Fickle Trader

Honorary veterinarian for a day

2006-10-16T00:54:00.000-05:00

My veterinarian-student girlfriend, Crystal, and I were walking up to my apartment this morning when we both heard a scratching sound coming from a pinched closed gutter pipe running down the side of a nearby building. At first I didn't think anything about it, but it came unmistakably from the gutter pipe a second time. Crystal said, "that sounds like a squirrel trapped in the gutter." It sounded that way to me too, so we quickly devised a plan to free it from certain doom in that diabolical pipe. It gives me claustrophobia just thinking about it. The poor animal may have been in there all night, or perhaps days.

I grabbed my toolbox while telling Crystal where to find a pair of gloves for protection in case the animal became aggressive while we tried to free it. Our plan was to pull the bottom of the gutter open with my biggest pair of plyers.

Unfortunately we were forced to change our plan on two accounts. First, opening the bottom of the gutter would drop the animal right into a second drainpipe that went straight down into the ground, and second, the plyers were bending the pipe in ways that could have crushed the trapped animal. We used tape from my toolbox and a nearby piece of plastic to cover the hole in the ground below the pipe, but our makeshift lid crowded around the gutter that we needed to somehow manipulate open.

Crystal observed that the gutter was old and flimsy, so I asked her if she thought tinsnips would cut it. She said yes, they probably would. It was slow going, I was standing next to the building holding the pipe while she made small clips out of the bottom of the pipe. It was very noisy and traumatic for the animal inside, which we found out when it crapped on my tinsnips! It was bird poo, which was a relief because birds don't bite like squirrels might.

After quite a bit of careful cutting, Crystal was able to see feathers, and then a dangling leg on the left side of the gutter. We could hear it shifting itself inside the gutter. At that time we thought it was a good idea to cut away on the right side of the pipe to make sure we didn't accidentally maim the bird. Minutes later we paused to re-evaluate the next place to cut when a big red head poked out of the pipe and started looking around! We backed away and the bird wiggled out of the pipe, which we had cut in such a way that there were no jagged edges.

That bird jumped around on the ground for a minute, and then flew up to a bush to join a few other birds, and they all flew off. I don't know if those other birds were watching us save their mate, or just hanging out on some branches, but I felt pretty amazing when I saw our rescued bird take flight.

Crystal and I have been together for almost 5 years, and the whole time she's had her focus on becoming a vet but I never really knew what gave her the drive. Today was the first time I got to feel the gratification that comes with making a life-saving intervention for an animal, and I feel like I know Crystal a little bit better because of it. She wants to have the knowledge and position to do this kind of thing every day. I will never have that knowledge, but today was my chance to do it in a small way. I was so proud of what we did that she agreed it would be okay that I could be an honorary veterinarian for a day!

Watch lists, ads, and vendors

2006-10-11T23:30:00.000-05:00

Jimmy, over at Trend Following with CANSLIM wrote a piece on trader watch lists that reflects my own opinion about bloggers posting stock watch lists. He says, "I sometimes find watch lists funny... Most people who post up lists will point out all the great stocks they posted up. 'If you bought X stock when I posted it, you would have a XXX% gain!' They don't mention the losses, 'If you bought X stock when I posted it, you would have had a margin call!'" Interestingly, a few people with ads on their sites are getting pretty defensive in the comments section of Jimmy's post.

There's nothing wrong with having ads, but realize that as soon as you put them on your site, you're more than just a trader, you're also vendor. Ads can make a site look more authentic, but they can also be a red flag. I know enough to filter out the good content from the bad, but there are a lot of impressionable people who visit our blogs and websites that don't.

I wonder if traders look at the ads on their own sites? Most of the ads I've seen on trading and finance related sites link to pyramid schemes or aggressive vendors that could be a mismatch for the reader, or worse, outright fraud. I would never dream of posting a link in the body of one of my blog posts to just about any ad destination I've ever seen based on the merit of its content. I don't believe in protecting people from themselves, but when they come to me to learn in good faith, I'm not going to point them in the wrong direction.

There's a relevant discussion going on over at Trader Mike's blog. Michelle says:
Other criticism directed at trading blogs is they do not say anything these critics do not already know, that you can get valuable information only if you are willing to pay, and if these bloggers were good at what they do, they wouldn’t be blogging. Apparently these critics have not considered perhaps the reason why a trading blogger writes is because he has something to write that has merit to someone, and he has a generous spirit, but nothing to sell — he is already making a good living.
I would disagree with the statement that blogs with ads aren't selling anything. Regardless of whether or not there are ads on a blog, I do feel that most highly read blogs add value because inevitably there will be readers who are being introduced to the content for the first time.

In the comments over at Jimmy's blog, No Doodahs points out a trader's cost of not being some kind of vendor:
If a "good trader" could make 40% annual and needs to take 10% off the top to pay for living expenses, or that same trader could make 40% annually and defray those expenses by having adverts and/or selling merchandise, which is smarter? Which will get that "good trader" retired faster? By the way, 10 years of 40% gives you equity that is twice as much as 10 years at 30%.
I guess my counterpoint is that if our hypothetical trader cares about the difference between having $7mil and $14mil at some fixed point in the far-away future, he would be better off managing accounts and collecting the fees and performance incentives over that time period.

About a year ago an old friend of mine had heard that I was knowledgable about trading. He called me up and started asking me very basic questions about options. I knew he was beating around the bush, and sure enough I found out what this was about. He asked if I would go with him to an Optionetics seminar, mentioning that he had 2 tickets. I told him not to even bother with it, that it was crap. He argued that he had went to the same seminar a few days ago and was interested. He wanted me to tag along and look for anything suspicious and share my general opinion about it. I agreed since it was only an hour long and I didn't have anything else planned that evening.

A few days later I arrived at the seminar. The hotel conference room was full of probably 30 people, with at least half looking like they had been invited in off the street to fill up seats. My friend warned me that the guy giving the seminar was a slick salesman, and as soon as I got a look at him I almost laughed at how slick he looked. As he pointed at slides and moved around on the stage, he kept rousing the audience and asking us rhetorical questions to invoke a peer pressure crowd response. It was obvious that many people in the crowd had practice with this sort of thing on Sunday mornings, and that slick guy worked it. He stopped looking at me when he would rally his audience because I wasn't joining the hype, and my friend was probably too embarassed to get into it like he probably would have if I wasn't there.

The worst part that sticks out in my mind was when this slick guy told everybody that people who bought stock were suckers. He claimed they had a 1 in 3 chance to make money because stocks could, A) go up, B) go down, or C) stay flat. These uninformed masses were just giving away their money because they only profited when stocks went up. If you took the optionetics course he was selling, you would learn how to make money no matter what stocks did.

This premise is completely false. I've won free lunches and all kinds of change from people by playing a similar game. It works like this: after buying in for a 3:1 jackpot payout, the buyer flips a coin and I flip a coin. The jackpot pays out if both coins land heads-up. There are 3 possible outcomes to this game, let's look at them for a $1 buyin:

Two heads land. I keep the buyin and give the $3 jackpot, so -$2 for me.
One lands heads and one lands tails. I keep the buyin, so +$1 for me.
Two tails land. I keep the buyin, so +$1 for me.

When negotiating the game, it should be pitched this way so as to represent a game of pure chance with 3:1 payout on 3 possible outcomes. However, the probability of the outcome with one coin landing heads and the other one tails is actually twice high as the probability of the other two outcomes, giving me an edge. People who buy US stocks usually have a similar edge: the market's natural upward drift. Unless, of course, they trade too frequently thus reducing portfolio correlation to market direction and large transaction costs to crowd out the edge, or fail to diversify enough for the edge to materialize.

So anyway, after the seminar, I spoke with my friend about all kinds of reasons I thought it was crap. But he still wanted to do it. Even after what I told him, he asked me to reduce the cost of the course by signing up with him and getting a two person discount! Unbelievable. I said, no way, and to watch me go verify these suspicions with the slick guy who gave the seminar.

I waited my turn to speak with him, and the first thing he asked me was, "So are you going to sign up today?" He was kind of smiling. As soon as I asked my first question, he stopped smiling. I asked him about the hedge fund he mentioned that was run by Optionetics founder, George Fontanillis. I pointed out that the hedge fund could potentially be on the other side of a lot of the trades recommended in the course, and how could I be sure that wasn't going to happen. You know what he told me? "I'm not even supposed to mention the hedge fund. That's all I'm saying." He was threatened, and my friend could see it by the way this slick guy was frowning at me. I wasn't going to let him off that easily though. I kept grilling him until he just stopped responding to my questions.

There's more to the story, but we'll leave it at that. The point of that story was to show that there are harmful vendors out there who are selling it as hard as they can to whoever they can. There are also curious and well-intentioned people like my friend, who didn't know enough to see that what was being sold at the seminar was just hopes and dreams. That kind of mistake can cost an aspiring trader years to make up for.

MNG chart

2006-08-21T03:01:00.000-05:00

I haven't posted a chart in a while and I thought this one looked good enough to post. Notating it is left as an exercise for the reader.

Winning entry to the writing contest

2006-08-08T21:39:00.000-05:00

This is the winning entry for the writing contest. As you can see, it is quite a production. Thanks to everybody who participated!

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Risk management

By Terry Zink

“You get paid for taking risks.” This one phrase is critically important to understand if we want to make money in the stock market.

What do we mean when we say we get paid for taking risks in the market? I believe we can understand it thusly: buy before you are certain and sell before you are sure. To put it another way, our returns our better if we act before all uncertainty has cleared.

Risk and uncertainty are two terms that are often used interchangeably. When we say that we are paid for taking risks we are usually referring to uncertainty. Uncertainty is the probability that an investment we make will work out positively for us. If we make an investment whose outcome is uncertain, we will typically expect a higher rate of return. If the outcome cannot be predicted with a high degree of certainty then it makes sense to look elsewhere where the outcome is more predictable. However, if the potential payout is higher, then some investors are willing to overlook that uncertainty in order to maximize return.

Logically, it makes sense that the more uncertain the outcome, the more potential return we ought to expect. If we have to pay a price for uncertainty then we should expect to get more if it works out. In the bond market, long-term bonds have (or should have) higher rates of return than shorter term bonds. The reason is that longer term bonds ties up a person’s money for a longer period of time, and a lot of stuff can happen in that longer time period. It becomes more and more difficult to predict what might happen as the passage of time progresses. Thus, the price of tying money up longer is a higher rate of return.

In real terms, how might we quantify uncertainty? It is unfortunate that risk and uncertainty are often used interchangeably, for while risk is measurable, uncertainty is not. So, how might we go about measuring risk? In practical terms, I believe we can define risk as the most amount of money we are likely to lose in the case that trades or investments do not proceed the way we planned. For example, if we were to invest in a stock, we might define the maximum amount of money we will allow ourselves to lose is $500 before closing our position. We would then call this our risk, or to put it another way, we risk $500. If we invest in real estate, we might say that the most we will be willing to lose on the property is $10,000 before we sell. In either case, the amount we risk is the most we would be willing to lose before closing our position and cutting our loss.

Risk is closely correlated to reward. In all investments we must always ask the question “What is the risk/reward ratio?” The risk/reward ratio, conceptually, is evaluating how much money we think we can make versus how much money we will allow ourselves to lose. If we believe that our potential reward is considerably greater than our potential risk then we have a favorable risk/reward ratio and the investment is probably a good one. How favorable the risk/reward ratio ought to be depends on the individual investor, but in any event, it had better be less than 1.

Using this concept of defining risk, the phrase “you get paid for taking risks” might be better stated as “your payouts are better when you act before all uncertainty has cleared.” We use various tools to guide us in our decision about whether or not to act, including fundamental or technical analysis, or a combination of the two.

The risk/reward ratio is one of the most important ideas in investing, because an analysis of the risk/reward ratio often answers the question of whether or not a potential investment ought to be made. It also can help eliminate the uneasiness associated with uncertainty. When it comes to uncertainty in the market, an investor will often want to predict whether or not the investment will work out. By analyzing the risk/reward ratio the investor need not predict whether or not an investment will work out, he (or she) can weigh the facts and a decision will naturally present itself.

Let me create an example. Suppose an investor is trying to decide whether or not to take a position in a stock. They really don’t know if the stock will go up or down. Let us assume that the stock has been trading in a range between $40 and $50 per share for two years. The stock is now at $48 per share. Should the investor buy the stock? We know the stock usually hits $50 and bounces down, that means it has $2 to go before it probably turns around and trends down. There is not a lot of room on the upside, but plenty of room on the down side. We could only let the stock go down to $46 for a risk/reward ratio of less than 1. That is not a lot of downside room. A tighter stop might be $47 for two-to-one odds, or $47.50 for four-to-one odds, but that is not a lot room as stocks can fluctuate that much in a single day. Indeed, this is not a great risk/reward ratio. If the stock were trading at $41 or $42, we now have a lot of upside room and we can still set a $1 or $2 stop that gets us out. Note that in this case, we didn’t need to worry if the stock will break out of its trading range, the risk/reward ratio ruled out the first case but left the door open for the second.

What are some real life examples of taking risks in the market? One is taking action in a potential head and shoulders top before the change in trend has been confirmed. Figure 1 is an example of a stock in an uptrend, bouncing up along the trend line along subsequent rallies and pullbacks. However, at point 1, it pulls back and breaches the trend line it had always successfully held. It makes a successive rally at point 2 but fails to attain the high of the previous rally. At point 3, it closes below the low point of the preceding pullback. This is a confirmed change in trend from up to down. At that point, traders might decide to close their existing positions or go short on the stock.

Figure 1 - Confirmed change in trend

Note that we must wait for the stock to close below the previous pullback low. Is this the optimal time to close the position? While the trend has confirmed a change from up to down, we have given up a good proportion of our potential gain. After trading costs, commissions and slippage, waiting for consummation of the down move can wipe out a significant portion of our potential profit.

Instead, we might decide to go short around the peak of a right-shoulder in a potential head and shoulders top. If we can see that an uptrend has been violated and the successive rally fails to clear the high from the previous one, we can act before we are sure that the trend has reversed. All uncertainty has not cleared, the previous pullback support level has not been violated but the return will be greater if we capture as much of the move as we can. This is illustrated in Figure 2. The up trend has been violated at point 1 and the subsequent rally at point 2 has failed to carry up to the high of the head. At point 2 we have a potential head and shoulders top and we can take action by closing an existing position or going short. We do not know if the trend will be confirmed but our return will certainly be greater by acting sooner rather than later. We then minimize our potential loss by clearly defining how much we are willing to lose before we conclude we are proven wrong. We might incorporate some technical analysis that will prove us wrong, or use a volatility reversal against our position, but in any case, we manage uncertainty by defining our risk.

Figure 2 - Possible head and shoulders top

Another example is at the end of bear markets, fear is rampant and investors are hesitant to go long in the market for fear of losing more money. This is a justifiable fear; nobody likes to lose money and the reason we buy stocks is because we expect them to go up. However, even bear markets come to an end. There are numerous systems that produce signals to get back into the market, and the earlier we get into them, the better our potential gains. The problem is that hesitation can come into play for fear of the market reversing again and shaking us out of our positions, netting us another loss. We can wait for the market to provide us a clearer signal but by the time that occurs our potential returns have been reduced. Again, adding in commissions and trading fees, not to mention slippage, our potential returns are shrinking the longer we wait. We must act before we are certain, and we manage our risk by clearly defining how much we are willing to lose.

In trending markets, we must keep in mind that the longer a trend has been in existence, the closer it is to its end. Thus, we need to have faith in our market analysis when it is telling us to get back into the market and we then manage our risk to keep us in the game in the event we are proven wrong.

This illustrates the concept of minimizing our risk vs. managing our risk. Minimizing our risk would certainly guarantee the probability of a positive outcome but that outcome would be quite small. By comparison, managing our risk is accepting that we don’t know for sure how an investment will turn out, we accept that fact, but we go ahead and do the investment anyways because we can potentially make a substantial positive return; we will close that position if we lose money according to a predefined condition.

There are several systems of managing our risk, one of which is diversification. Diversification is the practice of investing in numerous different industry groups; when one industry group goes down the losses are offset by the gains in another. Thus, a large loss in one can be counter-balanced by another. Diversification is not limited to investing in a broad number of industry groups, however. A smaller concentration of industry groups may be invested in with a specific amount of total capital risked for each trade, say 1%. A method that concentrates in high performing industry groups but limits itself to a few individual positions manages risk by avoiding overexposure to a major downturn in any one group and protecting total trading capital. Indeed, the protection of initial capital is crucial to managing risk; it takes a larger proportional gain to make back what you lost. For example, if your capital drops 10%, it requires an 11% gain to break even. If your capital drops 25%, it takes a 33% gain to break even. Thus, selecting strategies that protect trading capital is a method of risk management that is imperative for any speculator to make use of. Note that we have not necessarily dispelled any uncertainty but we have minimized our potential loss if conditions move against us.

Of course, no system of risk management is perfect. Acting before we are sure has its downsides, as markets can quickly reverse with little to no warning. Sometimes the moves that we anticipate would happen don’t happen after all. Fundamental news changes can drastically alter the decisions we would have made had we had access to that news. If we buy a position in a stock and plan to get out if we lose 5% of our original position, that assumes that we actually can get out before the 5% has elapsed. What if we buy the stock and the next day the company declares bankruptcy and the stock goes to zero overnight? What if we are short the stock market and the Federal Reserve decides to cut interest rates from 5% to 1%? What if we buy a California-based home builder and the next great earthquake hits and California breaks off from the continent and submerges into the sea? Indeed, all of these sudden changes in market conditions can hurt us much more than we planned. Our risk management system breaks down.

But even in these cases, it is not as bad as it sounds. While these sudden changes are possibilities, they are not probabilities (except for perhaps a sudden change in policy from the Federal Reserve or political decisions by government). It is a possibility every day that we may get into a car accident but most people still drive cars to go to work. We can get food poisoning from contaminated food but most of us rarely think about this in the food we buy from the supermarket. They are possibilities but not probabilities. We make decisions based on the most probable outcome and take the necessary steps to minimize our risk. In the case of a car accident, we can fasten our seatbelts and buy cars with airbags. With supermarket food, we can buy canned goods and wash our vegetables. In the market, we can allocate only a portion of our trading capital to any one position and define our exit criteria. None of these will protect against the absolute worst case but it manages risk and, in this case, reduces it. It is a matter of taking steps to minimize the damage in the event that we what we don’t expect to happen, happens.

