|Thousands of trading systems are available in the marketplace today; some are relatively inexpensive to buy or lease, while others cost several thousand dollars or more. These systems can be based on volatility breakouts, moving average crossovers, neural networks, genetic optimization, oscillators, and linear regression. But no matter how plain or fancy the trading logic is for a system, all that matters are your answers to the following two questions:|
- Is the system's logic based on an observable (with my own eyes and a price chart) market dynamic that repeats again and again?
- Will I be comfortable trading this system in the markets with real money on the line?
If you can honestly answer "yes" to the first two questions, you might also want to ask yourself a third question, which is:
- Based on the system's cost and ongoing maintenance fees (upgrade fees, data fees, training, and so on) is it cost effective for my trading account size, commission costs, and markets traded?
If you answered all three questions honestly, you can learn to become a consistently profitable trader, even if you use a simple system that you can create yourself using standard indicators found in virtually every popular trading/charting platform (and your own eyes).
|A SIMPLE AND VISUAL SYSTEM|
Here's a look at my simple, visually based "trading with the trend" system that is nonoptimized, noncurve-fitted and is a no-brainer to construct and maintain. The key ingredient for success in trading with this template is you, because there are no secret market indicators or forecasting tools that can guarantee you trading success. But this no-cost trading template that is easy to construct will help you stay on track with the mental and emotional discipline needed to learn to trade profitably. After that, you may want to further fine-tune it by obtaining education in other market dynamics like relative strength analysis, money management techniques, price cycle studies, or wave analysis.
THE RIGHT CANDIDATES
Before you begin, you first need to locate stocks and ETFs that tend to make relatively smooth, regular swing and/or trending moves (up or down, and preferably balanced over long periods of time) if you expect to achieve success with this system. In other words, look for volatile (high-beta), high-volume stocks from sectors and industry groups that tend to go on a bullish/bearish tear several times per year, and which don't spend too much time chopping around in directionless funks. Fast-moving, news-driven technology, mining, financial, or energy stocks are likely to be good hunting grounds for such desirable issues; you'll likely want to avoid sluggish markets like electric utility stocks or other highly regulated public service issues that tend to trade within small ranges most of the time.
UNO, DOS, TRES
The daily chart of Citigroup (C) in Figure 1 shows the three-indicator trading template; this was created using three standard indicators in TradeStation 9.1 (see Figure 2):
- A 50-day exponential moving average (EMA; blue line)
- A five-day simple moving average of the daily highs (SMA; gold line)
- A five-day simple moving average of the daily lows (SMA; red line)
FIGURE 1: THE THREE-INDICATOR TRADING TEMPLATE. In this sample daily chart of Citigroup (C), out of the four most recent long trade entries, two closed out for a gain, one resulted in a small loss, and the last trade is still open, also with a decent gain to date. Taking entries when their direction is aligned with the trend bias of the 50-period EMA seems to be effective in historic testing.
FIGURE 2: FORMATTING YOUR INDICATORS. Here is an example of how you can format your three moving averages. Most popular technical charting platforms also allow for similar customization of the simple and exponential moving averages.
The trading logic is very simple:
|Long entry: |
- Go long when price exceeds the upper (gold) moving average of the daily highs by five ticks (0.05) and the price bar prior to the break of the upper moving average has closed above the blue 50-day EMA. (Note: If trading low-priced or high-priced stocks, you may want to decrease/increase the five-tick parameter as needed, since five ticks in a $300 stock is a much smaller entry filter amount than five ticks in a $40 stock, so adjust accordingly).
- Once you are in a long trade, use the lower (red) moving average of the daily lows as your initial/trailing stop-loss for the life of the trade. Aggressive traders can use the low of the entry bar as the initial stop, but this will sometimes result in premature stop-outs and will entail extra commissions and effort; newer traders should just use the red line as the initial/trailing stop to keep things simple.
The rules for short entry are simply the inverse of the long entry setup.
PRETTY SIMPLE, HUH?
