Notes for December 30, 2011

[grems8544]

Long-only traders (especially if trading on a longer timeframe than a single day) as well as investors tend to do particularly well in Dec for obvious reasons (outlined by you). Long/short traders may be at a disadvantage, however. For instance, if a long/short strategy does not adequately take into account market seasonality and market volume levels in its approach, then abnormally large and/or abnormally frequent losses in the strategy developing during a holiday period, especially on the short side, would not be surprising. Short trades that would be avoided by a more sophisticated (but not necessarily ultimately better) strategy can end up being taken by a less sophisticated (but not necessarily ultimately worse) strategy, during a holiday period.

So you got me thinking about the long/short plays available. We've been in a range-bound market, with the 200d resistance lines looming over our heads, so this points me to mean-reversion strategies over trending strategies.

EdgeRater is a good program to evaluate Connor's TPS strategies, and they've been doing well on the short side for the month of December. I provided a copy of the strategies in my sticky thread here some time ago. Scroll down to the PDF section and you should be able to download the file, and more importantly, review the criteria for long/shorts on the TPS strategy.

When I present Connor's work in seminars I frequently get beat up by people who think the gain / trade is not worth the effort. Whether you subscribe to this view is individualistic -- profit is profit, and I know a few people who trade Connor's works exclusively and have beaten me this year.

In a perfect world, taking the signal at the end of the day on each side, the trades would look like this:



If you had a $100K to play with using this strategy you'd have $6250/position (hindsight), and when the dust settled, you would have netted about 1.5%. *I* didn't net 1.5% in December, so I should have been paying better attention to this strategy. Kicking myself right now because I play Connor's strategies all the time.

For those of you interested in the stats for the trades above, here are they are:



The long side has been poor:



This simply means that we've been in an up trend for December, contrary to being flat or range-bound, and given the high number of short candidates, we've been more overbought than oversold.

===============

2010 Wasn't nearly as exciting as 2011 from Connor's point of view. Mean reversion doesn't usually work across the board when there is a strong trend, and if you recall, last year saw a sneaker trend rise starting just after Thanksgiving 2010 and continuing through the month of December.

There are no Connor's TPS short candidates that fired last year (in hindsight, of course), but there were 11 trades on the long side:



The low profit / trade tells me that there was not a great deal of exuberance in the market -- prices were not overly volatile and hence were not overbought/oversold. We don't have the luxury of choosing our trades so take what is given ...

December 2008 was an interesting year, specifically in that it also generated NO Connors TPS Long positions, but fired a number of buys on the Short side:



Whether January 2012 will look like January 2009 based on this is anybody's guess. The key here is that there are strategies to play, and for the most part, they appear to be lower-risk / higher probability plays.

===================

If there is interest I'll continue to dive into these, especially from the leveraged point of view, because leverage can give us movement where some of the underlying does not.

Happy New Year everybody!

Regards,

pgd

[nickola.pazderic]

Paul,

This is very interesting research. I have the Connors book on my shelf, and HGSI provides some tools for the trades. Nonetheless, this type of analysis does not come easily to me. So...please continue. I might even humbly suggest/request a video if you are so inclined.

Many thanks,

[asomani]

Thank you for sharing that, Paul. Incredible work given the time within which you have responded. Please do continue at your leisure, as Nickola suggests.

If the emphasis here is on testing strategies that work during holiday periods, I think the focus should not be on the whole of December - as about the first half of it certainly does not exhibit holiday tendencies, in my opinion, as volume holds up okay in the earlier to middle part of the month and bullish seasonality does not take effect until later in the month. In fact, seasonally speaking, the SPX performs poorly for the first half of December (serving as a tailwind for shorts) and strongly in the second half (and this December has once again followed this pattern, almost to the letter).