Risk management, then, does not involve eliminating risk but instead managing it by accepting what might go wrong and how to prevent damage that can occur. It is a matter of making intelligent decisions on how to allocate capital and taking action before certainty becomes completely known. Any mediocre trader can become an excellent trader by incorporating risk management into his or her methods.

Watch list for week of 8-7-06

2006-08-07T01:16:00.000-05:00

If you look at the weekly charts of these stocks in addition to the daily charts it will become a lot more clear why I found them interesting. There appears to be long term bottoming patterns happening on a lot of them, but they aren't in the clear yet. I may enter small long positions in a few this week and add shares if they break out.

Also, it seems like the NYSE is getting all the action lately. Today it had far more new highs than the naz. Not really my kind of market, but it does show an underlying strength that gives me the incentive to place a few longs.

Breaking Off A Piece: Part 1

2006-08-01T02:59:00.000-05:00

Here's the blueprint for one of the more interesting basic pyramidding campaigns that you can do in a stock. This is nothing original, I'm just throwing it out there for discussion because it is useful and the numbers work out nicer than many of the other variations.

The strategy can be used when two conditions exist: a) the stock is strongly trending up, and b) you want to own shares. For your campaign, you must identify up front the amount of "risk capital" for your operation. If your campaign is successful, you will have a block of stock, and have converted all of your "risk capital" back to cash for use in the next campaign.

Say we want to break off a $5k block of stock. For this specific campaign you will need 3 times that amount in risk capital, so $15k. After carefully identifying a good risk:reward entry point using your favorite technical analysis or tape reading, 1/3 of the risk capital ($5k) is committed.

If the stock moves in your favor 10%, commit another 1/3 of the risk capital ($5k). You will have committed $10k of risk capital and are carrying $10,500 of stock.

After the position moves in your favor another 10%, commit the final 1/3 of your risk capital. You will have committed the full $15k of risk capital and are carrying $16,550 of stock.

A limit order is placed to sell 3/4 of your shares 21% higher than your final entry. After the stock has advanced 21% from your final entry point, your position will be worth $20,025.50. If your limit order fills completely, you will have reclaimed your entire $15k of risk capital, and have a $5k block of stock.

At no point are you excessively exposing your capital to great risk. As the position moves in your favor, you will gradually be enabled to reclaim most or all of your risk capital if you stop out. If the position moves against you from the start, you will only take a loss out of 1/3 of your risk capital. What you have done is taken shares from people who are not managing the risk as well as you are. By managing risk in ways similar to this, a trader can break off quite a lot of stock over the years.

Here's a spreadsheet recap of the strategy:

Risk capital Percentage multiplier Position size
5000 1 5000
5000 1.1 10500
5000 1.1 16550
0 1.21 20025.50

These numbers are just used as an example, there are all kinds of variations that can be used in different scenarios. A variation of this strategy can even be adapted for use by market makers to build inventory by adjusting the percentages way down.

Watch list for week of 7-24-06

2006-07-24T01:07:00.000-05:00

The stock charts I looked at were pretty dismal this weekend, but I've listed the best ones I saw above.

I expect to be able to announce the winner of the writing contest this week. Although only one entry can win, I would like to publish all of the articles on this blog because each writer had a unique and insightful perspective.

Mid-week reading material

2006-07-19T11:45:00.000-05:00

Brett Steenbarger has a nice summary of the two primary schools of thought in trading on his blog. The first is the visual / discretionary trader, and the second is the edge / statistical trader. The differences and similarities between the two are worth studying, especially their often different relationships with leverage. Which school of thought sounds the most appealing to you? Which sounds the most like your trading? If there is a divergence, you might have found an opportunity to improve your trading results by consciously shifting your efforts.

Chris "Piranha" posted his newsletter for the weekend to his blog. Usually only subscribers get his full report. Chris does excellent work, I have learned a lot from studying his market analysis over the past several years. If you like what you see, check out his website marketstockwatch.com.

Watch list for week of 7-17-06

2006-07-17T02:13:00.000-05:00

Today (Monday) is the last day for submitting an entry to the writing contest. I received a few more last week. If you submitted an entry last week and haven't heard back from me yet, I'll get back to you by email this week to confirm your entry.

This week my software only came up with 3 interesting candidates to watch, probably because downside volume is causing a lot of stocks to be filtered out. Here's the list:

I wonder if we'll see major indices go into freefall over the next few weeks. They look particularly vulnerable to crisis right now. The trend on nearly all time horizons is down.

Pirates and Probability

2006-07-14T11:41:00.000-05:00

Was anybody else figuring all kinds of probability during the dice game scene in the new Pirates of the Caribbean movie? They put a little something for everybody in there. That used up my annual vote for "movie of the year". If you haven't seen it, check it out this weekend :D

Idea for an improved GA

2006-07-11T23:19:00.000-05:00

I just had a slick idea for an improved genetic algorithm. I have not read about this anywhere, but I'm probably not the first to think of it:

Lay a lattice over the surface map you are working with and only solve for points on the lattice to get a good idea about which hills to climb at a finer precision. This should stomp the performance of a vanilla randomly seeded GA.

If you're curious about genetic algorithms or you just want to play with one, you can check out an old applet I made here. There is also good information available on the GA entry at wikipedia. GA applications in systems trading development are everywhere.

Watch list for week of 7-10-06

2006-07-10T02:34:00.000-05:00

Not much to say about nasdaq stocks this week. I have a short watch list from my market homework software, but I don't see any reason to weight long or short heavily right now based on recent charts.

There is one week left to submit an entry to the writing contest. Thanks to everybody who has submitted entries so far.

Watch list for week of 7-3-06

2006-07-03T00:50:00.000-05:00

The nasdaq summation index $NASI has turned positive over the last couple of days, so if I had to guess I'd say that short term bias is probably up, but volume will probably be light due to July 4.

I had a relaxing weekend sitting around coding the market modelling software with my cohort Brandon, and IM'ing Michael Taylor. Michael is moving to Missouri! I'm stoked about it.

Brandon and I spent most of Saturday looking at a problem that occurs when generating weekly bars in my model. The problem was manifesting when we were truncating remainders off of the date of the weekly bar when the week was split across two consecutive years. For example: the week of Sunday December 29, 2002 runs into 2003 and is actually the 53'rd week of 2002. I'll be damned if we didn't find a bug in the Java API. I spent Saturday night until about 2 am coding around it, but until Sun fixes this problem it could rear its head in other places down the road.

There's nothing like crafting science in Java and throwing back some Budweisers with a Morlack chill/goa set playing. I just forget all about time and life is never better.

I'm considering making my market homework software available for free. In the past year since I originally created it I've developed far more sophisticated tools for analysing markets, so it no longer feels "cutting edge" to me. I think making it available to everybody would resolve a lot of issues for me. I would feel like I've paid my dues to everybody who I've learned from over the years without the headaches of open-sourcing the project. It would also level the playing field just a tiny bit more for people who can't program things like that for themselves. I made the market homework software with these things in mind:

Keep an eye on the strongest stocks without me having to look at their charts each day.
To watch when the public isn't watching.
Identify breakout candidates before they break out and show me their charts in an accessible manner.
Avoid showing me charts whose price is extended up or down.
Avoid showing me charts that are plunging (no chance for an uptrend).

Before I make a decision on whether or not to make the market homework software available, I have to speak with Brandon about it. I've been using the report from the market homework software as an excuse to write to the blog regularly, but I don't really want to do that any more. I think the blog would be even better if I only posted when I had something really good to say, sort of like how Michael Taylor runs his blog. The only way I can figure to do this and keep everybody happy is to give to my readers the means to run the market homework software on their own master watch list whenever they want. That way we're all free to focus on what I really love about the markets: deconstructing how they work for the purposes of exploitation ;D

Anyway, here are the highlights from my market homework software this weekend:

Watch list for week of 6-26-06, writing contest extended

2006-06-26T01:06:00.000-05:00

A small list like this means not too many stocks are consolidating at support.

Due to several requests, I've decided to continue accepting entries for my writing contest for three weeks, so the deadline for submission is Monday, July 17. The prize is a copy of Victor Niederhoffer's latest book: "Practical Speculation" shipped from amazon.com to your house. For all the details, please see the link.

Reply to a reader regarding overnight risk during the 2003 bull

2006-06-22T22:18:00.000-05:00

"About your observation about there being a big premium that daytraders miss by not holding overnight risk. You should take a closer look at your data. Re-run the spreadsheet and this time start from about September 2002. You will see the relationship almost breaks down. Shorting overnight or going long over night yields more or less the same return. Before 2002, the point you made on your blog was quite valid. The interesting question then is why this relationship changed. Presumably, the answer is because most daytraders were eliminated by the bubble bursting." - sc

This is a great observation, but it only shows half of what is going on here. September 2002 was a major market bottom, so let's also look at the results for the person who carried risk through the entire period, September 2002 until present.

Buying the close and selling the open: $100,000 becomes $100,598.40
Buying and holding: $100,000 becomes $171,178.80

This tells us that the public was not willing to pay a premium for overnight liquidity. We might conclude that they were frequently getting out of positions and taking small gains because they were willing to pay premiums (higher prices) to people who for the most part bought and held and in doing so improved liquidity over a four year timespan. The people who did most of their buying near the market bottom bought when supply was relatively abundant and demand was relatively scarce...

Criticism of Daytrading Followup

2006-06-21T20:23:00.000-05:00

"To play devil's advocate...if your test shows the tide is against daytraders and against investors. Is the tide with those brave souls willing to hold overnight and dump their holdings the next day? Hold short-term? Long-term? What criteria are you using to determine the tide is with if you trade like yourself? Are you adjusting your exits depending on certain conditions? Scaling out? If so, possibly daytraders and investors can and most likely are doing the same. Plus, your test is only showing one instrument. What happens if you choose a different one? What happens if you diversify across several instruments. Or diversify across time? I could go on and on. There are so many ways to skin this cat...that it's very hard to discount one methodology over another." -- Michael Taylor

This is a great subject for writing about because it is hard to pin down all the angles. I can't resist ;-) Rather than process of elimination, let's discuss some of the important factors that all market participants must deal with because no matter what strategy you use, they are a factor. Off the top of my head some important ones are:

commission
bid-ask spread
margin interest
taxes
slippage
gaps
dividends
money market interest
interest on short positions
dividends paid out for short positions

Every trader should have a good understanding of how these factors affect each of their strategies and tactics. I bolded the two that I feel are immediately relevant to my previous post regarding daytrading and "investing". Before I tear into these strategies again, let me say that each has their place for a well rounded and properly capitalized trader.

Most people have probably given some thought to whether or not they feel that market prices have an infinite fractal dimensionality or not. In otherwords, if I show you a chart of continuous prices I grabbed at random that doesn't have labels on the time axis and price axis, could you make a good guess about what time horizon and price range you were looking at? Could you do it repeatedly with any accuracy? For me, the answer is no. So I assume that daytraders in general are in fact trading the same kinds of chart patterns and price trends that I am, just on a different scale. The daytrader could employ twice as much leverage as I could, but he would also be paying the same bid-ask spread as I would have to. Regardless of how much leverage he chose to use, he's paying the spread on the whole thing, and when expressed as a percentage of his average profits, the bid-ask spread takes a ridiculously larger chunk of his profits using the same chart trading techniques! The daytrader also has a higher turnover, which means more chances for commission and slippage to eat into the profits.

"Ah," you might say, "but the daytrader could avoid the spread by using limit orders." That is correct, you can choose the time of your trade or the price of your trade, but the two are mutually exclusive. So our limit ordering daytrader can't even be sure that he will get the positions that his strategy requires him to have. Also, the best trades have a funny way of not quite getting to your limit anyway. There is no shortcut around the bid-ask spread that doesn't penalize you in another equally sinister way.

Let's not forget gaps. There is a mutually exclusive relationship to explore here as well, and it is all about liquidity. It is a fact that people will pay a premium to reduce their risk. If you can provide liquidity for these people and are good at selectively managing the risks involved, you will be paid a premium. Carrying stock positions overnight is one way of providing liquidity to people in aggregate. Any trader who's thought deeply about it understands that when he is successful in his trading operations, it just so happens that he has improved the liquidity of the market. He has bought when both supply was abundant and demand was scarce. He has sold when supply was both relatively scarce and demand relatively abundant. Buy uncertainty and sell hope.

All these things are the tide that I'm talking about. It is quite convenient that you can see it on the price series of the QQQQ. I'm not saying that you can't be successful daytrading because there are zillions of people who are, but they are grinding it out in an uphill battle for reasons that are fundamental to the way markets work. On top of that, daytrading takes a LOT of time that could be spent on things equally as gratifying. I like the easy road.

Watch list for week of 6-19-06

2006-06-19T00:55:00.000-05:00

I'm convinced that the long-term market trend is down and that we're experiencing the first bear rally. The naz gained almost 3% on Thursday. That's the kind of stuff you see in bear markets. I'm out of almost all long positions, and will be closing the rest out over the next two to four weeks. I'll be shorting opportunistically, but not aggressively yet. Before I show my computer generated watch list, let me point out the two scariest charts and the two best charts I've seen all week:

Scary:
HANS
NTRI

Best:
LBIX
AERTA

Here's the highlights from my market homework software this weekend:

By the way, if you are a daytrader or an "investor", don't even bother to email me. Also, if you have some pay_for_stock_tips service, don't email me.

Somebody might ask, so I feel like I should explain why I'm not going to hawk daytraders' websites. There are two reasons. Daytraders fight the tide if they are going long, which can be seen on this very simple trading system that buys the QQQQ at the open and sells out at the close:

The starting balance was $100,000, and ending balance is $18,914. Where did all our daytrader's money go? Simple. It went to the traders who bought and sold to the daytraders, ie. the ones who took overnight risk and avoided intra-day movement. It might occur that the daytrader should be shorting and cover at the close, but that is also less than optimal due to the inability of a short position to compound as it moves in your favor.

Anybody who wants to reproduce the spreadsheet above can download the price data into excel from this link at yahoo finance, sort the price data in ascending order by date, and use this formula in column J: =J1*(E2/B2) . Put the starting balance in the header row of column J, and you're set.

I can't wail on the daytraders without wailing on the investors. So how did they do over the same period? By buying and holding over the entire period, the $100,000 account is worth $76,192.37. A lot better than the daytrader, but a sharp stick in the eye for seven years worth of "investing". The investor figures his money would have doubled in seven years. Every seven it doubles, right? It never works out that way.

The point is that you have to have an edge, and if you aren't looking for one then don't come here. If I haven't pissed you off yet, then I probably don't mind if you email me.

To tell the truth, I'm thinking of taking a break from this blog. There are so many reasons why, but to name a few:

1) The market has turned long-term bearish.
2) I got ZERO responses to my writing contest.
3) I keep getting more and more annoying emails from people starting investing or daytrading websites and less email from legitimate traders.
4) There's no point in trying to help people make good strategic choices. The public cannot ever "solve" the market. As I get closer and closer to it, I find I have less and less to say to the public about it.
5) It is tiring to keep up with an exponentially growing community when the quality will never get any better than it was.
6) Almost all the blogs I used to love reading are either posting 12 times a day instead of maybe once or twice, switched to daytrading, moved to a pay site, or they don't post anymore. Maybe I'm the one who's crazy, but either way I just don't feel like there's much left here for me.
7) The "evil scientist hibernation" instinct is starting to become overpowering. I have more clarity now than I've had in about three years. When I'm working on my software, the only conscious thoughts that interrupt my concentration is that none of my other work matters. I've got to start cutting out other things, and this blog is one of them.

I like formulating my discretionary trading plan on here each week, it keeps me organized and disciplined. I haven't missed a weekly strategy plan posted to the blog in well over a year and I think I'm at the point where I don't need the blog anymore to maintain it, sort of like when you're a kid and you're ready to take the training wheels off the bike. I might discontinue the "weekly watch list" postings because it will give me more time to focus on improving my strategy and computer programs, and doing some real writing about trading instead of just snippets to the blog.

Watch list for week of 6-12-06

2006-06-12T01:30:00.000-05:00

This correction has become more severe than I anticipated. It seems that a lot of bulls capitulated on Thursday, along with some margin call liquidation. If Friday had been an up day then I would have a little more confidence in long positions. I think this bull might be close to its last legs, but I cannot be certain yet so I am still net long. My watch list this week looks far better than it has for months. It has been a while since such high relative strength stocks have consolidated long enough to meet the criteria my market homework software looks for.

I'll probably be re-allocating some of my portfolio from the worse looking positions into better looking consolidations on the list below. I've had GIGM since I posted about it in March and added to it again this past Thursday morning. I'll add even more shares if it breaks out from its current consolidation.

NTRI
PWEI
RIV
AOB
FNET
GIGM (I'm long GIGM)
GROW
LBIX

Watch list for week of 6-5-06

2006-06-05T01:07:00.000-05:00

Everybody probably thought I was nuts last Monday morning when I said we were in a short-term rally and the naz closed down like 40 points. I didn't sell a thing that day. Like I've said before: most days your best move is to do nothing. It was for me, the naz ended the week up 9 points; its second consecutive up week. In fact, on Wednesday morning I bought some TZOO shares just above its 50-day SMA. TZOO hasn't broken out yet, and sure enough it made an appearance on my market homework software this weekend as a buy candidate. I'll be adding to that TZOO position if it does in fact break out.

I'll be watching the nasdaq very closely over the next month because it has made a significant lower low, taking out the low put in at the beginning of the year. I don't sell profitable long term trend trades when the naz is having a correction off of a fresh higher high, even if the pullback is extreme like this one in May, but I will be closing out those positions if the naz makes a consecutive lower high and lower low, completing a bearish head and shoulders chart pattern. This is the period of the short-term market cycle I love right now because you can make a bet either way on contracting stocks and you will win as long as you realize any losses quickly. Most of my bets over the next couple weeks will be on the long side, but after that, I suspect on the short side.

