Wednesday, October 2, 2013

Time-limited trades

Traders typically look at the charts, the financials or the news, but spare not a glance for the calendar. Perhaps we're avoiding a tool that will help us escape one of the two major banes of our trading existence.

The first bane is the whipsaw, something we're all intimately familiar with. I have a strong bull signal, I have near term momentum, I open a position, and the next day the price sharply reverses, leaving me with a painful loss.

The whipsaw is why many a trader knows, deep in his or her heart, that the markets bear us a personal grudge. 

The second bane is less commonly noted and so far as I know lacks a name. I call it the "meander", where I get a strong signal, have the momentum, open a position, and the price goes nowhere, meandering sideways like a quiet stream until it gradually drifts into a loss.

I have many tools in place to guard against the whipsaw, mainly by delaying the trade until the last half hour of the day, when the big players position themselves, and by insisting on very short term momentum in the direction of the trade at the time I place it. 

Entering a trade in that manner involves staring at a five-minute chart shortly before the closing bell. In the end, it is fairly subjective, since charts at that level can rarely provide unambiguous guidance as to the trend. See my post "When is the best time to trade" for a discussion of the subject.

The meander is amenable to a rigorous solution.

My present operating database has daily market results back to the start of 2009, near the nadir of the markets in the Great Recession crash. 

Looking at 2,000 or so mid-cap stocks and exchange-traded funds listed on the major exchanges, I find that losing trades have shorter lives than do winning trades.

Losing bull positions last 16 days on average before getting a close signal, while winning positions last 44 days, a ratio of nearly 1:3. 

On the bear side, losing positions last 15 days on average, compared to 34 days for winning positions, producing a ratio of a bit more than 1:2.

Curtis M. Faith, in his excellent 2007 book Way of the Turtle, has an extensive discussion of how to test various trading methods. He found time-based exits to be among the most effective.

In testing that result he didn't combine the time-based method with anything else. Essentially, it's a case of open a position for whatever reason, hold it for a specified time, and then close it regardless of what the price is doing.

I don't quite have the grit for that degree of calendar dependency, but I think the time-based method can have a place in my trading scheme.

Here's a draft rule,
A position that has not broken beyond its 20-day price channel within the prior 10 trading days must be closed unless it breaks out on the 11th day.
A bull position that is truly rising will continually break above its price channel, and a bear position, below, every few days. Ten days without either a break beyond the 20-day channel or a move to a close signal means that the stock has become a meander. (A close signal is a break beyond the 10-day price channel in the direction opposite that of the position.)

I'm not yet ready to adopt this as an "official" part of my trading rules. The 10 trading day period is somewhat arbitrary, being about two thirds of the average life of a failed trade in either direction.

So I'll treat that draft rule as a preference for now, but shall freely depart from it in cases where it seems to not be working to my advantage.


My trading rules can be read here. And the classic Turtle Trading rules on which my rules are based can be read here.

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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