In my opinion, the real holiday period in December is basically the last 5 trading days of the month, and maybe a few more trading days than that (so perhaps the last 5-7 or even 5-10 trading days of the month, for instance). This year, at first glance, does not seem to be a good example of normal year-end bullish seasonality because the last 5 trading days of the month actually resulted in a rare negative return. However, taking a step back, one would've been well served sitting long for the last 9 or 10 trading days of the month. As an aside, from what I can recall, Jeffrey Hirsch defines the Santa Clause Rally as the last 5 trading days of Dec and first 2 trading days of Jan.

Regardless, to me, your analysis demonstrates a case where the edge of the strategy may not affected by the peculiar features of holiday trading. In other words, certain mean reversion based short strategies may be unaffected performance-wise from the low volume and bullish seasonality of holiday periods like late December, generally speaking, and thereby may be the best way to approach shorting during such periods. It is not surprising if this is true especially if the mean reversion strategy being employed is one that takes profits quickly and does not sit on a position for very long at all.

What about momentum-based shorting? I would be curious how shorting based on momentum rather than mean reversion works during a holiday period. My hypothesis would be that it would more often than not be less effective than during a non-holiday period.

[Rembert]

Thanks Paul,

Always interesting to learn new strategies. Connor's TPS strategy might be a good addition to diversify to the rest of the systems I trade. 90% winning trades seems like too good to be true at first sight so I looked up the trading rules. The strategy is one of scaling into a losing initial position by averaging down, a concept that is in general not a good one if you are on the wrong side of a trend. So I was hoping to see some kind of stop loss in the rules to prevent serious account damage in case of a black swan event where the trade goes completely against you. But there is no stop loss. Shouldn't be too hard to implement one of course. Do you have any toughts on that ?

Is there a site that gives signals for Connor's TPS strategy or is it something one has to implement on their own ?

Also best wishes to all for 2012, may it be a trending year.

update : found a recent Larry Connors webinar and some discussion on the use of stop loss orders with his strategies http://forums.worden.com/default.aspx?g=posts&t=53070

[mingpan.lam]

good to keep in mind the mind set necessary to trend trade

Thanks for the URL, Nickola. I don't have any problem if it is just bad luck but if EV becomes less effective when the volume is low then it is something the robots can be improved. From what I understand, the robots are not using the total volume compare to the past average as one of the decision process (pls correct me if I am wrong), of course we can simply ignore December, then we are not 100% mechanical following the robots. It will be interesting to see the robots' performance using total volume/average(total volume) as a filters.

[mingpan.lam]

Volume. Simply refer to average volume and see how much the daily volume is below the average.

My GGT system is showing volume -40 to -50% of the daily average volume:

Attachment 12090

If I'm not posting, then you can always check www.finviz.com:

Attachment 12091

The lack of volume of this magnitude should remove all doubt that the large players are enjoying the Christmas break. I think a separate indicator is not needed.

Regards,

pgd

Thanks Paul, the information is very useful !

[mingpan.lam]

Hi all,

Happy new year for you and your family!
Wish all of you have a happy trading year 2012.

Cheers,

Ellis

[grems8544]

Connor's TPS strategy might be a good addition to diversify to the rest of the systems I trade. 90% winning trades seems like too good to be true at first sight so I looked up the trading rules. The strategy is one of scaling into a losing initial position by averaging down, a concept that is in general not a good one if you are on the wrong side of a trend. (bold added by PGD for emphasis)

Absolutely agree 100%. I got my rear handed to me this year, losing almost 10% net, when I was fully engaged in the TPS strategy in multiple accounts and we went down, and kept going down. This is a weakness of the Connor's system that he does not mention in any of his literature (of course not, it wouldn't sell), and it's proof-positive that the strategies need to be tweaked. More on this below after I address your other comments.

So I was hoping to see some kind of stop loss in the rules to prevent serious account damage in case of a black swan event where the trade goes completely against you. But there is no stop loss. Shouldn't be too hard to implement one of course. Do you have any toughts on that ?