At the end of April I mentioned on the blog being up about 60% for 2006. In fact, I was up as high as 69% before the correction occured, but I was already unloading my weaker holdings. So how did I hold up through this recent correction? The gain in my discretionary stock trading account for 2006 has shrunken to 32%. Maybe I shouldn't be talking about this on here though because I don't want it to turn into a competition, but I do want to inspire people to learn about my style of discretionary trading and to strive for better emotional control and psychological discipline.

Well, the premier of Korgoth just came on cartoon network for the second time tonite and it actually looks kind of cool. I missed it earlier tonite but I'm going to watch it now, so I'm done talking ;)

Here are the highlights from my market homework software this weekend:

DCAI
TZOO (I own shares of TZOO)
AQNT
ANAD
CBIZ
FNET
FNSR
MICG
ESMC
MSO

Watch list for week of 5-30-06

2006-05-30T08:30:00.000-05:00

Sorry this post is about 10 hours later than normal, my internet went out last night so I could not finish my weekend market study until this morning. It looks like we are in the middle of the rally attempt I suspected we would be last week, so my analysis has not changed. If this rally stinks, I will begin shorting weak stocks. As for now, I am keeping only my outperforming stocks.

Here are the highlights from my market homework software this weekend:

Watch list for week of 5-22-06

2006-05-21T23:55:00.000-05:00

I don't have any new market commitments lined up for this coming week. The recent sell-off has been on huge volume, which is a big negative. Market breadth is terrible now, which you can clearly see on the Nasdaq summation index ($NASI at stockcharts.com). There are also more stocks making 52 week lows than are making 52 week highs. Still, I can't help but think that we're at a short-term market bottom. The most compelling evidence is found on the weekly chart of the nasdaq. 1) There is a decent wick on the bottom of last week's candle, 2) it sits very close to the long-term lower-channel line, and 3) it sits close to its 50 week moving average.

I'm net long right now, sitting in a little more than a half dozen outperforming stocks. All of my weaker holdings have been cut over the past three weeks. This means that I'm in a good position to watch how any rally behaves over the next month or two. If it craps out without my stocks moving to new highs, then I'll dump them, hopefully at an optimal time and probably start to pick up some short positions if the trend on the nasdaq weekly chart changes to down. Basically, I'm going to play this just like I played the market in Q1 2005 right after the naz cracked in the first couple weeks of January.

Here are the highlights from my market homework software this weekend:

Watch list for week of 5-15-06

2006-05-15T00:53:00.000-05:00

Over the past couple of weeks I've sold most of my underperforming positions. As a consequence, I'm sitting on more cash than I've had since late 2005 but I'm not probably not buying much next week based on what I've seen so far. All the stocks from my watch list last week have taken big hits except for PTMK. Thus, the breadth of stocks on my watch list has taken a turn for the worst. This is a big deal because it means that stocks that are trading near support prices are not being bought like they should be. The reason I track more stocks on my weekly watch list than I could possibly own is for this very reason.

A further warning sign that I consider to be particularly important is the $NASI (nasdaq summation index) breaking support on the daily and weekly chart.

So this week, I'll proceed with extreme caution. I'll settle only for the very best prices if I do decide to proceed with my campaign in PTMK, and I'll be quick to sell if support fails. I won't be shorting anything yet because the stocks I'm still long of are all still in aggressive uptrends, and the overall market trend on weekly charts is still up. If we do experience a rapid and extreme market crash in the next couple of weeks, my plan is to take profits on longs, and step aside so that I can be in a great position to be a buyer near the bottom. However, if the transition to a downtrend is slower and more obvious, then I will initiate some short positions. Regardless, the most likely event is that I will have to do nothing, sit in my long positions while the market continues its uptrend.

It goes without saying that the highlights from my market homework software this weekend is a very short list:

May 2006 Journal Musings

2006-05-10T23:26:00.000-05:00

I picked up Tool's new record "10,000 Days" this weekend and I've had it playing non-stop since. While there isn't as much philosophically interesting lyrical material to comtemplate as their previous record "Lateralus", there is an amazing track towards the end of the disc titled, "Right In Two." The chilling story that unfolds over almost a full nine minutes is told from the perspective of angels who are puzzled and amused as they watch the monkeys that they blessed with free will, logic, and opposable thumbs use these gifts to kill each other in a battle over resources, all while there is plenty to go around. "Monkey killing monkey, killing monkey, over pieces of the ground."

Not a lot has changed over all of history. Bloodshed over resources is still common to this day. Meanwhile, guys like me sit in our ivory towers while manuevering for more pieces of the pie. When is enough enough? Bud Fox posed this question to Gordon Gekko in the "Wallstreet" movie. Gekko is correct that it isn't a question of enough, it is a matter of monetizing the wastefulness and carelessness that inevitably results from humans being humans. Laws are levied, wars are fought, and lines are drawn for the rights to the spoils of any given group of people.

I too am puzzled and amused by this seemingly fundamental human character trait because it is both the holy grail and golden goose. Occasionaly I concieve some darwinian experiment that I can program into the computer and tweak, like Maynard's angels have done. What else can be their motivation? Are they not like me, selfishly curious? As for my more wasteful and not so curious fellow human beings, well... perhaps they might be interested in trying their luck at a game of chance. I'd be glad to arrange something ;)

I got caught in my first nasty gap down for 2006 this morning. On April 17 I bought a small "probe" position in AVII @ $6.73. AVII opened about 25% down this morning. I got out right at the open @ $5.22 for a 23% loss realized on a little more than 1/30'th of my buying power. Despite this loss in AVII and moderate pullbacks in a few of my other positions over the past few days, my account is up 61% overall for 2006 (no deposits or withdrawals). I've got 10 long positions on right now, some of them I've had for about 6 months. It's nice to think that a few of my big winners are half way to being long-term capital gains. Those who are quick to take a loss, but not so quick to take a profit are probably enjoying similar performance this year.

I had a really interesting conversation with my friend Jared earlier this week. I should begin by telling you that having Jared around is like having my own "market wizard" to talk to. The other day, he said that when a stock is late in an extreme move, most of the people who are getting into it are making a poor risk/reward decision and if you own that stock it is important to get some of your shares into their hands because their buying is incorrect. While this goes against pure "trend following," I believe Jared is absolutely on the money here. My response to his statement was something like this, "Well, most people aren't going to hold for more than one leg of a move either, so there is an exploitable niche managing that risk too." Pretty obvious I'm more in the trend-following camp than Jared is even though we came from a similar background. Regardless of the differences in our outlooks, we both agree that the psychological component of trading is the most important.

Watch list for week of 5-8-06

2006-05-08T02:18:00.000-05:00

Here are the interesting bases flagged by my market homework software for the upcoming week:

PTMK (see below for more details)
ECIL
FCN
BBD
BCON
CPSS

Dave Johnson asked in the comments last week how I use these weekly lists to trade. There are some good examples of how I look to trade these emerging bases in my blog archive from July 2005. The answer is that I use this list to make discretionary trades in a specific fashion. I've been buying longs exclusively since October of 2005 (no short positions since then) due to the slight up-trend on the nasdaq that began at that time.

I pyramid into each position a little differently than is convention. I start by trying to buy as closely to support in the base as I can. Sometimes this takes a few tries to get the best price. For example, I bought PTMK on Friday when an intraday surge of volume came into it making me think it was going to have a very short-term breakout. However, it did not follow through, so I may sell the shares I purchased at $10.58 and put a limit order to re-buy them around $9.85. The price may follow through on Monday though, so I may be good to sit and do nothing. The 50 week SMA line is $10.36, the 10 day SMA is $10.42, the 50 day SMA is $10.46, and the low on Friday is $10.30. If all of that support is broken, then I will stand aside while the shares get cheaper, and as long as they stay above the recent low near $9.60 I'll try to get long. I'll add more to my position if the stock breaks out past $11.50 on volume. This means I've already got a profit when activity comes into the stock. I like to play from a position of strength and this is the best way I've found to do it.

I buy in such a way that I don't need stops. There are three reasons for this. When I make my first purchase, I buy in such a way that a close below a clear support line is my que to abandon my campaign for that stock. This recently happened to me in NDAQ, which I sat in for 4 months before realizing the loss and abandoning my long NDAQ campaign. The second reason I don't use stops is that I've only got a fraction of my position on while I'm waiting for the stock to decide whether to break up or down. An upward breakout out of a base I've bought is my signal to add to that profitable position. The third reason I don't use stops is that I have the discipline to pull the trigger to unload each and every time my campaign doesn't work out as I expect and while my losses are small and managable.

Watch list for week of 5-1-06

2006-05-01T01:41:00.000-05:00

Once again, I'm sitting on a lot of large long positions in my trading account, some of them since last October. The nasdaq sits right at the support provided by its 50 day moving average and also the lower-channel line for the most recent rally. Not much interests me in the market right now because I feel that a lot of the low hanging fruit has been picked. I'm not chasing this up move because I got in position months ago and I have patience and the discipline to hold my winners. Still, this isn't a bad spot to add to consolidating longs. I added to TASR on Friday morning, but I have a limit order to sell some at the nearby resistance.

Here's my software generated list of consolidating and possibly bottoming stocks that I'll be keeping an eye on throughout the week:

Getting Started In Chart Patterns by Thomas Bulkowski: a book review and interview with the author

2006-04-28T00:43:00.000-05:00

Getting Started In Chart Patterns by Thomas Bulkowski. A book review and interview with the author:

Pro's:

Chart pattern discussions in the book is grounded in statistical performance numbers. The chart pattern performance statistics can also be viewed in table form in the back of the book and on the companion website.

"Index of Chart and Event Patterns" near the end of the book is a very useful reference. Maybe we can petition Tom to make a wall poster out of it.

Numerous trading case studies of Tom's real trades, from entry to exit. These include excerpts from Tom's personal trading journal and round trips plotted on charts.

A chapter on "Busted Chart Patterns" that is probably new material for most seasoned chart pattern traders.

Tom identifies many potential traps and pitfalls throughout the book, and also concentrated in the chapter, "The Art of Trading". I found myself agreeing with basically everything Tom discussed in this chapter.

Chart pattern recognition software available on the companion website.

Con's:

Some sections in the middle of the book are difficult to follow because the referenced chart figures appear on the following page due to space restrictions.

Not much discussion of why chart patterns form or similarities between patterns.

No "find the pattern" quizzes for the reader in the book, but there are quizzes at the companion website.

Here's a link to the Tom's chart patterns companion website. It is also in the links on the right side of the page.

I use chart patterns for "digging in" to trending stocks, so Tom's book was a useful one for me. My biggest suprise was the chapter on "busted" chart patterns, because like any other chart pattern trader, I've been victimized by busted patterns dozens of times. This chapter is a good study of how to turn these events from losses into wins, especially if you've never been introduced to them formally.

To give you a flavor of the book, here is a quote from the chapter "The Art of Trading" (page 261) where Tom describes his trading style as an introduction to the useful guidelines that follow:

"I'm an end-of-day trader, a position trader. I don't day trade stocks but hold them for weeks, months, and sometimes years. I review the stocks that I follow, and if I don't see anything interesting, I'm done for the day. I can go weeks without trading a stock, and I usually spend about one hour each day looking for trades or updating my database. The rest of the day is free time."

Sounds familiar... It takes a lot of discipline to trade this way, but that is why the rewards are so great.

Here is a quote from the section on flags and pennants (page 154), which I think is particularly relevant for readers here:

"Patterns with throwbacks or pullbacks have postbreakout performance that suffers. For example, when a flag with an upward breakout has a throwback, prices rise 14% after the breakout. Those without throwbacks climb 26% on average."

I asked Tom if he was interested in doing an interview with me to go along with this book review, and fortunately he accepted! Thank you for the opportunity, Tom.

Jon: You have compiled a table of statistical expectations for dozens of chart patterns in the book ("Getting Started In Chart Patterns"). When trading these patterns, how big of a factor are the statistical expectations in your position sizing relative to total equity?

Tom: None. I take $15,000 and divide it by the stock’s price and then round up to the nearest 100 shares. That tells me how many shares to buy, and it places the trade in the $15k to $20k range. Nothing fancy here. I have found that I can buy enough positions such that I begin to sell stocks as I buy new ones (rotation), leaving me with a comfortable float for new positions without running out of cash.

Jon: Some of the chart patterns discussed in the book occur more frequently than others. When you find a rare gem like the high, tight flag, will you allocate a larger position size than you typically do to trade common patterns such as the symmetrical triangles?

Tom: No. I want to maintain diversity among my stock picks/portfolio so I’ll just buy the usual amount regardless of the type of pattern. Occasionally, I’ll increase my holdings in the stock, 2x, 3x, or even higher if I see value, usually averaging in at a higher price but not always. Sometimes, if I feel the market might tumble or doubt whether the trade will work as expected, I’ll trim the position size (I usually round down instead of up in the shares calculation).

Jon: Do you pyramid in or average out of your positions? If so, does it depend on the pattern, and can you describe how you prefer to do it?

Tom: Scaling in or out (pyramiding) is not pattern related. I do scale into a trade but that’s rare, and I almost never scale out (the exception being a long term holding. I scale in and out frequently, selling the most recent shares first to keep the taxman away from potential long-term capital gains). If I buy a stock on the breakout and it throws back to the breakout price and then starts moving up, I might buy another $15k. But, once I get the sell signal, I’m out. I’ve found that scaling out means I lose more money than if I just sell the whole thing at once.

Jon: When trading a familiar pattern, you have a pretty good idea going into the trade how it has performed in the past, as described in your book. In your own trading, have you found that you do better overall by going with more or less aggressive targets than the average? How about with stops?

Tom: It depends on what you mean by target. There’s a price target and there’s a chart pattern target, searching for a particular chart pattern to trade. For a price target, I just use the measure rule (the height of the chart pattern added to the breakout price) as a price target tempered with how close overhead resistance is. Resistance is a better predictor of how the trade will do than most any mechanical calculation.

For chart pattern targets, I don’t scan for a particular chart pattern. Chart patterns are just buy and sell signals. They are a starting point to an analysis of each trade. I have learned to dislike ascending triangles, for example. They tend to fail more than anyone expects despite breaking out upward 70% of the time (that’s not a guess: I measured this). Now, a busted descending triangle with a downward breakout, meaning price drops less than 10% before reversing and shooting out the top of the triangle, is better than having sex. Well, maybe not. I’ll have to test that some more and get back to you.

Stops: Setting a stop is an art. I found that you just can’t use one type of stop. In a study I did recently, I found that using a volatility stop improved 63% of my trades. Almost 2 out of every 3 trades would make more money or lose less if I just used a volatility stop. The bad news is that a volatility stop would have cut profits almost by a factor of 10. Ten! In other words, it helps, but it also can cash you out of a potential winner.

I like to hide under minor lows. If the stop is too far away, then I’ll use a volatility stop (I compute the high low range of EACH day over the prior month, average the results, and multiply by 2. Then I subtract the result from the current low price to get the stop price – that’s a volatility stop. And before you ask, I found that the high-low calculation performs better in my tests on actual trades than the average true range and standard deviation). My Patternz chart pattern recognition program (free on my website) calculates it automatically with a mouse click. Sometimes I’ll duck under a 62% retrace of the prior up move (think Fibonacci) providing it doesn’t place the stop too far away.

A trader wannabe I know puts his stops 1% or 2% below the current price and keeps being stopped out. He’s losing a fistful of money, but the brokerage firm loves him for the commissions. I tried to get him to widen his stop, but he won’t. I haven’t heard from him recently, so he may have flamed out. Moral: Learn from your mistakes.

As to aggressive stops, I’ll start out with them wide, say 10% or 15% not out of choice, but closer targets in low priced, highly volatile stocks are hard to find and you risk being stopped out quickly. As price climbs, I’ll move the stop up so my potential loss closes fast. The bad news is that when I’m wrong, it could cost me dearly. Last year, my average loss was 6.9% and my average winner was 19.5%. That’s almost 3 to 1 win/loss ratio. At one point, I had it up to 5 to 1 but lost control of one trade. That happens.

Jon: You mentioned that market trend is a considerable factor with how you place your trades, stops, and targets. Are there any trend analysis resources (books, websites, etc.) that you have found to be particularly helpful?

Tom: Let’s exclude your blog…My favorite site is finance.yahoo.com. That’s just for general info on a company, not market trends. I do my own research, well, guess really, and take it from there. I post my research findings on my website (http://mysite.verizon.net/resppzq7/). It’s a great resource for studies, chart patterns, and my Patternz program. Other than that, I don’t go search the web for that trend analysis information. Price tells almost everything you need to know, so if you look at the S&P 500 or Nasdaq trends, and trade in the direction of those trends, you should do well.

Jon: Do you find chart patterns to be more predictable of future price direction in large cap or small cap stocks? If so, is there anything noteworthy that you attribute to the difference in reliability?

Tom: My Trading Classic Chart Patterns (Wiley 2002) book explores this question for the major chart patterns. I found the obvious: in a rising market, you want to be in the small caps (less than $1 billion in market cap). In a falling market, the large caps (over $5 billion in market cap) hold up best.

For example, most people know what a double bottom is. On page 163 of the TCCP book, the table shows that for an Eve & Eve double bottom (a special type of double bottom describing wide, rounding turns for each bottom), small caps rose 39%, mid caps climbed 38%, and large caps climbed 33%.

A head-and-shoulders top, which is a bearish pattern, shows small caps dropping 22%, mid caps 21%, and large caps 19%. Large caps hold up best, small caps drop farther. The sample counts are smaller than I would like, but that’s how the trends play out, on average.

At the back of the book, page 425, I show a table of which market cap does best in a falling market. Small caps win 8 out 13 times, mid caps four times, and large caps once. That means small caps decline most in a falling market, mid caps are in second place and large caps decline least (assuming that you wanted to short a stock, so a large decline is good).

On page 416, I shows the results of upward breakouts: small caps tie (twice) or win 11 out of 13 cases, mid caps win twice and large caps tie twice. Small caps rise most, large caps barely register.

Knowing these types of statistics give you a trading edge over other traders.

