Cry in the dojo, laugh in the battlefield

January 20, 20209 Comments

“Cry in the dojo, laugh on the battlefield.”

Samurai wisdom

 

Some readers are aware that I am a competitive cyclist. It’s kind of odd when I call myself an athlete, now that I’m in my late 50’s. But I’ve been an ametuer athlete since my 20’s, and a competitive cyclist since my early 30’s. In fact, my original post-secondary education was in Phys-Ed – which lead me to own a serious training gym (the Olympic Health Club in Brampton, Ontario) when I was in my mid-20’s. Always the entrepreneur.

Right around the time I started racing bicycles, I also got involved in the investment business (I was 29).  When I first got into this business in 1990, I did what every uninformed Financial Advisor does. I bought mutual funds for clients. By 1994, I began trading stocks – albeit in a fairly ill-informed manner.  It was around that point that I began studying Technical Analysis, and attained my CMT. Over time, the structured training and systematic approach I had learned from bike racing began to influence the structure of how I would formulate today’s ValueTrend Equity Platform. I learned the discipline of Technical Analysis. I formulated a structured trading routine – just like I had formed a structured training plan for bike racing.

Race training is different than training for fitness. It’s far more structured, and frankly, involves far more pain and suffering than one endures in the pursuit of a healthy level of fitness. Race training (if you want to win) is about pushing your body and mind to its limits. When you need to respond to “attacks” by your competitors on the hills late in the race, and you feel exhausted, you’re ready. You’re never comfortable with it, but you’ve trained to deal with it. Below is a shot of me in the final kilometer of a time trial. Trust me, I am suffering here – but I’ve trained myself to accept that discomfort.

Trading is similar. You need to familiarize yourself with the pain of taking losses. You need to harden your mind to the uncertainty that is the stock market. Do you place this trade today? But what about (fill in the current market worries here…Iran war, Trade wars, US debt, Brexit…)? You need to employ a structured approach that gets you out if the trade sours. You need to accept that a stop loss strategy might result in getting out, to then watch the stock move back higher. You need to accept that you missed the winning trade. You need to embrace taking a loss, or making less of a gain than you could have. You need to feel comfortable that, despite all of these downsides, you will still come out ahead over time if you adhere to your disciplined structure.

For all of this to happen, you need to make your mistakes through backtesting a trading system. And then, you need to make some mistakes in real time.

You need to laugh on the trading battlefield by crying in the dojo.

Testing your trading strategy

Here are a few of my thoughts regarding how to test a trading strategy. This is not a computerized programming approach. Its for those readers who prefer an old fashioned chart-eyeballing strategy. Note that this is not a recommended trading strategy. I am using a very simplified system to illustrate the principle of backtesting. In other words, I am not suggesting that you adapt this very simple series of trading rules.

Step 1: You want to do some testing on a few security types that you might typically trade.  For example, at ValueTrend, we mostly trade country ETFs, NA sector ETFs, commodity ETFs and individual mid-large cap stocks. On these charts, add all indicators that are part of your strategy. For example, you might use weekly charts because you want to trade in 3-12 month time horizons like we do.

Let’s say that you want to buy on a move by at least one bar above the 200 day (40 week) SMA in combination with a minimum 3 month chart consolidation pattern breakout. You may want to avoid stocks trading at an RSI of over 60. You will sell on a break of the 200 day SMA by more than one bar (one week). For each chart, go back in time and start at your furthest back period. For illustrative purposes, I have chosen the S&P 500 chart beginning in 2012 and ending in the fall of 2016.

Step 2: Move the chart forward, bar by bar, and spot possible trade setups according to your rules. On the chart above, you will see that the SPX was contained below a level of 2100 between June of 2015 to June 2016. Then the market broke that lid in July 2016. It was above the 200 day SMA. That lasted for more than a week (one bar).

Step 3: When you find a trade setup based on your trading strategy and rules, pretend you entered it. In this case (above chart), we have a breakout from a consolidation that lasted over 3 months. We have a move above the 200 day SMA (red line). RSI is not overbought. Support at the breakout point of 2100 is holding. So you enter the trade.  Make note of the date, position size, and price of “entry”

Step 4: Now, move forward in the trade’s history. Your sell rules must be adhered to as you note your actions. Note that the SPX retraced to the breakout point in a classic test that November. You wait a week. The SPX looks to be holding above 2100 and its 200 day SMA. No need to stop out of the position yet. Keep holding the SPX until your rules say to sell–whether its a loss or a gain. On the chart below, I’ve scrolled ahead to November of 2017. You will see that the SPX continued to hold 2100 and moved ahead nicely after that test of the 200 day SMA. As of November 2017 you are still long the trade.

