IBD MEETUP/NORTHRIDGE LET’S MEETUP TO DISCUSS STRATEGY FOR THIS NEW YEAR, 2015 AND CREATE OUR 2015 WATCHLIST January 10, 2015
DISCLAIMER • During the course of this meeting we will review stocks that should be considered as additions to your watch list. • These are not trade recommendations. These are candidate trades. Do your own research, keep position sizes modest, and stay diversified. • Also past performance is no indication of future stock trends. • We will also discuss Trading Strategies we believe to be effective; however keep in mind that nothing works100% of the time sothere is no guarantee these strategies will work for you.
THE JANUARY EFFECT - Will Markets Buck the Trend Again? Watch the Dow as it approaches the 50-day moving average, and see how it reacts. • The 2014 Dow closed up 7.5%. • Per market statistics, we should see a very similar performance in 2015. • In years the Dow gained between 0% and 10%, the following year has historically averaged a 7.2% return. • A positive year has occurred 66% of the time coming off a year that gained between 0% and 10%. • There is some initial weakness in January. • We also saw weakens to begin 2014 (the S&P 500 dropped 3.6% in January of 2014 its first January loss since 2010.) • The Stock Trader’s Almanac says this sets a negative tone for the entire year. • Stocks finish the year higher 73% of the time when January is a positive month. • In 2014 that did not occur. January was lower - but the market still ended in positive territory. AND READ IBD’s BIG PICTURE AND MARKET PULSE DAILY!
FIVE THINGS TO CONSIDER BEFORE A TRADE • TIME • TREND • MOMENTUM • PATTERNS • SUPPORT AND RESISTANCE
A STOCK TRADING GAME FOR 2015 • Log onto the URL: • Sign up and select 5 stocks maximum to trade. • All players can see how any one is progressing. • Each month, we will have the monthly winner tell us his/her strategies. • This will be both a fun contest and a learning experience so I hope that all will play. http://www.marketwatch.com/game/northridge-meetup
I. TIME • Mark Twain famously observed that October is one of the most dangerous months to speculate in stocks. The others, he added, "are July, January, September, April, November, May, March, June, December, August, and February.“ • There's ample evidence that the stock market's performance is tied to the time of year and even the days of a month. • One of the most visible calendar patterns is the so-called Halloween effect, also known as the "Sell in May" indicator, which holds that stocks typically are weaker during summer than winter. • Another pattern appears in the final trading days of the month and the first trading days of the new month. • A subset of that is the "first day of the month trade" -- buying and selling a market index on the first trading day of the month and not going back in until the first day of the next month. • Other market biases: Stocks tend to be stronger during the middle of the month, particularly over the five trading days before St. Patrick's Day, March 17. The ninth trading day of March has been positive for the Nasdaq index more than 70% of the time since 1986. • Stocks also tend to rise in the two or three trading days before a market holiday, such as July Fourth or Christmas.
STOCK MARKET CYCLES There are many types of business cycles including those that impact the stock market. The major cycles of the stock market include: • The four-year presidential cycle in the US, attributed to politics and its impact on America's economic policies and market sentiment, which could be the cause for the stock market's statistically improved performance during most of the third and fourth years of a president's four-year term • Annual seasonality, also known as Sell in May or the Halloween indicator • The month-end seasonality cycle is attributed to the automatic purchases associated with retirement accounts. • The "January effect"wheresecurities' prices increase in the month of January more than in any other month. This calendar effect would create an opportunity for investors to buy stocks for lower prices before January and sell them after their value increases. • The lunar cycle, where basically, stock prices tend to be higher around the time of the New Moon each month and reach a temporary low point around the time of the Full Moon. • The 17.6 Year Stock Market Cycle sImplyput, the stock market will experience 17.6 years of monster gains followed by 17.6 years of volatility ending with next to no returns.
BALENTHIRAN 17.6 Year Cycle Which brings us to the tag-end of the current secular bear market that has been under way since 2000 and which Kerry Balenthiran, a mathematician, believes will finally end in 2018, at which point a major bull market will get started and run until 2035.