As to the reliability question, you’re talking about failure rates. I define a failure as a count of how often price after a chart pattern breakout fails to rise or decline more than 5%, what I call the breakeven failure rate. And, gulp, I haven’t looked at failure rates according to market cap. I only looked at it in terms of performance. My guess is the results will be the same because the failure rate is just a measure of performance anyway (price climbs by less than 5%).

Jon: If you see a similar pattern developing at the same time on industry related stocks, does that give the pattern a higher chance of following through and reaching its target?

Tom: The honest answer is I don’t know. Certainly, when I see multiple bogies (chart patterns) flying around, I can pick and choose which ones to shoot at (trade). If many of them are bearish patterns, then I’ll want to tighten my stops of any holdings or avoid buying anything in that industry.

Jon: Is there anything you would like to say to the critics of technical analysis and chart patterns who might be on the fence about the predictive value of those techniques?

Tom: Chart patterns, like technical analysis in general, works for some people and not others. Find something that works for you and use it. When it drifts (begins to lose profitability) then tune it. You’ll have to do that from time to time. The markets are not static and your strategy shouldn’t be either.

A novice trader once emailed me and said “I made 10 triangle trades and 9 of them were profitable!” What did he do? He threw away his winning strategy and sunk his money into one stock. That stock was a gold mining scam, and he lost everything. Trading isn’t entertainment, and that’s not the type of tuning I’m talking about. Try small changes with lots of testing.

Watch list for week of 4-24-2006

2006-04-24T00:16:00.000-05:00

Here's the computer generated watch list for this upcoming week:

Most of these stocks are emerging consolidations that have a lot of maturing to do before I would even touch them. Patience is key!

If you haven't seen it yet, be sure to check out my "win Niederhoffer's book" writing contest. Also be sure to check back here later this week because I've got a very cool suprise in the works.

Victor Niederhoffer: 2, RoW: 0

2006-04-19T00:32:00.000-05:00

I've got a couple books by Victor Niederhoffer. I have a copy of his latest on my bookshelf. I haven't read it yet, but I plan to at some point this year because I admire all of his accomplishments, and most of all, how he deals with failure. He is still just a human, like the rest of us. I've read much of his older book "The Education of a Speculator" and various web articles he's authored and I can tell you that his biggest weakness is his romantic fancy for drama. But enough introduction. Have a look at this profound excerpt from Dave Goodboy's interview with Victor:
"Victor: ...I consider his (Benjamin Graham's) basic idea of value investing one of the worst big cons."

"Dave: Value investing is a con!? Why?"

"Victor: In general you get paid for taking risk in the market. The basic idea of value investing is to invest in companies that can’t lose money. If you can’t lose money there’s no profit, there’s no return, since there is an unchanging demand structure.The rate of return quickly goes down to the risk-free rate."

I don't understand people who try to run around and debunk market gospel. I've always prefered to focus completely on what does work so that I can exploit it rather than worry about identifying and catagorizing the endless strategies and techniques that don't work. I've done that with Vic's interview on Dave's site. Think long and hard about what Vic is saying here:

"In general you get paid for taking risk in the market." Brilliant! Simple. Now exploit it.

I've never done this before, so this will be sort of an experiment. I am going to have a contest on this blog, and the prize is a copy of Victor's latest book: "Practical Speculation". I'll have the book shipped directly to your house from amazon.com if you are the winner.

Contestants must submit an article to me by email: jon.tait@gmail.com. Put "risk management article" in the subject line of the email. By submitting your article, you consent that your article may be republished on this blog. The deadline for submission is June 1st. I will announce the winner some time in June and republish the winning article here on the blog at that time.

Your article should touch on these items:

Real-life examples where return is highly correlated with risk.
How can risk be calculated?
Why is return a function of taking risk?
Under what conditions this assertion breaks down (if any).
Optimizing return: minimizing risk vs. managing risk.

I don't care if you want to focus on bond holding, swing trading, day trading, no-limit poker, horse racing, monopoly, or any other games where risk is involved. I'll also accept articles that seek to debunk Victor's assertion: "In general you get paid for taking risk in the market."

Watch list for week of 4-17-2006

2006-04-17T01:22:00.000-05:00

I'm hanging on to a lot of winning long positions. Unfortunately, my market homework software scan came up pretty empty this weekend, but what it did find were interesting stocks. I may take a position in AVII early this week.

AVII
AIRT (bottoming pattern)
DCAI (bottoming pattern)
LONG (bottoming pattern)
OATS (watch for more consolidation)

In other news, my java market software project has expanded quite a bit over the last few weeks. I've brought on two local programmers, Brandon and Dan, who I've known for years to help with the development of both the open source java 1.5 API and the private automated trading systems built on top of the API. It has been very interesting so far because they are "in" on all of my private market research and are quite a bit excited about what we've covered so far. They are full of great ideas for the project, which is very refreshing for me. A few months ago I mentioned some .css problems in the Firefox browser with the site I am developing for the open source java API, and Dan was nice enough to point out the fixes for me, so look forward to a debut of a "fickle trader" companion site in the near future. I'll post here when it happens.

Here's a snapshot I took this weekend of the "fickle trader" office:

Watch list for week of 4-10-2006

2006-04-10T02:51:00.000-05:00

The trend on the nasdaq is still very much up. There have been dozens of headlines over the last month, including today, calling the rally into question or even going so far as to proclaim it dead. Being leveraged long, this is music to my trend following ears. Here's the highlights from my market homework software this weekend:

Many of these stocks are bottoming patterns! Cross check each symbol's weekly chart to get a feel for the big picture.

Watch list for week of 4-3-2006

2006-04-03T01:12:00.000-05:00

My market homework software scan this weekend was very sparse, which means that there are not many bases and consolidations left after the nasdaq moved into new multi-year highs this week. For me, this is a time to sit on existing positions rather than chase stocks that are already on the move. Here is the list of the best looking bases and consolidations from my scan this week, but they are laggards by definition. I still find it beneficial to watch their behavior.

If you haven't been following along last week, then take a glance through my watch list. Many of those stocks are up huge since I posted them one week ago. These are good times for the market.

Watch list for week of 3-27-06

2006-03-27T01:35:00.000-06:00

Still a lot of strong bases as the nasdaq tests the top of its 2006 range. Check 'em out:

LONG
TAYD
BLUD
FCN
AUY
BCRX
BIDU
CVCO
ENG
SWSI
TGE
TOMO
TRE (I have a long position in TRE)
VRTX

Thanks to those who have sent me charts recently in email and in the comments of this blog, they have been high quality. I'm still long a ton of stock, and doing quite well for the year (about 30% gain for 2006 right now). I'd write more tonite, but I'm beat from working on financial market software development earlier today with my sister's boyfriend Brandon.

Watch list for week of 3-20-06

2006-03-20T00:44:00.000-06:00

There are still quite a few good looking bases and consolidations out there. The nasdaq still hasn't really broken out to new highs since January, but it looks like it could happen any day now. I'm encouraged by all the bearish headlines on yahoo finance that are calling this rally a false one. I've been long stocks for months and don't see any reason to change that. Consolidations between rallies and walls of worry for climbing are bull items in my book.

I bought GIGM and TRE last Monday, and added to the GIGM position on Friday afternoon as it traded through an upper channel line on good volume.

Here are the results of my market homework software this weekend:

Frank, nice call on $COPPER last week.

Mike from StockMonster, I like your stock coverage as well. It seems like our styles are similar. It is always a pleasure to stop in at your blog.

Watch list for week of 3-13-06

2006-03-13T01:58:00.000-06:00

Here's the usual weekend update. This weekend I saw the strongest list of bases that I've seen since December 2005:

My favorite two bases are that nice consolidation on TRE, and the high-tight flag on GIGM's weekly chart. I'll probably be buying these two stocks next week.

For anybody who might be wondering, last week I sold the RURL that I bought due to a break of support. The stock may recover and move higher over the next few months, but I'd rather be in stocks that are being supported at technical price levels.

I spent most of this weekend re-writing my "OhlcTools" java market software project using java 1.5 and junit under the new name "Market Objects". I spent some time last week looking through sourceforge at the open source java projects for modelling financial markets and all of them were either not targetted as an object oriented framework for modelling financial markets, or weren't mature enough for me to want to use.

The new features of java 1.5 solve a lot of the design issues that "OhlcTools" had with object oriented modeling of market data. Here are some examples:

Enumerated data type for "trade direction", giving each direction "long" and "short" explicit and meaningful values. Also, no other value can be assigned to the "trade direction" variable, as enforced by java 1.5. In java 1.4 I had to use a boolean value "true" for long and "false" for short to keep it simple, but it was semantically ugly.
Lists of OHLC bar data are now strongly typed, so you can no longer stick any arbitrary object into the middle of an OHLC bar series thanks to java 1.5's generics support.

There are a lot of other changes for the better but I won't be going into all of them here. Due to this strategic re-write decision, I have to scrap the tutorial that I spent hours snapping pictures and cropping onto a webpage, but it is for the better. When the "Market Objects" is mature enough, I'll make a new tutorial including an introduction to the Eclipse IDE. It won't be for a while though because I've got to rebuild all my existing tools using the new object oriented framework. I'm very excited about how scalable the project will be due to the extensive unit tests that I've written this time around. I won't have to worry about breaking anything when I want to make a small change, add a new feature, or fix a bug, and other developers will have an easier decision to invest their time into the project because they will be able to verify that the code works according to specification by running the tests and adding some of their own if they choose.

For the past couple of months I have put off re-doing the .css file for the website I'm developing to go along with the open source project "Market Objects", various articles, and other software projects I'm developing. The good news is that the .css works with Internet Explorer, the bad news is that it doesn't work with Firefox. If any web design gurus are interested in contributing to the site by either redo'ing the .css that I've got so that it will also work with firefox, or creating a new .css from scratch, please send me an email.

Fickle trading

2006-03-05T23:33:00.000-06:00

"I’d say the biggest mistake I see from the average reader is that people seem to think a long-term trading approach can fit on top of an itchy day trader’s finger. That takes discipline to learn. And that, for some people, takes a lifetime." -- Bill Cara link

One of the most puzzling paradoxes of trading is that you have to show up every day, but most days your best move is to do nothing.

I don't day trade, but I do look at a lot of time horizons, sometimes as short as 1 minute bars. But I've learned to focus my attention on shorter time horizons only when longer time horizons are at a critical juncture. My trading life became much simpler when just owning a stock was no longer a reason to look at a shorter time horizon than daily bars. I don't even load up the quote streamer until I've made the decision to buy or sell a stock that day based on daily and weekly charts.

It can be more optimal to trade extremely short time horizons, but the benefits of trading very short term don't scale linearly due to transaction costs becoming more difficult to beat. For me, it is important to not have to grind for every dollar. I don't want a full time job from the markets, but I do want to make high returns on my money, so I consistently reform my trading to be in line with these goals.

I start off every campaign in a stock very fickle, weak handed. As a position works for me and I pyramid into a larger position, I become a strong hand; I'm dug in. This blog is titled "fickle trader", which at first seems like it would clash with Bill's statement above, but I'd like to think that I've struck a balance and found the discipline to make it work.

Watch list for week of 3-6-06

2006-03-05T22:59:00.000-06:00

This past Friday wasn't such a good day for the nasdaq, I would have liked to see a more positive close on such big volume. However, the big picture is what counts. I've been aggressively long for months now and I haven't seen any reason in the charts to change that yet.

Here are the most interesting consolidating stocks that my market homework software identified this weekend:

My 2005 SBUX bear campaign revisited

2006-03-05T20:43:00.000-06:00

My SBUX bear campaign ended in October 2005 when the price closed above the downward sloping upper-channel line on its weekly chart. I won't be shorting it again until it makes a long term lower high the way it did in early 2005.

Unfortunately I can't tell you anything about the fundamentals of SBUX that you don't already know.

Quote: Bill Cara on cornering the market

2006-03-02T01:08:00.000-06:00

"You know what happens when a small group of people try to take control of the capital market, don’t you? A large group of people hand them all the stock they want." -- Bill Cara

http://www.billcara.com/archives/2006/03/huge_day_for_te.html

I couldn't resist taking a snapshot of this one for the record :D

Watch list for week of 2-27-06

2006-02-26T23:44:00.000-06:00

Highlights from my market homework software this weekend:

RURL (I'm long RURL)
SWSI
NGPS
STEM
CRUS
UPCS
AOB
EBIX (very thinly traded)
FUEL
GEPT
NFLX
REGN
TFSM

Not a whole lot has changed during the past week maybe in part to it being a 4 day trading week, but I should say that I am encouraged by the nice "bull flag" type of consolidation we are seeing on the nasdaq composite daily chart. I am carrying a lot of stocks long right now in anticipation of a market breakout to new highs. As always, I don't know what will happen but I'm always positioning my equity to be on the right side of the market trend on the daily and weekly charts. Right now, that is up.

RURL triple cup base

2006-02-22T00:26:00.000-06:00

RURL triple cup base

Watch list for week of 2-20-06

2006-02-20T00:24:00.000-06:00

Here are the highlights of my market homework software this weekend:

RURL

SWSI

GRMN

DESC

IPII

VPHM

BCON

EBIX

GEPT

NFLX

REGN

USEY

Some of those stocks are near new highs, but most of them look like they might be trend reversals where the stock has been below its 50 day SMA for a long time and has recently been able to hold its ground above it. The most interesting chart in my opinion is the first one, RURL. RURL is consolidating near multi-year highs, and is towards the end of a triple cup base on its daily chart. I don't know if RURL will break out or not, but it is one of my favorite chart patterns to trade because support and resistance in the pattern are so obvious.

Watch list for week of 2-13-06

2006-02-13T00:01:00.000-06:00

The list from my market homework software this weekend is quite small again. With all the stocks that have pulled back lately, you'd think there would be more attractive bases and consolidations than there are. For any new readers, let me explain that my market homework software has been written to identify stocks that are near technical price support and shouldn't fall much from their current levels if they are healthy enough for me to be interested in owning. Because it doesn't take much of a drop in price to tell me whether the stock is good or not, it presents a low risk buying opportunity for me. However, usually I just watch the stocks that I list here without buying them, so just because I list a stock doesn't mean that I recommend buying or selling it. So here's this week's list:

EBIX (very thinly traded)

TRAD

TSCM

VPHM (dicey on the weekly chart)

Gorden Gekko at the Knight Trader sent along a handful of stocks that he's watching right now, and the most interesting one I saw was ABP.

On another front, it has been very interesting to read the systems development blog posts over at The Taylor Tree and Dayve Johnson's blog. If you haven't seen these yet, head on over.

Watch list for week of 2-6-06

2006-02-06T00:02:00.000-06:00

There's nothing from my market homework software this weekend that I'm too excited about. Here's the list:

GRMN

AIRT

DCAI

CRXL

ECIL

PWEI

Some of these stocks look to me like they may be putting in bottoms, and others are nicely consolidating in such a way that leads me to believe that higher prices are ahead. The quantity of stocks is noticably smaller this weekend, and it may have something to do with fewer stocks hitting new highs. There is a chart several people have posted to their trading blogs over the past week or two and I'll post a link to it too because it is worth looking at:

$NASI weekly chart

$NASI is a breadth indicator, and is currently near the top of a contracting range. I don't know if it will keep going higher or not, but if it starts to turn down, it will be because the market is getting hit with broad selling. I'll also be closely watching GOOG, AAPL, and SNDK to help guage market strength. I may ease back on the margin if these leading stocks start to really fall apart. I have a big position in NTRI, which is a very strong stock that has also seen a lot of significant selling lately, but fortunately is still holding at the "50 day moving average" support.

The quick 'n dirty on INCX.

2006-02-01T08:58:00.000-06:00

Sorry for the delay. I forgot about posting this yesterday.

Reviewing my 2005 trading mistakes: TRE

2006-01-31T22:28:00.000-06:00

This chart shows what I consider to be one of my biggest mistakes in 2005. I didn't lose much money on the trade because my position was very small like how I always start, and I cut my loss around 10%, but the reason it sticks out so well in my mind is because I made two mistakes instead of one. If I hadn't made either one of these mistakes, I would have made a very large profit from this stock.

The first mistake was buying wrong. I usually don't buy at the top of a handle like I did here, I buy at the bottom of the handle. In this case, I bought TRE at $2.95 expecting a "gap up" breakout the following day. When it didn't happen the next morning, I should have exited the trade and waited on the sidelines because the range of the handle was already greater than my pre-defined "max pain" stop of 10%. So I didn't make a mistake in selling for a 10% loss when the stock travelled back down towards the bottom of its range, the mistake came from buying hope and paying too much for it.

The second mistake came later on the day that I sold. After my sell, the stock quickly reversed and headed higher, breaking out of the handle by the time the close came around. It wasn't a clean breakout though because it had already had a false breakout earlier so I didn't buy the position back. Over the next few days, my original thesis for the stock proved to be correct as TRE headed higher. My mistake now was not buying back the stock after it proved me correct. I've made that mistake many times, so I'm going to work hard on correcting this "scared" behavior.

Watch list for week of 1-30-06

2006-01-29T22:43:00.000-06:00

Here are the highlights from my market homework software:

INCX

CRXL

ECIL

NUVA (I'm long NUVA)

PTMK

PWEI

UPCS

CNET

CPST

EBIX

I want to give a special thanks to Gorden Gekko at The Knight Trader for contributing to my survey of the most recent market rally. I try to keep the most relevant and tradable stocks on the radar of my market homework software, and Gekko's stock coverage when the market is rallying is perfect for it.

I've got a monster headache so I need to go to bed. To keep this short, instead of posting my usual Sunday night market commentary, check out a summary of the markets last week from my mentor over at the Market Stock Watch blog. I mentioned a few weeks ago that this is the best kind of market environment for our trading styles. Well, since January 1st 2006 my account is up 33%, mostly from building long positions in the stocks that I've posted about on this blog and riding the uptrend despite all the doom and gloom. January has been a great month for me, and I hope it comes across on the blog.

Interesting quote over at Michael Covel's blog

2006-01-26T23:15:00.000-06:00

Michael Covel had a great quote a few days ago in a blog post:

"I did find one thing that worked. In fact almost all technical analysis can be reduced to this one thing, though most people don't realize it: the distributions of returns are not normal; they are skewed and have "fat tails." In other words, markets do produce profitable trends."