What you have constructed is a basic momentum/breakout trading system that takes an entry in the same direction as the intermediate-term daily chart trend (as defined by the 50-day EMA). As with many swing/trend-based systems, you'll rarely, if ever, get in near the exact low/or high prior to a major trend reversal. Instead, you will be able to take out modest chunks of every decent swing move that erupts in the same direction as the intermediate-term dynamics that are powering the stock progressively higher or lower. Will it make you a million dollars trading AAPL next year? Not likely, unless you're well funded, but the method appears to work well in all high-volume (that is, one million shares per day average trading volume over the prior 50-day period) stocks that regularly make powerful swing and/or trending moves.
Plot this template on the daily charts of your favorite energy, technology, regional bank, airline, home builder, or precious metals mining stocks and see if you can locate a handful of trading candidates from a variety of diverse sectors with which to trade using this method. If they trend well, keep 'em, if not, ditch 'em and look for a stock that has a long-term history of regular trend moves.
That's the beauty of this system; you become the final arbiter of what, when, and how to trade the markets by:
- Using a basic, nonoptimized system that is based on an enduring market dynamic
- Trading in the same direction as the primary trend
- Looking at a chart and, within a minute or two, be able to determine if a stock or ETF is a good, potentially profitable trading candidate.
I don't want you to get the idea that this is the greatest trading system ever devised and that you're going to be the new "king of the hill" in your local trading/investing club or chatroom. But since you've now constructed a logical momentum/breakout model of your own using this system template, you can now make the time to read your favorite trading 'zines and interact with other market participants as a competent, profitable trader seeking to hone his/her market edge rather than as a perpetually struggling newbie who can't seem to settle on a particular trading method or system to work with. You will also be building your self-confidence as you visually analyze stocks to find the ones that are most suited to be part of your long-term stable of swing/trend-worthy stocks to use with your simple, logical, and straightforward trading system -- one that's easy to understand and easy to construct in virtually any trading/charting platform.
|With all of that said, here are a few of the hypothetical results of trading Citigroup with this method since early 2012:|
Hypothetical Trade Results
- Trade test span: January 23, 2012-February 12, 2013 on daily data
- $10,000 hypothetical allocation per trade signal (commissions and slippage not included)
- Number of closed trades: 21
- Long trades: 15
- Short trades: 6
- Win %: 47.62
- Profit factor: 3.77
- Avg. trade: $191.48
- Avg. winner: $692.90
- Avg. loser: $167.09
- Biggest winner: $1,659
- Biggest loser: ($385)
- Ratio avg. win/avg. loss : 4.15
- Max. closed trade equity drawdown : 18.57%
- Maximum consecutive winners: 4
- Maximum consecutive losers: 3
The system is currently in a long trade initiated on February 1, 2013 that is up by 3.81% as of the close on February 12, 2013, which is not included in the above statistics.
MOVING FORWARD, SLOWLY
The simulated test results aren't too shabby overall; the system made money on both sides of the market, although more on the long side. The closed trade drawdown was decent, and the profit factor was exceptionally good. Winners were much larger than losers on average, and there were no "catastrophic" losing trades -- a major plus. This means the model has good overall risk control even as it allows winning trades sufficient breathing room to develop.
|Of course, this is just a sample trading strategy and no one knows if it will continue to perform as well as this in the future, but you can alter it, fine-tune it, automate it, add multiple exits, or just run it as-is, being sure to select a suitable, diverse universe of stocks or ETFs to trade it with. |
Try using a longer or shorter EMA as your trend-confirmation line. Consider using, for example, a 21- or 30-day EMA to generate more trading opportunities, or perhaps an 80- or 100-day EMA to slow things down a bit. You can accomplish much of the same thing by lengthening/shortening the moving averages of the daily highs and lows, too. You can even control the dollar/share allocations by limiting your maximum account risk to perhaps 2% per trade or 0.75% to 1% per trade if you are trading it with a portfolio of six or more stocks. The possibilities for further development of this system are limited only by your understanding of the financial markets, trading skills, imagination, creativity, account size, and confidence level.
Charts: TradeStation 9.1 (TradeStation Securities)