17.4 4 Up Days and Short for 1%All Trades
All TradesAverage Profit/Loss %Average Bars Held
230.92%1
Winning TradesAverage Profit %Average Bars HeldMaximum Consecutive Winning Trades
20 (86.96%)1.21%111
Losing TradesAverage Loss %Average Bars HeldMaximum Consecutive Losing Trades
3 (13.04%)–1.01%11
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63.5063.0062.50
62.37
62.0061.5061.0060.5060.0059.5059.0058.5058.0057.5057.0056.5056.0055.5055.00
Volume6.00M4.00M2.00M
FIGURE 17.2
QQQ on August 25, 1999.
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THE 4 PERCENT BREAKOUT MOVEDay traders and hedge fund managers love to fade sharp moves, particularlysharp up moves. The market moving up ferociously midday is the worst thingfor the average hedge fund manager. Why is that? The refrain I constantlyhear on those days is, “It’s like 1999 again.” It is a big party, every stock is goingup, the old mutual funds are making a ton of money. It is one of the few dayswhere those funds are probably making more money than the hedge funds.So what does all the smart money try to do then? Well, they try to short andfade the greed. And on a 4 percent up day, this strategy is a big mistake.The problem is that at the 4 percent point, everyone is looking aroundand saying, “It can’t possibly go any higher.” So people jump in on the shortside, and when it starts moving higher, a panic results as people try to covertheir short positions.
The 4 Percent Breakout System• Buy QQQ when it hits 4 percent higher than the close the day before.• Sell at the open the next day.The results of applying the system to QQQ for March 24, 1999 to June30, 2003, are listed in Table 17.5, which shows a 63 percent accuracy ratewith 0.77 percent profit per trade.
Example: QQQ, 7/5/02Figure 17.3 is a 30-minute chart of July 5 and July 6, 2002. Before July 4, themarkets were in a constant state of panic that there would be a terroristTABLE 17.5 4% BreakoutAll Trades
All TradesAverage Profit/Loss %Average Bars Held
1240.77%1
Winning TradesAverage Profit %Average Bars HeldMaximum Consecutive Winning Trades
79 (63.71%)2.41%18
Losing TradesAverage Loss %Average Bars HeldMaximum Consecutive Losing Trades
45 (36.29%)–2.11%16
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26.6026.5026.4026.3026.2026.1026.0025.9025.8025.7025.6925.6025.5025.4025.3025.2025.1025.0024.9024.8024.7024.6015.00M
Volume
12.50M10.00M7.50M5.00M2.50M
FIGURE 17.3
QQQ on July 5/8, 2002.
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attack on the 4th. Everyone was mass dumping their stocks. I called threedifferent brokers to see what their clients were doing, and all said that theirclients were convinced that a terrorist attack was going to happen so theywere getting the hell out of the stock market. Why they waited until twodays before if they were convinced of this I do not understand. Nothinghappened, and all the people who had hedged their long portfolios werenow stuck with shorts and nowhere to go but cover. So cover they did.By 10:15 AM on July 5 we were already at the 4 percent point. The market had closed on July 3 at 24.75. At 10:15 AM the system triggered a buy signal 4 percent higher at 25.74 and then sold for a 1.79 percent profit at 26.20at the open the next day.
A Variation of the 4% Breakout SystemA slight improvement is to add the following variation:• Buy when QQQ is 4 percent higher than the close the day before andthe day before was down more than 2 percent on the day.• Sell at the open the next daySee Table 17.6 for the results, which are much better, having a 75 percent accuracy and an average profit of 1.86 percent per trade.
TABLE 17.6
4% Breakout VariationAll Trades
All TradesAverage Profit/Loss %Average Bars Held
331.86%1
Winning TradesAverage Profit %Average Bars HeldMaximum Consecutive Winning Trades
25 (75.76%)3.31%15
Losing TradesAverage Loss %Average Bars HeldMaximum Consecutive
8 (24.24%)–2.68%12
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CONCLUSIONThe 4 percent breakout system is one of the few times where the principlesof mean reversion are basically out the window. Too many people are attempting to fade the move. Consequently, the move proves to be unfadable.For an example of the 4 percent breakout system applied to South SeaCompany stock, see under Famous First Bubbles in Technique 20.
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TECHNIQUE 18
The WednesdayReversal
here is a saying that the “the dumb money invests in the beginning ofthe week and the smart money invests at the end.” It does turn outthat Wednesday is a statistically significant day for reversals to occur.
T
THE WEDNESDAY WIDE-RANGEMIDWEEK REVERSALPrice momentum cannot sustain itself for too long in either direction. Thereare all sorts of reasons for this fact, but the primary one is that people simply get exhausted. Suppose there is nonstop selling for 10 days in a row. Atthat point it seems like the world is ending. It seems like the only smartthing left to do is sell some more. Well, who is left to sell? The only holdersof stocks left are strong holders who have withstood the dips and mighteven be buying more.Often the week starts off with some momentum in one direction orother. However, the stronger that momentum is at the beginning of theweek, the more likely it is to reverse. Wednesday, dead center in the middleof the week, is the likely candidate day for the reversal.
189
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The System• Buy QQQ when the low of Tuesday is 5 percent less than the high fromMonday (the wide-range condition) and the low of Tuesday is less thanthe low from Monday. Buy at the open on Wednesday.• Sell QQQ when two consecutive up closes occur. Sell at the close of thesecond day.Note that in the buy conditions we are not requiring that Tuesday actually be a negative day. It could be that the selling has been spent by midTuesday and has already begun to reverse.