INTRA-DAY BIAS TO THE MARKET Figure --> – $100,000 dollars invested (8/31/2010 – 2/11/2011) in each third of the trading day (Red = 9:30 – 11:40, Green = 11:40 – 1:50, Blue = 1:50 – 4:00). The fourth line represents the day-to-day returns.
COMPARING MOMENTUM AND MEAN REVERSION Momentum and mean reversion are common characteristics of stock price movement. These characteristics have opposite behavioral natures. Their behavior offers a convenient mode for the testing. At the risk of oversimplification, if mean reversion strategies do not produce profitable results, then momentum strategies must be profitable; or, if momentum strategies do not produce profitable results, then mean reversion strategies must be profitable. - Momentum and Mean Reversion (Average Net Profit for 1–30 input values, since 1983). (Red = 9:30–11:40, Green = 11:40–1:50, Blue = 1:50–4:00)
II. TREND Profiting from long-term trends is the most common path to success for traders. The challenge is recognizing the emergence of a trend and determining where to enter and exit the market. • “Let’s break down the term ‘trend following’ into its components.[Van Tharp] • The first part is ‘trend.’ Every trader needs a trend to make money. If you think about it, no matter what the technique, if there is not a trend after you buy, then you will not be able to sell at higher prices. • ‘Following’ is the next part of the term. We use this word because trend followers always wait for the trend to shift first, then ‘follow’ it.” • Trend following trading seeks to capture the majority of a market trend, up or down, for profit. It aims for profits in all major asset classes—stocks, bonds, currencies, and commodities. • Unfortunately, however simple the basic concepts about trend following are, they have been widely misunderstood by the public.
INVESTOR OR TRADER? Do you consider yourself an investor or a trader? Most people think of themselves as investors. • However, if you knew that the biggest winners in the markets call themselves traders, wouldn’t you want to know why? Simply put, they don’t invest; they trade. Investors put their money, or capital, into a market, such as stocks or real estate, under the assumption that the value will always increase over time. • As the value increases, so does the person’s “investment.” • Investors typically do not have a plan for when their investment value decreases. • They usually hold on to their investment, hoping that the value will reverse itself and go back up. Investors typically succeed in bull markets and lose in bear markets.
WHAT IS TREND FOLLOWING? It is a trading strategy that attempts to capture gains through the analysis of an asset's momentum in a particular direction. • The trend trader enters into a long position when a stock is trending upward (successively higher highs). • Conversely, a short position is taken when the stock is in a down trend (successively lower highs). This strategy assumes that the present direction of the stock will continue into the future. • It can be used by short-, intermediate- or long-term traders. • Regardless of their chosen time frame, traders will remain in their position until they believe the trend has reversed - but reversal may occur at different times for each time frame.
WHO WINS AND WHO LOSES Investors anticipate bear (down) markets with fear and trepidation, and therefore, they are unable to plan how to respond when they start to lose. • They choose to “hang tight,” and they continue to lose. • They have an idea that a different approach to their losing involves more complicated trading techniques such as “selling short,” of which they know little and don’t care to learn. If the mainstream press continually positions investing as “good” or “safe” and trading as “bad” or “risky,” people are reluctant to align themselves with traders or even seek to understand what trading is about. • A trader has a defined plan or strategy to put capital into a market to achieve a single goal: profit. • Traders don’t care what they own or what they sell as long as they end up with more money than they started with. They are not investing in anything. They are trading. It is a critical distinction. A trend follower [Trader] can wait weeks or months for the right trade that puts the odds on his side. As Ed Seykota was fond of saying, "One good trend pays for them all!". Should a decent trend start to materialise, then it is quite possible that the run of losses suffered could easily be eliminated. Such is trend following.
A SIMPLE TREND FOLLOWING SYSTEM • Here are the rules for this system. • If the current price is higher than the price one year ago, go long. • If the current price is lower than one year ago, go short. To make it a little easier to read, the lower chart shows the yearly results as well. The green bars show the returns and the red bars the maximum intra-year drawdown. This simple strategy showed annualized return of 22% against a max drawdown of 26% and a Sharpe ratio of 1.1. This is before fees, so you’ll need to shave a bit on that, but it’s still better than most do in real life.
