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52.0051.0050.0049.0048.00
47.70
47.0046.00
45.4945.0044.0043.0042.00
41.74
41.0040.0039.0038.0037.0036.00
35.77
35.00
Volume
15.00M10.00M5.00M
FIGURE 5.2
CHKP on July 11, 2001.
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If the stock is touching the upper band, then the %b is 100, and if it is belowthe lower band, then the %b is negative. The following formula is used tocalculate %b: Stock Price − Lower Band 100  Upper Band − Lower Band Which all leads to the following:• Buy when %b is less than –20 using Bollinger Bands on the 10-day moving average with 1.5 standard deviations and hold at least until theclose of that day even if profit target is hit.• Sell when either a 15 percent profit target is hit or four days go by,whichever comes first.With this system, we are using the 10-day moving average to get quickerand sharper spikes. We use a –20 %b to make sure it is a decisive break ofthe bands. And if we don’t get our target within four days, then we are runlike hell out of the trade.
Example: SEBL, 8/31/98August 31, 1998. The markets had been in turmoil all summer, culminatingin the Long Term Capital Crisis. Panic had set in and everyone was worriedthe party was over. After nine down days in a row, during four of which thelower Bollinger Band was broken through, the stock price finally hit ourbuy target at 4.81 on August 31. The next day it bounced, hitting a 15 percent target at 5.54 (see Figure 5.3).
Example: BRCD, 4/14/2000April 14, 2000, was not a pleasant day to be long tech stocks. In fact, itseemed like the world might quite possibly end. At the time I was workingat 44 Wall Street, and when I left the building that evening pedestrians werejokingly being warned to stay away from the sidewalks just in case peoplewere jumping out of buildings. Nevertheless, despite the pain, it was certainly an important day to be buying short-term moves in stocks. As shownin Figure 5.4, on that day, BRCD triggered a buy signal at 46.42. It started tomake a comeback on Monday the 17th and finally hit the 15 percent profittarget on the 18th at 53.38. (See results in Table 5.2, page 74.)
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7.207.006.80
6.686.606.406.20
6.126.005.995.805.605.40
5.305.205.004.804.60
Volume
2.00M
1,000K
FIGURE 5.3
SEBL on August 31, 1998.
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73
72.0070.0068.00
66.4766.0065.38
64.0062.0060.0058.00
56.1656.0054.0052.0050.0048.00
46.9446.0044.0042.0040.00
Volume4.00M2.00M
FIGURE 5.4
BRCD on April 14, 2000.
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TABLE 5.2
Short-Term Bollinger Band System: Nasdaq 100Stocks, January 1, 1998 to June 1, 2003All Trades
All TradesAverage Profit/Loss %Average Bars Held
2658.66%2.46
Winning TradesAverage Profit %Average Bars HeldMaximum Consecutive Winning Trades
202 (76.23%)14.75%1.9821
Losing TradesAverage Loss %Average Bars HeldMaximum Consecutive Losing Trades
63 (23.77%)–10.87%43
WHAT ABOUT SHORTING?Just as the markets rarely go down in a straight line, neither do they go upin a straight line. For shorting, try the short-term Bollinger Band system inreverse:• Short a stock when its %b is greater than 120 using Bollinger Bands onthe 10-day moving average with 1.5 standard deviations.• Hold at least until the close of that day even if profit target is hit.• Cover when either a 15 percent profit target is hit or four days go by,whichever comes first.
Example: NVDA, 8/19/99As can be imagined, there were a lot of examples to short in 1999 when theInternet bubble was in full force. Look at Figure 5.5. NVDA, a darling notonly during the bubble but also in the down years of 2000 and 2001, shot upon August 19, 1999, and crossed its upper band by over 20 percent, uponwhich event a short signal results at 6.80 before going a further 5 percent at7.09. Four days later the trade is closed out at 6.25 for an 8 percent profit.The results as shown in Table 5.3 are not that great really: 1.50% pertrade, which is fine, but only a small number of trades compared to othersystems we have looked at with similar profit per trade results. Also, prob-
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75
7.057.006.906.806.70
6.64
6.606.50
6.416.406.306.206.106.005.905.80
5.77
5.705.605.505.405.30
Volume2.00M
FIGURE 5.5
NVDA on August 19, 1999.
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TABLE 5.3
Bollinger Band Shorting System: Trading NVDA,August 19, 1999All Trades
All TradesAverage Profit/Loss %Average Bars Held
2191.50%3.59
Winning TradesAverage Profit %Average Bars HeldMaximum Consecutive Winning Tables
139 (63.47%)9.79%3.3511
Losing TradesAverage Loss %Average Bars HeldMaximum Consecutive Losing Trades
80 (36.53%)–12.91%4.016
ability is not as high as in some of the other Bollinger Band systems described in this technique.While in general I could care less whether I am going long or shorting,the reality is that shorting is not the opposite of going long. It is more like adistant second cousin of going long; a weaker version that seldom works,even after extreme moves.
