Tuesday, March 25, 2008

Strategy Session: You Rob a Bank Cuz That's Where the Money Is

The same principle applies to the market: Trade where the odds are.

Last week I discussed a unique approach to determine where trades with the highest winning percentage exists.

Read here to fully understand this approach which relies on the power of The OddsMaker to determine whether going Long or going Short in the market makes the most sense.

My purpose here is to dig deeper into the strategy I started in the previous post and show you in simple steps how I got to a very good strategy with high odds of winning in the market today.

A Strategy's Ingredients

Let's recall what basic strategy I described last week:

  • a Min Price of $10
  • a Max Spread of 25 pennies
  • a Max Distance from Inside the Market of 0.1% (helps avoid the presence of trading on bad prints when backtesting)
  • a Min Daily Volume of 250,00 shares/day
  • a Min Current Volume of 3 (meaning stocks should be trading 3x average volume at the moment of the trigger event/alert)

Recall that this strategy, as is, was not practical in real life - it traded over 1500x in 3 weeks!

So we add additional filters based on a theme we want to test in the market. The purpose of the theme is to further discriminate against the stock opportunities and arrive at a clear - biased result that contains a high winning percentage.

Stating Your Theme and Adding to the Mix - The Strategy

My theme is simply: Does fading uptrending stocks after a short-term price and volume 'pop' produce winning trades?

To test this theme I added the following additional alerts to my strategy:

  • a Min Volume 5 Minutes filter of 200% (i.e., 200% higher than usual)
  • a Min Up 5 Minutes filter of $1 (i.e., up at least $1 in the last 5 minutes)
  • a Min Up from the Open filter of 5% (i.e., up from the Open by at least 5%)

Ok. So then I run The OddsMaker with the following position management rules (the same ones I used last week); namely,

  • Go Short with each alert opportunity
  • Exit the position if it goes against me $0.40
  • Trade anytime during the market session
  • Hold each trade for no more than 20 minutes

The alert I've chosen in my strategy is a simple Heartbeat alert that simply tells me the moment all of the filter conditions are met - nothing else required.

The OddsMaker Results

Here's a picture of what I saw when I ran the results:





(to fully understand what all the numbers mean, refer to The OddsMaker Manual)



From these results I observe first that the overall number of trades is manageable at 36. Next I see that 20 of those trades achieved success (the average winner being $1.0395/share!). What's nice is that there's a healthy ratio of my average winning trades over my average losing trades - an almost 2.5x difference! This explains why my net winnings over the 3 week timeframce are so good at $15.00.

The daily log of my P&L tells me which days were profitable and how many trades I made each day of the test. The only dark cloud I see is the last day of the backtest results. Does this red day indicate a turning point in the usefulness of this strategy? Could it continue or go back to green like it did on March 18? If I decide to trade the strategy then my position rules still apply and I know clearly what my stop loss (i.e., average loser value) will be!

That's an example of how to test a theme with such a revealing tool like The OddsMaker. Test your themes in the market, know their odds of winning based on your position management rules, and get better answers and better trades out of your precious capital and time!

I look forward to reading your about your experiences in the comments!

Related

Interested in automating a trading strategy like this one or one that you design with even better odds? Consider opening an account with optionsXpress and fully automating these strategies with the specialized application for OXPS by Trade-Ideas called the Robot. Details on the tool and OXPS' special pricing can be found here: http://www.optionsxpress.com/trade-ideas/index.aspx

Footnotes

  • Link to other Strategy Sessions
  • Remember that these set-ups are sketches meant to give you an idea how to model your own trading plan. Use this 'as is' or modify it to your own liking as many others do. Know, however, that Trade-Ideas.com and all individuals affiliated with this site assume no responsibilities for your trading and investment results. The indicators, alerts and all other features are for research purposes only and should not be construed as investment advice
  • See this video on our Collaborate function to learn how to open these strategies inside Trade-Ideas PRO

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