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Here are the final results of the trading automation experiment I conducted about 3 weeks ago.  The two stocks I chose for the experiment is FAZ and SRS.  Both are leveraged ETFs.    FAZ ended up making 30% on the first try.  However, SRS ended up having 5 losers in a row.  So the net is up 2.5%.   Here is the whole series 1 2 3 4 5

Here is what I learned so far from this experiment.  100% machine trading is probably not feasible.  If I had turned on the machine when FAZ and SRS were close to 100, then I would have lost my shirt trading this reversal pattern.  Nevertheless it does not mean that this reversal pattern is bad or not even tradable.  We need to find out WHEN we can turn on the machine. Preferably, it should be close to when a true reversal will happen.  It does not have to be very precious.  Using this experiment as an example, if a true reversal started now and the machine opened a trade, it would hit the 25% target.  This would cancel out all the 5 previous losers, which would result in a break-even in SRS.   That would leave us with a net 30% profit in the FAZ position.  So it is my next major project to find out when I can start to automate the trading of this reversal pattern.

Here is SRS’s chart with 5 losers on it.   Click on the image to have a better view

Machines can beat a lot of traders out there since machines do not have 4 very lethal problems that human traders have

1:  hold onto losers
2:  cut winners
3:  fear
4:  greed

However machines are susceptible to the following.

If my machine is based on trend following, it might be whipsawed to death without even knowing it being in a range-bound market.  Because it has no fear, it will keep taking fake signals.

If my machine is range-bound based (mostly using some type of oscillators), it might trade against a trend when it keeps shorting a overbought signal in a bull run. Because it has no fear, it will keep doing that until it has no money left.

Today is the second day of the experiment. The computer closed both of them.  The FAZ trade was up 30% and the SRS trade lost 5%. 

When I woke up this morning, FAZ was up 15% in pre market.  And the computer sent a sell order right after the opening bell rang.  It kept checking the gain/loss of these 2 positions tick by tick.  In terms of the FAZ position, if the gain was = or > 25% and a sell order would be executed. Due to the gap up, it was 5% more than the targeted 25%.  That was a bonus.  Of course, that would be extra risk if it were in the different direction than my trade. For the SRS position, the gain never reached 25%, and it hit the stop loss, 5% and it was out.

The FAZ exit was perfect.  It was almost the high of the day.   Question is whether it should be considered luck or discipline.  The computer knew it captured a giant return (30% in 2 days) and it was neither afraid nor greedy.   Greed and fear are the biggest enemies of traders.  The computer has none of those issues.  So It held onto the FAZ position and closed it according to the plan.  It never flinched in any order executions.  I have no problem closing a position when it hits its target.  If you have been reading my blog for while, you know that.  But I still have issues pulling the trigger when there is entry signals  The computer also showed rock solid discipline in the execution of the SRS trade because it followed the trading plan religiously.  The experiment will carry on with SRS.   Let’s see if SRS will show us the darkest side of machine trading.  That is 5 losers in a row. 

Here are the 2 trades closed today.  Click on the pictures to have a better view

What do you think?

Today is the first day of the experiment.  The market dropped really hard today and my inverse leveraged ETFs did pretty well. There was not any meaningful retracement during the whole session.  This means the bears were in total control. So we might see further weakness in the next few days.  As I mentioned a week ago that 8000 is a very strong resistance.  And it is.  The market has been chopping around 8000 for a while.   It is way overdue for a correction.   The economy is not going to get any better just because the accounting method was relaxed.

Bank of American released their first quarter earnings that is 10 times what most analysts expected.  And it tanked hard. Some people must be perplexed.  Do not be.  Most traders/investors think their earnings are just fluff.  Price action triumphs over anything.  Capital One and C also tanked hard.

I did not take any day trades. I was basically just monitoring the automated executions of SRS and FAZ.   Sometimes Tradestaion malfunctions although the software is very stable for my regular trading. Monitoring  is a piece of cake since all I have to do is to make sure it takes/exits the trades as planed, the Internet connection is on, and the trading windows are not jammed.  I did not have to make any trading decisions,which made my life a lot easier.

Probably you are more interested in seeing the trades than hearing me babbling. OK without further ado, here you are.  I will do a thorough analysis of the trades after the experiment is finished. The significant bars are marked with white arrows. Please note this is a variant of the engulfing pattern I showed you.  Fill the gap with some green play doh, you have a big green engulfing bar. In real life, it is rare to see text book set-ups.

Click on the pictures below to have a better view. 

SRS opened @ 30.16

FAZ opened @ 10.18

I am going to have an experiment here to test out automation of trading SRS and FAZ.  I do not know if it works.  It just might. I will open 2 small positions, 5k each in SRS and FAZ.

