In my June 1st posting I state:

And in trading system news, I believe I'm about 1 month away from testing another trading system.  I haven't figured out if I want to use options or just plain stock yet.  It's a quick "in and out" type trading system with a maximum hold time of about 10 sessions.  It may be tough to overcome the option spreads in so little time. This is what testing is for though.  I may test with both vehicles and see which one makes the most sense.  I'll share results here. 

Welp, I'm ready to go live and I've decided to go with options.  I've made some slight modifications to the system to support more liquid contracts which resulted in less symbols in the watchlist which increased the hold time and reduced the number of trades.  The selection of options over stock has also increased my hold time because part of the adaptation results in being short theta (i.e. drawing benefit from time decay).

So the testing will begin.  As I've mentioned before, backtesting results do not always translate well into the real world.  There are a number of reasons for it, curve fitting, data mining and emotions all come into play.  So I like to take it slow and enter in with single contract positions.  I'll share my entries and exits along with the options strategy.  I'll lag my actual entries because I don't want anyone to stupidly follow me.

This is the testing phase!  It will probably take several months (if I'm lucky) to put any real money from my speculative pot into this idea.  This is also a low frequency trading system.  Again, most of the benefit is drawn from letting short options expire.  When I enter the trade, I'll feel that there's a high probability that the current price will hold, increase or decrease slightly over the next month.  I expect the system to average one trade per month.  And I do mean average because we could go 5 months without a trade and then get 5 trades in a month.

Be warned, few of my trading system ideas make it to the testing phase and even fewer make it beyond testing. 

Someone made a good point yesterday regarding technical analysis and market timing among the asset allocators.  These are the buy and hold folks (like me on my long term holdings) who all of a sudden know and practice technical analysis.  They start with something simple like the 200 day simple moving average and then graduate to SMA crossovers and then when those two seem shaky, it's the EMA that's the REAL holy grail.  This new found love for TA just so happened to flourish when the market tanked.  Up until that point, most buy and hold guys despised technical analysis.

What doesn't help one bit is that the 200 day SMA did provide a great exit signal this time around. Imagine if you gave your kid $5,000 to invest.  The kid picked a bunch of bio techs that went to the moon and doubled the money to $10,000. You know how that kid would feel? He's a better stock picker than Cramer (well, he probably is, but that's not the point). So he continues to take wild risks thinking that he knows the next greatest thing. There's a high probability that he will lose in the end. Hopefully, the experience humbled him.

This has been the basis for my studies posted over the last couple of days.  I feel the need to debunk a lot of the crap floating around and get people to understand and test for themselves.  Don't shoot the messenger, but these extremely simple strategies have been known for decades and have been proven random by the system builders many times over. To think that all of a sudden they work is fooling yourself.

Back when the VIX was at 10 in 2006, long term holders began to pile into risk.  There was supporting evidence that emerging markets, small caps and even a diversified individual stock portfolio was the key to outperforming.  Now the crowd discussion has turned to commodities, gold, bonds and even currencies.  It will be interesting to see if this is also cyclical.  The VIX will some day hover in the low teens, risk will be forgotten, TA will be a way to "surely underperform", high risk asset classes will be all the rage.  We can only wait and see.

In the meantime, I sincerely hope those that are newly crowned technical analysis experts do take the time to study and understand how system building works and how to test trading systems for randomness.  This doesn't mean reading other people's studies! This means doing your own homework and understanding the risk you're taking.

I lost a lot of money in my early days of system building thinking that I knew what I was doing and found the grail. It's easy to get the comptuer to lie to you or fool you with data. Please exercise caution!

OK, it's that time again where the market hits a moving average point and everyone becomes a moving average expert.  It's easy, you can point to a chart during a cherry picked timeframe on a cherry picked index and make it look like it's a flawless entry point.  Sorry if this has a bit of a negative, smart assy tone, but to me the only thing that's flawlessly predictable about index SMA encounters.  There will be countless 'experts' coming out of the woodwork telling us about how wondering moving averages are for market timing.  The last time this happened, I did a little research of my own regarding whether or not the SMA alone was a good indicator for market timing.  The results can be found here.   I'm updating my SMA test results with a twist, I'm going to pit the simple moving average against the exponential moving average.

OK, enough of my jibber jabber.  This time we're going to run the same system, but instead of using the simple moving average, we'll substitute with an exponential moving average.

Just like last time, the data is from Yahoo. The system is done with RightEdge and I posted the trading system on the RightEdge web site for download here.

