Three trade systems explained
1. 50 week moving average
This incredibly simple system tracks the FTSE 100’s weekly closing levels in comparison to 50 week moving average of those closing levels.
A moving average is so called because a new 50 week average is calculated at the end of each new week.
The system’s rule is simply to follow the FTSE 100 when it is above its 50 week moving average and move to cash when it is below the 50 week moving average.
This long term trading system probably won’t satisfy the action seekers amongst you, but it certainly did a good job of avoiding the full depths of the last two bear markets.
You wouldn’t have exactly made a lot more cash than the FTSE 100, because the system is slow to re-enter, but crucially you would have reduced your drawdowns (loss on capital) by half in each of the last two bear markets.
2. Go with the flow – buy stocks making new highs.
The hedgefund BlackStar funds recently performed some fascinating analysis on the distribution of stock market returns. They looked at all stocks on the US market between 1983 and 2006 and found that:
· 39% of shares were unprofitable investments!
· Nearly 1 in 5 stocks lost 75% of their value (this would be a lot more now!)
· Just 25% of stocks were responsible for all the market gains.
· There were an equal number of stocks that either lost or won significantly. The difference is that losses are limited to -100% while gains can be 1000%+.
· Individual shares are much more likely to underperform the market and outperform it. It’s rarer big winners that make all the difference.
· High performing stocks had one thing in common.
Incredibly, just a quarter of all stock market listed companies accounted for a all the gains made on the stock market between 1983 and 2006.
The one thing that the 25% of high performing stocks had in common is that they spent most of their time making fresh new highs.
Blackstar tested this idea and bought any stock making a fresh all time new high and sold it when it broke below its 10 day average true range.
This simple system returned 15.5% per year on average compared to the 7.9% from the S&P 500.
The key to the system is that it loses less on the bad years on average and makes more on the good years on average.
I’ve experimented with this and found that a stop based on the 40 week Bollinger band with a 2.5 standard deviation gives shares enough room. There are sophisticated ways you can track the system, but one simple way is to scan the financial pages of a paper like the Times and note any companies that are close to their 52 day high. Note these and buy if that 52 day high is also the all time high.
You can find a spreadsheet to help you manage investments here: http://www.gummy-stuff.org/trends2.htm
To input UK stocks you need to end each with a .L (that’s dot L). Each company has a unique ticker code that identifies them, for example, RBS is RBS. To look up RBS, you’d type in RBS.L and click the button. You can get company codes from finance.google.com.
There was an extended article on this in the August edition of What Really Profits. If you are a subscriber and missed this, drop me an email.
3. Buy on the first trading day of the month.
2010 got off to a storming start with the FTSE 100 rising by around 80 points on the first day’s trading.
It turns out that there may be a trend in this, with the first day of the month being a consistently positive day to trade since the 1980s.
Rob Hannah at http://quantifiableedges.blogspot.com had some great research on this. He found that since 1987, the first day of the month is profitable 59% of the time with the average winning day being one and a quarter time times bigger than the average losing day.
Trading such a pattern would have made a 65% return on your money since 1987, not bad for making one trade a month.
How does this work? Hannah points out that it may be because since the 1980s defined benefit pensions (i.e. not final salary) became popular in the states and the first day of the month is when fund managers will be putting their money to work.
If seasonality trading floats your boat, there’s a stack of fascinating findings presented by Trading The Odds here and some more unusual ones here. For example, the week after daylight savings has been found to be a negative period of stock markets. Maybe traders have trouble adjusting like the rest of us!
This week’s hot trading buttons
This week’s main event is the rate statement from the European Central Bank. Interest rates are unanimously expected to remain at 1%, but the statement on the condition of the eurozone from president Trichet will be followed very closely. Recently a European central banker was quoted as saying that the ECB was prepared to cut Greece adrift. While his comments have since been played down, there’s no doubting the potential danger to the euro’s unity.
“Trade small until you get a consistently reliable methodology and success rate. This works best with brokers who offer a per share based commission and while you may not make the total return you’re targeting, that’s not the object. Practice makes perfect, but you have to practice what makes successful trades. Just trading willy-nilly makes no sense whatsoever and only reinforces bad trading habits, attitudes and technical set-ups.” –