Link: What Makes a Good Trading System

Jul 3, 2007: 9:05 AM CST

JMOT’s Blog is offering a series of free articles for trading beginners, and the most recent post is entitled “What Makes a Good Trading System?”

For those just starting out in the world of trading, or those gripped by greed or fear, a personally developed trading system can help reduce the effects of these emotions, especially if you judge the results of trading as a function of your system and your ability to execute it, rather than your personal decisions regarding when to buy or sell.

A system is – at its core – a written set of rules based on observations/experiences you have gathered while trading/studying. It simply tells you what to buy, when to buy it, how much to buy (risk), when to sell it, and how to record progress (of course, there are many other aspects, but this makes a good start).

JMOT offers a description of emotions, and why a trading system can help reduce their effects:

Trading systems try to take the emotions out of trading. When we are trading, we are always plagued by fear and greed. When the stock price is moving up, you keep asking yourself if you want to take profits now because you are afraid that you will lose out on more profits if the stock price continues to move up – This is greed.

The next thing you know, the stock price come tumbling down and you lose whatever profits that you had in the first place. When the stock price is moving down, you keep asking yourself if you want to exit the trade and cut losses now because you are hoping that the stock price may move up the next minute and turn your losses into profits – This is fear. The next thing you know, the stock price fall even lower and you regretted not exiting your trade eariler to savage whatever that is remaining.

Trading is both a mind and emotions game. Trading systems help to contain our fear and greed.

Check out the post for more information and seek other resources if you have yet to develop your own personal trading plan/system. There’s no time like the present, and having a plan/system will significantly increase your confidence if you do experience ‘trade entry phobia.’

Another compelling thought is that most new/retail traders do not have a written/developed system. It is no wonder why such a large percentage fail when they have no set course of direction to guide their decision making in such an uncertain environment as the market. Put yourself ahead of the crowd and develop a system, or continuously test and modify your existing system for greater profitability.

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Martin Pring – The Investor’s Guide to Active Asset Allocation (Sector Rotation)

Jul 2, 2007: 8:03 AM CST

Martin Pring’s recent (2006) book The Investor’s Guide to Active Asset Allocation details one of the most complete explanations I have seen so far (in easy to understand format) regarding sector rotation, the business cycle, stock market cycle, money/portfolio management, intermarket relationships and many other concepts. Not only is the text a virtual reference manual for these concepts, Pring provides specific easy to follow strategies for proper asset allocation and targeted diversification to maximize returns using Exchange Traded Funds and other vehicles.

In the book, Pring details his proprietary Six Stages of the Business Cycle and how to identify them (hint: It deals with bonds, commodities, and the S&P 500). He further describes his new research including detailed charts of how certain sectors/industries have performed during each of the six specific stages he outlines and provides strategies to take advantage of specific strength and weakness of under- or over-performing sectors at key times.

It’s not enough to recognize what has happened in the past, but to recognize conditions/relationships occuring now, as well as position long-term portfolios to take advantage of these developments. Swing traders can also benefit by active trading of larger key themes with individual stocks or broader ETFs.

The following bulleted points are from the official description at Amazon.com:

The Investor’s Guide to Active Asset Allocation provides you with proven investing expertise on:

 

  • Basic Principles of Money Management
  • How the Business Cycle Drives the Prices of Bonds, Stocks, and Commodities
  • The Pring Six Business Cycle Stages
  • Technical Tools that Help to Identify Trend Reversals
  • Putting Things into a Long-Term Perspective
  • Recognizing Stages Using Easy-to-Follow Indicators as well as Models
  • How the Ten Market Sectors Fit into the Rotation Process
  • How Individual Sectors and Groups Performed in Each of the Six Stages
  • Asset Allocation for Specific Stages
  • I highly recommend any trader/investor to read Pring’s work to learn sector rotation or economic/business cycles at a deeper level that provides actionable strategies for profit. Martin Pring is recognized as one of the Masters of Technical Analysis, and is often referenced as “The Technician’s Technician.” I have heard Pring speak at two conferences and enjoyed the material and his depth of knowledge regarding the topics discussed.

    Pring wrote an earlier guide in 1996 entitled The All-Season Investor: Successful Strategies for Every Stage in the Business Cycle which details these concepts. I have not read this work yet, but wanted to highlight it as well as one of Pring’s reference guides.

