Golden Braid Analogy to Investing

img_1769I want to tell you the story of the Golden Braid because its a great analogy to active investing. 

In the beginning, its very awkward to grow out your hair.  Likewise, with a stock or other investment, a new position can feel awkward.   We check it often, and sometimes find its not looking as we want — maybe going entirely the wrong way.    After awhile, if neither the stock nor the hair has disintegrated, we can get comfortable.

In the middle phase, to grow a long braid, one has to do nothing.    Sounds easy but funny it doesn’t come very naturally for most of us!  With hair, everyone from friends to stylists – and stylists are the worst! – suggests a shorter cut or wonders aloud about the upkeep.   

Likewise, in the middle phase of growing a big investment position, if its moving the right way, you have to sit on your hands and skip many opportunities to sell.   Neither hair nor position can grow to its full potential if you keep messing with it.

Nothing grows forever.  We have to remain alert for a change of character and eventually make the hard decisions.   My blonde hair darkened.  Okay, I could deal with that.  Faced with gray wisps coming in, I had a choice:  Hang on and watch the gold slowly whittled away or lop the braid while it was still useful (undyed hair is made into wigs for kids on chemo.  see before and after pics of my “harvest”.)

Similarly, a change in character of the markets begs a decision whether to let the downdrafts slowly erode positions, or get out while the getting is still good.

Today’s Analysis – Example Using MACD Div Signals Pages

I’m posting my weekend market analysis today for two reasons: 

  • to illustrate how I use the MACD divergence signals
  • because it looks like something interesting may be afoot

Step 1 – Form an overall opinion of the market direction

I use several indicators, factors, and experts to form my overall opinion of the markets.   Some methods I’ve back tested, others await testing.  For today, I’ll cite the following:

  • McClellan Summation Index Negative Divergence
  • SPY down hard and closing at its lows, after exhibiting repeated negative MACD divergences
  • Weekly Trade Triangle Sell Signal — check out this video by Adam Hewison for a very articulate rundown

I come away with a bearish outlook for US stocks.

Step 2 – Check the Weekly MACD Divergences, then Daily MACD Divergences

Since my outlook is bearish, I will be looking more at the negative MACD Divergence signals.   I have yet to publish the back test results for shorting MACD Divergences but let me just say that I know to be VERY cautious with these signals on the short side.     If I owned any stocks on the negative divergence lists, however, I would sell them in a heartbeat, given my outlook from Step 1.

If my outlook were more bullish, I would examine the positive divergence signals for possible buy candidates.  But it isn’t, so I don’t.

Always check the larger timeframe first so that means looking at weekly charts before daily charts.  Whether you choose to review MACD Histogram divergences or MACD Lines divergences or both will depend on your goals and temperment.

I check in this order:

  1. Weekly MACD Divergences
  2. Weekly MACD Histogram Divergences
  3. Daily MACD Divergences
  4. Daily MACD Histogram Divergences

As of Friday’s close, two stocks appear as negative MACD divergences on all four lists: BIDU and SBUX

Step 3 – Gather more info about the candidate stocks

I check the charts of my two favorites from the lists.  Both charts look like reasonable negative MACD Divergences.   I also take a brief glimpse at selected Key Statistics.   BIDU is showing moderate but not overwhelming growth.   SBUX sports 4-figure earnings growth which I take to mean they have recovered a bit from the abyss.   Still MCD is making strong competition.

I also check my affiliate INO.com’s trade triangle trend analysis.  Again, I haven’t yet published my back test results but let me briefly say that my interest is to emphasize the Weekly Trade Triangle.   I don’t take all the signals but won’t trade against them, that’s for sure!

As it happens, SBUX  just got a weekly triangle buy signal so that scratches it from my list for now but I add it to my portfolio to watch.   BIDU is listed as “sideways mode” so that remains a viable candidate for a high-risk short sale.

Along the way, I noticed a fresh weekly triangle sell signal on AAPL.  That catches my eye because AAPL showed up on the weekly negative divergence list and my friends were talking about its upcoming product announcement Wednesday.   I also add AAPL to my watch list for consideration late in the week.

(if you want your own Trend Analysis, just click the symbol and enter your email address)

Step 4 – Apply Risk Management

The final step in assessing trading opportunities is applying judgement to reduce risk.  

I first consider what I know of my best current candidate from the steps above, BIDU:  its a crowd favorite that’s defied gravity before.  That’s not to say it hasn’t been knocked down, it just that as it hit a New High earlier in the week, I know it will come to the attention of lots of momentum traders.    

I decide to short BIDU, but select a risk amount on the small end of my scale.

I consider where to put my stop loss and realize due to the high price per share, it will be over $50 per share away from my likely entry point.  That means to keep my risk low, I will be trading very few shares indeed.   So be it.

I enter the order to sell short, along with an automatic stop loss and wait to see what next week will bring.

In summary, this is an example of my process of stock market analysis which highlights how the MACD Divergence signals can be used in the context of a broader market analysis.    I hope you can learn from this example and apply these tools to help your own trading.

How About Doing What Works?

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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.

What Time is Good for You?

marketclubminute2 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:

  • Buy and Hold Investor – forever
  • Active Investor – longer term of a year or more but has a plan to sell eventually
  • Position Trader – catch one leg of a trend, hold trades for weeks or months
  • Swing Trader – get in for a quick pop and out within days
  • Day Trader – doesn’t hold overnight
  • Market Maker – constantly offers a bid and ask price

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.)

One Minute Towards Successful Trading

Adam Hewison with Market Club MinuteProfessional 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:

  • Build knowledge of markets, charts, and indicators
  • Follow strategies of experts such as Adam Hewison
  • Back test strategies and indicators
  • Trade small and then scale up once successful
  • All of the above

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)

Maximum Adverse Excursion

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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.

Free Email Trading Course by Adam Hewison

 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.

Click here to begin.

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.

Click here to begin.

Every success,
Adam Hewison
President, INO.com & Co-Creator, MarketClub

Profit Trading: How to Choose Buy or Sell Signals

jackieannpatterson_editor_backtestingreport_moneyshow

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:

  • 200 days models an active investor who may hold a position for a year – potentially getting favorable capital gains treatment for trading profits. 
  • 20 days models a position trader who looks for trading profit after a few weeks in each trade.
  • 2 days models a swing trader who looks for a quick trading profit almost immediately but is willing to hold a stock overnight if necessary to ride a profitable trade.

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:

  • Timed – as discussed above
  • Symmetric – often a mirror-image of the buy signal.  For example if the buy signal is moving averages crossing upwards, the symmetric sell signal is moving averages crossing downwards.
  • With stop losses – setting a fixed price to cut losses and sell.  Another technique is a trailing stop loss which raises the stop price as stock price moves up and trading profit accumulates.
  • With profit targets – picking a price or indicator configuration in advance to take profits

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