Learning to Trade 106

One should always use a trading plan for the simple reason—it’s more profitable. A good trading plan consists of rules that cover all contingencies, can be backtested for profitability, and avoids emotional trading, which usually results in losses. Further, various alternatives or competing versions of trading systems can be compared to determine the most profitable. An example of such comparison is addressed in Learning to Trade 104 and 105.

A trading plan or system contains rules for entry, exit, and, most important, risk management, usually called money management. In the sample system treated in previous Learning to Trade entries, a rule determines when to go bullish and when to go bearish. Once entry is made, one is always invested, and switches between a bullish and bearish position. It can be backtested and results quantified.

The basic rule is invest fully in QLD, an Exchange Traded Fund (ETF) when the market is bullish, and QID, a bear-market ETF, when the market is bearish. QLD and QID represent the 100 largest cap stocks on the NASDAQ Exchange, thus provide diversification without further consideration required by the investor.

Determining whether the market is bullish or bearish is accomplished weekly using the New York Stock Exchange weekly accumulated totals of 52-week Highs minus 52-week Lows. These are available graphically at $NYHL. Scroll down to the weekly graph since both daily and weekly are shown.

An alternative tested in Learning to Trade 105 uses the highs minus lows from the NASDAQ Exchange found at $NAHL. In looking at $NAHL, scroll down to the weekly. The rule is simple, when the graph is going up, be in QLD; when it is going down, be in QID. When the graph switches directions, switch between QLD and QID. Since the graph is weekly, one need not look except on weekends. During the week, the latest week is only week-to-date instead of the entire week, and could result in numerous false (read: expensive) signals.

This method of market determination can be used in other ways such as withdrawing one’s 401K from market exposure during bear markets, then returning when the markets go bullish. Had one done that, one would have not been one of those many whose retirement funds decreased by half during 2008. Better to enjoy a modest 1- or 2-percent return from bonds than endure a 50% decline in stocks or mutual funds.

Until bear-market ETFs, IRAs could not “go short” or invest in ways to profit from bear markets. Now they can.

In this system, QLD and QID were chosen because they’ve existed long enough to enable two years of backtesting to determine profitability. New ETFs, such as TNA-TZA, BGU-BGZ, should outperform these two, but have not existed long enough to backtest through all market phases.

This, then, is a most simple system containing entry and exit rules, and uses the diversification of the ETFs for money management. Using either $NYHL or $NAHL, performance over a two year period averages over 100% per year. Not bad for a system that requires less than 15-minutes each Sunday night.

Future entries will cover more complex systems that should outperform these simple systems, but require more knowledge and involvement.
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To “look at the $NAHL graph close up,” take the following steps:
1. Go to the $NAHL site.
2. Scroll down to the weekly graph and click on it. This will take one to a weekly graph with controls displayed.
3. One can click on the Color Prices box to display downward price movement in red, while upward movement remains in black. The graph will not change until the Update button is clicked.
4. Change the Range box from “Fill the Chart” to “3 Months” as an example.
5. Press the Update button; the last three months of the chart should display.
The same procedure is used for $NYHL.