The set-up is simple.  I am looking for an engulfing bar using the 60 min charts.   The engulfing bar must be big enough to engulf(cover) the last significant red bar. A market order will be sent right after the close of the engulfing bar.   Here is the illustration of the engulfing pattern.   

Here is the Set-Up

• Go long right after the close of the 60 min engulfing bar
• Stop Loss will be 5%. If it gaps down by 10% and it will be considered 2 losers in row. 
• And the risk/reward ratio will be 1:5.   That makes it 5%:25% 

A good outcome will be anything that I do not have 5 losers in a row. The experiment will finish either when one hits the target before sustaining 5 losers in a row or when it loses 5 times in a row. It will start from Monday.  The computer will totally take emotion control out of my hand.  Let’s see how it works. I think it is going to beat me.  The trades will be excluded from my portfolio.   Feel free to ask me questions.

Here are the 60 min charts of SRS and FAZ at the end of 4/17/2008.

Here is the ongoing experiment:  Day 1 Day 2

The market was very choppy today and I took a beating(-1300).  I took 3 trades that were 1 small winner(bidu) and 2 big losers(SRS and FAZ).   You can see the trades in my portfolio.
 

I guess this had something to do with  the Somali pirates that were shot dead by the Navy snipers.  What were these pirates thinking?  They had a horrible set-up(asking the massive warship to tow them) with a horrible risk/reward ratio of 3:1. How did they come up with this kind of set-up? This question bugged me all day long and totally distracted me. These Damn Pirates!  However, I still had a tiny winner and they were all losers.  So I beat them by a very small margin today.

Here are the 2 big losers. 2 pictures are worth 2 thousand words.

Tell me whether I have beaten the pirates…….

A lot of people love FAZ because they can make a killing quickly when their bet is right on the target and they hate it because they are killed when their bet is off. It is all attributed to its volatility. Volatility is the nickname of all these triple leveraged ETFs. Analyzing or back testing stocks is the homework I do every night to better myself. I have already passed the stage of losing money due to my solid risk control. But I still need to work very hard to improve my emotional control.

How do I improve my emotional control? If I am very confident in my system, I would never hesitate to pull the trigger when there are signals for an entry.  So let us analyze FAZ. The chart below is the daily chart of FAZ.

Here is the trading plan that we use to run the back test. It is 100% TA driven.

1.  I am a swing trader. So no day trading is involved in this test.
2.  I run a 100k account for the sake of easy calculations
3.  My risk/reward ratio is 1:3.5
4.  Buy major support and short major resistance

For condition 3, my risk/reward ratio normally is 1:3 or 5% : 15% for regular stocks.  But for FAZ, let’s raise it slightly to 1:3.5 due to it is volatility. So percentage wise, it will be 15% : 53%. Why 15? It is because it is a triple leveraged fund. We need to multiple our regular 5% by 3.

Assuming I run a 100k account and I am conformable with a 20k swing position in a regular stock. For FAZ, I need to reduce the position size to 7K per trade because it is triple-leveraged. OK let us trade…..

When the first bottom labeled “1″(a major support) was formed, I took a trade and held onto it until it hit the target, assuming I had been desensitized. As we can see, the 15% stop loss gave me quite some room to wiggle.  It resulted in a successful hit, a 3500 profit. Let’s move on.

When the second bottom labeled “2″(another major support) was formed, I took another trade and held onto it until it hit the target, assuming I had been desensitized again. It gave me another successful hit, a 3500 profit, totaling 7000 after 2 trades.

When the third bottom labeled “3″(another major support) was formed, I took another trade and it was stopped. So I lost 1050. Since the major support was cracked after this trade, I would not touch until another major support is formed.

So I would have totaled 6000 in profits after 3 trades.  Of course I would make 60k if I increased my position size to 70K. And if I had the “courage” to bet 70% of my total stake on such a volatile stock and hold onto it overnight, I would NOT last long in this market.

So from this back testing, we can say that these would be very solid trades if I actually took them. And these trades would be successful only if I religiously followed my plan.  One key element besides “cut the losers and let the winners run” is never second guess your system. That is you need to take all the signals it feeds you.   Would you have a lot more confidence when you have a good understanding of your system?  Random shooting is absolutely a no-no. Let me know what you think.

I did not take any trades in the past 2 days since I was not prepared for the long side. Have a nice long weekend ,everybody!

Tomorrow I will focus on these 2 stocks, MGM and RIMM. These 2 stocks shot up too fast and too much. They are due for a serious reaction.   What I mean by a serious reaction is a 4-5% drop or even more.  They are definitely good for day trading.  I will not swing short them though, especially RIMM since it has been very strong lately.  I might go swing long on FAZ again tomorrow if it shows signs of strength.