ExamplesQQQ, 5/24/2001 On Monday, May 22, 2001, the high was 82.25, the lowwas 75.58. The next day the low was 74.25, over 10 percent less. Buying atthe open on Wednesday, May 24 (Figure 18.1), at 75.00 and holding for theclose of the second consecutive up day would have allowed you to sell at93.62 on June 2, 2000 for a 24 percent profit.Why do we wait for two consecutive up closes? After such a wide rangein the early part of the week, the selling has become exhausted. More oftenthan not, with Monday being down a decent range, Tuesday is often worsedue to margin calls that must be met. People start to get nervous that thecarnage is going to continue all week, so they attempt to bail before it reallygets painful. With the range so large, the selling does not usually stop witha whimper, but with a bang. When people realize the worst is not over(with the first up day, usually that Wednesday), they jump back in, causingmore than one up day in a row.QQQ, 10/30/02 Monday October 28, 2002, the high was 25.04 and thelow was 24.17. The market had just come off a ferocious rally beginning onOctober 9 and people were still skeptical. So, after a weekend to thinkabout it, they took a break from the buying. The market continued to sell offon Tuesday with a low at 23.37. Although Tuesday was a down day with aclose at 23.92, it is interesting to note that we were almost 3 percent off ofthe lows. Buying the gap up on Wednesday morning, October 30 (Figure18.2), at 24.06 would have caused you some initial worry when it dippedback down to 23.85 before closing 2 percent higher at 24.56. Finally, the second consecutive up close occurred a week later on November 4 and youwould have sold at 25.90 for a 7.64 percent profit.
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95.0094.00
93.75
93.0092.0091.0090.0089.0088.0087.0086.0085.0084.0083.0082.0081.0080.0079.0078.0077.0076.0075.0074.0073.0072.00
Volume40.00M30.00M20.00M10.00M
FIGURE 18.1
QQQ on May 24, 2001.
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26.8026.6026.4026.2026.0025.8025.6025.4025.2025.0024.8024.6024.40
24.3124.2024.0023.8023.6023.40
Volume
100M80.00M60.00M40.00M20.00M
FIGURE 18.2
QQQ on October 30, 2002.
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ResultsTable 18.1 shows the results of applying this system to QQQ trading March24, 1999 to June 30, 2003. You can see an average profit of 3.20 percent pertrade with 70 percent accuracy.
TABLE 18.1
Wednesday ReversalAll Trades
All TradesAverage Profit/Loss %Average Bars Held
523.20%3.77
Winning TradesAverage Profit %Average Bars HeldMaximum Consecutive Winning Trades
36 (69.23%)6.05%2.56
Losing TradesAverage Loss %Average Bars HeldMaximum Consecutive Losing Trades
16 (30.77%)–3.21%6.632
Wide-Range System (non-Wednesday)Is the Wednesday condition critical? If we apply the same system but onlywhen the wide range occurs on any two days other than Monday–Tuesday,we get the results shown in Table 18.2.
TABLE 18.2
Wide-Range (Not Wednesday)All Trades
All TradesAverage Profit/Loss %Average Bars Held
800.90%5.09
Winning TradesAverage Profit %Average Bars HeldMaximum Consecutive Winning Trades
48 (60.00%)4.49%3.69
Losing TradesAverage Loss %Average Bars HeldMaximum Consecutive Losing Trades
32 (40.00%)–4.50%7.315
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We can see this is definitely a playable system, with a 60 percent accuracyrate and an average profit of 0.90 percent per trade. However, note that the average bars held, 5.09, is greater than the average bars held for the Wednesdayversion, which is 3.77. The profit per bar is significantly less in the nonWednesday system: 0.17 percent per bar versus 0.84 percent per bar in theWednesday version. Typically, I like to have an expected value of at least 0.40percent per day before I consider a system playable given that the reality isusually much less when taking into account commissions and slippage.If we add the condition (in the Wednesday version) that Tuesday be adown day, the results get better but not better enough that I’d be willing toonly play this system when Tuesday down. With Tuesday down the resultsare 33 out of 44, with an average profit per trade of 3.40 percent. An improvement, but not good enough to become a mandatory condition.
THE WIDE-RANGE MIDWEEK REVERSALSYSTEM APPLIED TO STOCKSThe wide-range system can also be applied to stocks. First, though, ratherthan use a static interpretation of what is defined as a wide range, let usborrow the concept of the average true range of the stock. The average truerange is defined by Welles Wilder in his 1978 book, New Concepts in Technical Trading Systems (Trend Research, 1978), as:• The current high less the current low.• The absolute value of: current high less the previous close.• The absolute value of: current low less the previous close.On large range days, the first condition usually applies. On days thatgap up, the second condition will usually apply. And on days that gap down,the third condition will usually apply. The average true range (ATR) is then theaverage over some specified period of the true ranges. We will use an ATRover a 10-day period.
The System• Buy a stock when the Tuesday low is (1.5 × ATR of the past 10 days)less than the Monday high (the range is 50 percent higher than its average range) and the Tuesday low is less than the Monday low. Buy theopen on Wednesday.• Sell when there have been two consecutive up closes.
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ExamplesPIXR, 7/24/02 PIX