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TECHNIQUE 6
Stocks LessThan $5
nvestors as a rule shun low-priced stocks (stocks trading for less than$5). Using a Google search for “stocks less than 5” and “low-pricedstocks,” I came across dozens of articles, newsletters, advisory services,and so on that stated that buying low-priced stocks was the quickest way toruin. Some of the common reasons include:
I
• Stocks never come back once they go below $5.• Stocks are more easily manipulated below $5.• Stocks go below $5 “for a reason.”However, this is all good news for the hedge fund trader. The fear that isspread throughout the marketplace about low-priced stocks translates intoa higher-risk premium and, as a category, these low-priced stocks tends todo well and are important trading vehicles.
EXAMPLESOVER, 12/21/01OVER was still called GoTo.com in late 2001, and the dot-com backlash wasstill happening big-time across the market. GoTo.com could not figure outits business model (Was it a search engine? Was it a collection of hightraffic sites selling advertising?), and the market was not tolerating its indecision. The stock slid all through December (“tax selling,” the message77
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board posters on Yahoo! tried to claim in defense), and it seemed like therewas no hope for the stock—until it hit 5 bucks a share to make a 52-weeklow on December 21, 2001 (Figure 6.1). Buying at $5 and holding for onemonth would have allowed you to sell on January 24, 2002, at 12.19 for a 143percent profit.
INFT, 9/30/02INFT, Inforte, describes itself as “a customer and demand managementconsultancy,” which seems to be an obscure way of saying they are an information technology (IT) services company. Demand for IT services hadfallen for two straight years, and the environment was not getting any better. Many of the companies that had gone public around the same time asINFT had gone bankrupt or had been bought for pennies. INFT crossedbelow $5 on 9/30 and then hit a 52-week low on October 3, 2002, when itwent as low as $4.75. Nevertheless, the company had $50M cash in thebank, no debt, and was trading at a $50M market cap at that price. And wasprofitable! Buying at $5 a share, holding for one month and selling on October 29, 2002, would have allowed you to book a 56 percent profit (see Figure 6.2).However, not everything is so rosy in low-priced land as the followingexample shows.
WCOM, 4/10/02WCOM basically disintegrated overnight as a company. I remember readingan interview in the spring of 2002 with a fairly prominent value investorwho was saying “people are just now starting to realize WCOM is a valuestock. We can easily see it double or triple from here.” Within months people realized that WCOM had committed billions of dollars worth of fraud. Itis hard to make money on the long side in the face of massive fraud. (Although Technique 3 on bankruptcies describes how you could have mademoney shortly after WCOM filed for Chapter 11.)On April 10, 2002, WCOM hit below $5 for the first time that year (Figure 6.3, page 83). Within a week it looked like there might be a chance at recovery as the shares went as high as $7. Nevertheless, holding for onemonth would have cost 60 percent of your investment as you would havesold at 2.01 on May 9, 2002.
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79
14.5014.0013.50
13.1913.0012.5012.0011.5011.0010.5010.009.509.008.508.007.507.006.506.005.505.00
Volume
1,000K800K600K400K200K
FIGURE 6.1
OVER on December 21, 2001.
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8.208.00
7.95
7.807.607.407.207.006.806.606.406.206.005.805.605.405.205.004.80
Volume
600K500K400K300K200K100,000
FIGURE 6.2
INFT on September 30, 2002.
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81
6.806.606.406.206.005.805.605.405.205.004.804.604.404.204.003.803.603.403.203.002.802.602.402.202.001.80
1.651.601.401.20
Volume
600M500M400M300M200M100M
FIGURE 6.3
WCOM on April 10, 2002.
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BUY LESS THAN $5The WCOM example clearly shows the risk of playing low-priced stocks.And, INFT aside, the difficulty in differentiating between the potentialWCOMs and the potential OVERs makes it hard to justify buying any stockfrom a fundamental or technical perspective. That said, the following system produces some interesting results:• Buy when the 52-week low of the stock is greater than 5 or buy the moment the stock crosses below $5.• Sell one month later.For results, see Table 6.1, which shows an average return of 11.2 percent per trade versus an average monthly return of approximately 0 percentacross the universe of stocks since 1998.
