Quarterly Portolio Update

There were no trades closed this quarter. The system is fully invested in the market and has been for several months now.

Just thought I'd put in an equity curve - probably not the best you've seen!

Start up date was the 9th October 2007 with $66,000 in capital.

Since then 51 trades have been closed.

We are still in the middle of a drawdown - max.DD stands at 40.56%.

System flaw

The gap fading system that I was hoping to trade on US stocks has run into a bit of trouble. Actually alot of trouble. The problem is that it can't be traded, and here's why.

I believe the opening auction system works differently in the US compared to the ASX. In the local market, the most liquidity for the large cap stocks especially, always occurs at the open and at the close (usually higher at the close).

BHP or CBA, for example, each of which routinely turnover hundreds of millions of dollars per day , would do about $2-10million right on the open.

But over in the US, even some of the high turnover NYSE tickers like WYE and JNJ, you only get 100 shares going through on the open! And these guys turnover the same or more than BHP or CBA. What i noticed in the course of sales is, about 5-10 seconds after the open, the party finally gets started and you see the 10,000 share and 20,000 share parcels start going through. Which is useless for a system that is supposed to buy "the open" as you wouldn't be able to catch this liquidity using "limit-on-open" type orders.

The NASDAQ opening auction system must work differently to the NYSE because they seem to have much higher opening liquidity across the board (in the hundreds of thousands range, so still not the millions I was hoping for).

So its back to the drawing board for the short term system. It looks like I may need to turn to intraday timeframes if I want to maintain my 100% overnight cash position and still generate a super smooth equity curve.

The leveraged model

Considering the maxDD stats were acceptable, even during the 2008 Black Swan, the system will be leveraged up. Here are the charts of CAR and maximum drawdown over a 10-year test (01-01-1999 until 31-12-2008), using 30% margin as per I.B.

The beauty of trading short term

You just can't beat that super smooth equity curve.

This system uses a different entry to the one in the system posted below (US stocks) but was tested over the same universe of stocks.

Seems to have more of an edge. High Pfactor, lower maxDD, higher win%, higher payoff, less trades. And did I mention the equity curve?

The performance report shows the system in its inherent form, to provide a fair comparison with the system below. The equity curve and monthly profit chart show the system traded on 30% margin, which is what it would be traded on, if it gets to that stage.

US Stocks

I've recently been looking at US stocks and the potential to trade short term systems there is amazing due to the wide range of stocks and their liquidity.

The system that I've come up with is similar to the system described here a few months ago that traded ASX stocks through CFDs. Both systems are based on mean reversion and never hold overnight. But while the ASX system shorted overbought stocks and bought oversold stocks, with several days lookback and magnitude moves considered in the entry criteria, this US system just fades opening gaps and trades long only.

I have found gap fading (particularly going long gap downs) to be a robust edge that has worked well over many different universes of stocks. The idea came from James Altucher's book and also from this trader describing fading extremes as one of his favourite setups.

There are no CFDs in the US but my broker does allow 4:1 leverage intraday if required. The universe of stocks consists of 50 tickers from either the Nasdaq 100 or S&P 100, so I'm looking for liquidity and scalability in the system.

The system makes about 30-100 trades a month and performance is consistent with profitability on average 10 months of the year. 2008 was a tough year, but out of 10,000 portfolios, monte carlo testing shows that 98.59% were profitable last year, with the median portfolio gaining about 10%.

So the previous STMR system will not be traded; and this new one will take its place. I intend to use IB's PaperTrader to simulate it for about a year before committing real dollars to it.

Performance stats below are from 01-01-2003 until 31-12-2008. Position sizing is 10% of equity. Commissions are included (however, slippage, is not accounted for).

FY2009 Performance

"Don't love open equity. It won't love you back"

The above quote is what a great trader once said to me. Watching open equity get whittled away is something that nobody tells you about when you design long term trend following systems. All you tend to focus on is the bottom lines of profit and maximum drawdown. But the journey to get to that destination is what we all must go through. And that journey can be much harder than you expect.

I was looking at where the system was at the end of FY2008 and PRC I saw was up 82% and the pyramid up about 37%. When they were closed, profit was just 38% and 10% respectively.

You will notice all of a sudden I'm only down just 10% for the year - how come? It's because I've decided to try and focus less on open equity and more on closed equity. Sure I won't have those weeks when i "make" $2,000+ but I won't be "losing" that amount either. For interest's sake, the system was down 21.00% for the year on an open equity basis.

So from now on, no more reports on open equity, and I will only be reporting closed equity on this blog. And since I only close trades every few months, even monthly blogging will not be needed. Perhaps quarterly.

My other system (short-term mean reversion) will be started up on a small scale sometime in the next few weeks/months and its progress will be monitored here.

Thanks to those who have followed and commented on this blog for the past 12 months. Good luck for FY2010.

-0.15

-0.15. That's the correlation between the above two systems after analysing monthly returns over the past 8 years. One is my longterm trend following system (LTTF) that I have traded for about 20 months, and the other is the low exposure system described in this blog recently. Lets call that a short term mean reversion system (STMR). Due to the low correlation, the combined performance of both systems in a portfolio will perform better than either system on their own, as the table shows.

The graph shows the monthly returns of both systems. As you can see, the STMR system performs better in the past year or so and also near the beginning of the test. It seems to like the volatility that often comes with market crashes. The LTTF system outperforms in between.