I do, and I'll address that topic separately, as I've done considerable work looking at Stop Losses and his strategies. Note the MAE column tells you about your intra-day drawdown, which (psychologically), will give you a taste of the main course. In general, SL significantly reduce the profit factor (PF) as well as the W/L ratio, so the better path is to not have entered the trade at all. This is accomplished using a macro signal outside of the Connor's strategy. Again, let me get my material together in a way I can present it coherently and I'll address this important topic.

Is there a site that gives signals for Connor's TPS strategy or is it something one has to implement on their own ?

HGSI implements a filter and every night the candidates are available.

Hsin Yen has written some TradeStation code for the radar screen function (indicator) and I've modified it for my use as well as have implemented management strategies using his foundation. Once in a trade, I use the strategy code to manage the trade so that I do not have to be present at 3:59 pm to execute the sell. This is a deviation from the rules in the book, but I find the statistics somewhat improved.

Chris White has written ETF Bandit, which is a stand-alone program for scanning Yahoo! data (end of day is base package, intra-day is an add-on that is totally worth it). Here's the link: http://www.edgerater.com/products/etftradingbandit/ Tell Chris I sent you -- I get nothing for the referral except an exchange of good will.

Also best wishes to all for 2012, may it be a trending year.

Gosh, I hope so. I'm tired of treading water. Same to you and all of us here.

==================

So, onto the topic of "When Connor's TPS Fails", or better entitled "How to Have Your Butt Handed to You when Reality doesn't Match Backtesting"

Take all of the Connor's TPS trades on the long side since the beginning of time (or available data) and trade whatever is available. The equity curve looks like this:



Good news: lower left to upper right -- Over a long time, it appears you'll make money.
Bad news: large volatility causes spikes, and this (psychologically) will kill your ability to consistently trade the strategy. It will also hurt your bank account, as it did to me this past year (note the "Yeouch" highlight).

The statistics look solid too:



Worse case drawdown on the long side was 20%, and worse running losing streak was 8 consecutive losses.

What keys you in that this strategy has legs is that the distribution of returns is positive, specifically the mean and the median:



Despite the positive bias, note that the tails to the left and the bars below 0 are significant, and if you're heavily invested in those ETFs when they lock in their losses, you're losing money quickly.

So the goal here is to minimize losses, so that the distribution improves on the right side of the graph above and that the number of trades below 0 decreases.

While obvious to me now, it was not obvious in my original backtesting, simply because I was not looking for failure mechanisms, is that THE LENGTH OF THE TRADE IN DAYS has a material impact on P/L values. Here's some findings:

This is a snapshot of the trade blog, sorted from highest wins downward. The trades are constructed differently than I've presented in other places -- here, instead of a fixed ceiling of (say) $6250, I am buying 100 shares on entry, then 200 shares as price drops, then 300 shares as it drops further, then 400 shares. A fully loaded-trade would be 1000 shares of the equity. This is the strategy of the TPS system.

Here's the trade blog, with the best performing trades at the top:



Note that:

1) in general, the most winning positions do not "fill" to the 1000-share level before they are executed for sale.
2) in general, the number of days to achieve a winning position is single-digits with rare exception.

Also note that with a little mental math, that the P/L % value divided by the MAE% value is often quite larger than 1.0, which means that you've taken less risk for achieved reward.

Hence, we can conclude from this presentation that higher probability trades typically do not "fill" to the 4th buy (e.g., we're holding 1000 shares on the 100-200-300-400 TPS buy schedule), and that higher probability trades last relatively short duration in time (e.g., single digit days).

As further example of this, take a look at the same listing of trades, but now with the worse trades at the top:



First of all, note the following:

1) many of the bad trades fill to 1000 shares (all four scale-ins are executed)
2) The number of days to the exit point is more-than-often double-digit, e.g., greater than 9 days
3) The MAE% is incredibly poor, e.g., volatility is higher, intraday drawdowns are higher than normal, and overall, the reward/risk ratios are quite poor (P/L% divided by MAE%).

Hence, we can conclude from this presentation that we need to pay attention when we have fully "scaled in", as this fact, in combination with the hold time of the trade, can give us indication that the trade is a candidate for failure.

