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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?

Only triple leveraged ETFs can give you that kind of reward.   Of course, the same goes for the risk in trading these leveraged ETFs.  The rally lasted for a few days for a few reasons

1.  FED said something that I do not even remember.
2.  The CEOs of Bank of American and Citi said they were profitable last month.

I still remember clearly that  Dick Fuld, the CEO of now bankrupted investment bank, Lehman Brothers, said “We are not Bear Sterns and We are in a very good standing”  when the price of their stock stood around 44. 

As I indicated in this post http://www.momdaytrader.com/blog/2009/03/18/stock-market-which-hat-are-you-wearing/,  I was going to swing trade FAZ and SRS.    That is exactly what I did.  Well I did not trade SRS because they move in the same direction and FAZ is more volatile.  All my trader friends on Twitter talked about this and knew that I was going to trade them. You can see all my trading thoughts published here http://twitter.com/trader_mom.   It takes 2 minutes to join us on Twitter and it is totally free. 

Here is the FAZ trade.  Click on the picture to have a better view.

If you have been following my portfolio, you know that I did not take the 10% profit in my last FAZ trade.  Had I taken that profit, I would have ended up with only 10% in this trade too. That is why a trading plan is very important. For readers not familiar with these inverse ETFs,  they go up when the market goes down and vice versa.  They are leveraged short funds.  If I think the market is going down, then I will go long on FAZ, which is equivalent to shorting the market.  Here are my thoughts on the FAZ trade above.

1.  Odds were in my favor since my system had had a bunch of small losers in a row. It was about time to hit something. 
2.  It was a 26k worth position.  If we multiple it by 3(triple leveraged fund), it is 78k. I normally outlay 50-60k for one batch of trades.  So I increased the position size, which I explained in this post http://www.momdaytrader.com/blog/2009/02/02/day-trading-fas-one-shot-one-kill/ 
3.  Here is the most important thing. I was up close to 10% on the same day as I opened it. 3X ETFs rarely gap-down more than 15%. If it had gaped down next day by 15%, I would have lost only 5 %( 1300). My target was 40% or around 10000. 1300:10000 was a very good R/R set-up.  My first stop loss was 10% that would make the R/R ratio 1:4 which was not bad at all. 
4.  The Odds was in my favor and it had a solid risk/reward ratio. I had to pull the trigger.

Tactically speaking, here are 2 things

1. I did not try to catch the bottom as you could see from the chart above. 
2. I would have held onto it for the 40% target if it were not for the weekend.   And because I had a specific target in my mind, I did not prematurely exit it. I moved my stop loss to break even after I was up around 10% and never touched it again until I closed it.

The market has seen a bear market rally lately. I was not able to catch this rally since my system did not generate any signals. I am totally fine with it since it is very hard to catch all the moves.  The question is how much longer this rally will last. I am wearing a bear hat now. My bearish view is strictly pertaining to swing trading. Here is why.

From the start of this bear market that started in Nov. 2007, it has been right to short into every single rally. Why is this rally different than every other? We can not rule out the possibility of mid term reversal. But that kind of probability is quite low until I can see some tangible signs indicated by weekly and monthly charts.

As a successful trader, you and I always choose the path of the least resistance. That path is of course on the bear side because we are in a very big bear market. You should always try to short 70% of the time and long 30%. In other words, follow the trend aka Path of the least resistance. Ok, so we know what the general direction is. Shorting is my strategy.  We need tactics also.

The first is timing. That is I will not short into this rally blindly. I will wait for my indictors to show signs of weakness. Of course we all know technical indicators will be off the mark quite often. But that is OK. I will get out of my short positions as quickly as possible to keep my losers small.  As you could see from my WLT, FAZ and GS, I had 10% paper profits from both FAZ and WLT. I had to close them since I don’t allow such positions turn into losers once they have a 5-7% paper profits before they hit their targets. People who have been following my portfolio for a while know this. GS was a completely loser. It just hit my stop loss.

The second is that I will keep shorting into the rally until my system tells that we are possibly going to see a major reversal. I will not hesitate to short into it just because my first attempt failed.

The third is that I will hold onto my winners once they start to move in my direction.

All these 3 are very important. If any one of these 3 is missing, it will greatly increase my risk.

Which direction do you think SRS and FAZ will give us the best Risk/Reward set-ups?   I will go long on these on any signs of weakness in the general market and my profit target for FAZ will be at least 40% and 30% for SRS.  When they were high up over 100 dollars, I could not short them.   Now I should have no issues going long on them

Click the photos to enlarge them

 FAZ

 SRS

The stock market had a big rally today. This is actually pretty predictable. I have been talking about shorting FAZ since last Thursday night on Twitter. I mentioned that we might have some opportunities to short FAZ for really fat profits (20-30% in a matter of 2-3 days). Let’s take a look at the daily charts of FAZ

As we can see that it approached the previous high on last Thursday and rose from 40-80 in a matter of a few days . Forget about the fundamentals and forget about that we are a in a big recession. Technical analysis says you do not have good set-ups on the long side of FAZ and your risk-reward-ratio would be totally out of proportion if you do.