Here are the inputs:

IXIC = Nasdaq Composite. Data available was from 1972 to present

GSPC = S&P 500. Data available was from 1960 to present.

DJIA = Dow Jones Industrial Average. Data available was from 1960 to present.

I've also rerun the SMA strategy with the most up to date data and so that we can compare them side to side.  I've also included buy and hold results, so we can compare three ways.  The starting capital is $100,000.

The results are in:

There are some notable omissions.  There is time spent out of the market, so loss of dividends is not factored in.  Second, transaction costs.  I didn't put the # of trades per system for lack of room, but the trades per index averaged about 10 per year.  Third, taxable events.  Buying and selling like this could trigger multiple taxable events.  And for U.S. investors, the short term gain rate is higher than the long term rate.

The results for EMA seem a little bit better than SMA, except for the Nasdaq where they seem about the same.  We're talking about less than 1% APR on either side (whether EMA did better or worse than SMA).  I'm not sure this is something to shout from the rooftops.  To me, this seemingly slight edge is within the range of statistically insignificant.

But let's say a 1% additional return was significant enough and sustainable, on average, the EMA based trading systems had more trades than the SMA trading system.  So trading costs and taxation should be a large concern.

An interesting development here is that almost all of the moving average systems have now done better than buy and hold since I last ran the test.  It just so happens that the moving average was a great indicator to get out and saved you a ton of drawdown this go around.  It might be fun to run this again in another couple of years to see how whipsaws and potentially a new bull market play into the results.

By special request, someone asked to see the results of a moving average crossover system.  Specifically the 50 SMA over the 200 SMA.  I took the liberty of doing it against the 3 major averages as done in my last tests.

Rules:
The rule is to get in when the 50 day SMA crosses over the 200 day SMA and to exit the market when the 50 day SMA crosses under the 200 day SMA (signaling weakening demand).

Inputs:
IXIC = Nasdaq Composite. Data available was from 1972 to present
GSPC = S&P 500. Data available was from 1960 to present.
DJIA = Dow Jones Industrial Average. Data available was from 1960 to present.

Starting Capital: $100,000

Results:

I don't see anything statistically significant here.  The system seems fairly rotten, but I do have one excuse for it.  It did not enter the Nasdaq for over 6 years because the 50 day SMA was always above the 200 day SMA during that time.  If this system showed some signs of promise, I'd tweak it to enter the market on the first date of data knowing that being long the market is typically better than being out of the market for long stretches of time.  Of course, that's a bias and may not be true moving forward.

I only have a week and two days left until expiration.  At the risk of being assigned, I closed my calendar spread.  I've been waiting on a 1+% down day to hopefully spike volatility a bit and give me a few nickels back.  Today was the day.

I opened the spread for .70 debit and closed for .50 for a net loss of $20 per spread.  I may open another bearish spread on the JUL/AUG calls within the next few days.  To be quite honest, I'm impressed with the market's resilience.  I honestly expected to be defending my calendar spread, but to the downside.  My sweet spot was 840-860 on the SPX, and seeing sub 840 wasn't completely out of the question in my eyes.  Shows you what I know.  The punishment for being wrong wasn't much though.  The reward for being right could've been much better.

My next stop for jumping in front of the freight train that is the market is likely 950ish.  There have been gap ups in the morning that come close to this level.  If I can catch one some morning, I may hop on and see where it takes me.

What'll be extra funny is if the SPX is hovering between 840-860 by next Friday. I can only laugh because it's happened to me more than once. :)

The conventional wisdom is that closed ended funds, or CEFs provide a bit more volatile ride than open ended funds.  This is usually because they can trade significantly higher or lower than the net asset value.  The premium/discount of the CEF represents the value that it is above or below the net asset value or NAV. Typically, during bull markets, CEFs tend to run at a premium to NAV, during bears, a discount.  At the end of last year, CEF discounts were significant across the board.  I don't like to speculate on whether a discount represents value, which is one of the reasons why I don't do too much with CEFs.  However, the broad based discount was too much to ignore for a 'buy low' kinda guy like me.  In fact, I picked up some BEP in November and Decemeber when I felt asset prices were very depressed and add to that a decent discount to NAV on BEP which doesn't happen very often.

At the risk of monkeying around too much with long term holdings, my BEP holding has caught my eye for the same two reasons why I purchased it to begin with. Except for now I feel that equity prices are a bit rich short term and that BEP is at a high premium to NAV.