TREND FOLLOWING COMPONENTS Any mechanical system (trend following included) has the following components: • Entries - Every system has a condition or trigger for entry. • The turtle system used standard break-out (channel) entries. For example, the highest high (or lowest low if going short) of the last 55 days was used in one of the turtle systems. Not sexy, nor does it do much for winning percentage, but it enables that you are there for the ride if a trend starts. • Exits - Once we are in a trade, we need to know when to get out if it goes against us (initial stop loss) or when to exit a profitable trade. • Standard trend following systems don’t use profit targets. The turtles used the same strategy on exits as they did with entries – lowest low of the last N number days. As expected, it is impossible to catch the top with such a strategy. It does, however, keep you in the trade through normal fluctuations for the full ride. • Risk % - Almost all trend followers limit their risk to a certain percentage of capital on each trade. Typical ranges are 1-2%, using fixed fractional position sizing. • You have some options here, as you can use open equity (more aggressive) or closed equity (more conservative) for determining position size. • Using a simple example, if you are trading a $100,000 account and your open equity (capital + open profits – open losses) is $110,000, risking 2% would yield $2,200 per trade. Using closed equity, you would risk $2,000 per trade (2% of $100,000).
INVEST IN A FEW GOOD BOOKS Read a few good books that really steer towards trend following: • Market Wizards • The Jesse Livermore books also set the wheels in motion. • Digging into the “Turtle Traders” in great detail, especially their thoughts/methods for risk, correlation, normalizing each instrument traded, and the worthlessness of winning percentage will seal the deal. You will be sold on the idea of being removed from the markets, being removed from the NASA type trading screens and simply“REACTING” to price. The DNA of trend following really comes down to “never arguing with price – ever”.
III. MOMENTUM In momentum trading, traders focus on stocks that are moving significantly in one direction on high volume. • Momentum traders may hold their positions for a few minutes, a couple of hours or even the entire length of the trading day, depending on how quickly the stock moves and when it changes direction. • One potential explanation for why momentum strategies have been found to be more promising is that momentum strategies have both a cross-sectional and a time-series component, whereas pure trend-following strategies have only the latter.
A DAY IN THE LIFE OF A MOMENTUM TRADER • Get up an hour before the market opens, switch on the computer, go online and immediately log into one of the popular trading chat rooms or message boards. • When looking at these boards, focus on stocks that are generating a significant amount of buzz. Look at stocks that are the focus of trading alerts based on earnings or analyst recommendations. These are stocks rumored to be in play, and they are anticipated to provide the most significant price movements on high volume for that trading day. • While surfing the web, also turn on CNBC and listen for mentions of companies releasing news or positioned to undergo significant movement. • Eye the morning equity options pages to find stocks with significant volume increases in calls. Any increase in calls written indicates that a price increase or decrease above or below the option premium is expected. • Once the market opens, watch your initial list of stocks in relation to the rest of the market: Are these stocks going up when the market goes down? Are they significantly increasing in price in relation to the rest of the market? Are they behaving consistently with expectations based on pre-market assessment? • Then narrow the watch list to include only the strongest stocks: those increasing more rapidly on higher volume than the rest of the market, stocks trading contrary to the market and stocks with movements clearly propelled by external factors.
ANALYZING THE CHARTS Next, a momentum trader will analyze the list of stocks he has chosen to focus on by examining their charts. • The primary technical indicator of interest is the momentum indicator - the accumulated net change of a stock's closing/ending price over a series of defined time periods. • The momentum line is plotted as a tandem line to the price chart, and it displays a zero axis, with positive values indicating a sustained upward movement and negative values indicating a potentially sustained downward movement. That upward or downward momentum indicator often immediately portrays a breakout for the stock, which means that even a period or two of sustained momentum will propel that stock in the direction of the breakout. • While watching the momentum chart, he has his Level 2 screen up, looking for evidence of a push, where bids start to line up (indicated by the presence of market-makerlimit orders) and offers start to disappear. When the trader believes he has identified a breakout, he does not necessarily need to jump immediately into the stock. • He is not generally worried about missing the first one or two breakout ticks, but he has his hand on the buy trigger (or sell trigger in the case of a short sale, but a short sale must be done on an uptick) for one of the next momentum periods. • And he is generally not too concerned about hitting the bid either, as he will have an easier time getting in at the market price. Then he places a market order.