Click on the pictures to have a better view

MGM has a long upper shadow with huge volume on its daily chart, which is a tpyical sign of weakness.

RIMM has not showed any signs of weakness yet.  I will be patient.

Here is how I lost only a little bit over 300 on my GS short position. Here is the playback of this swing trade.  I opened a short position on 3/30/09 @ 103.91 and it tanked to around 100.  So there were around 400 paper profits and I ended up losing 300+.  If I had the ability to look ahead in time, I would have covered my GS around 100.  This kind of scenario happens only in my wildest day dreams. To achieve something extraordinary, you will have to be a dreamer, a doer and a calculating risk taker. Here is why…  For example, when you were a kid and your parents always told you that you should …….  I am sorry about digressing.  Back onto trading.

Ok so that was like 700 dollars from +400 to -300.  I am totally fine with this. I was just following my trading plan.  If every time I take a small profit like this, I would never ever catch anything like this (FAZ: 31% Gain (8k+) in 2 Days) or that (How I held onto FAS for a 26% gain for a day trade.). I closed the position this morning when I saw something strange. The market gapped down quite deeply. Yet GS showed all upward strengths.  Within 5-6 minutes, it turned green while the market was still very weak.  Something was not right.   If a stock does not act right, get rid of it.  GS should have gone down with the market.  Yet it did not.  So it did not act right and I got rid of it quickly. I would have been stopped out later anyway. But my quick reaction saved me a couple of hundreds dollars. Here is the chart and my GS trade.

I took a day trade in FAZ and made 400+ and I also opened a small swing long position in FAZ.  Let’s see how it plays out.

We have seen a solid rally for the past 3 weeks that almost erased the entire loss of 2009.   Have we hit a major bottom here?  It is possible.  But it is meaningless for day traders and short swing traders like me since our timeframes are very short.  Let’s assume that we have hit a major bottom here.  The market is going to chop after such a big rally.   I firmly believe that 8000 is a formidable resistance for the bulls.  It is equally hard for the bears to bring the general market to a new low.  So we will perhaps see a chopping range for a few weeks before the market chooses a direction to break out.    Since targets for my swing positions are mostly 15%, so the ensuing range-bound moves should be good enough for my set-ups.    Occasionally my target is 12% for big cap stocks like AAPL, GS or RIMM etc. or 20% for volatile mid-cap such as WLT or NOV.  I like breakouts/resistance/support for day trading.   Day trading is like all you can eat buffet for me.   I almost only buy support and short resistance for swing trading.

 
Since I believe it is very hard for the rally to continue beyond the 8000 level.   I have been looking for short set-ups or long set-ups in the inverse ETFs.   The first one is of course the most loved and hated FAZ. Click on the pictures to have a better view

FAZ

From the chart above, we can see a few characters that are quite interesting.

1.  There is a pretty solid double bottom formation, which is one of my favorite patterns

2.  The first dead cat bounce met the resistance around 22.33 or 23.60% of the Fibonacci retracement line.

3.  The volume has slight increased, meaning there was some buying interest at this level.

I hope it does not gap up on Monday so I will have a chance to get in.  My first target will be around 25 (30% from here @ 19.87).  Second target will be around 29, which is 50% of the retracement.  My stop loss will be around 18.

AMG  [Affiliated Managers Group]

1.  It is a text book double top formation.

2   It is very close to the last resistance area which formed around 2/5/09

APOL [Apollo Group, Inc]

1. It has had very sluggish moves in the past few days.

2. It has touched the suppressing trend line



GS [Goldman Sachs Group, Inc]

1. A double top is in the making.

2. The financial sector has seen a very strong rally.  It might require a strong reaction

WLT [ Walter Industries, Inc]

1.  The coal sector was quite strong in the past few weeks.  It might require some reaction

2.  It has sluggish moves in the past few days.

BXP [ Boston Properties, Inc]

1.  it is extremely weak

2.  It seems to have broken the last trading range
This stock is not volatile.  My target will be 12% if I decide to open a short position

 
FLSR [ First Solar, Inc.]

FLSR is actually very interesting.  It has formed a very bullish wedge.  The consolidation seems to be very healthy.  I will not touch it for now.

No matter how convinced I am by my own technical analysis, my risk control will always be in place.

I think we have hit a massive resistance. As we can see from the Dow’s Daily Chart, the last trading range was very thick and a lot of people went long thinking that was a bottom are eager to get out.  So there will be massive selling in that range. It will take some time for the market to wear out those trapped bulls.  Once some of them are out, we might see upward moves with the help of some good news.

Click the pictures to have a better view

I am still bearish. That is why I have FAZ.  Now I am up 10% in FAZ again. So I will move my stop to break-even. My target is 30%.  I think 30% is very conservative here.

Where do you think FAZ will stand 3 days from now?