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BackTesting Blog An Educational Resource for Strategy Development
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Watching the football teams psych up for the playoffs today, I’m reminded how big a factor emotion can be! In sports and many other competitve endeavors we strive to pump ourselves up emotionally to win. Check out this video by Adam Hewison to see how dangerous those same emotions can be to your trading.
Tags: psychology
Adam Hewison’s Minute 3 video (click here to watch) suggests traders choose between technical and fundamental information for their trading decisions.
I have to ask: How about using what works?
We have the technology now to check out how well each of the different types of data performed in the past. You can look at the track record of experts writing newsletters, back test technical indicators, back test fundamental numbers like Earnings Per Share (EPS), Price/Earnings, and most of the key statistics of a company. Services tell how well seasonal predictions correlated with actuals, and even programs to data-mine for dates a market “always” moves.
With all that at our fingertips, we’re in a great position to estimate the quality of data source, and cherry-pick the data sources that demonstrated their effectiveness — or at least avoid the ones that are complete hooey.
However, our human brains are wired for stories. Both fundamental analysists and technical analysists can weave compelling stories. Unfortunately, at times the juiciest stories are not based on the strongest data.
Perhaps the key question is: Do you want to make your decisions based on objective data with a known track record, or do you want to remain a sucker for a good story? Adam Hewison is right in that you need to decide what type of information you will use to trade.
Tags: behavior finance, fundamental, INO, technical
In the 2nd Market Club Minute, Adam Hewison talks about a key decision you need to make as a trader – choosing a time frame. Click here to watch his 1-minute video.
One way to facilitate that decision is to list the types of traders and their time frames:
Understanding yourself is essential. Understanding the different risks and rewards of trading in each of these timeframes gives you a framework to find the optimal spot for you. A good place to find out more is the BackTesting Report Baseline - click here to download it directly (no registration required).
(BackTesting Blog is an INO.com affiliate.)
Professional trader Adam Hewison is distilling his decades of experience into one-minute videos.
Click here to watch the first one directly
The key word in the video is clearly “Confidence”
What do you need to do to gain the confidence you need to trade successfully? Your answer might include items like these:
Your answer is unique to you but whatever it is, I encourage you to take time early in the year to plan for your success throughout 2010 and beyond!
(BackTesting Blog is an INO.com affiliate)
Tags: INO
Click to view my Maximum Adverse Excursion video.
The Maximum Adverse Excursion or MAE is a measure of how far a trade went against you. Read this previous post for a definition. BackTesting Reports measures MAE across thousands of trades, allowing you to use it as a metric to assess and compare trading strategies.
Of course the idea is to pick a strategy with a low Maximum Adverse Excursion. You can also reduce the MAE (and risk) of a strategy by using a stop loss.
I get Google alerts on every MACD blog posting which is quite a lot. Most are not noteworthy and some are downright off base, but every once and awhile, a really good post on MACD comes along. That happened most recently when I came across a well-done video by Adam Hewison using MACD and MACD divergence. I liked it well enough to see what else he had to offer and now have some goodies to share with you. See the guest blog post below from Adam Hewison. You can sign up for his free email trading course by clicking here. I’ve taken the first lesson so far and thought it a succinct and timeless lesson.
First of all I want to thank you for having me as a guest today!
My name is Adam Hewison. You might want to Google Me to confirm what I am about to share with you.
There are plenty of people out there that create “exclusive email courses” with little or no credentials to actually backup their teachings. So, I think it’s right that I share a little bit about myself with you before we even start.
I was a former floor trader on the IMM, IOM, NYFE and LIFFE as well as a risk manager of a large, multinational corporation in Geneva, Switzerland. I also have written books on forex trading and trend following. In 1995, I founded INO.com and later co-founded MarketClub. I’ve been in the trading biz for over three decades and have seen it all. I created this course as a way to give back and share trading tips and techniques that I still use in my trading today.
In my Free Mini Email Course, I will show and explain the tools and strategies you need to increase your success rate in the marketplace.
(1) The importance of psychology in price movement
(2) How to spot mega trends
(3) Understanding of technical price objectives
(4) How to picture price objectives
(5) How to trade with moving averages
(6) How to use point and figure trading techniques
(7) How to use the RSI indicator
(8) How to correctly use stochastics in your trading
(9) How to use the ADX indicator to capture trends
(10) How to capitalize on natural market cycles.
Plus, you will you will learn all about fibonacci retracements, MACD, Bollinger Bands and much more.
Just fill out the form and we’ll get you started right away.