IV. PATTERNS Chart patterns are a very useful tool because they occur regularly—providing you with lots of trade candidates—and also provide everything you need to trade. The idea is that certain patterns are seen many times, and that these patterns signal a certain high probability move in a stock. Based on the historic trend of a chart pattern setting up a certain price movement, chartists look for these patterns to identify trading opportunities. While there are general ideas and components to every chart pattern, there is no chart pattern that will tell you with 100% certainty where a security is headed. This creates some leeway and debate as to what a good pattern looks like, and is a major reason why charting is often seen as more of an art than a science. There are two types of patterns within this area of technical analysis, reversal andcontinuation. • A reversal pattern signals that a prior trend will reverse upon completion of the pattern. • A continuation pattern, on the other hand, signals that a trend will continue once the pattern is complete. • These patterns can be found over charts of any timeframe. In the next slides, we will review some of the more popular chart patterns.
Figure 1: Head and shoulders top is shown on the left. Head and shoulders bottom, or inverse head and shoulders, is on the right. HEAD AND SHOULDERS • This is one of the most popular and reliable chart patterns in technical analysis.Head and shoulders is a reversal chart pattern that when formed, signals that the security is likely to move against the previous trend. • As you can see in Figure 1, there are two versions of the head and shoulders chart pattern. Head and shoulders top (shown on the left) is a chart pattern that is formed at the high of an upward movement and signals that the upward trend is about to end. Head and shoulders bottom, also known as inverse head and shoulders (shown on the right) is the lesser known of the two, but is used to signal a reversal in a downtrend. [An upward trend is a period of higher highs and lows. The head and shoulders chart pattern, therefore, shows the deterioration in the succession of the highs and lows. ] Both of these head and shoulders patterns are similar in that there are four main parts: two shoulders, a head and a neckline. Also, each individual head and shoulder is comprised of a high and a low. For example, in the head and shoulders top image shown on the left side in Figure 1, the left shoulder is made up of a high followed by a low. In this pattern, the neckline is a level of support or resistance.
CUP AND HANDLE Figure 2 • A cup and handle chart is a bullish continuation pattern in which the upward trend has paused but will continue in an upward direction once the pattern is confirmed. • As you can see in Figure 2, this price pattern forms what looks like a cup, which is preceded by an upward trend. • The handle follows the cup formation and is formed by a generally downward/sideways movement in the security's price. • Once the price movement pushes above the resistance lines formed in the handle, the upward trend can continue. • There is a wide ranging time frame for this type of pattern, with the span ranging from several months to more than a year.
Figure 3: A double top pattern is shown on the left, while a double bottom pattern is shown on the right. DOUBLE TOP/BOTTOM • This chart pattern is another well-known pattern that signals a trend reversal - it is considered to be one of the most reliable and is commonly used. • These patterns are formed after a sustained trend and signal to chartists that the trend is about to reverse. • The pattern is created when a price movement tests support or resistance levels twice and is unable to break through. • This pattern is often used to signal intermediate and long-term trend reversals. In the case of the double top pattern in Figure 3, the price movement has twice tried to move above a certain price level. After two unsuccessful attempts at pushing the price higher, the trend reverses and the price heads lower. In the case of a double bottom (shown on the right), the price movement has tried to go lower twice, but has found support each time. After the second bounce off of the support, the security enters a new trend and heads upward.
TRIANGLES • Triangles are some of the most well-known chart patterns used in technical analysis. • The three types of triangles, which vary in construct and implication, are the symmetrical triangle, ascending and descending triangle. • These chart patterns are considered to last anywhere from a couple of weeks to several months. The symmetrical triangle is a pattern in which two trendlines converge toward each other. This pattern is neutral in that a breakout upside or downside is a confirmation of a trend in that direction. In an ascending triangle, the upper trendline is flat, while the bottom trendline is upward sloping. This is generally thought of as a bullish pattern in which chartists look for an upside breakout. In a descending triangle, the lower trendline is flat and the upper trendline is descending. This is a bearish pattern for a downside breakout. FIG. 4
FIG. 5 FLAG AND PENNANT • These two short-term chart patterns are continuation patterns that are formed when there is a sharp price movement followed by a generally sideways price movement. • This pattern is then completed upon another sharp price movement in the same direction as the move that started the trend. • The patterns are generally thought to last from one to three weeks. • As you can see in Figure 5, there is little difference between a pennant and a flag. • The main difference between these price movements can be seen in the middle section of the chart pattern. • In a pennant, the middle section is characterized by converging trendlines, much like what is seen in a symmetrical triangle. • The middle section on the flag pattern, on the other hand, shows a channel pattern, with no convergence between the trendlines. • In both cases, the trend is expected to continue when the price moves above the upper trendline.