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    Intermarket Relationships Chart Update

    Jul 1, 2007: 3:20 PM CST

    The major story over the last month has been the impact of rising bond yields and their effect on the overall market.  This updated chart from StockCharts.com provides a graphical representation of what has transpired over the month of June in terms of major market relationships:

    intmkt-rel-july-1.jpg

    Interpretation:

    The Yield on the 10 Year Treasury Bond (Note) has indeed taken a toll on the overall market and on interest rate sensitive areas.  The 3.18% rise during July resulted in a stock market (S&P 500) correction of 1.76% (and a few major distribution days) as well as the Financial (and Banking) sector being taken down 4.81% and 3.96% respectively.

    Housing and Real Estate Investment Trusts were hit hardest in June for a variety of reasons, suffering 9.62% and a major 11.56% respectively.  Utilities – a sector that is very sensitive to interest rate increases – was not hit as hard as it could have been.

    What this signals for the overall market is that continued upward pressure on bond yields, or some extraneous market dislocation could send already skiddish investors to cash out their positions and move to safer positions, which would undoubtedly put large negative pressure on US equities.

    Problem areas remain the sub-prime mortgage/lending areas, as well as global interest rates and economic conditions.

    Always view the larger picture when considering swing trading or position trading candidates.

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    Market Index Updates at a Glance

    Jun 30, 2007: 9:30 AM CST

    It was a wild week of trading, to say the least!  I’m glad we made it to the weekend so we can pause and update our charts and catch a breath!

    Next week is expected to be a very low volume week because the 4th of July falls directly in the middle – on Wednesday!  Some people may take off Monday – Wednesday, some Wednesday – Friday, and some may take the entire week.  I’ll still be trading but it will be small positions and I’ll be trying out new ideas I believe.

    As of the close Friday, the Dow and S&P remain trapped between their 50 period and 20 period moving averages and appear to have hovered there for the last few sessions.  I’d like to see a clean break before committing larger swing positions – it appears the market is in pause mode (finally) now and volatility shouldn’t pick-up too excessively – if it does, a lot of traders will be caught unawares.  Don’t be lulled to sleep in low volatility environments.

    I have purposely zoomed in to two-month charts of these indexes to highlight the contraction in swing and volatility – and to show the ‘trap between the moving averages’.

    The Dow and the S&P chart are similar (from a perspective of technical analysis)  in terms of swings and relative price levels:

    spx-june-30.jpg

    dow-june-30.png

    On these charts, we almost set-up a “Sweet Spot” trade.  These occur when a market has had an extended run, momentum divergences are present, a lower swing high forms (initial warning), a lower-low forms, price swings up to attempt a retest of the highs, failure occurs and price takes out the recently established lower low.

    In terms of a swing chart perspective, this has not happened, but the market was dangerously close.  Luckily (for the bulls) price only bounced off the recent low and did not create a lower low – rather, we setup a support zone and should be entering a trading range for the time being (which coincides with low volume in the “summer doldrums” which has yet to materialize.

    From what I’m seeing, it’s probably best not to put on bold, ‘all in’ swing or position trades just yet, but only you can determine this based on your analysis and your style.

    The Nasdaq is also choppy, we was the Russell.

    nas-june-30.png

    russell-june30.png

    Take some time off to do some study and analysis this week… or just take time off and have fun.

    I’m a big proponent of the notion that there is much more to life than trading.

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    Link: Paul Castro’s Blog at Vestopia

    Jun 30, 2007: 9:08 AM CST

    I wanted to highlight a blog and service some of you may not be aware of yet.

    Paul Castro is an author and investment director at Vestopia.com  and he provides timely analysis on the market and news events, including his recent post “Tick-Tock” which is definitely worth consideration.

    In the post, Mr. Castro discusses various points regarding China’s $5 billion investment in the recent Blackstone Group IPO, the fact that foreign purchases of US equities reached a record in April 2007 (foreigners purchased a total of $28.1B worth of US equities… the last time this happened was February 2000), implications of a falling bullish percentage reading on point and figure charts, and an interesting take on the “trucker” indicator (read to find out what that is!).

    For those who wish to subscribe to his free service (invitations limited), he provides deeper analysis and also a listing of all the transactions he has entered or is monitoring (has buy orders in the market) for entry.

    Head over to his blog, check out some of his posts, and learn from his unique perspective.  Momentum or certain swing traders will be rewarded, as his style of investment approach utilizes those skills and pattern recognitions.

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