Do More Of What Works – Finding An Edge In Systems Trading

There’s so much information out there for traders. You stick your finger in the air and get bombarded with advice, strategies, stock picks, analysts projections, and that’s all good for traders. The more information you have the better. So, the process of learning how to trade should be easy, right?

Oh, that is so wrong! The problem is everyone has an opinion, and shows like CNBC have at least 100 people everyday telling you what to buy. Fox business, Bloomberg TV, and all those Internet sites all offer you an opinion, which often sounds like statements of fact. Often you’ll here something like…oil is up due to the weak dollar, then within the same minute you’ll hear that oil is up due to the strengthening dollar. It happens all the time.

You can go on the Internet and look up trading strategies, and how to trade. But few if any of these bits of information are quantifiable. In other words there’s no backing study that shows statistical evidence of what works and what doesn’t. And so, you are left to figure it out for yourself. But most of us simply don’t have the time, so we rely on what we think are authoritative sources.

The problem with authoritative sources is that besides the fact that they may be peddling a bunch of bull, but let’s assume they aren’t…a lot of the data may be good for now, but a few months down the line, a year or two from now, it may all be worthless. Things change, for the most part. However, there are some things that seem to endure, basic principles that work. And so I’m going to list them for you here. Future articles will cover each of these points in detail.

  • Choose to trade short term (overnight to days, or weeks) vs intraday.
  • Buy pullbacks over breakouts, learn about hidden divergences
  • Buy after the market has dropped, not after it has risen (kind of like #2).
  • Stops hurt stock performance, the tighter the stop, the worse the performance.
  • Futures are more stop friendly, but dynamic exits are almost always better
  • Buy when stocks, ETFs and futures are above their 200-day moving average.
  • Buy when the VIX is 5% above its 10-day moving average.
  • Lock in gains when the VIX is 5% below its 10-day moving average.
  • Act on intraday highs and lows to increase your edge.

When you apply these broad principles to your trading, you will do better than had you not applied them. As a general rule, strategies that I have developed or are in the process of development, which lead to entries into the market, and my exit components, all follow these general rules. There are other very specific tools I use, that have held up to the test of time as well.

There are two specific indicators I use to help filter out noise and produce clearer signals. One is the 2-period RSI, the other is the rate of change of volume. These two oscillators are as close as one comes to the holy grail of indicators. Neither are standards, for example the RSI comes out of the box with most charting programs with a 14-period, and the ROC Volume doesn’t even exist in most platforms, the Chaikin Money Flow indicator is closest. But from a statistical point of view, these two clearly outshine everything else.

The 2-period RSI does the best job I’ve seen at identifying markets that are overbought and oversold, and the ROC Volume is the best leading indicator prior to a market move.

There is one other thing that I find curious, and that’s the need for traders to find a good shorting strategy. And while I’m sure there are some excellent ones out there, that probably work wonders in specific stocks, futures or markets. I can’t for the life of me find a universal principle to lay my hat dow on, that makes shorting a bit easier. So, as a general rule, I avoid shorting unless it’s handed to me on a silver platter.