Every success,
Adam Hewison
President, INO.com & Co-Creator, MarketClub
Here’s a short interview at the MoneyShow on the topic of choosing buy or sell signals in order to profit trading and reduce risk of loss. Click here to play video
To summarize:
Before risking any money in the markets, I want to know that I have a reasonable chance to profit trading. With that in mind while choosing technical indicators to give buy signals and sell signals, I first evaluate them by whether I think they will yield a profit trading. My preferred method is to backtest and then publish the results in BackTesting Report.
Trying to figure out whether it’s the buy signal or the sell signal which is the source of profit when trading brings a chicken-and-egg problem. Is the trading profit due to the buy signal or is the trading profit due to the sell signal? One way to sort this out is to first backtest the buy signals as independently as possible and then later backtest several sell signals using the buy signal that showed the most potential trading profit.
Backtesting Report does this by setting a timed exit, meaning that the strategy will sell after a given number of days. This is not meant for real trading, even if it does show a profit. It is simply to get an idea if the buy signal is any good.
Different types of traders favor different timeframes. To make the hunt for a good buy signal more realistic, BackTesting Report models three different types of traders and reports the win rate or percentage of profitable trades. A timed exit of:
If you already know what timeframe you prefer you can just look at the results for that timeframe. I have also found it useful to compare win rates across different holding periods to help me decide which timeframe I want to target to maximize trading profit.
After picking a buy signal, then it is time to choose a sell signal. The BackTesting Reports compare several different exit strategies for the same buy signal to see which results in the best potential for trading profit. The main criterion for measuring potential for trading profit at this stage is expectancy. The different types of sell signals in BackTesting Report are in these categories:
Here again it’s useful to look at the amount of time each strategy held a position and match it up to your needs. Of course, the main point is to choose a strategy with the highest potential for trading profit.
Along with backtesting results, it’s also a good idea to do forward testing to confirm the choice of buy signal and sell signal.
Of course there is more to learn about how to profit trading than just picking a buy and sell signal. You need to decide how to opportunities to trade and how to keep track of trading profits and losses, for example. Most important, is deciding how to manage risk to be sure to stay in the game and hang on to your trading profits!
For more info on technical indicators tested as buy signals and sell signals, see BackTestingReport.com
Tags: backtesting, MoneyShow, profit trading, signal, strategy, timeframe
Here is part 2 about stock entry strategy or the buying process. The previous article talked about stock screening, which is the background investigation to select a pool of candidate stocks to buy when the time is right. The trigger or market timing signal is the topic of this article.
Once you have a universe of candidates, you need an entry signal or trigger. Stocks can sit around looking good enough to buy for a long time, and you need a discrete event to say “Buy Now”. Hard experience has taught me that “when I have time to complete research” and “when I feel excited about stocks” are not the best entry conditions. In retrospect, it was usually a price extreme that got me pumped enough to research stocks and hit the buying point. I’ve found that exercising the judgement to pick a better entry point can be more financially rewarding than just jumping in. Personally, I suspect that even a random entry point would be better than emotion-driven buying, and backtesting can help identify strategies that do better than random.
I see three broad categories that can be used as in entry signal: news events, clock or calendar events, and price events, especially as indicated by objective technical analysis. Let’s compare them.
If you’re new to the stock market, reacting to news events may seem the most natural thing in the world. However, a little experience shows that the market anticipates and prices in news before it happens. This is called discounting. As an example, remember the recent situation with Steve Jobs and Apple. It follows the saying, “Buy the rumor, sell the news”, only in reverse because bad news is what moves the market lately. Here’s what happened: Amid rumors of Jobs’ recurring illness, the price of AAPL declined, all the while Apple insisted Jobs was healthy. Then Jobs announced that he was taking a medical leave of absence. If the rumor of illness prompted a decline, then one might think that the news of his departure would tank the stock – he has had an unquestionable impact on the company, after all. What actually happened, though, is that AAPL traded down to a new 52 week low in after-hours trading on January 14, the day of Jobs’ departure. The following day, the price opened low, but regained most of it to close at near the high of the day. Price bounced around the lows for 3 days, and then began an ascent that ended 3 weeks and 30% later. The market had already priced in the news and the reaction went in the opposite direction, as it often does. The upshot of this example is that it is difficult, if not impossible, to form an objective strategy around the news because the news may be priced into the market and always must be subjectively interpreted.
The second type of entry signals, clock and calendar events, are more objective than the news, but that’s not saying they’re 100% reliable. Some of the people who use this category of signals are
Some of the calendar-driven moves truly are driven by the calendar. Others are due to coincidence, while still others are illusion. Backtesting – either automatically or by manually checking the charts – can weed out the pretenders by determining which have been profitable in the past, and that is a useful first step. I think you owe it to yourself to take it one step further and look for a plausible cause for the move rather than betting good money on a pattern that came about by chance.
