Saturday, January 22, 2011

Price Channel Backtesting

I've added price channel analysis to my suite of technical tools used to analyze stocks.

Read "The Guide" for an explanation of price channels and the rules I'm using in trading.

I tested the last two years worth of data on the exchange-traded fund that tracks the S&P 500. It's ticker symbol is SPY.

I'll go immediately to the bottom line:

Price-channel trading under the rules I'm using produced $31.94 per share in profit, which works out to $32.4% in five trades. That works out to $6.39, or 6.5%, per trade.

That works out to profit of $15.97, or 16.2%, per year.

Now, clearly, this is a system for people who don't want to spend a lot on brokerage fees or overcoming trade spreads. It's a longer-term system.

The average position lasted 107 days, ranging from a 2-day whipsaw to a juggernaut 321-day position.

There's a lot to be said for a longer-term approach like this: Less money spent on brokerage fees and overcoming bid/ask spreads, more time spent selecting trades rather than watching for an exit, less stress because this system tends to avoid whipsaws, reliance on public domain tools that can be used with nearly any charting software, and frankly, more time spent doing other things: Taking hikes, riding a bike, reading a book that has nothing to do with the markets.

The main drawback is that this method is more complex and therefore requires more thought to implement. The PFE/PPS analysis relies are very clear charts. The Channels approach needs a close look to understand the message of the chart and a checklist to be sure than none of the four exits has been triggered.

All in all, I like the slower approach a lot. One lesson that I learned in last Thursday's small market break it that when the unexpected happens, a lot of small positions can be difficult to handle.

Far better to have far fewer, larger positions under a system that allows more time for a trend to mature.

I'll continue to work with this system on my own account, focusing on stocks (and options on them) having daily volume of 5 million shares and greater, and having low bid/ask options spreads. (That means selecting from the CBOE's inventory of penny-increment issues.)

Tim Bovee, Private Trader tracks the analysis and trades of a private trader for his own accounts. Nothing in this blog constitutes a recommendation to buy or sell stocks, options or any other financial instrument. The only purpose of this blog is to provide education and entertainment.

No trader is ever 100 percent successful in his or her trades. Trading in the stock and option markets is risky and uncertain. Each trader must make trading decision decisions for his or her own account, and take responsibility for the consequences.

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