Active-Trader - The Ultimate Trading System

 

Welcome back, Active Traders and Wealth Builders.

"Nothing succeeds like success." What can this recursive truism penned by Alex Dumas, 18th century French novelist tell us about trading and investing?  Enough to fill an adventure novel if you ask me.  And since trading an investing is always an adventure, let's get right to it.

This statement and concept gets to the heart of what I would call The Ultimate Trading System.  Like any good trading system, the Ultimate Trading System answers these questions:

• What securities to trade
• When to enter
• Entry size or how much to trade and of course
• When to exit

What to Trade

This system is about trading individual stocks.  I trade stocks because I find they fit my personality and risk tolerance.  Put another way, I understand how they work, the fundamentals that affect their movement, and I am awake for the key hours that they trade.  While all this might seem obvious,  if I ask the same questions for other instruments such as commodities, bonds and currencies, I cannot answer in the affirmative.  In other words, trade what you know.

As for which securities to trade,  this one is simple, trade stocks which are making new all-time highs.  It also helps if the stock has good fundamentals such as positive earnings, and a Price to Earnings (PE) ratio lesser than the 5 year earnings growth rate.  You can find a good discussion of the scan conditions for winning stocks in my prior post New High, Low PE, High Growth.   TC2000 is a key tool for this and there is not a market day that goes by that I don't run this scan to see what winners will pop out.

When to Trade

This one is simple, buy when the stock breaks out to a new all-time high after a period of consolidation.   This is another lesson in the obvious, but great winning stocks always break out to new-all time highs.  Note the key caveat about after a period of consolidation.  This means don't buy a stock after 8 straight new-all-time closing highs.  Its best to enter in the last hour before a daily close at a new all-time high.  At this point, it should be clear in retrospect what the daily chart will look like, and it should be clear that the stock is breakout out of a range of consolidation to the upside.

Entry Size

An easy rule of thumb I like to use is to limit any typical position to about 10% of my portfolio.  So for a 100K account, and a stock under $100, I start with 100 shares.  For stocks in which I have a high degree of confidence, I might go as high as 20%.  I always keep some spare cash in the account and I never trade on margin.  Of course I'm not going to win any investment contests with such a conservative approach, but it works for me because I am a conservative guy, particularly when it comes to my money.

When to Exit

Position Exit is always more difficult than entry, but to keep it simple, follow this rule.  Sell when the stock breaks the Range Bands to the downside on the daily chart.   For a discussion of my range bands indicator, see this posts Range Bands - Part 1.   In the post Range Bands - Part 3, I coded the Range Bands indicator in TradeStation and coded it as a Paint Bar study that you see on most of my charts.

For you market technicians, the range bands indicator says to sell when the stock breaks the midpoint on the 14-bar daily chart minus 1.06 times the 14-bar ATR (Average True Range).  Some other studies says to sell when the stock breaks the top minus 2 times the ATR to the downside.  These rules are pretty similar and they basically provide an exit point, but still give the stock plenty of time to gyrate.

Testing the System

To test the system, I fired up TradeStation and put together a simple strategy which looks like this:

The New High LE (Long Entry) is built into TradeStation.  The Parameter of 5 says buy on a new high for the year.  In reality, it doesn't matter so much since I will filter out entries for new all time highs myself using TC2000. Also, the system does not check for the "after a period of consolidation" criteria.  But since the system gets evaluated bar-by-bar from left to right, its going to buy the first breakout it sees.

The exit is handled by my RangeBandsLX (Long Exit) strategy discussed in my prior post Range Bands - Part 3.  The system sells on a break below the lower range band line with a 14-bar lookback.  Note that this is 2.12 times the average true range, so depending on the range of the stocks, it could be a significant loss from the entry.  If all goes well, and we picked our stocks properly, we should not see too many losses.

I ran the system (in retrospect for testing purposes) against every stock in the Dow Jones Industrials and it made money on 26 out of 30 stocks for 2013.  This is not much of a surprise since its been such a raging bull market in 2013.  But it goes to show if you throw winning stocks at this system, it will produce good returns.  Interestingly, I ran it against the DIA ETF itself and did not get positive results.

You might look at all this and say its not really trading, its more like investing.  I don't dispute that since it is somewhat of a buy and hold type system.
It also greatly favors bull markets and we are certainly in one of those.

I'm going to trade this system in my newly funded TradeStation Account with 100K in 2013 and beyond and keep you posted as to my long positions over on the right side pane of the blog.

Enjoy your weekend.