This is a very powerful realization. In Jack Schwager's "Market Wizards" book series, quite a few of the trader's who were interviewed spoke about using option pricing models with fat tailed price distributions. In essence, these early options traders were betting on trends before the crowd knew how to price them in to the options.

However, I disagree with another assertion that was made in the same quotation:

"I was very, very skeptical that technical analysis had value. So I used the computers to check it out and what I learned was that there was, in fact, no useful reality there. Statistically and mathematically all these tools - stochastics, RSI chart patterns, Elliot Wave, and so on-just don't work. If you code any of these rigorously into a computer and test them they produce no statistical basis for making money; they're just wishful thinking."

I think "straw-man" statements like this one contain a lot of misdirection for traders and investors. Of course no single indicator is going to have any consistent predictive value, it is only by combining technical indicators that you can get a significant statistical edge. So maybe that guy did try every indicator. So what? Did he try combining them? There are many fundamental reasons why various indicators have value, consider this post I recently made regarding simple moving averages.

The market is a deterministic system. Price movement is simply caused by market and limit orders. There is a natural structure that emerges from those market and limit orders, and an understanding of that structure provides an edge to the aware trader. There are two ways to identify an edge. You can do it with an exhaustive "trial and error" search, or you can identify conditions that cause the edge to emerge and validate by testing.

Millions of Stelco shares traded after judge strikes shares worthless

2006-01-24T23:37:00.000-06:00

I wanted to do what I can to bring attention to this Stelco issue, so please read this post at Bill Cara's blog about 40 million shares of Stelco traded today after the judge struck the shares worthless earlier this week. Cara explains this seemingly idiotic behavior as short covering, and a tactic to evade the unwanted scrutiny that would come with filing special tax paperwork. I'm no accountant, but it is easy to see that short positions held all the way down to zero are special circumstances that need to be reported differently.

So why wouldn't the shorts just hire accountants to take care of the extra paperwork and let the shares become worthless to realize the full potential of their short positions? One likely explanation is that many of the parties with large short positions are masking illegitimate manipulations of the company and its stock, explains Cara.

It will be interesting to see how this situation resolves. If there is no accountability and different laws for corporate hijackers, the markets become an even more unfriendly game than they already are. I'm not a sympathetic or charitable person, but I do believe that shareholders shouldn't have to fear the rug getting pulled out from under their feet by lawyers and charading courts.

I don't practice value investing for the most part, but cases like this Stelco one dramatically increase the risk premium that value investors must demand in order to put their capital at risk. The financial markets are an echosystem, so damage to this foundational investor group is damage done indirectly to me. I advise traders and investors to look more deeply into what has transpired in Canada, and more specifically, at Stelco, and discuss the implications openly. It is in our best interest.

Watch list for week of 1-23-06

2006-01-23T01:05:00.000-06:00

Here are the highlights from my market homework software this weekend:

CAAS

DCAI

INCX

AQNT

ASPM

ASPN

CVO (I'm long CVO)

DGIN

IVIX

LIFC

MNTA

NUVA (I'm long NUVA)

PTMK

PWEI

RURL

SPTN

CNET

CPST

IVIL

VCLK

It is quite a large list tonite. I didn't want to trim it down any further because I use the list as an indicator of market health. How these stocks behave at technically important turning points tells me how I should position my equity. I'm primarily interested in seeing how aggressively traders and investors come in and support these stocks with buy orders.

Interesting links and some market commentary

2006-01-19T22:06:00.000-06:00

Some stuff I've been reading lately:

LINK
Michael Taylor, a fellow systems trader shares some hard earned knowledge about creating a system's exit strategy. Whether you are a discretionary trader, a systems trader, or both, Michael's post is an informative read about an absolutely crucial subject.

LINK
The new URL for my mentor's market blog. We have just entered into the most favorable kind of environment for both of our trading styles, and he has increased his posting frequency accordingly. One basic criteria we use for identifying a bull market to ride trends in is daily new 52 week highs consistently greater than 500.

LINK
"Charter 2", free charting software from technicator.net. This is the sequel to Frank's "Taxi" software, and contains many great new features including several watch list capabilities.

LINK
Jim, from my hometown Columbia, shares his watch list this week.

LINK
Ugly posts about speculations that GOOGLE may play a role in the singularity. The singularity is an ongoing interest for me, and its pursuit is one of the motivations behind my trading campaigns. The singularity means many things to many people. For me, its realization is the ultimate milestone of progress.

LINK
Brett Steenbarger's ongoing historical market research blog. There are tons of ideas for building a trading edge to be found on his blog.

LINK
More good trend following philosophy at the Trenders blog.

LINK
TraderMike's daily market recap. This is the link to today's.

LINK
Daily dope and coverage of explosive stocks from The Knight Trader

LINK
Blog by a trader who has a trading style shockingly similar to my own. The charts he posts are all near low-risk buy zones, which is where I prefer to begin my buying. It doesn't usually cost you very much to find out if you are right to be long or not when you start buying this way.

LINK
Ron Sen's daily market analysis and helpful commentary.

LINK
My girlfriend's latest adventures at Mizzou's vet school.

There is tons of other great stuff being published on the web every day by the maintainers of the blogs from my blog roll. I use Bloglines to easily monitor them for new content, and to maintain the blogroll you see on the right of this window. If you're not hip to bloglines or any of the other newsreaders yet, check it out.

And of course I'm still having a good laugh at all the non-trend-following traders who are starting to sound desperate under the mounting pressure of performance anxiety. Lots of people in cash positions are saying to themselves:

Surely we will pull back, won't we?

Maybe this is just exuberance?

Can't find anything to buy. (do they not visit this blog?)

Things are too high, maybe instead of buying we should start shorting...

Well it looked too high before, but now it's even higher! It can't come down, so we may as well buy!

No way! We bought the top! Now is when we should have shorted!

Repeat cycle

It is easy to get stuck in this destructive psychological pattern. I think trending environments are harder for most traders to deal with than choppy ones. Thought patterns like the one above only get worse as the market carries higher because, after missing the first boat, the perceived risk/reward of each successive boat is progressively worse. Flat markets give non-trend-followers plenty of opportunities to grab quick profits and take second-chance entries, but trending markets are a lot less forgiving in that regard. The beauty of it all is that money can be made in both environments, no one approach works all the time. Remember your edge, and stick to it!

REDF: watch list item gone sour

2006-01-18T23:07:00.000-06:00

REDF was featured on my watch list for this week so I thought I'd use it as an example of something I would not buy after seeing what it did on Tuesday and Wednesday. If I did own it and hadn't sold yet, I would get out ASAP.

The problem with REDF right now is that, from a trader's perspective, it will be getting cheaper before it gets more expensive, meaning that shares sold now can probably be bought back for less in the near future. Aggressive traders don't bat an eye about taking trades like that. I should point out that REDF is already past the optimal sell point, which was on the first day that the price closed below the lower-channel line (drawn in purple) on large volume. This happened the day before today. Late in the day, if you're looking at intra-day charts, it becomes pretty obvious that a close above the line isn't going to happen and the stock should be sold.

So what do I look for from here? I will watch for the stock to carve an upper-channel line that slopes downward across price peaks. When I see an impending close above that line, then my outlook will become: the stock will get more expensive before it gets cheaper. That is a trader's buy signal.

I probably won't trade this stock because there are too many other interesting fish in the sea, but it makes a nice example.

Watch list for week of 1-17-06

2006-01-17T00:59:00.000-06:00

Another good list from my market homework software this week. It makes me think that there is still fuel to propel the indices higher, but remember that these stocks are lagging the market in the January rally:

NDAQ

NUVA

PTMK

SYNX

CBIZ

CBST

CNET

CVCO

FUEL

IVIL

REDF

A couple of stocks that came up in my market homework software this weekend look similar to the way TASR did when I posted about it back in late December. These stocks may be putting in bottoms:

TZOO

INCX

Less Talked About Properties Of Simple Moving Averages

2006-01-14T20:33:00.000-06:00

Institutions who are buying a stock don't put their entire position on in one day. They buy over time, therefore their cost basis isn't a quoted price, it is the average cost of all their buys. While any given institution won't buy the same ammount every day, I think an assumption we can make is that in aggregate all the institutional buying is at prices close to the average. From this assumption it follows that the institutions who have been buying a stock for the last 50 days will in aggregate have a cost basis close to the 50 day simple moving average.

An important implication of this conclusion is that we've identified a reason why moving averages will often act as support for a rising stock. If an institution has been buying a rising stock for 50 days and has a cost basis near in price to the 50 day simple moving average, buying at any price under the 50 day simple moving average will lower the firm's cost basis. Buyer firms will compete with each other for shares below their current cost basis, often rapidly driving prices higher.

Another factor to consider is that firms who have been purchasing a rising stock for less than 50 days will most likely have a higher cost basis and are likely settle for higher prices that still reduce their own cost basis, thus providing additional buying competition. The reason newer buyers probably have a higher cost basis is that the shorter the moving average interval, the higher it will typically be for a rising stock.

There are obviously many other forces at work on the price. Chief among these in my opinion is whether or not the price will get cheaper before it gets more expensive from a trader's perspective on various timeframes, but that is a subject for another post.

Watch list for week of 1-9-06

2006-01-08T23:08:00.000-06:00

I was suprised that my market homework software identified so many basing stocks this weekend because the market moved up so much last week. This leads me to two mutually exclusive conclusions: these laggards will break out and carry the market even higher as buyers chase this market up, OR the market isn't as strong as I believe and these laggards will lead a market decline. Either way, if a stock hasn't broken out yet, it probably won't until earnings or some other news event. With that in mind, here are the highlights from my market homework software this weekend:

NGPS

NTRI (I'm long NTRI)

PACT

TZOO

ASPM

NUVA (I'm long NUVA)

PTMK

RURL

BCON

CCI (I'm long CCI)

CPST

EBIX (Caution: very thinly traded)

FINB

SWSI

ROFL

2006-01-06T15:17:00.000-06:00

LOL at all the traders trickling back in from their expensive vacations. My account is up 17% this week. Thanks so much!

Audacity

2006-01-05T00:57:00.000-06:00

About 3 or 4 years ago, I played basketball pickup games on a regular basis at the mizzou rec center with several friends. One day I will never forget, I was shooting horse with Will and John when all the courts were full at that time. We were finishing it up, and many people were waiting for a court to open up when I recognized a person from the night life named Terry. I knew the guy was an ass and I didn't want to speak with him, but it was too late, he and his friend were already walking over to our court. They stopped on the sidelines where we had set down our stuff to play, and Terry came out onto the court. We said our hello's and Terry jumped up and grabbed the rim of the basketball hoop. He looked over at my friend Will, who was the tallest out of us, and asked if he could do that. Terry jumped up and did it again a few more times to illustrate, and we all stared up at him while he interrupted our game. Will tried it once and couldn't get to the rim, then we started shooting the ball again. Terry exchanged glances with his friend and they walked off.

About ten minutes later, we grabbed our stuff and got ready to leave when John noticed his wallet was missing. I think he had something less than $100 of cash in there and some credit cards. I don't know if they were trying to get my wallet or not, but I got lucky because I didn't bring mine. John called and cancelled the credit cards immediately, but there was nothing to do about the lost cash. I never saw Terry again, and years later I'm contemplating the significance of that event in my life. I got a first-hand lesson that people are audacious enough to take from you right under your nose.

The reason this story is in my mind is that over the past couple of weeks I learned something so radical about trading markets that my mind is blown. I feel like I did on that basketball court at mizzou because people are clearly using strategies based around the techique I have just conceived, but I have never read anything that describes it in detail anywhere. Could it be so simple and obvious that I'm an idiot for taking so long to recognize it? I don't think so. It seems more likely that techniques like this one are kept hush-hush by those who discover and use them, like some sort of class warfare among market participants.

Watch list for week of 1-3-06

2006-01-03T00:55:00.000-06:00

Lots of big name stocks made appearances this weekend on my market homework software. Here are the highlights, my watch list for this week:

NTRI (Big winner from 2005, I own shares currently)

TASR(Big winner from 2003, I own shares currently)

TZOO (Big winner from 2004)

NGPS

AQNT

ASPM

CWTR

RURL

SPIR

CCI (I own shares currently)

CNET

NFLX

REDF

I am very skeptical about the quality of many of these "pullback" chart setups. I get the feeling that many of them will get cheaper before they get more expensive. We'll know more at the end of this week, but if the nasdaq composite isn't higher, I wouldn't expect many of these stocks to be either.

Watch list for week of 12-27-05

2005-12-27T01:29:00.000-06:00

The list of highlights from my market homework software is big this weekend. This tells me that stocks in general have been consolidating for weeks now. Makes sense when you look at the chart of the nasdaq. A few of these stocks are already starting to turn up, which is a positive sign if you're leveraged long like I am.

I always love seeing a stock that I've been particularly interested in to pop up in this report, like DPZ this week. Here's the list:

CCI, I'm long CCI currently.

NGPS

AQNT

ASPM

DGIN

KYPH

PTMK

RURL

SYNX

CPST

SWSI

TASR(E) possible trend reversal?

2005-12-22T00:48:00.000-06:00

$COMPQ late 2002, early 2003 market bottom

TASRE possible bottom

"Divergences between weekly MACD-Histogram and prices are the strongest signals in technical analysis... ALLY had managed to put in a bullish divergence of MACD-Histogram, a hugely powerful signal that is rarely seen on weekly charts." -- Dr. Alexander Elder, Come Into My Trading Room, Pages 132, 133

When I saw TASRE's chart this weekend, Dr. Elder's passage came to mind, and so did the bottoming pattern on the nasdaq's weekly chart in late 2002 and early 2003. Because of the multiple converging buy signals I put on a long position yesterday, and today it is up nicely. I wouldn't bother to post this, except for two reasons. I want to document this position for myself so I can easily refer to this possible bottom in TASRE when I want to see whether it worked out or not. The other reason is that if this really is a trend change, today's 10% gain will be a drop in the bucket. I wonder if TASR will have an echo boom similar to the nasdaq's 2003 rally?

Here's a recap of my reasons for buying TASRE:

I couldn't believe it when TASR became TASRE earlier this year. How the mighty had fallen, I couldn't believe it! But the reality is that TASRE helps insiders and financiers to accumulate shares cheaply. When the "E" dissapears off the end of the symbol, you can bet that the insiders will already have increased their stake and are ready to run it up. TASRE is a buy signal for me.

MACD-Histogram / price divergence on weekly chart.

TASRE made a higher low on the weekly chart and may soon make a higher high.

The price has already begun turning up from its higher low on the weekly chart.

There is visible accumulation on the daily chart over the past 3 months.

The nasdaq trending up on many timeframes, and at new 52 week highs.

There is a nice "wall of worry" to provide the uncertainty that fuels an uptrend.

Watch list for week of 12-19-05

2005-12-19T00:08:00.000-06:00

Here are the highlights from my market homework software this weekend. These are spotty setups in my opinion and I probably won't be acting on any of them, but it will be interesting to watch how they act at these key turning points:

PRGS

SWSI if it was strong it wouldn't be pulling back already...

NFLX, and Thomas Weisel just downgraded...

CCI (I've been long CCI for weeks)

MMUS first consolidation after a ridiculous breakout

Kirk Report on improving watch list research

2005-12-15T23:30:00.000-06:00

The Kirk Report had a great article today about reviewing the biggest winning stocks each year to see where you could improve your methods for identifying and making money from them. This is something that I have also been doing more than usual lately. The description I made for this blog when I started it over a year ago is about that exact subject: "Talk about stocks that are in play, and strategies for taking $$$ out of them." I've thought about changing this description many times, but I always change my mind because this blog chronicles my quest to make audacious returns from the best stocks the market has to offer.

After reading Kirk's post, I did some personal assessment. NTRI was the best performing stock of the year according to Kirk's scan. Well, I bought it on April 7'th, and you can read about how I played it here. It is kind of embarrassing to read this post now. The first stock I bought long this year was the biggest winning stock in the market! I knew it would be very good, but I did not expect it to be the next TASR. After buying near $6 and selling for a quick gain near $12.50, I bought NTRI again months later at a much higher price when it broke out from $32, but this time I'm not selling it so easy. The reason? I've looked back on charts like AAPL, GOOG, NTRI, CERN, SNDK, and the dozens of other stocks that have been in great uptrends this year. Finding the best stocks is easy for me, but making LOTS of money from the trend is so much more difficult for a lot of complicated reasons.

My reflections lately have really hammered home the idea that betting on the resillience of uptrending stocks pays so much more than betting on rare crashes and trying to outperform even these wild uptrends by trading in and out of them. This idea by itself was not enough though, it wasn't until I visualized the expansion and resulting volatility of my trading account with positions that had tripled and quadrupled while I pyramid into them with margin that I was ready to advance from a swing trader to a trend follower with a much longer time horizon and insensitivity to the day-to-day fluctuations.

Earlier this year I read Brad Koteshwar's book The Perfect Stock. Among other things, the book talks about a disciplined trend follower's trades in TASR. I highly recommend this book to anybody interested in trend following. It is another one of the great trend following fables like I talked about a couple weeks ago.

Cup & handle on TWX weekly chart

2005-12-14T00:53:00.000-06:00

TWX weekly 12-14-05

I like to put on a probe position near the low of the handle when a stock makes a well defined cup and handle chart pattern like what we're seeing here on TWX's weekly chart. I've done that with TWX today. I'll add to my position if it breaks out above its upper-channel line, the one I've drawn across the top of the recent price peaks. If it breaks out, and as long as everything still looks good, there will be one last chance to add to my initial position when TWX pulls back to a 10 or 20 day simple moving average. I usually don't use all three of these buy points, but they work well as checkpoints for monitoring the stock's progress.

To review, the three buy points I use for putting on an initial position are:

1) Buying near the low in a handle or consolidation. I use intra-day charts to get the best price I can. I tend to buy slightly after the actual low.

2) Buying an upper-channel line break that appears on daily and weekly charts. I usually make these buys towards close of the day or week, but if it gaps across the line then I'll buy at the open.