So the question now becomes "How many days is too many to hold a position?" and "Should we have another rule that states that after X days we sell no matter what?"

To help answer those questions, the following chart was created:



Here, I've rescaled between +20% Profit and -15% Loss to better visualize the data.

What this chart shows is that as the duration of the trade marches on, the probability of failure increases. Note that in the entire history of trades that durations of less than 4 days have NOT resulted in losses. Durations of 5 days to 9 days typically result in positive trades (but not exclusively), as indicated by the trend line, and certainly past 10 days (where the trend line crosses 0%) the odds are moving against us.

Correspondingly, trades lasting longer than 9 days should be exited from a historical view point, and trades longer than 4 days but shorter than 10 need to be watched for a forced exit.

As I alluded to above, the key here is to identify when not to get into a trade, rather than trying to figure out what to do once the trade goes against you. Also, Stop Loss settings will trigger according to the the MAE% criteria, effectively locking in the losses, so in general, Stop Loss settings should be avoided with the Connor's TPS strategies. More on this latter point in a different post.

Regards,

pgd

[Riskslayer]

Good analysis Paul.

Mean Reversion (trade against breakouts/breakdowns) vs. Trending Trading (trade with breakouts/breakdowns) strategies - when to apply which one?? Knowing this with certainty would be like having a printing press, and knowing this some of the time and knowing when you don't know/have an edge and thus not trading at those time would make one a great trader. CANSLIMers don't trade MR, most don't trade short and all most all sit out when they believe the market is not trending up. The robots try to blend the two (MR and trend trading). I trade with the robots and CANSLIM when its "on".

Holidays 2010 were good for CANSLIM/trend trading, and Paul's work shows MR worked better in holidays 2011. During Holidays 2011, most experienced CANSLIMers have been sitting in cash this holiday season (see M Scott, e.g.) - this is knowing when you don't know/have an edge. It is also helpful to support a decision to spend more time with the family/friends, but the holiday/seasonality is not driving the decision the market is, and if 2011 was like 2010 or perhaps trending up better, then many CANSLIMers would be glued to their monitors looking for set-ups and breakouts this holiday season.

I track volatility daily, and consistently at the end of the year (meaning about the last 2 weeks), volatility and volume both decrease. See the chart below. Consistently, each of the last 4 EOY holidays, IWM ATR/volatility has dropped into year end, as has volume (but, everyone knows that).

I would be cautious about assuming that MR strategies will work consistently on a profitable basis at the end of each year.



The chart of IWM looks very bullish to me b/c volatility has contracted significantly since the Aug-Oct 2011 breakdown, volatility contraction, and recent lower volume, but are the recent contractions in volatility and volume just seasonal? The chart below shows classic "coiling" in IWM or Darvis boxes with a 3 month Jul-Oct peak-trough of 30%, then contracting to 13% from early Oct into the end of Nov, then 6% from the beginning of Dec to mid-Dec, and finally 3 % in the last week or so. This is very "tight" price action and considered to be bullishly constructive.

We will find out next week, but it looks to me like we are nearing a breakout/breakdown from the "coiling" - the intermediate trend (marked by early Oct lows) appears to be up, so odds favor a breakout.

All my best for a happy and prosperous New Year to All!

Shawn

[lisa]

paul,

maybe i'm being a maroon, but in the TPS test results and comparing the chart of QQQ to those first couple of best-performing trades from the trade blog, they don't seem to match up. the 3/13-3/20/00 trade looks like it should have been a loser, but it made 144% in only 7 days. even considering the internet bubble, 147% seems a little outrageous in such a short time. the next couple of trades looked similarly unrealistic. what am i missing?

i'm sure you've already pondered this, but i started looking at them and wondering if you flipped your entry rules since the bigger gains seemed to be made early--so buy 400 first, then 300, 200, 100--and add a rule of not holding more than X number of days.

thanks,
lisa