 My first attempt to short FAZ was on Friday. I had a relatively big position (50k worth). But it did not hit my target. Percentage wise, it was a small winner compared with today’s. Now let’s take a look at my FAS trade today since FAZ was not shortable. I only took one trade and it was up 26%. You do not see this kind of big day trading movers everyday. How on earth did I have the willpower to hold on it? We will come to that part later. Let’s take a look at the entry. A good entry is half a battle.

For frequent readers of my blog, you know I like this kind of entries very much. That is to short double tops and long double bottoms. Of course, I also like wedges, pennants, flags, and cup-and-handles. My entry was after a W bottom formed at 2. That entry was fine. However, if you entered around 3, that would make your entry perfect since that bottom completed the famous header and shoulder pattern if you include the bottom yesterday, which is 1. If you did not include 1, then bottom 3 and bottom 2 formed a double bottom on today’s chart. No matter how you slice it, there were very strong entry signals.

How on earth could I hold onto it for so long?

Normally, I have 6-7% profit targets for day trades. But it was not the case for this one. I aimed for a much bigger profit. I have been talking about big profits in shorting FAZ since last Thursday night. Why would I barge for a 6-7% gain? How did I cope with my emotions? LOL, I went to nap after I moved my stop loss to break even and when I woke up. Voilà! it was up big nice. It never had meaningful retraces, which made it easy to hold onto it. Had it gone down, I would have been stopped out break-even. That is my stop loss would do its job. It was also attributed to my small position (around 13k). I would have made 10k if my FAS position today was worth 50k like the FAZ trade I took last Friday. But I might not have been able to control my emotions well.

Here is the summary.

1: followed my plan
2: total conviction. When a trade is in motion, I never listen to anyone or anything including any news.
3: a small position.

My only swing long SOHU is doing great. Here is my portfolio and my real time stocktwits

It is good to respect risk in trading. However, if you are overly cautious, it is equally detrimental to your trading as you will see from my today’s FAZ trading.

Today, I went long on FAZ the first time. The entry was almost perfect. But I left so much money on the table. Why? I chickened out. Here is the chart. What makes trading hard is that we will have to make almost everything aligned for a successful trade.

1: a good entry.
2: a good exit
3: luck
4: willpower to stick to your plan(emotion control)

It was a text book set-up(a wedge) again. There are just so many patterns to trade. Check out the “Candle Sticks” and “Comprehensive” sections of my libray.

Here is the 5 min chart.

My entry was good, but not perfect. If I had waited a bit more, I would not have bought it on the head of that candle(upper shadow). Since this guy moves big and fast, we really do not have to fuss over a small spread like that. So the entry was very solid.

My exit was horrible. It was beyond the words. After it spiked by 2 percent, I started my trailing stop which took out of my stop. It was like a thief who stole my money and ran faster than anyone. See how big and fast it moved after shaking me out. The reason I started my trailing stop was because I chickened out. It was simple as that.

It was a brutal day for the bulls including me. The market gapped down big because of the following reasons

• Dismal economic data from Japan
• Possible downgrades for various Europe banks
• Possible bankruptcy of the Big 3 auto-makers

Day Trading: Down 1100

Swing Trading: Down 790

I was down around 1000 from shorting our beloved FAZ. My position size was a bit too big. Other than that, there was nothing particularly bad. Of course, I was on the wrong side of the game. The bears ruled all day long today. However, being on the wrong side of the game is very normal. It is just part of the business.

It was not really an easy day for day trading FAZ today. After its huge gap-up, there were not any meaningful moves in either direction. Because I am not good at scalping, I tend to lose in this kind of choppy market. The flip side is that I can catch big fish when it does move.

As for swing trading, my ERX is gone. It hit my stop loss. It was once up nice on paper and now I lost 700+. No big deal. I will try it again later.

Right now, I think I will stand on the sideline for swing trading. So should you. We have officially broken a very solid, multi-week support. If the low holds tomorrow, then we all can put on the bear hat.

I think following is a strategy to trade all these leveraged ETFs. This strategy is contributed by a trader friend. With his consent, I post it here so others can benefit from it too.

When you’re trading ETFS, find out what the components are and watch those and the news as indicators on your entries and exits. A lot of ETFs are administered by http://www.proshares.com/, it’s easy enough to find which stocks they are comprised of and what % those play. It changes a bit every so often but it’s a really helpful indicator.

If you’re trading SRS, watch SPG in particular but also know that:

Simon Property Group Inc. 6.82%
Public Storage 5.87%
Vornado Realty Trust 4.99%
Annaly Capital Management Inc. 4.90%
Equity Residential 4.64%
HCP Inc. 4.03%

To effectively trade SRS, open two level two boxes, one with SRS the other with SPG. Study the T/S, watch what each do in relation to the other. Open a chart and overlay SRS and SPG. Finally, if your trading platform allows you to follow spreads, create a spread between SRS and SPG and watch those. It takes a day or two of a somewhat intense study, but once you’ve figured out the relationship between the two, you can makes piles of money trading SRS.

The same stands true for FAZ, although it’s not a proshare and it’s harder to find information on it. I’ve watched it for a while and find that following JPM is the most accurate way of understanding what FAZ will do.

Do not swing these and make sure you have tight stop losses in place and honour those stops. I’ve watched SRS move $20 in a day, you really don’t want to be on the losing side of that. It’s much better to lose an opportunity than lose the money.

Of course, you still need to combine this strategy with your risk control and exit strategies .