3) Buying the first pullback to the 10 or 20 day simple moving average. This is my least favorite of the three, but it is important for getting aboard powerful market moves when I'm late to the party.

"So how 'bout those Pet Shop Boys?" -- Dave M.

Watch list for week of 12-12-05

2005-12-12T00:17:00.000-06:00

The naz has broken out of its range on its weekly chart. Could this be a trap to suck in the last buyers? I don't bet that way. I'm long for the uptrend. I love how the market has a huge "wall of worry" to climb right now. The higher we climb, the louder people will scream too :D

Last Friday I initiated a position in a stock that my homework software has been alerting me to for a while, NUVA. You will see it mentioned a few times in this blog's archives over the past month. The weekly close above its upper-channel resistance line is a buy signal for me. The trade is virtually identical to one I put on a little over a month ago in LKQX. I'm still carrying the LKQX position. I hope it is obvious after looking at both of those charts why I put the trades on. Of course I'm carrying other positions too. I started buying stuff in October just like everybody else, the difference is that lately I'm net long instead of net short like I was in October.

Here are the highlights from my market homework software this weekend:

FOXH

OPWV

EFJI

Here is a tangent for anybody who is bored or otherwise interested. I have found the most amazing radio station ever to have been conceived: RADIO NIGEL! The best part is that it is a streaming internet radio station, so it is free and available to everybody. The link for listening in can be found on the top-left corner of their page. It used to be that I just watched cartoon network all night (at my computer of course), but now I do cartoon network AND radio nigel at the same time!

A fiery quote from Bill Cara

2005-12-10T02:08:00.000-06:00

I thought this fiery quote from Bill Cara's coverage of the latest on Stelco captures the spirit that I approach the markets with:

So, by telling you about Stelco, I am telling you about the dishonesty that is widespread in capital markets, where the participants are politicians, judges, lawyers and accountants, management and Directors, and securities commissions, all wrapped up in self-serving affairs that do not lead to fairness in capital markets. You accept it and move on.

But you get even. You make 5 pct here, 5 pct there. When you sell, you make sure you leave the promoters holding the bag. Stocks are not your children; they are merely prices that you trade for gain. Your gains become your wealth. You are not an investor -- unless you happen to be Warren Buffett and others who get involved in the Boardrooms and the courtrooms -- you are a trader. Be proud of that. Go make money.

I doubt even the great Oliver Stone could improve that prose.

Chris "Piranha" on trading, and me on trend following fables

2005-12-06T23:10:00.000-06:00

One of my trading mentors, Chris at marketstockwatch.com has addressed an important question for traders: whether it is better to ride long trends or short ones? Here is a link to his discussion.

Chris has experimented for years with both short term trading and long term trading and describes his preference, "I am looking for the big, long term moves, not the short quick gains. The big moves make you rich, not the quick little gains; they make you impatient and hesitant. Patience is the key to success if you want to make the big bucks on Wall Street." This position is familiar to people who have read my all-time favorite book, Reminiscences of a Stock Operator.

Unfortunately, long-term trend following is one of those things that is much easier to say than to do, as anybody who has tried can attest. I love all the long-term trend following fables that great traders tell each other for strength. Reminiscences of a Stock Operator has plenty of them in it, one of the more memorable ones is about "old man Partridge". The entire book itself is even a trend following fable! The trenders blog linked on my blogroll had a great one a couple weeks ago, this zen story has popped into my head countless times since I read it. Ed Seykota tells a memorable one about a jademaster and student in his book The Trader's Window. Jack Schwager liked it enough to include it as a prologue to his The New Market Wizards book. Michael Covel, author of Trend Following covers all kinds of great trend following fables, which leads me to one of my own. People who know me are going to laugh at this one if I haven't already told them!

When I first opened a forex account I tried to trade the same patterns on the EUR/USD that I do in stocks. I don't do that anymore, and when I first realized it wasn't going to work, I noticed something else. I saw that when the price deviated much from its average, there was a very high percentage chance that it would revisit its average price again, and even swing past it on momentum. In fact, it would revisit almost ANY price! So I put on a small position, and when it went against me, I averaged down into it. When it kept going, I averaged down again. As the price revisited each level where I had added to it, I took some of my position back off, so that when it reached my original entry, I had the original position, only I had slightly reduced my cost basis. A little bit more movement in my direction would cause me to close the trade at a respectable profit. I would never have dared to trade stocks this way, and I knew what I was doing was wrong, but I did it anyway.

Well a couple days later, the inevitable happened, the trade didn't come back my way and my loss was snowballing. I happened to be doing some reading while I was babysitting my currency position because it was getting very late but I was stuck at the computer to finish this trade. Maybe you can guess what I was reading. I thought, "I wonder what Victor Neiderhoffer would do? He was in a jam like this in the beginning of his book The Education of a Speculator." Now, mean reversion works for some people, but when they blow their tops, it is spectacular. Victor's demise being an example discussed in Michael Covel's book. So I'm reading Victor's yen trading story while I've got this loss is snowballing out of control and I had a moment of clarity. Averaging down like I was doing is destructive behavior. John Maynard Keynes may as well have been standing right beside me with a chalk board chanting, "Markets Can Remain Irrational Longer Than You Can Remain Solvent. Write it one hundred times and think about what you've done." I was lucky to be trading small enough when that happened that my large loss in currency was smaller than an average loss in stocks for me at that time.

I guess mine wasn't much of a fable, more of a trading sin confession, but the lesson is relevant. And I wanted to be in bed an hour ago so I'm through here for now :D

P.S. I respect Victor as a trader, and I mean no disrespect with this post. Vic, you're a legend and I like your books!

60 degrees eh?

2005-12-06T19:08:00.000-06:00

I just read an article on exit strategy from TradingMarkets.com that was linked from the yahoo finance front page. The author has a nice quote at the beginning: "Let your SLOW MOVING winners ride, and cut your TOO FAST winners and all of your losers short." Ok, I'm with you. Sounds agreeable to me. So what's this exit strategy I came here to see? Here we go:

"When a stock is moving in your direction, "let it ride" if the angle of the trend is a 60 degree slope or lower, and exit into the sharp wave on big, sharp movements in your direction that look closer to 90 degree angles."

Wow, what a completely useless strategy. Did you know that the angle you see on your chart is completely dependent on the timeframe, how many bars you are viewing, and whatever cosmetic settings your chart software is using at that time? I knew this, but I'm sure there are plenty of people who didn't know any better and might actually try this one at home!

Is the ANGLE of this thing 70 degrees or 40 degrees?

CHART 1

CHART 2

Both charts are of the same publicly traded issue on the same date, just different timeframes and number of bars. So is it a sell or a hold according to the article's supposed exit strategy? The correct answer is to use a better exit strategy.

Watch list for week of 12-5-05

2005-12-05T00:24:00.000-06:00

Here are the highlights from this weekend's market homework software:

NUVA

RURL

SMTS

EFJI

REDF

REGN

ADST

RNAI

My favorite bases on weekly charts right now are:

NUVA

CRUS

One thing that worries me about stocks that are still basing is that the nasdaq has advanced about 10% in the last 8 weeks, so any stocks still basing are lagging the market and may not be the best ones to be in.

Watch list for week of 11-28-05

2005-11-28T01:03:00.000-06:00

Last week's watch list fared quite well. This is the week we get to find out if light holiday volume was masking a fakeout of the upper-channel line break on the nasdaq composite. I drove around a bit on Friday and didn't see much traffic for what was supposed to be the biggest shopping day of the year, but the market might not care anyway. Too many of the confirmation indicators I follow suggest not to be short of the market right now. The new highs / new lows ratio is fine, and the nasdaq summation index still shows an uptrend.

Here are the highlights from my market homework software this weekend:

SWSI

EFJI

NUVA

RURL

There are a couple more from last week's watch list that I am still watching with interest. I suspect that breakouts in these stocks will coincide with a nasdaq breakout confirmation. If these stocks turn sour, I would expect the nasdaq to do the same:

ALY (triple-cup base on daily chart)

CRUS (cup & handle base on weekly chart)

I'm still making these blog post lists by hand, but not for long. It takes a lot of effort to take a software prototype like my market homework software and turn it into something user friendly. Sometimes it feels like my time would be better spent writing new software rather than refining something that I've already got functioning at a level that satisfies my basic needs, but I remind myself that I've made it a personal goal to build a refined set of tools that will be a foundation for cooperation with other traders and programmers.

Thanks to all the people watching this project with interest. My original goal was to have the first version of the website online by the end of the year, and I'm on pace to meet that goal.

Early 90's Nikkei crash compared to Nasdaq dot-com crash

2005-11-21T23:49:00.000-06:00

The above chart is the early 90's Nikkei crash compared to the Nasdaq dot-com crash. You can click on the image to enlarge it. I wanted to post this up here as food for thought for the people who believe that historical precendent has at least some predictive value. I am one of those people.

I have lined up the peaks of both booms to make it easy to see that the two bubbles have behaved similarly. It is interesting how many characteristics the price movements of the two bubbles have in common. Most importantly, after the Nikkei had an "echo boom," it crashed again, ultimately surpassing the lows of the original crash. By comparison, the Nasdaq is at the heigh of its "echo boom." Will it crash even lower than the 2002 lows? I don't know but it is certainly one of the more likely scenarios in my opinion. If next year's Nasdaq follows the Nikkei precedent, then this is not a bad time to begin building short positions (not advice).

Watch list for week of 11-21-05

2005-11-21T00:09:00.000-06:00

The nasdaq has rallied right into a major multi-year resistance area. I wanted to post the weekly chart illustrating this but the chart uploading service seems to be down right now. I'll try again later. With that in mind, the highlights from this week's market homework software scan are also right at major resistance. If the market breaks down instead of up here, these stocks may make better shorts than longs. Here is the list:

CRUS

CRXL

KOSN

NUVA

RURL

UPCS

Those links are all the daily charts, but I also look at the weekly charts. Of particular interest is the cup & handle pattern on CRUS's weekly chart. CRXL's weekly chart shows a long uptrend. ALY's weekly chart is interesting because you can really see the price action tightening up as the stock becomes more liquid. If you look back at the price action in TZOO before its monster runup, the price also tightened up in a very similar way as the stock gained interest. It is easy to see lots of volume move into both of those stocks.

This week will be an interesting one. At key turning points like this one, my activity goes way up as I make bets in both directions. I build on the positions that work and quickly cut the ones that don't. The trading range the nasdaq has been in since the beginning of 2004 has got a lot of people in short-term trading mode because it has worked better than anything else for so long. For example, Trader Mike switched exclusively to day-trading after being a swing trader for years. I'm also guilty of shorter term trading more than usual over the past 6 months or so, but I'm trying to orient my thinking more towards a longer term approach where positions are built over weeks and months.

I'd also like to shout out a special thanks to Gorden Gekko at The Knight Trader for giving me the heads-up on an amazing chart: SWSI. I'll be watching this one with interest.

Watch list for week of 11-14-05 and website news

2005-11-13T23:15:00.000-06:00

In case anybody was wondering, I'm not dead, and this blog is not dead. I haven't posted much over the last couple weeks because I've been spending extra time working on getting together the website I talked about earlier in the year. After dozens of painful hours researching and testing, I've hammered out almost all of the technical problems that I expect to encounter with the hosting service and web technologies I'm using, so expect to see some very cool stuff soon :D For example, this watch list that I manually post each weekend. It is going to be automated, and available fresh each day in an even easier to view format. No more tedious posting by hand for me. That will free up my time and blog space for dissecting charts, doing book reviews, and discussing some of the more interesting contents from the links on the right. I will also be open-sourcing the api that I am designing as a foundation for a backtesting and automated trading platform. This api makes it trivial to scan and manipulate ohlc and tic data, and to generate trading simulations in java. The advantage to doing it this way rather than using something like tradestation or wealthlab is that you can incorporate neural networks, genetic algorithms, and any other advanced algorithm you can conceive into your data mining. In the java environment, time and personal creativity are the only limits.

Not only am I a blogger, but I am also an armchair philosopher, moonlight gamer, and pillager of science for my own benefit. I forsake mathematics in favor of the more functional computer programming descriptions of science. Academic longbeards despise me, but that's ok. I like to do things on my own terms, and that is what my up-and-coming website is going to be all about. I hope to inspire people to do great things in the markets, and in all other endeavors of life. I feed off of that energy. Just like this blog, don't expect ads or subscription fees (until I sell out, fickle remember?). Everything I have ever studied with a passion culminates here and will continue to evolve over the coming years. The website will be the beachhead of my campaign for a more satisfying life. It isn't about money, it is about achieving a mastery of the fundamental dynamics governing our reality. Here is a website by somebody who has done just that. This is also the path I am on, but I'm only 24 years old so I have a ways to go.

I hope that tirade was bearable. Here are the highlights from my market homework software this weekend:

RURL

EFJI

There are some pretty decent bases, but the nasdaq only has about 60 points to the top of the channel it is in on its weekly chart. Buying at the tops of channels is dangerous business. I did that in TRE last week and got shook out right at Friday's low. I bought at the top of the channel a few days prior, expecting a gap-up breakout the next day. It didn't happen, and my mistake was to hold when my expectations for the trade were not fulfilled.

Watch list for 11-7-05

2005-11-06T23:21:00.000-06:00

No compelling bases were reported by my market homework software this weekend. There is a good reason for it though. At this point in the rally, the strongest stocks have already responded to the market strength and began making new 52 week highs again, but my software is only scanning for bases. So here are the best of the laggards that haven't broken out yet but are worth watching:

LMLP

IPII

KOSN

LKQX

RNVS

TFSM

I should mention that I'm carrying a position in LKQX.

And so that people don't accuse me of only talking about winning trades, I got long a small position in XWG on Thursday at $10. It closed Thursday at $10.90, a 9% gain on the first day. But management decided to blow out the stock in the conference call that night and the stock opened at $6.70. I got out at as quickly as I could assess the situation, and filled at $6.50 for a 35% loss in one day. This loss wiped out much of my gains from trading XWG earlier in the year. So where did I go wrong with my XWG play? The reason I bought it was because XWG's chart was decent from a technical analysis of price and volume perspective, and I wanted to be long stocks because the nasdaq has been strong in the short-term and probably will remain so for the intermediate term. It was a small part of a much larger basket of stocks I bought last week. XWG was an example where fundamental analysis might have prevented the loss and maybe even profited from the price drop. But that doesn't change the fact that losses are inevitable, and having a plan for dealing with them before they happen is vital.

It is also important to remain emotionally and psychologically stable at all times as a trader. One of the exercises I do is to pretend that I have a crushing loss like this one, only across many positions that I have all at once, and imagine what my equity will look like so that it isn't such a shock if it actually happens. Then I mentally rehearse assessing the situation and doing what I need to do to exit the positions in such a way as to minimize the damage. The most important part is cutting my risk exposure as quickly as possible so as to contain the damage. I know from experience that if I can live to fight another day, I can make back any amount of lost money, but experience also tells me that I need to take my time about it.

Long candidates for a potential bull run

2005-11-02T23:15:00.000-06:00

If the market really is going into a bull run, I want to have positions in the current leading small-caps. Here are my favorites:

NTRI

FORD

I'll also be closely monitoring the symbols on my watch list from this weekend. I have already put on long positions in several from that list already.

Gorden Gekko at The Knight Trader and Budd Foxx at The Visual Trader alerted me earlier this week to a couple of compelling buy candidates: BEAS, and a very interesting stock chart that may turn into a great mover, TRE. The coverage these guys provide is very helpful to me during bull runs.

Market turning point

2005-11-02T21:17:00.000-06:00

This is where the bears' last stand will happen. Check out the included nasdaq composite chart. I hope to see a resolution tomorrow so I wanted to lay out my plan here. I mentioned this weekend that I felt it was probably a good idea to stick my toes in on the long side and I've done that. However I still haven't covered any shorts. This is my primary concern at this point.

I see the QQQQ is up in after hours. Typically when the market gaps, I will fade it, but it has been my experience that gaps through key trend lines will tend to continue in the direction of the gap. And the line I've drawn on the chart above definetely counts as a key trendline. An example of this gap follow-through behavior is GOOG. On the GOOG chart, I start the upper-channel line on the peak in July, and cross over the peaks in September and early October. Clearly it was not profitable to fade that breakaway gap!

If the nasdaq does gap up significantly tomorrow, I will cover half of my QQQQ short position in the morning, and if the close is going to be higher than the open, then I'll cover the other half at the end of the day. I also have a bunch of individual stocks short, so I've identified the most dangerous ones to be short of as CERN and SBUX. If the nasdaq makes me think at any time that it will close above that line on the chart above, then I will cover these two shorts immediately, even if it is at the open and I have to really pay up :D

I'm not too worried about most of the shorts I have in the retail sector though because they are in solid downtrends and quite a ways from my entry prices. These shorts are: SPTN, DECK, and HOTT, which is currently down about 7% in after hours on dissapointing same store sales numbers. I'm a firm believer in cutting your losses short and letting your winners run.

I was going to talk about my long candidates for the rest of this week, but I just got a call from my friend Jarod to play a game of DOTA for Warcraft 3 with he and the rest of the crew so I'll do it later tonite.

Watch list for week of 10-31-05

2005-10-30T23:45:00.000-06:00

I ran my market homework software this weekend and prepared a watch list for next week composed of the highlights from the scan. I was pleased with the quality of the chart setups on the first three charts in particular that I've listed here:

LKQX

CNET

EFJI

VPHM

WSSI

One of the stocks on my watch list from last week PYX had quite a nice rally. This is the kind of action I need to see before I start buying stocks. Gorden Gekko at The Knight Trader had coverage of the PYX breakout last week. I'll be watching his commentary more closely in the coming weeks to help determine the demand for speculative stocks, which I think may be starting to improve. That said, I may try to do some buying in stocks from the top of this week's list.

Another arrow in the bull's quiver is the XLF. It appears to be breaking out to new highs on the weekly chart.

I'm not going to run out and cover all my shorts yet though, the new 52-week highs:new 52-week lows ratio is still horrible (31:94 on the naz) and the market is still in a technical down-trend on the nasdaq composite daily chart. This overrides any anecdotal bullishness on individual stock and sector charts.