The same can be said of technical indicator signals – you need to understand why they work — plus you need to make sure they are objective. Aronson’s book makes a good case for using objective indicators rather than relying on subjective information for trading decisions. A signal is objective if there is no “wiggle room” in describing it, if any two people always see it the same way (not like pattern recognition) and/or you could program it into a computer. Elder’s first book gives good descriptions of technical indicators grounded in crowd behavior.
You can also think through the implications of the strategy. For example, consider the trend-following strategy of buying when price hits a new high. A new high doesn’t guarantee that the price will keep going, but all runaway stocks had to make new highs along the way. A good thing to know is how many stocks making new highs go on to make a profit for investors holding for, say, one year. Backtesting is one good way to estimate this info. Sign up for email alerts to find out when new highs will be featured in BackTesting Report.
Backtesting can also help us overcome our human tendency to become overconfident in a signal because we can easily spot on a chart the times that the signals worked and all too easily overlook the false signals. A false signal is where the signal comes but the stock price doesn’t go in the expected direction long enough for the trader to profit. It’s expensive to learn about false signals and our little foibles of human cognition in live trading.
The previous article used the example of price above the moving average to illustrate a potential stock screen. A corresponding signal using moving averages is price crossing the moving average, or moving averages crossing each other. They offer objective, discrete events to replace emotional guesswork with rational decision-making. To find out more, check out the BackTesting Report MA Buy Signal package.
Updated on 3/17/09 to add: (BacktestingBlog is an Amazon Associate. )
Updated on 3/19/09 to add: (Author has a position in stocks mentioned in this article. )
With a rally coming together over the past week, I want to review two distinct and important elements of the buying process. Before I jump in, let me say that I don’t claim to know if this is The Time to buy or not. I do want to give you two steps to consider when making that decision for yourself. They are:
This first, stock screens, is more time invariant – a fancy way of saying the list doesn’t change much day to day. In fact, you may not want to change you stock list much year to year as there is a lot to be said for getting to know a handful of stocks inside and out. If you’re like me, you itch to scan a huge number of stocks to see offer up the best opportunities. Of course, you can do both. I have my screeners delivering new stocks every day and I also have my favorites that I’ve gone back to so many times over the years that I am part of the reason support and resistance works because I know from memory what is a low buying price and when to take the money and run. On the other hand, a decidedly Bad Idea is obsessively returning to a stock on which you lost thinking that it “owes you”. This is where an objective plan can really save you.
Sit down at a quiet time and think through the things you want in your candidate stocks. I consider three categories: practical matters, fundamentals, and technical screens. Other folks might want to consider social values, or what their friends say, or worldwide demographics. I have a hard time making the last three objective myself.
On the bare-bones practical side:
Do fundamentals matter or is the sum total of available information reflected in the price? You will have to make your own decision on that, dear reader, because the fundamental data I had at my disposal last I looked was not clean enough to make a good determination. Even so, I do use fundamentals as a tie-breaker for the times when I get too many signals at once. Then I’ll take the signals on the stocks with fundamentals (and story) to my liking. A better way is to refine the objective rules to come up with just the right number of stocks to fit your account.
Technical stock screens are an important component of your plan. They can and should be tested thoroughly. First define what you want, say stocks in an uptrend, or beaten down stocks, or stocks trading in a nice range, whichever. Then figure out which tool from technical analysis delivers the best candidates for your needs. This means know how well the various technical analysis tools have performed. This applies whether you are picking the short list of stocks you will grow with for the next couple years, or setting up a daily screen. If it’s done right, your technical stock screener can give a solid list of candidates. Remember, the point is not to go out and buy all of these right away, but instead to stalk them for the right time to make your move.
For example, a moving average can function as a stock screener, where stocks above the moving average are said to be in an up-trend and stocks below the moving average are said to be in a downtrend. Many experts recommend buying only stocks which are above their moving average, although some will say you can capture more of the move by getting in well below the averages. Of course the advice varies on which length of moving average and what you use may depend on whether you have a short- or long-term outlook. Click here to order your copy of the BackTesting Report on moving average stock screens and find out which moving averages have potential and which have not proven out as a stock screener.
This post talks about screens stocks to build a candidate list that is bigger than you can use at any one time. The examples — price, volume, above/below moving averages — showed objective, testable tactics that can identify out a candidate list. But the stock screener doesn’t pinpoint the time to buy. For that we need a more precise entry signal which I’ll discuss in the next article.
Tags: backtesting, entry strategy, moving average, risk, signal, Strategy Development
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