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Archive for July, 2008

Good lesson in sticking with a trade from this one.  On July 8th, I recommended taking positions in XLE, XOP and/or XES.  On July 9th, I took those position but was quickly shaken out of them.  But what I realize is that I was trading with too tight a stop.  So while I didn’t do too badly, I could have been doing a lot better if I had just ridden out the drawdown.  Actually, what probably would have made more sense would have been half position on the 8th, half-position on the 9th.   Anyway, let’s take a look at how they done since that post:

  • XLE: 0.54%
  • XES: 3.22%
  • XOP: 1.79%

So not bad returns.  Here was the real problem – I didn’t really define for myself when I would be out of the trades.  No plan, no trade.

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Nick Gogerty over at designing better futures (via Worldbeta) has an excellent post on the importance of not losing money.  Here’s the chart and the money quote:

Hardlyworking

The acceleration point for losses requiring greater gains is around a 13% loss.  Think of it as inverting the power of compounding returns.  Currently the S&P is 26% below it highs.  To get back to the previous high point for domestic investors the S&P 500 needs to gain a little over 35%. The long term +80 year historical average return for equities is around 7-8%, so back to break even then in around 4 years.  Based on historical average return would be 2012-2013.The ex dividend annual return for the S&P for a dollar based investor since 1998 has been roughly .3%.  When one factors in an inflation estimate of 2.5% per year, one ends up with an effective loss of purchasing power of 25% over the last decade.  Welcome to the lost decade.

His point is well taken – that when you consider being down 20%, it will not be a 20% gain that takes you back to parity.  Once you cross the 13% rubicon, you’re into needing a huge amount to recover.   This is why I am interested in different approaches to investing – consider that some people who invested in the Nasdaq during the dot.com boom are still underwater.

But what really got me was when he laid it out in terms of time given an average equity return – 4 years to get back the gains.  Now, obviously the S&P has had returns greater than 7% in any given year, but we’re talking average returns which might well be what we are in store for over the next decade (as readers know, I’m not a predictor of future returns).  Nick’s blog has some other great posts and thus will go into the blogroll.

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I said there would be a SMALL reversal!  Small!  Market, listen to me! (The silence from the market is deafening).

Ah well, the selloff today was interesting – such is life in the market.  One interesting thing about the selloff – and believe me I’m not trying to justify my past positions – the volume today was average.  This says to me that we haven’t yet met the “I give up” point.

On the energy side, I did ok with the trades highlighted last night – I traded out of them for small profits as they started to fall back.  This wasn’t any brilliance on my side – just a trailing ATR stop that got me out with some small gains.

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I meant to post about this last night but just ran out of time due to me being sick all day, but the T2108 indicator from Worden went down to 8% yesterday – a very good sign for a bounce. For those that don’t know anything about this indicator, it is a calculation of the percent of stocks above a 40-day moving average.

  • Dave over at TheTradingDigest has been talking about this for a while and has a simple system you can follow once it gets below 15 – definitely a very interesting system.
  • Rob over at Quantifiableedges has talked about the T2108 in the past and today had an excellent post on the T2116 which looks at stocks making 2 standard deviations below a 40-day moving average – basically it shows extremes in selloffs. Btw, if you’re not getting his newsletter you’re really missing out (I have no affliation with Rob other than we are both Celtics fans and write blogs about the market).

Bottom line is that just about every indicator was showing the market extremely oversold. I was already long going into today as the everything has been oversold for quite a while – more than 5 days – so I was just hoping that we’d see a reversal. That we did – and a pretty good one. Now, the question is what happens from here – I would expect:

  • Up a bit more tomorrow with the exception of those equities that shot off like a rocket.
  • Some retracement over the next few days.
  • After the retracement, a move higher.

Obviously this may not play out – but on a probability-basis, this has historically had an 80-100% chance of working. So that’s what I’m going to play.

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Well, my TREND1 and MOMO1 strategies have really been taking it on the chin the past few days – this is to be expected as they are so heavily in commodities. But looking at a few charts, I think we might see a reversal – OIL has an RSI of around 7, DIG is even lower at around 3. But what really has me interested tonight is a chart I created of the Bullish Percent Index for the components of XLE. It is now down to about 3% – near a historic low. Usually this means you’ll get a reversal. Here’s a chart:

And here’s the corresponding chart from Stockcharts.com of their $BPENER symbol:

Pretty damn compelling in my mind – I’ll be looking at going long DIG in the morning and possibly XLE, XES and/or XOP – all the charts look about the same.

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I like the folks over at Bespoke, but today they committed one of the great sins in statistics – mistaking correlation for causation:

“While fund raising statistics suggest that Barack Obama has strong support in the Wall Street community, the performance of the stock market in relation to Mr. Obama’s popularity suggests that investors may have a different view.  In the chart below we show the S&P 500 (red line) versus the price of the Intrade futures contract for Barack Obama to become president (blue line).”

Clearly what they’re trying to say here is that Obama futures are predictive of the S&P 500.  This, of course, is showing correlation, not causation.  I could find any number of charts which shows the same thing.  For instance, a chart of oil.

Leaving off the problem of relying on data from Intrade (which has been shown to be responsive to events rather than predictive) I could see the right-wing blogs picking this up as “see, some great market (because the Bespoke guys are great) economists are saying that Obama is causing the stock market to sell off!” – which, in any multi-factoral environment, is pretty obviously false. We don’t have to look far for other possibilities – sub-prime, war in Iraq, price of oil.

I don’t really care if you’re for McCain or Republicans in general, or for Obama or Democrats in general – what I can’t stand is stuff like this.  This isn’t the first time I’ve seen this, and it won’t be the last – this same sort of thing was written about by the Stock Chartist a few weeks back.

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So one of the reasons why I was late in updating my strategies was an issue with my software – or at least I thought it was – turned out to be my dumb-headed operating of said software.  I had set my commission rate, somehow, to a flat dollar per trade, regardless of the number of shares.  Here’s the equity curve that came out for MR1:

Now, I was very confused to see the backtested curve of MR1 showing about 2x the returns of the normal system.  But it does serve to illustrate a point: namely that in systems that trade frequently with a small edge, you had better have a cheap commission structure or you will be eaten alive.  It also shows just how much of an edge can be taken by commissions – so next time you see someone showing you an equity curve without commissions, make sure you see what one looks like with them added back – you could actually have a negative curve if the edge or expentency is too small.

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