SUPPORT AND RESISTANCE Support and resistance represent key junctures where the forces of supply and demand meet. In the financial markets, prices are driven by excessive supply (down) and demand (up). Supply is synonymous with bearish, bears and selling. Demand is synonymous with bullish, bulls and buying. These terms are used interchangeably throughout articles. As demand increases, prices advance and as supply increases, prices decline. When supply and demand are equal, prices move sideways as bulls and bears slug it out for control.
WHAT IS SUPPORT? • Support is the price level at which demand is thought to be strong enough to prevent the price from declining further. • The logic dictates that as the price declines towards support and gets cheaper, buyers become more inclined to buy and sellers become less inclined to sell. • By the time the price reaches the support level, it is believed that demand will overcome supply and prevent the price from falling below support. • Support does not always hold and a break below support signals that the bears have won out over the bulls. • A decline below support indicates a new willingness to sell and/or a lack of incentive to buy. • Support breaks and new lows signal that sellers have reduced their expectations and are willing sell at even lower prices. • In addition, buyers could not be coerced into buying until prices declined below support or below the previous low. • Once support is broken, another support level will have to be established at a lower level.
WHAT IS RESISTANCE? • Resistance is the price level at which selling is thought to be strong enough to prevent the price from rising further. • The logic dictates that as the price advances towards resistance, sellers become more inclined to sell and buyers become less inclined to buy. • By the time the price reaches the resistance level, it is believed that supply will overcome demand and prevent the price from rising above resistance. • Resistance does not always hold and a break above resistance signals that the bulls have won out over the bears. • A break above resistance shows a new willingness to buy and/or a lack of incentive to sell. • Resistance breaks and new highs indicate buyers have increased their expectations and are willing to buy at even higher prices. • In addition, sellers could not be coerced into selling until prices rose above resistance or above the previous high. • Once resistance is broken, another resistance level will have to be established at a higher level.
V. SUPPORT AND RESISTANCE • Many traders who use technical analysis often hear phrases that suggest a "broken support level will become a future area of resistance" or that a "previous level of resistance will become a support". Even many experienced traders never fully understand or appreciate this intriguing role reversal. These slides will attempt to shed light on the importance of support and resistance and illustrate why traders should take note when they reverse roles. • Support and Resistance – The BasicsTo understand the role reversal between support and resistance, you must first have a basic understanding of these important concepts. Support and resistance are terms used by technical traders to refer to specific price levels that have historically prevented traders from pushing the price of an underlying asset in a certain direction. • For example, let's assume ABC stock has attempted to fall below an ascending trendline several times over the past few months, but although the price approaches this line several times, it fails to move below it. In this case, the trendline is known as a support level because it corresponds to a price level where most investors feel comfortable buying the asset, preventing the market from sending prices drastically lower. On the other hand, traders use resistance to describe when the price of an asset has difficulty moving above a given price level, which then forces the price of the asset to decline.
THE REVERSAL FIG. 1 – Support becomes Resistance One of the most interesting phenomena regarding support and resistance occurs when the price of the underlying asset is finally able to break out and go beyond an identified support or resistance level. • When this happens, it is not uncommon to see a previous level of support change its role and become a new area of short-term resistance. • As you can see from the chart to the right, the dotted line represents the price that was able to prop up the price movement at points 1 and 2, but this support turns into resistance once the price falls below it, as illustrated by points 3 and 4.
AND THE OPPOSITE FIG. 2 – Resistance becomes Support. • The opposite of this process occurs when the price breaks above resistance. As you can see in Figure 2, points 1 and 2 begin as price barriers, but once the bullsare able push the price above the dotted line, it becomes an area of support (illustrated by points 3 and 4).
