Switching System Update

Before beginning to split this blog into several, I wished to post an update of the performance of the automated switching system. In the future, this information will be found in a new blog containing just trading notes. The 09/14/09 quote does not indicate a sale on that date but merely posting of the opening price to calculate system performance. The system actually continues to hold the TNA ETF.

Investment Switching

The Nasdaq New Highs vs New Lows ($NAHL) reversed direction this week, indicating a market shift to at least a bull-market correction. Investments should be switched from TNA to TZA.

The prices shown for 07/13/09 are opening prices for 07/13/09. This was originally posted with closing prices from Friday, 07/10/09, in order to allow those who wished to trade on market open Monday. Instructions for the system are listed in previous posts.

Year-to-day profits declined from the previous amount because the switching delay of a weekly system is not as efficient as desired, but it does profit handsomely in bear as well as bull markets.

Investment Switching Update

With system changes, performance averaging 96.7% per year!

Performance changes have definitely improved performance, so henceforth are incorporated into system. These changes were using the weekly direction of $NAHL instead of $NYHL as the switching indicator, and investing in TNA-TNZ in place of QLD-QID. TNA-TNZ could not be used for the life of the system since they were only available after November 19, 2008.

This performance level also serves to place a minimum performance requirement of other trading. If I cannot beat this return with trading, why trade? In fact, the changes raise that criteria as their year-to-date performance shows.

Year-to-date performance 79.8%.

Market Switching System Error

An error in calculating the annual percentage has been corrected, and past postings have had the incorrect per annum percentages omitted. The per-annum percentages here are believed to be correct, verified by calculating each year to arrive at the present balances. Actual system performance does not change; only the calculated reporting of that performance.

The performance year-to-date has improved since last reported, but is just now passing zero, or break even. This performance, although satisfactory overall, is not satisfactory in the short run.

In a first effort to resolve this year-to-date performance, a switch to using the NASDAQ highs-lows was proposed and definitely improves performance in this time frame.

However, over the life of the system, performance lags that of the New York Stock Exchange high-lows. Determining an alternate manner that will improve performance remains on the "to-do" list. Now that the NYSE high-low system has made the switch, performance in the immediate future should be excellent.

An immediate improvement can best be realized by switching to alternate ETF Pairs such as TNA-TZA, the ETFs for the Russell 2000. Small cap stocks usually lead out of a bear-market bottom, which was March 6, plus TNA-TZA are 3X ETFs where are QLD-QID are 2X. Should one prefer large caps, BGU-BGZ are 3X ETFs representing the Russell 1000. These 3X ETFs did not exist during the backtest period of the system, thus could not be used for system development, but they outperform QLD-QID during the period of their existence.

Although the $NAHL did not perform over the long run as well as $NYHL, it also didn't have the near 30% draw down experienced year-to-date. It had some, but only half that of $NYHL. The bottom was March 6, and the $NAHL called that well, switching definitively March 23. Until a better manner can be determined, $NAHL is now outperforming $NYHL significantly (76.7% vs 16.7% year-to-date).

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.

Learning to Trade 105

This continues the discussion of improving the recent return of a system that alternately invests in QLD and QID, depending on the direction of the new 52-week highs minus the new 52-week lows. Performance using the New York Stock Exchange (NYSE) vs NASDAQ was in question, since NYSE was down over 13% since January, 2009.

Using the NASDAQ new highs - new lows definitely improves performance this year. Instead of being down almost 14%, performance shows a 10% gain. This makes sense since the NASDAQ is leading out of the bottom March 6th, the NASDAQ contains tech stocks, a leading sector, and the NASDAQ contains smaller cap stocks which generally lead a new bull markets. It also makes sense from a seeming logical standpoint that QLD and QID are Exchange Traded Funds (ETFs) representing the 100 largest cap stocks of NASDAQ.

If one backtests the system back to July 2006, using the NASDAQ highs-lows, returns indicate 305%. July 2006 approximates the creation and start of trading for the two ETFs, which points toward a weakness of this system.

Normally when testing a mechanical trading system, one divides the data into at least two segments, usually representing all market phases, bull, bear and transitions. One tweaks the system on one data set to gain maximum performance, then tests it against the other data set to determine if the performance continues. If it does, one most probably has a good system; if not, one has merely over-conditioned the system to the initial data set, and it probably not perform well in reality. Better to find this out without paying real money for the results. The problem with QLD-QID system is that ETFs have not existed over sufficient time to have two all-market-phases data sets. It is just completing the first with this transition from a bear-to-bull market.

Although the recent recent of the NASDAQ-based system improves over the NYSE, performance since onset in July 2006 does not. The NASDAQ system performs at 305% compared to the NYSE version's 368%, showing why the NYSE system was used.

We still desire an altered system to improve system performance in recent months while maintaining or improving long-term. However, do keep in mind that either system version is performing at enviable rate, especially considering 2008 had many peoples IRAs and 401Ks down 50%.

Learning to Trade 103

Trading can be simplified to a number of decisions that do not need to be made simultaneously. For example, one can distill the buying decision into what to buy and, later, when to buy it. Once bought, the decision becomes when to sell it. By constructing rules, one avoids emotionally poor decisions of trading without a system. Rules give one a trading system that can be backtested to determine profitability and potential risk.

What to buy can be simplified by only trading Exchange Traded Funds (ETFs). These come in pairs, so when the market are going up, one can buy a bull-market fund, and conversely, when the markets are going down, purchase the bear-market funds. By purchasing a fund representing a wide-range of stocks, one has handled concerns of diversification without having to think about it.

For example, use SSO and SDS, which represent the 500-largest capitalized stocks of the stock market. During market appreciation, own SSO; during market declines, own SDS. The question then becomes: How does one know when to sell one and buy the other? A simple manner would be to use some indicator that would tell you mechanically when to switch. Using two moving averages was discussed in a previous entry, Personal Finance 101. This system provided a 38% average annual return including through the otherwise bad year, 2008. Not bad.

An even better way was covered in Trade Switch, posted March 23, 2009. This system uses QLD and QID, ETFs using the 100-largest capitalized stocks of the NASDAQ. At the time of the switch, this system was performing per the attached graphic, or 131% per year--including the infamous year, 2008. That system switches when the New York Stock Exchange's accumulative 52-week Highs minus 52-week Lows, as measured weekly, reverses from positive to negative or vice versa. This is graphed here. Be sure to use the weekly graph, and use it after Friday's trading day has been posted. Otherwise, the latest week will only include week-to-date, not the entire week.

These two systems use ETFs that have existed since July 2006, allowing backtesting in both bull and bear markets. The new 3X ETFs did not exist then, but should perform even better. However, one is advised "test before using." Testing is often cheaper than reality.