Things are very interesting for my bearish position.  As I mentioned, my new profit target is around 875 for the SPX, which seems like light years away.  After the employment numbers and the futures way up on the news, I was ready to close my bearish calendar at a loss, but before I could do so, the market ran right back down to breakeven on the day.  This feels very weak to me because on 'surprisingly' good numbers, the market could not muster a big rally day.  This feels weak on the short term and made me keep my position opened.  At this point, it is still open but the time is fading.  There is two weeks until expiration and I'm about 65 points away from my profit target.  I'll be looking for an exit in the next couple of weeks, naturally, but I'm highly skeptical that my profit target will be met.

This is one of the drawbacks of a calendar spread.  Sure, you get a low barrier to entry, but in exchange for that, timing is of the essence.  You get to sweat around expiration and what's more, your short option could be assigned.

My point here is to let anyone who is trading short term to understand the psychology.  It's easy to look at a chart or a position after the fact and justify the response, but if you're a bearish / overbought person, what do you do now?  It's not easy on the bull or bear side.  Hopefully I'll alleviate some the pain by telling you that I'm both long and short.  At least this helps me cope with a strange market.  The bearish position was put in place to hedge some of the gains I received on the long side. I'm happy to see the market move up, but not as sad as most to see the market move down.  This is probably the psychology that should be when in a bull situation with a small bearish hedge. 

The market is toppish at this point.  Anyway you slice it, 40% off the bottom in just a few months is a hell of a move.  It almost rivals the speed at which it raced for the bottom.  I've made a bearish move and I'm also looking to take a little profit on some items that have run hard.  Besides that, there isn't a whole lot to do and I'm quite nervous about putting fresh money into the markets.  There is still an option, pun sort of intended.  Short puts.  I've used this strategy in the past with some success and some pain, but I ended up owning indexes and stocks that I wanted at a discount.  The key for me is to find a stock or index that you'd like to own and determine your 'steal' price.  Sell a put or two below that price.  There are three possible outcomes.  The stock rises, the options expire worthless and you keep the premium.  The stock stalls in a range, above your strike, option expires worthless, you keep the premium (and write more next month).  And finally, the stock moves south, you're assigned and you get a holding you wanted at a discount.

There are some pitfalls, of course, but the worst case situation is that you own the stock.  So if you understand the risk of owning stock (i.e. it can go to 0), you have defined your risk.  There is a subtle pitfall in the way of leverage.  Let's say I sell 10 puts at a 10 strike with a premium of $10 apiece for a $100 credit.  I'm pretty well on the hook for 1,000 shares of stock.  If XYZ falls below $10 on expiration day, I'd better have $10,000 free in my account to accept the assignment.  It is important to understand the aspects of levrage here.

Practice makes perfect.  Don't like the idea of being a cash covered short, start off with a vertical spread.  Back to the $10 strike example, you sold your 10 puts for $100 credit.  What if for $5 per option you could limit your downside to $2,500 instead of $10,000?  You would buy 10 puts at the $7.50 strike.  Now your total risk is the distance between the strikes, minus the credit, for a total risk of $2,450.  That's a pretty expensive hedge, but just serves as an example.

I also prefer vertical spreads on items I don't want to necessarily own, but feel are in a very favorable place for a trade. 

My calendar spreads (discussed here) have received very little drawdown up to this point.  It seemed like I damn near picked a top at SPX 920 (lucky), until today. The SPX never hit my original profit target of 850 and expiration is coming up in the next couple of weeks.  Reviewing the technicals, a reasonable profit target appears to be right around SPX 875.  Now that time has passed, this should offer me a reasonable reward and it's a reasonable pull back point.  What if it doesn't pull back?  Then I lose.  But I had my risk clearly defined and well established going in, so it's not a huge deal.  I also have a lot more eggs in the bull basket than the bear, so I'm happy to see up moves.  I'm in this to make money, not be right.  

On the upside, VWO is really moving.  It is up 18% from my cost and is the strongest performer in the portfolio.  My only regret is that I didn't get filled on a 19.99 GTC order late last year.  I'll settle for up 18% though.

And in trading system news, I believe I'm about 1 month away from testing another trading system.  I haven't figured out if I want to use options or just plain stock yet.  It's a quick "in and out" type trading system with a maximum hold time of about 10 sessions.  It may be tough to overcome the option spreads in so little time. This is what testing is for though.  I may test with both vehicles and see which one makes the most sense.  I'll share results here.