SUPPORT AND RESISTANCE ZONES • Because technical analysis is not an exact science, it is useful to create support and resistance zones. • Each security has its own characteristics, and analysis should reflect the intricacies of the security. • Sometimes, exact support and resistance levels are best, and, sometimes, zones work better. Generally, the tighter the range, the more exact the level. • If the trading range spans less than 2 months and the price range is relatively tight, then more exact support and resistance levels are best suited. • If a trading range spans many months and the price range is relatively large, then it is best to use support and resistance zones. Returning to the analysis of Halliburton (HAL)[Hal], we can see that the November high of the trading range (32 to 44) extended more than 20% past the October low, making the range quite large relative to the price. Because the September support break forms our first resistance level, we are ready to set up a resistance zone after the November high is formed, probably around early December. At this point though, we are still unsure if a large trading range will develop. The subsequent low in December, which was just higher than the October low, offers evidence that a trading range is forming, and we are ready to set the support zone. As long as the stock trades within the boundaries set by the support and resistance zone, we will consider the trading range to be valid.
GETTING STARTED • GOOD TRADING METHOD • NO OF STOCKS TO OWN • ROUTINE • ESTABLISHING POSITIONS • MONEY MANAGEMENT
GOOD TRADING METHOD • Manage Trade – Starts with trading plan which must be written and followed at all times; revise as required. • Identify Lower Risk – Higher Probability trade which leads to a net positive income. If you don’t know what your trading edge is, you don’t have one. • Set-up conditions are mandatory parameters that must be met before placing an order. • Entry Rules actually get you into a position. • Initial Stop when the market goes where you didn’t expect it to go. • Exit Strategy allows you to manage the trade with profit target limits where you close at least 50% of the trade and move your trailing stop to protect the second half of the trade. • Risk Management is key – Never risk more than 2% to 5% per trade
ANOTHER SIMPLE TRADING PLAN • Market is in an UPTREND and pulls back to SUPPORT. • New 30 bar highs within 8 bars of new 30 bar lows. • Market breaks out above Highest High of last 3 bars. • Market is in an UPTREND = Buy • Market is in a DOWNTREND = Sell • Initial Stop • Sell below recent lows [Long] or Buy above recent Highs [Short] • Place where you don’t expect to go • Exit Strategy • Sell 50% at initial target • Change stop to breakeven on remaining half • Exit at Lowest Low of past three bars in UP Trend; or • Exit at Highest High of past three bars in DOWN Trend
Apr 4 is a new 30 day bar high within 8 bars (5) of new 30 bar low. Market breaks out within 3 bars above Highest High of last three bars on Apr 15. We place Market Order for open on April 16 with stop 3 ticks below the Low of April 11. We are filled at $17.54 with a stop at $16.65 hence our risk is $0.89. We set our profit target at 4 times risk, or $3.56 ($21.10). We exit trade on May 12 at open of $21.23 for a profit of $3.69/share. • NOW HOW MANY SHARES? – We can risk 2%-5% of our portfolio depending on size. Say our current portfolio is $25,000 and we are willing to risk 3%, or $750 per trade. On this transaction our risk per share was $0.89 so we divide $750 by $0.89 which equals 842.7 shares. If we buy in round lots we could by 800 or 900 shares. At 800 shares, ignoring fees we would have a gross profit on this trade of $2952 in 26 days. EXAMPLE
SUMMARY • Someone once said the reason more people don’t take advantage of opportunity is it often looks like work. • Unfortunately, investing/trading is work. • The people who work the hardest reap the biggest gains. • There is no sure fire system that wins 100% of the time. However if you have a system and win only 30%+ of the time, you will make money by good money management which keeps your losses<7%. • A good routine is a written routine that is absolutely followed. • If you stick to Trend Following and limit your trades to low risk, higher reward trades, you will make money.
MARKET SMITH SUMMIT • Hello Members! • Scott O'Neil will be hosting a LA Trading Summit in a few weeks. The link to RSVP is below. • Other speakers include: Amy Smith, Justin Nielsen, IrushaPeiris & Scott St. Clair • http://www.marketsmith.com/special/tradingsummit/?src=MCIM51 • See you there!! • - IBD Meetup