Developing a Trading System for QQQ/NQ Part 2 – 12/31/12

This will be the last blog post for 2012 and although I feel compelled to write about the fiscal cliff, for a technical trader like me, it is just another piece of news and an opportunity for the many talking heads on TV to show their faces and argue. We need the higher earners to pay more taxes and we have to seriously cut spending. We cannot keep spending $1.50 for every $1.00 we earn! Perhaps that will be discussed in more serious detail when we need to increase the debt ceiling – which we have to. So enough said and let me move on to developing my trading system on QQQ/NQ.

After developing a shorter duration QQQ system I manually ran it through to see where the entries (shown by arrows) and exits (shown by X’s) would be on the first chart I had printed. I was originally looking in the 2009-2012 time frames. My intention is to start trading straight call and put options on these and later switch to futures on the NQ after I gain some confidence. I can trade the ETF QQQ which is what it is based on. I realize that futures on NQ and QQQ will differ; but by trading options on the Q’s I am using the same data.

My initial findings were very positive. I was showing somewhere between a 70-100% win rate and the losses were on average much less than the amount for an average win. Not bad….

I wrote down my rules for trading. First was the Long entry, and then the Long exit and next the Short Entry (using long Puts as I don’t want to short stocks or an ETF) and the Short Exit. Shown below are the entry exits for the time period 11/2011 to 12/2012, the most current data. It generated 100% wins over 15 trades and 13 months. Seems impossible but there it was! Realistically, I will take anything from 70% -100% wins, given that a typical trend following system only generates 30-60% win rate; except the average win is much higher than the average loss.

Next I printed charts of QQQ (not NQ as shown) from 2002 – 2012 where each page had about 18 months of data. I went to the first chart and applied my rules manually and saw where the entries and exits were. From 9/2001 to 2/2003, I had 19 trades of which 14 were winners. Also the losers were on average much less than the winners. I also noted that the worst consecutive losses were 2 in a row and the best consecutive wins were 6 in a row. I think I can live with that. Attached below is a scanned document of the 2002 QQQ (not NQ) chart and the indicators and entry exit points. It is somewhat weak and hard to see, and I apologize for that. It is a document that I will use to run the next several years of data through to see how it does under the same trading rules. Then it will be “Start your engines” for live trading!!!

Developing a Trading System for QQQ – Part 1 12/14/12

Friday I flew into Pittsburgh to take care of some family matters. During the flight I pulled out my charts on QQQ with all the indicators I wanted on them. I am sorting through my favorite indicators and linking them to see if they yield a reliable trading system.

First I looked at basic trend following systems. They are reliable but tend to give a lower probability of success. That also means I would face several losses in a row – possibly as many as six. Those losses would stretch over 2-3 months on a daily system. Not a good system for me.

Next I started looking at shorter duration trades based on price movements in waves. I want to catch the waves with my indicators and not wait for the waves to form visually before making a decision to enter. By the time I see the price wave forming, I am entering late. Mentally it is hard to enter long when price is falling.

My preferred method is to use a price accelerator/decelerator to tell me turning points. Stochastics is good but this is the second derivative of price movement, the first derivative being a price change. I am a trend follower in my heart as a trader, so I still want to keep a watch on whether the tide is coming in or going out. When the tide is coming in, the waves for going long are easier to catch and bigger in size. When the tide is going out, the troughs are larger than the wave tips and a reverse approach is better – that is to sell short or buy put options or sell futures at high points.

I had three pages with each page representing about a 14 months of QQQ data. One of the charts is a nice trend following chart. The second one was a nightmare – as QQQ stayed in a sideways mode for a full ten months; enough to destroy any trend follower’s system! The third page showed some smaller up movements, but very distinct medium sized wave formations that a trend following system would have done well in. I want my system to do well in all three scenarios....

401K Still going strong long – 12/9/12

The overall market signal on SPY (S&P 500) is to exit any short positions – defacto go long in my books. I have re-entered positions in equity and in my 401K.

The 401K monthly chart analysis on my current company’s choices suggests I put my monies into WFA SPL Midcap VL, Fidelity DIV Intl, and Fid Eq Income, although the Freedom 2050 and 2040 funds looked strong as well.

In my previous employer’s 401K funds, TRowe Price Intl discovery, Fidelity DIV Intl and Lazard Emerging Market equity funds looked the best. PIMCO Real Retn bond fund looked the best among the bond fund choices. See charts on the top 401K funds below.

SPY Gives a change in Signal 12/5/12

My trading system on SPY (S&P 500) gave a change in signal showing an exit on short positions. This can be interpreted as a tepid long signal. I will place more long positions.

In addition, I saw up signals on several currencies in their end-of-day charts recently. I have taken long positions in FXA, FXC, FXF and FXE. This is going to continue to evolve into a method by which I will hedge our portfolio by placing a portion into the strongest currencies based on them showing up signals. I believe this will allow me to hedge against a potential weakness in the US dollar in the coming years in case the Fed continues to print money. I am also long in IIF and TLT. See my chart and comments on IIF in a recent post.

Despite our debt situation, I remain bullish towards the future outlook of the US. One of the reasons is that we are gaining strength in oil and gas production. The word on the street is that we will surpass Saudi Arabia for oil production by 2017. Wonder when that will be felt in the pumps or if the Iran fear factor will keep gas prices propped up for eternity?

I am holding put positions on some stocks such as SNDK. Apple got hammered today with a 6.5% drop. Intel has not been fairing well either.