TABLE 6.1
Data on 7000 Stocks Including All NYSE, Nasdaq,AMEX Stocks Including Deletions, January 1,1998 to January 1, 2003All Trades
All TradesAverage Profit/Loss %
1,88611.2%
Winning TradesAverage Profit %Maximum Consecutive Winning Trades
1110 (58.85%33.25%23
Losing TradesAverage Loss %Maximum Consecutive Losing Trades
776 (41.15%)–20.21%17
CONCLUSIONThe key is to use very small amounts of equity per trade. Since so manytrades are generated, there is no shortage of ideas for putting money towork.
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TECHNIQUE 7
The SlowTurtle
robably no trading system in existence has produced as much cultlike fervor as the Turtle trading system originally developed byRichard Dennis and William Eckhardt and now being used by possibly hundreds of hedge funds to manage currencies, stocks, and commodities. The original story goes that Eckhardt was convinced that tradingcouldn’t be taught and Dennis was convinced it could be. They made a betand then used very minimal criteria to select a group of students to teach.These students became the original “turtles” (named after the Turtle systemthat they were taught) and most of them went on to manage fairly impressive funds. All of them were sworn to secrecy about the details of the original system. However, I doubt at this point any of them use that originalsystem and if they do, it is certainly not the version we want to be using, theTurtles trade trends.Basically, if a commodity or stock is breaking to new highs, the idea isthat that momentum should continue and you should just ride the assetuntil it is no longer making new highs. By trading a basket of uncorrelatedmarkets, you can take advantage of the fact that at any given point, somewhere in the financial universe, something is in a bull market.Trend-following can offer huge returns. If you catch close to the beginning of a huge bull move in a market, the returns on that trade can be multiples of 100 percent. Similarly, the drawdowns can be enormous. Dennishimself has gone in and out of the hedge fund business several times, mostrecently closing shop in 2000, primarily because his drawdowns have beenimmense and clients have withdrawn money. The key to success in a trendfollowing system is not in picking the right entries and exits, but merely
P
83
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staying in the game to be able to withstand the drawdowns. That said, if onechooses a basket of assets carefully so that they are as uncorrelated as possible, it may be possible to smooth out drawdowns. We will see a simpleexample of that possibility in a bit.
MY VERSION OF THE TURTLE SYSTEMAs for the system itself, there are many variations of the basic Turtle systemand its trend-following cousins. The version presented here is based onone told to me by a manager of a multibillion-dollar trend-following fund. Although most of the systems presented in this book are short-term countertrend systems, I do think a properly diversified trading strategy shouldinclude some trend-following component. This is the system I currently use:• Buy if an asset’s 22-week closing simple moving average crosses overits 55-week closing moving average; buy at the market open the nextMonday.• Sell if an asset’s 22-week closing simple moving average crosses underits 55-week closing moving average; sell at the market open the nextMonday.Note the simplicity of the method. The more complicated a system is,the more likely it is to suffer from severe curve fitting. Basically, I am notas interested in using complicated methods from quantum mechanics toidentify trends. If an asset is moving up so that its slow- and fast-moving averages are moving up, then I am happy to say it is trending.Why no shorting? As we have seen in Technique 5, shorting is not necessarily the opposite of going long. Along with the fact that the marketshave a natural bias to move upward over the past one hundred years, yourupside is also capped at a 100 percent. When following a long-term trendfollowing system, it is possible to have trades that make well over 100 percent. Also, if you choose your basket of assets correctly, you can be goinglong some assets, while other assets are on their downtrends.
EXAMPLESS&P 500, June 1958 to June 1961The lowest line in Figure 7.1 represents the 55-week moving average. Theline directly above it represents the 22-week exponential moving average.On June 23, 1958, the lines crossed, and we bought at the open of the next
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68.0067.0066.0065.00
64.8664.8164.0063.0062.00
61.7661.0060.0059.0058.0057.0056.0055.0054.0053.0052.0051.0050.0049.0048.0047.0046.0045.0044.0043.0042.00
Volume
250K200K150K100,00050,000
FIGURE 7.1
S&P 500, 1958–1961.
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week holding until the bottom line crossed under on May 2, 1960, when weclosed out the trade for a 19.6 percent profit. The market seesawed for ayear or so afterwards before we bought again on January 3, 1961, at thestart of the next bull market that lasted throughout the 1960s.