On intra-day reversals

2005-10-27T00:31:00.000-05:00

I was asked a great question today, and with that person's permission I wanted to post the question here along with my response, and anybody who has anything to add or dispute, please comment.

"Why does a stock rally a good amount after an earnings release that shows great earnings.. Then drop to a loss in the last hour of trading.

I made great gains on build a bear and buffalo wild wings.. Only to have them lost in the last hour of trading. Should i have sold along with them?"

Here was my response:

Your observation regarding the action in the last hour of trading is a very good one.

It has been my experience that a stock that is making lower highs and lower lows (downtrend) on the daily chart will have a tendency to close in the lower half of its price range for the day. The reverse is true for stocks making higher highs and higher lows on the daily chart (uptrend). For this reason, I make my trades almost exclusively in the direction of the trend on the daily chart when it is the same as the trend on the nasdaq composite daily chart, and refrain from making most of my buy or sell decisions until the last hour of the trading day. Most of my trading is done in the last 30 minutes of the day, but occasionally like today when there is an intra-day reversal I will make quite a few trades in different stocks I've been watching throughout the last half of the day.

The closer you wait until the close to do your trading, the more information about the price action that day you will have, but like you pointed out, that information comes at a cost because you possibly could have had more favorable prices earlier in the day. I've told you what makes me comfortable, but it all comes down to whatever is comfortable for you.

It is interesting that you mentioned being long BBW. I shorted that stock about a month and a half ago when it was upgraded (the gap up in September) but I took a loss on the trade, I covered my position a day before the gap up that your profits came from. You can probably see why I covered, and I suspect maybe that was your reason for going long at the same time? The problem with BBW and BWLD is that the nasdaq composite is trending down, so lower closes are more likely for those two stocks than you would otherwise expect.

Don't worry too much about losses. Trade the charts, not your account equity. If you catch yourself trading based on your account equity, then shrink your trade size.

Here are the related charts, including my notes (click to enlarge):

Note the reversal candle today on both the nasdaq composite and BWLD. This is no coincidence.

Profit factor walk-through in my backtesting software

2005-10-26T01:17:00.000-05:00

I've talked a bit recently about the java software I've been developing for backtesting and automating trades so I thought it would be a good idea to outline some of my recent progress here with companion images.

One of the primary statistics that I'm concerned with when looking at the results of a trading system backtest is the Profit Factor. The Profit Factor is computed as follows:

(PW * AW) / (PL * AL)

Where

PW = Probability of a trade being a winning trade

AW = Average win size

PL = Probability of a trade being a losing trade

AL = Average loss size

Profit Factor basically describes the historic profitability of a series of trades. For example, a series of trades with a profit factor of 1.0 is break-even. Another more specific example might be a system that generates trades with a 50% chance of losing and a 50% chance of winning. For this system, the average win size is 3 times the size of the average loss. So:

PW = 0.5

AW = 3

PL = 0.5

AL = 1

And when we plug it into the formula, it looks like this:

(0.5 * 3) / (0.5 * 1) = 3

As long as the numbers remain the same in the future, we can expect this hypothetical system with a profit factor of 3 to be very profitable. In fact, the more frequently we trade it, the larger we would expect our compound returns to be. The reason for this can be simply explained by considering two casinos, each with a house edge of 55%. Obviously the higher volume casino will have larger earnings over an identical timeframe.

When backtesting a system, it would be useful to know what the best stoploss and profit target values are for that system, so I wrote a module that computes the profit factor of every combination of stoploss and profit target, and outputs the data to excel where I can graph it easily. Here is the graph for one of the systems I've began to develop (click to enlarge):

One of the major reasons graphs like this are important is so that you can make sure you aren't over-fitting your system to the data set you are testing it on. If you simply have the computer find the very best profit factor out of the batch, you may end up with system parameters that merely take advantage of a coincidental price sequence that never repeats and won't be profitable in the future. Parameter clusters that form broad hills tend to be more robust and reproducible in the future. In the graph above, there are two significant hills, with a spike at the top of the one on the left. I wouldn't necessarily expect the parameters coinciding with the peak on the left to reproduce quite that good of results in the future, but the fact that it is on top of a hill means that it is still a favorable parameter set, and a good candidate to look further in to.

So here are the backtested trade results from one of the parameter sets at the peak of the left hill (click to enlarge):

As you can see in the totals at the top, the longs are more profitable trades to take. That is because the market is trending up in the 3 year data sample that this backtest covers! When I filter out the short trades, only analyzing long trades, the profit factor of the system goes from 3.1250 to 9.6654! However, the long-only system is less profitable over the same three year timespan because it is taking only 28 trades with a profit factor of 9.6, whereas the bi-directional system has 56 trades with a profit factor of 3.1 -- slightly more profitable, and makes money in a wider range of market conditions. So a possible future direction for this simple system of mine might be to find a good way of identifying long-term market uptrends and downtrends as an indicator for overweighting long or short trades.

Watch List for week of 10-24-05

2005-10-24T00:30:00.000-05:00

My software didn't come up with anything I'm interested in putting money on this week. Most of the bases it showed me did not look very mature. Here are the highlights:

SMTX

WSSI

I saw IBD featured an interview with Ray Kurzweil on pages A4 and A5 of this weekend's paper. I've mentioned Ray Kurzweil frequently on this blog. Most recently was in September when I wrote about the role of accelerating technology in the area of risk management. I almost jumped out of my seat when I read this paragraph from IBD's interview with Ray because of his own remark on risk management:

The interneural connections [of humans] do computations at about 200 calculations per second, which is a million times slower than electronics. And there are many ways human intelligence gets easily confused, like in understanding risk. We can create nonbiological systems that are thousands of millions times faster, and we'll be able to combine our strength of human intelligence, which is principally our pattern recognition.

This is already going on. My own stock trading strategy is a synthesis of machine strengths and my own strengths. I feel that I've reached the point where it is easier to improve the machine side than improve my own assessment abilities so I have been focusing the bulk of my efforts on that for the past few months. I have been developing in java a suite of tools for scanning and manipulating price data, technical indicators, backtesting, and statistical extrapolations from the backtesting. Eventually my plan is to let the machine take over my trading in derivatives and forex almost completely. I still plan to do discretionary trading of common stocks as a way of diversifying, and because it is pretty fun too =D

Ed Seykota on trends

2005-10-21T19:14:00.000-05:00

I noticed a new article on Ed Seykota's site, a discussion on trends. Ed quickly gets to the bedrock in his usual lean and powerful philosophical approach. He says, "Motion, velocity and trend do not exist in the now. They all disappear in snapshots." The argument is similar to those put forth by Zeno in his famous paradoxes, however many of the objections regarding the discreteness of time and space that people make to Zeno's paradoxes do not hold at all for market prices. It is plain fact that bid/ask quotes are discrete. Ed says it follows that, "Technically, since trends do not exist in the now, they do not exist at all and there is no such thing as a trend."

So how does one of the greatest trend followers of all time make his money if trends don't exist? Simple! A trend is an arbitrary definition of conditions that can be queried with price data. When the conditions are met by the given price series, it can be said to be in a trend state. From this premise, Ed goes into some examples and an exercise.

What I took from Ed's article is that the way you define price action, whether mentally or systematically, has everything to do with your ability to profit from it. More robust price action models naturally have more profit potential.

Nasdaq bounces off of dual resistance

2005-10-19T00:59:00.000-05:00

Nasdaq bounced off of dual resistance today: the declining 10-day SMA and 200-day SMA. You have to weight the price action by the volume, so this is pretty bearish stuff over the past couple weeks. If the volume balloons while price declines over the next few days, then the nasdaq may stay oversold for quite a while.

Watch list for week of 10-17-05

2005-10-16T23:50:00.000-05:00

GOAM

CTLM

Why even bother with a watch list of buy candidates when I'm up to my eyeballs in short positions? Because it is my business to keep close tabs on the demand for speculative stocks. The reactions of these stocks this week as they reach their boiling points will give me early clues if the speculative money starts to get frisky. I'm not holding my breathe though.

Another interesting chart that my software spit out at me this weekend is one of my favorites from last year: AIRT. You can see on the weekly chart that it has found support at $10, but if that price level fails, the next support looks like $5 to me. I think the $10 price will fail soon because the trend on the daily charts in both the market and the individual stock is down, but I don't short low-float stocks like this one. This is my spectator sport of choice =D

Based on all the charts I've seen lately and the new 52 week lows outnumbering the new 52 week highs by a wide margin, I'd say the odds are high that this earnings season will turn the markets into a trainwreck. A glance at the weekly nasdaq composite chart shows that if the markets start tumbling, it may yet have a long way to fall. The way I see it, you can either trade chart setups, or use the setups to get you into trends where the money is made during extended periods of overbought or oversold. It is fairly obvious from the notes in this blog that I prefer the latter.

Complacency, conspiracy, and liquidity

2005-10-15T15:04:00.000-05:00

I know what investor complacency is. It is running in and buying every "oversold" dip in the market because it has worked for the last three years. Or buying on a bullish osscilator crossover coinciding with a put/call ratio of 1.0 because "thats what markets do when they bottom".

This past Thursday morning, the market was on the precipice. It was going to crash or rally. I was already short up to my waist, but I sold even more stocks. I sold stocks to a lot of different people, some of them were complacent buyers, and others were sharpshooters like my friend Jarod, who correctly called the short-term bottom that morning. I don't trade like any of those people though. I'm perfectly happy to sit short through a limp-volume rally in a market that has been trending down for a couple months because it tells me that my position is as secure as I could hope for.

The problem with being on the wrong side of a rare event is that you can't count on liquidity when you need to get out. However, on the other side of the trade you have plenty of liquidity if it moves against you, and the best situation in the world when it moves for you.

My point is that there are catalysts in place for a rare market event in the next couple of months: Greenspan and Snow are over in Beijing hashing out currency and trade issues while congress has their finger on the trade war button labeled "currency manipulator". Meanwhile, back in the states, the Refco (RFX chart) plot keeps thickening. It now looks like Goldman Sachs (GS chart), Bank of America (BAC chart), and Grant Thornton may get dragged into the mess, and the smoke is far from clearing. And bond yields keep creeping higher as the yield curve is getting flatter.

Maybe this is all much ado about nothing, but the market seems to indicate otherwise: the nasdaq composite is already down about 7% from its high in August, but it really hasn't broken its intermediate up-trend until a week or two ago. This is why over the past week I've changed tactics from hedging a lot of long positions with a large short position in the QQQQ, to hedging a lot of short positions including the QQQQ with only a couple of long positions that are still technically healthy. The nasdaq still has long-term support near 2000, but if that price level is broken, the market will have confirmed my positioning.

I can't wait to see what Bill Cara has to say in his week in review today. His commentary this past week has been timely and informative. I can't recommend his blog enough to anybody who hasn't seen it. It is great to see Bill really back into his rhythm, and I suspect it has a lot to do with him smelling blood in the water.

No Sunday post this weekend, casual market commentary

2005-10-07T15:41:00.000-05:00

I'm going out of town for the long weekend, so I won't be making my usual Sunday night post. I am still way net short the market. I got short the QQQQ back in August when it was above $40 and I added to my position every $0.20 down for a few days. Although I have done a little bit of trading in and out over the last two months, I still have 3/4 of that original position and a little more added recently. I must admit, I started to sweat a little on Tuesday morning when the QQQQ had rallied all the way back to $39.88 and I read Monday Dan Zanger was anticipating an up-side breakout this week on the AIQ website. Turned out to be a fake-out.

I don't expect to act on any buy candidates until I can gauge the strength of the next rally. I've only got three long positions remaining right now (GIGA, GEPT, and ENTU) and I'm either flat, or just slightly underwater on all of them, but they are still technically healthy. ENTU looks the most favorable right now, as it is pulling back on light volume, making a clean upper-channel line to break out from on the daily chart. I will be quick to sell any of these positions if I see high volume pushing them under key price support levels.

I closed out SPIR at a small loss today. I was carrying it long from $10.10, rode it up to the top of its range near $11.50, and right back down. I got out because of its failure to recover the 50-day SMA today, and the large sell-off in the energy sector will likely catch up to it soon. It helps to look at other similar stocks. DSTI is also a solar play. I mentioned last week that I sold my DSTI position for a loss at $12.50. My average cost was $13.50, making my loss about 7.5%. Today DSTI closed at $10.92, 13% lower than where I cut my loss, and 19% lower than my original entry point. This serves as a good reminder why it is so important to cut losses without hesitation when you are trading in these volatile stocks.

So my plan? Basically to sit tight and manage what I'm carrying. If this selloff gets real nasty, it should be pretty easy to pick out some great short-sale candidates. But the long-term trend is still up for the time being, so I don't feel rushed trying to find more shorts. Besides, the naz still in a range. I read a great quote from my favorite Market Wizard Ed Seykota in Michael Covel's book, Trend Following, last night: "To avoid whipsaws, stop trading." Timely advice, because I know a lot of people are stopping out all over the place right now.

Watch list for week of 10-3-05

2005-10-03T00:01:00.000-05:00

The market appears to be in a contracting range and not trending right now. When the market isn't trending, most stocks won't be trending. There has been more negative action than positive action on my watch list from last week which is a big red flag to me. Here are the best low-risk buy candidates from my market homework software this weekend:

ECIL

FOXH

KYPH

LKQX

ORCT

BCON

LCRD

SOSA

I've been going through a tougher than normal losing streak this past month. I can trace it back to the first hurricane, when the market started going higher. To summarize my strategy, I basically buy explosive nasdaq stocks from the lists produced by my market homework software, and offsetting my risk during nasdaq downtrends by being short larger blocks of QQQQ and cutting positions that are no longer technically healthy. Well when this first hurricane hit, the speculative money seems to have dried up for the time being, but the nasdaq composite hasn't gone down! I've been getting whacked on both sides this month, and as a cautionary measure I have much less market exposure than I had at the beginning of the month. The last time I can remember the market behaving this way was December of last year. The hot-money stocks were blowing up left and right but the naz kept grinding higher, until the January blowout. I went heavily short in January and didn't buy another stock until April. It wouldn't suprise me to see the next few months play out similarly. This time I am already way net-short after taking losses on quite a few longs, but I may be too early and decide to trim back some next week.

I tried to buy the breakout in LONG this week, and exited the trade with a loss the same day. It was evident that it wasn't going to follow through. I've been talking about DSTI a lot on here lately, and I'm no longer carrying a position in that stock. As it violated support at $12.50, I scaled completely out of the position. I may have sold at the bottom, it happens sometimes, but the first loss is the best loss! If you can't take small losses, you will take big ones and I'm not really into doing that =D

So what is in store for next week? I'll be monitoring the health of my current positions and the ones on the list above. Maybe we'll see the market break out from its range, but I think it is too early to expect that. I don't think this is a good time to be very busy as a trader, but when you stop paying attention to the market, your positions, and emerging opportunities, you are basically dead meat. In this business it's the steady players who bring home the bacon. If you are inconsistent in applying your strategy, you may miss the small handful of trades that makes it profitable that year. This blog has helped me maintain that discipline and I'm grateful for all the interesting people I've met because of it.

Market Wizards

2005-09-25T23:27:00.000-05:00

Market Wizards by Jack Schwager is such a great book. I had a few quotes from that book on this blog a few weeks ago in an article on risk management, and I see that the Trenders blog has a much more comprehensive list of quotes from the interviewees in the book this weekend. Having just read the book myself, I found myself nodding and smiling as I read through the quotes. They are good ones.

I have an opinion on the segments at the beginnings and ends of the Market Wizards books where Jack Schwager talks about some of his own trades and his mixed success. He comes to some very good conclusions himself in the text, but I get the feeling that a mistake he is making is trying to ramp his account up too fast during and after winning streaks. From what I can tell, there are two ways of making money in the financial markets. You can make a lot of money fast, but the way you got it makes you incapable of keeping it. Or you can make money consistently, which is the only way to keep it. From what little Jack describes of his own trading, it doesn't sound like he is trying to make money consistently and that probably goes a long way towards explaining his difficulty in keeping his impressive winnings.

Watch list for week of 9-26-05

2005-09-25T22:46:00.000-05:00

My thoughts on the nasdaq index are written on the attached chart. Although the number of new highs on the nasdaq (34) is outnumbered by new lows (44), there are a number of fairly decent chart setups this weekend. Many of them may break down though, so if the nasdaq sees some high volume selloffs next week I'm not going to be caught overexposed on the long side.

Here are the low-risk buy candidates identified by my market homework software this weekend:

ABLE

FORD

LONG

PACT

TAYD

DSTI

SPIR

AVII

RGEN

SOSA

A couple others worth watching but are in VERY young bases:

KYPH

If the market does pick up some bullish steam at this juncture, I'm probably going to be like a kid in a candy store buying off of the lists here with the cash proceeds from short covering. Otherwise, there isn't much to do but sit tight. I should mention that I'm already carrying a position in DSTI.

DSTI weekly chart case study

2005-09-22T23:37:00.000-05:00

To understand why I'm so bullish in DSTI in particular right now, I have to show you its weekly chart. You should compare this weekly chart with the raw chart on stockcharts.com to see if you can see what I see without all my lines everywhere =)

The only thing making me sweat a little bit about DSTI right now is that there are more wicks on top of the candles on the daily chart than there have been ever in the past. Perhaps the underwriters are trying to make sure it doesn't get overheated right now. Or they could just be selling out.

In my opinion DSTI in 2005 is the closest chart to TASR in 2003 and TZOO in 2004. As long as both the energy market and DSTI remain in long-term uptrends I am comfortable holding a core position in the stock. I like trading around my core position though, making me a buyer when the sellers dry up and taking some profits when it gets overheated.

Some pretty decent setups tonight

2005-09-21T22:56:00.000-05:00

I was suprised at the chart setups spit out by my software tonight:

FLOW

FORD

DSTI

FOXH

RGEN

ECIL

In a more bullish market I would probably be taking positions in many of these stocks, but as it is I'll mostly just be watching them for signs of strength on the nasdaq. I've already got a large position in DSTI and I may do some buying in one or two others, but it depends on how badly the nasdaq is going down and whether I'm seeing other breakouts work out ok. Today I had a nice gain in GEPT, so the follow through tomorrow will tell me a little about how interested people are in chasing breakouts. I've been holding a position in GEPT since the beginning of September after I mentioned that my market homework software identified it as a low-risk buy candidate at that time.