Time to put more money back into long funds in my 401K now that the master switch has been pulled back to signal exit short..

Ford (F) and IIF are back pointing up North 11/30/12

Ford has triggered another buy signal. Looks like it held at the trend line and powered back up with the market. I think I will wait for a pullback before re-entering. It is these kind of delayed decisions that I always seem to regret later, as the stock moves on up without me.

SPY is still saying exit long; but it has gone up since the down signal. It looks like the slower stochastic is saying it is moving up strong but the faster stochastic says it is high and due for a pull back. As far as I am concerned, I still have a down signal and will not rush in at this point. Maybe I will miss the Santa rally! Too bad…

IIF (India Fund) also gave an entry signal. So did several currency funds such as FXA, FXC, FXE, FXF. Attached below is the latest end-of-day chart on the India fund.

How can I be Anti Fragile? 11/25/12

Nassim Taleb’s new book “Antifragile: Things that gain from disorder” is likely to be another hit as he uses a catchy title, excellent reputation and his academic standing to promote his extreme but correct theories. I have to admit I was one of the readers of the “The Black Swan” and wondered how I could make money from a market crash. Options came to mind certainly. But I felt I would have to take a thousand cuts of the sword before the black swan event unfolded, whenever it did. I am not too good at taking a thousand cuts. After a few cuts, I am out of there. I think I am still fragile; but I do have plans for risk management of my portfolio. the few people who did massive bets against the sub-prime also had to take a thousand cuts as the markets kept climbing against their positions and they were paying out money against their credit default swap positions. The investors in those pools riled against their money managers and one famous investor and his company sued their momeny manager but the money manager held firm, held the money and remained antifragile and came out with a huge win.

The notion that we are fragile, robust or antifragile is interesting to me. Someone who can handle volatility and actually gain strength from it is antifragile. Taleb talks about his drinking a drop of local water in India to make him stronger. David Cameron supposedly considers Taleb his “Guru”.

I remember thinking about the housing markets in its prime and wondering how I can shelter myself from a possible market drop. The idea of buying put options against a major ETF like IYR or against the housing stocks like HOV occurred to me. But no one else was talking about it and soon my own ideas withered away. I would have bought put options worth my mortgage when the housing market was indicating a fall. Would that have worked? Yes. But I did not act on it.

So what is the next Black Swan event and how do I make myself antifragile? I like to use put options as a hedge and it feels like a thousand cuts when the market climbs like it did last week. But does that make me more robust? Yes. But antifragile? Hmmmm not sure that I have reached that far. Governments and States are extremely fragile and it will take a huge change in the Government to think of them getting antifragile. Taleb talks about allowing institutions to fail so that there is learning memory from the events. But Paulson, Bush, Bernanke and Obama all backed away after Lehman Bros and Bear Stearns… and other like AIG, Bank of America and Merrill Lynch who made very bad bets survived in one form or another. And what about Goldman – well they pulled off the two sided bets that kept them antifragile I suppose.

The next black swan event we will see will be Governments unwilling to take a tough course and instead continuing to print money. I need to map out a plan that Taleb refers to as being more heuristic in nature and not too complicated. The damage in those fat tails can be a lot more than investors like me can withstand.  I will always want to protect myself against them fat tails. But what can I do to truly make lots of money from those events without facing a thousand cuts? I think I have to learn to take those cuts in order to be stronger.
How about protecting my portfolio with alternate currency and gold trading positions? Yes – I need to take some time out during Christmas and finalize those plans and put them into action by 2013 January…I also need to learn to be more contrarian and keep positions in those tails, regardless of the direction.

Ford (F) Changes Direction 11/18/12

I was pretty upbeat on Ford (F) a couple of posts back. I feel obliged to post this and note the change in direction for F and the down arrow that has come up. I still see that the blue trend line I have drawn touching the past lows has not been violated, and the up trend could still survive. Yes – I went long and took half my position out when it started pulling back and closed out the entire position when the down arrow came along. I have pointed out before that I will theorize as to what is happening and sometimes hope; but will not permit such thoughts to cloud my judgment regarding whether to be in a stock or not when my system drops a down arrow on me!

A Down arrow or an exit signal is like Pavlov’s bell ringing to me, and I am the dog. No way that I will sit on a stock and hope it will go up with a down arrow saying it is now tilted towards the downward direction. Staying past your welcome is how people get burned in the stock trading business. Just take a look at the chart on AMD. It is now at a sorry $1.86 after being as high as $7.00 a few months back. There were plenty of down arrows indicating get out.

Gold (GLD) has been down as well and I am currently not in GLD. I will be the first to jump back in when the signal changes to an up signal however! I have also exited major portions of my long position in my 401K and in the last couple of weeks, made a little money on my SPY put positions on the down side. But the charts are pretty oversold and I am expecting a bounce on some good news. Better to close out some of my puts at a profit. I am using the down signals on SPY as my master switch to bias me up or down. Right now the bias is definitely down. The fiscal cliff is the key excuse, along with EU Union going back into a second recession. I certainly would be very surprised if those politicians agreed and compromised on anything! But surprises do happen and that would make the markets joyous for the moment in that the uncertainty would be removed. More likely is a long drawn out protracted process while the market sheds some more value. The drop so far has been  quite orderly. No signs of panic yet.

Pls note that the AMD system chart above shows large and small arrows. Large arrows are overall trend direction. The small arrows are meant to provide guidance within the large arrows - trade only in the direction of the larger arrows.