S&P 500, July 1987 to May, 2003Of course, no trend-following system would be worth its weight in salt if itdid not capture the trend that occurred throughout the 1990s as shown inFigure 7.2. As seen in the figure, the system was long the market from February 19, 1991, right after the Gulf War, until December 11, 2000, for a 271percent return. (Also see Table 7.1, Table 7.2 (page 88), and Table 7.3 (page89).)You can, of course, run this system on stocks. Table 7.3 shows the results of the system on Nasdaq 100 stocks, starting with $1M and using 2 percent of equity per trade.The system was almost always in the market and had, of course, its equity peak at the peak of the bull market in 2000 (see Figure 7.3, page 90).Figure 7.4 shows the annual returns of the system.Using the Turtle system on stocks, you would have been able to maximize the advantages of the bull market while keeping drawdowns somewhat low in the bear market even though they existed. Notably, despitebeing a horrible year for the broader market, 2001 was up 8 percent in thissystem. The annual returns are shown in Table 7.4, page 93.
TABLE 7.1
Results for the Turtle System on the S&P 500,1950 to 2003All Trades
All TradesAverage Profit/LossAverage Profit/Loss %Average Bars Held
16$29,217.5129.26%123.63
Winning TradesAverage Profit %Average Bars HeldMaximum Consecutive Winning Trades
12 (75.00%)41.14%158.510
Losing TradesAverage Loss %Average Bars HeldMaximum Consecutive Losing Trades
4 (25.00%)–6.39%192
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1,500.001,450.001,400.001,350.001,300.001,250.001,200.001,150.001,100.001,050.001,000.00950.00
931.87930.00900.00895.69850.00800.00750.00700.00650.00600.00550.00500.00450.00400.00350.00300.00250.00
Volume
100M80.00M60.00M40.00M20.00M
FIGURE 7.2
S&P 500, 1987–2003.
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TABLE 7.2Position
LongLongLongLongLongLongLongLongLongLongLongLongLongLongLongLong
Trades for Slow Turtle on S&P
Symbol
Shares
Entry Date
EntryPrice
^SPX^SPX^SPX^SPX^SPX^SPX^SPX^SPX^SPX^SPX^SPX^SPX^SPX^SPX^SPX^SPX
3,9293,8682,1182,2271,7401,7641,7201,5081,1241,0851,1041,024748596359270
8/4/19521/25/19545/27/19576/30/19586/20/19608/15/19601/3/19612/4/19633/13/19671/4/19715/12/19757/17/197810/18/19828/27/198410/10/19882/19/1991
25.436/15/195323.62–7.1225.932/18/195743.4667.6146.789/30/195742.42–9.3245.245/2/196054.1319.6557.168/8/196055.52–2.8756.619/26/196053.06–6.2757.576/4/196259.122.6966.316/20/196686.5130.4688.897/22/196994.956.8292.156/11/1973107.0316.1590.535/31/197796.276.3497.589/28/1981112.7715.57133.59 6/18/1984149.0311.56167.51 12/7/1987223.9833.71278.06 9/24/1990311.311.95369.06 12/11/2000 1,369.89 271.18
Exit Date
ExitPrice
%Change
Looking at Figure 7.5 (see page 92), an analysis of the maximum adverse excursion (the amount a trade went negative before closing out), thelight gray trades represent the trades that eventually were closed out asprofitable trades but underwent a drawdown in the process. One trade wasas much as 40 percent down before returning to profitability, and 17 tradeswere between 20 percent and 40 percent down before returning to profitability. We can see in the results that the maximum drawdown from peakto low was slightly over 58 percent. Nevertheless, this system greatly outperformed the market from 1998 to 2003 and was able to benefit massivelyduring extreme bull market moves. Again, having a trend-following systemin your arsenal is an important weapon in addition to the various countertrend systems we have demonstrated in this book.
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TABLE 7.3
Simulation of Slow Turtle on NAS 100 Stocks(1997–2003)All Trades
Starting CapitalEnding CapitalNet ProfitNet Profit %Exposure %Risk-Adjusted Return
$1,000,000.00$5,423,025.50$4,423,025.50442.30%91.32%484.34%
All TradesAverage Profit/LossAverage Profit/Loss %Average Bars Held
213$20,765.3885.84%59.24
Winning TradesGross ProfitAverage ProfitAverage Profit %Average Bars HeldMaximum Consecutive Winning Trades
107 (50.23%)$6,383,812.50$59,661.80193.19%80.1114
Losing TradesGross LossAverage LossAverage Loss %Average Bars HeldMaximum Consecutive Losing Trades
106 (49.77%)($1,960,787.38)($18,497.99)–22.52%38.1813
Maximum DrawdownMaximum Drawdown $Maximum Drawdown DateRecovery FactorProfit Factor
–58.44%($6,169,147.50)9/17/20010.723.26
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FIGURE 7.3
TRADE LIKE A HEDGE FUND
Portfolio equity curve.
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FIGURE 7.4
Annual returns.
The Slow Turtle