ENTU chart setup

2005-09-21T01:06:00.000-05:00

I mentioned ENTU this weekend as one of the highlights from my market homework software. This is one of the reasons why I continue to run the software even when the market is dead! Today ENTU had a reversal candle that was almost identical to the one XWG had back in July before running up nearly 100% in a few weeks.

To review, the way I like to trade chart setups like this is to try to get a small position when the volume is very light and I feel the stock is near support (the lower purple line on the given chart). Today's reversal candlestick reinforces a high probability bottom because it flushes out all the sell orders. I'll add to my position when the upper-channel line is crossed. The upper channel line is the downward sloping line across the top of several price highs (the upper line drawn in purple on the given chart).

It is important to remember that no chart is an island and must be considered within the context of the market direction in which it is trading. I'm bearish on the market so I'll be hedging any buying that I do in ENTU against a large short position in the QQQQ, which looks to be on the brink of disaster.

Trimming down ahead of fed meeting

2005-09-19T23:44:00.000-05:00

I thought I'd be sweating my shorts after the big gains in the market on Friday, but instead it was many of my long positions that proved better to liquidate. Today (Monday) I sold SIRI and BCON in the morning, and STEM at the close. I took a small gain on SIRI and a small loss on BCON and STEM. I had a larger than normal position in SIRI and ended up liquidating the entire thing within the first 30 minutes today because it fell below that key support level of $7 and didn't look like it had a prayer of recovering it today. I quickly scaled out in the $6.90's, and SIRI closed at $6.70. When you can buy it back cheaper than what you sold it for, you are ahead of the game.

The fed will announce whether they are increasing the interest rates or not tomorrow, and is probably the main reason for the unpredictability in stocks' daily charts lately. Making and losing money in an unpredictable environment is pretty much the definition of gambling. Not that that is a bad thing in itself, but it is a loser's game over the longer timeframes throughout which I plan to grow my equity. I believe taking money out of the financial markets requires planning in terms of decades rather than moving from one trade to the next, thinking each is the most important trade in your financial career. My plan is to make damn sure I'll be in the game decades from now, and from that perspective the day to day wins and losses seem a lot less important because they are just small parts of a bigger picture.

So with a lot less exposure than last week, I fell pretty good coming into this fed meeting tomorrow, and I've got plenty of powder to put to work when the time is right. Once again, it is a waiting game, and realize it or not, that puts me in a position of control.

P.S. I was on the phone with Jarod today when he referred to the fed meeting tomorrow as "judgement day". I jokingly reminded him that he was the one going into this fed meeting net-long. He currently only has one ridiculously tiny long position left after closing out all his other positions in the middle of last week =)

Watch list for 9-19-05

2005-09-18T23:04:00.000-05:00

In this week's market review from Bill Cara he makes a compelling argument that the fed may not be raising interest rates at Tuesday's meeting. And I must say, nothing would suprise me in the equity markets next week. I almost closed out every single position I had last week after my equity closed at a new high for the first time in 2 months, and slipped right back into its range the next day. I would have been better off for it too. Almost every position I had moved against me on Friday, which was a freakishly huge volume up-day on the nasdaq. It wasn't a naz +40 up move like I would have expected on that kind of volume, but it should still be considered accumulation so I've got my finger on the "Cover" button for my QQQQ shorts and every other short position I've got that isn't showing a profit. So Friday I closed beneath the bottom of the range my equity has been in for 2 months...

The quality of the low-risk buy setups identified by my market homework software this weekend were notably poor. Here is a list of the best ones:

FORD

PACT

RACK

ENTU

LMIA

DSTI

I should mention that I currently have a position in DSTI. Also worth a look, Frank over at the technicator blog identified a decent chart setup this weekend in IMX.

This low volatility, sideways market action is like the mesmerizing siren's call for my style of trading. So unless my current holdings make a nice recovery next week, I'm probably going to be lightening up and trading smaller until there is more direction to the market. As important as I feel it is to make money consistently, my over-riding objective is to not lose money so that I can capitalize on the best opportunities in the market when they come along. I haven't posted many charts on this blog recently because I really haven't seen anything worth jumping up and down about, which is a shame because I really like posting them here.

Easing back to net-short

2005-09-13T23:38:00.000-05:00

On January 3rd, the first trading day of 2005, the nasdaq cracked at the same price level it has paused over the last two days, about 2,180.

During the last two weeks my overall exposure has changed from slightly net-short to slightly net-long, but I'm going to ease it back towards net-short starting tomorrow as long as the 2,180 level remains the ceiling. I can tell that I've got too much volatility on the long side because my account equity has been opening strong and closing poorly since this recent mini-rally began.

Watch list for 9-12-05

2005-09-11T23:29:00.000-05:00

Last week was another dull week in the markets. It is tough to get ahead in the recent environment and it usually doesn't pay to force it. Here's the results from my market homework software this weekend:

STEM

VLFG

LMIA

DSTI

RADS

I've got long positions in DSTI and STEM. I just picked up the STEM position at the close on Friday and I'll add to it on a strong breakout. I first identified STEM as a low-risk buy candidate on my watch list two weeks ago, and I included it on this week's watch list because it is still in a low-risk price range from a technical analysis perspective.

And finally, a helpful quote for traders:

"Main thing in an emergency is to stay calm." -- Panthro, Thudercats Episode 2

Risk management

2005-09-10T15:50:00.000-05:00

"I would say that risk management is the most important thing to be well understood." -- Bruce Kovner, page 82, Market Wizards by Jack Schwager

Jack Schwager: "How much of a role does luck play in trading?"
Richard Dennis: "In the long run, zero. Absolutely zero. I don't think anybody winds up making money in this business because they started out lucky."
Jack Schwager: "But on individual trades, obviously, it makes a difference?
Richard Dennis: "That is where the confusion lies. On any individual trade it is almost all luck. It is just a matter of statistics. If you take something that has a 53% chance of working each time, over the long run there is a 100% chance of it working. If I review the results of two different traders, looking at anything less than one year doesn't make any sense. It might be a couple of years before you can determine if one is better than the other."

--Page 97, Market Wizards by Jack Schwager

"Don't focus on making money; focus on protecting what you have." -- Paul Tudor Jones, page 139, Market Wizards by Jack Schwager

A couple weeks ago I was reading the "New Era thinking" chapter in Robert J. Shiller's Irrational Exhuberance, the original edition that was published shortly before the nasdaq crash of 2000. Shiller found that media buzz about an emerging "New Era" historically happened before and during large stock market advances that ended with crashes. So naturally I bought a copy of Visions by Michio Kaku when I saw it in the bookstore. The significance of Visions was its publication date, 1997. Kaku wrote Visions as a guide to the cutting edge of science at the time, and as a roadmap of how we could expect our lives to be changed by emerging discoveries.

Kaku is a physicist himself. The book jumped out at me because I remembered his name from a mind-blowing article Kaku wrote and published on Ray Kurzweil's site that I had read several years ago. One of the most interesting passages I've seen so far in Visions was this one:

"If these difficulties in computer technology can be overcome, then the period 2020 to 2050 may mark the entrance into the marketplace of an entirely new kind of technology: true robot automatons that have common sense, can understand human language, can recognize and manipulate objects in their environment, and can learn from their mistakes." -- Michio Kaku, page 16, Visions

What I find to be so interesting about this statement is that there may not be sufficient demand for these automaton housekeepers. The fact is, it is so much easier to create software "risk managers" of the kind talked about in the above quotes from Market Wizards than it is to create robotic servants.

As computer hardware and software technology continues to advance, the financial market computer models and risk management computer software gets more sophisticated and more difficult for humans to outperform. The people maintaining and controlling the best of these software programs will control the world in a sense. The primary function of financial markets is to optimize resource allocation. These software programs are the ultimate resource allocators.

There will always be profit opportunities in the financial markets for humans, but let me put forth a scary scenario. Consider that software systems are responsible for more and more of the bidding and offering that goes on in markets, and at some point they might reach the point where they can have markets moving so erratically that traditional technical analysis loses all predictive value. Many readers familiar with the markets probably think it is absurd that this could happen, but let me introduce a science experiment called the Prisoners' Dilemma. In 1984 a tournament was held where anybody could write and enter a computer program to compete in games of iterated prisoners' dilemma. The winner of the tournament was a strategy called Tit-for-Tat. Tit-for-Tat was the dominant strategy for a long time, but more recently a program was written that could detect whether it was playing against a Tit-for-Tat program by analyzing its opponents' reactions to its moves. If it detected a Tit-for-Tat program, it would make moves that destroyed Tit-for-Tat's score, at a small loss for itself.

If you have sophisticated enough software controlling enough money in the markets, by collusion they could keep humans out. For example, if you don't flash the right series of bids and offers at the exactly correct time intervals, they could determine that your bid is a human bid. Or if your stop isn't rotating through the correct price series, then it must be a human stop, or foreign software and is now a target.

This is just another reason why money today is worth a lot more than most people fathom, because it may not be as easy to come by in the future. There are many patterns in the stock market today that provide profit opportunities and haven't been arbitraged out because it is too expensive to fade them. One makes more money by amplifying the pattern than disrupting it, but the risk vs. reward ratio for any given pattern is certainly subject to change over time. Higher failure rates tip the scales in favor of the very best risk managers, whether they be human or machine.

In response to hurricane relief criticisms

2005-09-08T15:57:00.000-05:00

This post is in response to hurricane relief donations criticisms: Roberto's criticism of the NYSE and Peter the speculator's criticism of oil and gas company contributions.

There are good reasons why the people who are giving the most have the least to give. It is tough to get ahead if you are bleeding out anytime somebody else could use some money. I can't say I blame Grasso, but it doesn't matter anyway. The public will have a shot at his money after he passes away and it is taken in estate taxes and piddled away by inheritees.

We all contribute to this disaster relief whether we want to or not with tax money and higher energy prices. I'm helping out by driving my car 5-20 mph slower than I used to, this gives a small relief to energy prices even if I can only convince a few other people to do it. Doing this has improved the gas mileage of my 3000GT VR-4 by 20%.

"Don't buy gas if you don't need it." -- President Bush

P.S. Liquid markets provide the most efficient resource distribution, think about it like an auction. Price controls create major shortages in markets and lead to rationing. You don't want people in dire need of a resource and the money to pay up for it to not have it available because "it got bid up too high". I can't think of a case where completely eliminating liquidity is a good idea.

P.S.S. I can tell that Peter likes it when liquidity disapears and he's on the right side of the squeeze, the url of his blog is http://www.limit-up.blogspot.com/ in reference to the futures markets price controls.

Watch list for 9-6-05

2005-09-06T00:12:00.000-05:00

Here are charts of the best low-risk buy opportunities that were identified by my market homework software this weekend:

GEPT

MNTA

NUVA

STEM

VLFG

FOXH

TAYD

Probably my favorite chart setup on the list is GEPT. This is exactly how I like to see a big rally cool off. There are a lot of people who paid too much for shares in late July and early Auguest between $5.50 and $7. These holders are in a very tight spot right now, many are scared or bored and ready to sell. I like to take shares off of these peoples' hands when the volume really dries up during the sell-off, just like GEPT has done over the last month. Take SPIR for example, we saw almost the exact same setup near the 50-day moving average (red line) in early August, just before the stock gapped up into a 50% advance within a single day.

It will be interesting to see how the market closes this week. With September 11 occuring next Sunday, it will probably be the riskiest weekend to carry equity positions through, so I expect the market to close lower on Friday than it opens Tuesday morning. It isn't worth trying to make money from these sorts of expectations though, at least I've never had much success with them. Rather, this is my que to not jump into any marginal plays this week.

A word on entering the financial markets

2005-09-03T00:28:00.000-05:00

I received a kind email from a reader who has been studying the market for a long time and feels ready to put some money to work soon. I wanted to post my reply on the blog in case any readers want to add to what I had to say, or challenge any part of it.

Thanks for the email, and I'm glad you like the blog. I wonder if you've read "Reminiscences of a Stock Operator" ? This is the best book on the financial markets I've read and is key behind how I try to trade. It goes further than that though. I don't know what sort of trading or investing appeals to you, but I'm interested in the study of making 50%+ annual returns consistently. One of the most important things I've learned so far is that money is made in the markets by managing risk better than other people, no matter what tactics you are using. It is just as true for Warren Buffet, Jesse Livermore, George Soros, you and I.

I would discourage you from getting into the markets in the first place because 9 out of 10 people come out behind in the long run, but you probably already know this. I don't know if you are trading yet or not, so let me tell you that it only gets easier over time if you pay attention. A beginning trader has to go up against the fact that he is under capitalized, lacking experience, unprepared for a relentless emotional rollercoaster, and beset on all fronts by rampant conflicts of interest. But after all of that, if your account survives that far, you will come to realize that the financial markets have to be played like a casino plays an edge: you win statistically over time. Your equity percentage trade size will probably go down and your winning consistency should probably go up. And eventually you will be rewarded by being around for the beginning of a new bull market and the experience and cash to really take a lot of money out of it.

Unfortunately the market homework software I use was written by me so there's nowhere you could get it for the time being because it is not at a point where I can release it, it is only a prototype currently. But you should know that half of my trading efforts are focused on determining market direction and positioning my exposure accordingly. It is something you can do, and easy when you get the hang of it. The trick is to have bets both ways when tension builds in the market. Then as you drop your losers you can add to your winners. If you do this correctly you will make money every time the market has a movement longer than a week or two.

If you want to talk about anything in particular, let me know. I love talking about this stuff with people who are interested. Regarding where I get a list of stocks to watch, they almost all come from watching the new 52-week highs list of nasdaq stocks. You can find this on stockcharts.com under the "Stock Scans" section. By the way, I went to Mizzou and currently live in St. Louis, so we are sort of neighbors. Pretty cool =)

-Jon

I'm buying strength here

2005-08-31T23:35:00.000-05:00

There quite a few compelling looking charts popping up on my market homework software tonite. I've found that you can make a lot of money in a short time by not ignoring when the market is flashing strength like it did today and there are plenty of good setups to choose from. Whenever there is news that credit is loosening, the speculative money goes to work, even if just for a short time. The feel of the market right now reminds me of earlier this year right before we got a quick breakout caused by news of a new 30-year long bond being issued in the near future. This time it is the hurricane relief money that is the catalyst. I'll probably be doing some buying to cover and buying longs tomorrow, but I don't anticipate a market advance lasting very long with the bond market acting the way it has been; the yield curve is rapidly narrowing these days.

Here are the highlights from my software scan for low-risk buying opportunities tonite:

SINA

TAYD

VLFG

DSTI

FOXH

NUVA

GEPT

Another one worth mentioning showed up on my scan a week or two ago that had a positive reversal today is GIGA. I've got a small position in it already, and if it picks up strength and volume I'll probably add to it. You've got to take profits fairly quickly in stuff like that though, and that's what I plan to do.

I've still got my DSTI position from about 3 weeks ago and I'm glad I do. It looks like it has good support around $13 (about where I got in) and may see a short squeeze if the market is able to advance.

Something not related to the markets, but possibly interesting to some readers on here, my girlfriend just started her first semester in vet school at Mizzou and is blogging about her experiences. Apparently she's got about 40 hours a week in classroom time and labs! Very intense, but the program sounds cool because it is structured to have a very close-knit group of classmates through sponsored and non-sponsored extra-curricular social events. I have attended a couple of these with her, and it has been fun. It's sorta wierd to work on getting drunk while trying to glean cattle contracts insight from rural farm-boys! Her classmates almost all have their undergraduate degrees, so the maturity level of the people is high. After meeting the classmates, there's no doubt in my mind these people are committed to working hard over the next four years. I'm proud of my girlfriend for getting to where she is, and it looks like she'll be a part of a good community.

Watch list for week of 8-29-05

2005-08-29T00:40:00.000-05:00

I have no idea what to expect from the market this week because of hurricane Katrina, but being way net-short the market I am well positioned to deal with a thrust downward by the nasdaq composite. The T-bond yield spread has narrowed further last week, which has bearish implications for the market, however there is a good chance that the fed will not raise interest rates anymore this year due to the impeding New Orleans crisis. My plan is to play it by ear, and when positions get too risky I'll reduce my exposure by passing them to someone else. The market really does work like a game of hot potato.

Here are the interesting charts spit out by my market homework software this weekend:

STEM

MNTA

VLFG

FOXH

I'm going to try to do some book reviews and trading tactics discussions on the blog over the few weeks to keep things interesting while the market gets cheaper. If anybody wants to discuss anything in particular, post a comment or drop me an email.

VLFG back on the radar

2005-08-26T00:00:00.000-05:00

VLFG back on the radar. The software spit this one out tonight and I thought it looked good enough to make a blog post about. I may or may not buy at the points drawn in green on the chart, it depends on how strong the nasdaq composite looks and the behavior of VLFG. Other notable charts to check out: FOXH, SYNX.

An old friend of mine called me up out of the blue last night to talk about how to trade stocks. He came over around 7 PM and we got some Taco Bell. By the time we realized it was late, it was 4:30 AM and we had run the gamut about the stock market. I didn't get to bed until 5:00 AM, and got back up around 7:30 AM this morning... So I've got to get some sleep! We had a great time though and I would do it all over again without a second thought. I really enjoy talking with intelligent people about the markets even though I know in the back of my mind that some of them will be net losers.

One last thing though, the Nasdaq composite is right on its 50-day moving average and looks like its ready to make a significant move up or down any day now. I'm fairly well hedged, carrying some longs and some shorts so we'll see which positions I get to fold out and which ones I get to stack the chips on soon. Over the past couple days I closed out PACT (long) and BMHC (short) for losses, so I'm feeling like anything can happen. So tired... maybe those Budweisers tonite were a mistake...

Risk capital	Percentage multiplier	Position size
5000	1	5000
5000	1.1	10500
5000	1.1	16550
0	1.21	20025.50