Step 5: Write down the results of the imaginary trade that you’ve taken. Enter the date, entry point, stop-loss point, take-profit if any, etc.

Step 6: Keep scrolling forward on the chart. Enter a sell if your sell rule kicks in. In the chart below, you will note that the SPX moved briefly below its 200 day SMA at the end of March. You wait a week. It rebounded, so you hold.

 

I’ll skip ahead. On the chart below, note the break of the 200 day SMA in the last week of September of 2018. That’s a sell signal if it lasts for more than a week. You wait a week. The SPX remains below its 200 day SMA. You sell in the mid-2600’s. You’ve made 23% between June 2016 to October 2018. The market falls further. You are now in cash, and await another buy signal based on your system.

 

Repeat Steps 1-5 if/as/when setups came about.

The “system” I described above is not the ideal trading strategy. It’s the principle of a strategy that I tried to illustrate. Hope that helps!

 

Housekeeping

If the subject of structured trading is of interest to you, I might encourage you to attend the next ValueTrend Webinar. We’ll be covering the subject of breakout trades – both in the identification for entry, and on exit strategies. Here are the details: Please make sure to tune into our next webinar on “Finding Breakout Setups” which will be hosted on February 13th at 2:00pm. You can sign up using this  link

Here is the link to our last webinar, covering the Valuetrend Bear-o-meter.

The surveymonkey response link for the last webinar is https://www.surveymonkey.com/r/JRWS8HB we would greatly appreciate it if you can take a few minutes and fill this out.

 

9 Comments

  • Interesting article Keith, thanks for posting it. I know you normally do not answer questions about specific stocks. I am hoping you will make an exception. I am looking at a 3 year chart of Transalta and it looks like a reverse head and shoulder pattern, which I believe is bullish. Assuming I am right, can I predict that the next level is $10 and then if it is broken, $12 is a possibility?

    Reply
    • Dave–TA is a sideways pattern–but if it takes out that last peak at $10, sure, $12 is possible. The trick is, will it take that level out?

      Reply
  • Keith, is this how you normally make a sell decision?
    I use a trailing mechanical stop at 15% that usually works well. It gives the stock a bit of room to move, but protects against a big drop. It doesn’t always work well. For instance last week, it stopped me out of BPY, I looked at it and bought it back for higher. If I had waited another few days, I would not have sold.

    Reply
    • Hi Bill
      As noted, this is NOT the system I use or recommend, it was a simple example of a system with the idea of an historic testing protocol

      Reply
  • Hello Keith
    Let me start by offering I will not be offended in anyway if you do not post this message.
    It just so happens I spent this morning watching a youtube video before reading your blog. I couldn’t help but notice how well your blog message and the video content complemented each other. I thought your readers might be interested in the video, it is actually a series of 4 videos (several hours) but I found the time spent worth it. The video is of a presentation Mark Douglas gave on trading. For those interested the link is : https://www.youtube.com/results?search_query=mark+douglas+how+to+think+like+a+professional+trader+1+of+4

    Carey

    Reply
    • Thanks Carey
      I’m all about education, so happy to share the link.

      Reply
  • You like to use the 200 day SMA, is there much of a difference in using the 200 EVA?

    Also, what are your thoughts on using 50 Day EVA instead of, or together with, the 200. I’m noticing that for smaller more volatile stocks which may be moving towards, or above the 200, this is more helpful.

    Finally can the MACD be of any assistance in watching the trend here?

    Bruce

    Reply
    • Bruce–I assume by EVA you mean EMA (Exponentially weighted Average)–this means that recent data outweighs older data over the lookback period in question (200 day EMA has more emphais on yesterdays price than the price of 200 days ago)
      I use the SMA because, well, everyone else does. Thus, more people are watching it, thus its likely to invoke a reaction by investors if it is crossed.
      I do look at the 50–but also as a SMA for the same reason–to me the MA’s are as much about crowd behavior and how investors will react as prices move about them.
      Finally–May I humbly recommend my book Sideways for more info on MA’s, and to address your question about MACD, and how to use it.

      Reply
      • Thanks, no need to be humble, I do have your book so I guess I need to reread it LOL …

        Bruce

        Reply

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