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Discussion
(ideas suggested by our members)

Table of Contents


- Strategies for the bear market
- Modification of the Basic Trading Strategy (plus questions and answers)
- Selling short strategy in 2000
- New method of dividing trading capital
- Stock options and trading strategies
- Buying stocks using LIMIT orders
- Price drop during the day of the analysis
- New BPTS idea
- Low risk trading strategy
- Extra money
- Stock selection



Strategies for the bear market
I was reviewing the stta material as I do on a periodic basis and had a thought I would like to ask about.  If I understand correctly--the short criteria are oversold in a 16 AND 32 day time frame.  The long criteria by contrast is oversold in a 16 OR 32 day time period.  My question is this---in view of the bear market environment we are in (and which I expect to continue for some time) would it make sense to apply the 16 and 32 day criteria to long positions.  I realize this would cut down the number but might improve chances for success in view of the basic system drawdowns in three of the last four quarters.  If there is an merit to this perhaps you could note the potential longs that meet both criteria and subscribers could use or ignore as they choose.  Anyway please let me know if there is any statistical significance to this idea.
 
Another thing I have been doing which may or may not be of interest to you.  Due to the severity of the bear market I have come up with a short strategy that I have been using with good success the last several months.  Simply stated I short the basic system long picks on the day the longs are sold.  I then place a buy stop of a dollar to a dollar and a half depending on the price of the stock.  I hold the position and sell half at a 10% gain and then move stop down and try for more profit.
 
Now I know this strategy would not work in a bull market and I suspend the strategy during market bounce periods like the last few days.  I also do not trade the basic system long picks during market meltdown periods.  I don't know if you would care to do a statistical analysis of this method but I can tell you it has worked well since the first of this year.
 
As always I thank you for your superior product.  I use nothing but your list in my trading and do a lot of day trading off the list as well.  I do think the bear market has had a dramatic effect on the basic system that will continue as long as the bear continues so I keep trying to adapt to the conditions.  I do not, however, have the knowledge of capabilities to analyze in a statistical sense so hoping you can give me an idea as to whether or not these things have merit.

By the way I would suggerst you folks pick up a copy of "Conquer the Crash" by Robert R. Prechter.  I hope he is wrong with his analysis but think all should be aware in case it continues to unfold as he predicts. 

 

Comments from STTA Consulting
An idea about using 16 AND 32 for bullish list has been checked many times. The list becomes very short and the average profit is very small. Yes, it is working better during the bear market but nobody knows where is the bottom.
 
We have recently finished analysis of playing options (buying put and calls). We used optional stocks only and this analysis confirms our conclusions.
 
We use more strong criteria for bearish stocks for two reasons:
1. Statistical analysis shows better quarterly returns
2. Shorting stocks is a dangerous game and better to have smaller but better list 
 
Described sell-short system worked well just because of the severe bear market. 10 year analysis shows that bullish stocks continue their rise but with smaller "speed"  and it is worth buying other stocks for short-term gain. However you are right: if you short old bullish stocks when a bear market signal appears (the market is short-term overbought) this system should work.

 

 

Modification of the Basic Trading Strategy

I am a long term subscriber to your service and think it is the best thing I have ever seen in my long career in the markets.  I have made a lot of money just using your basic system but I think the markets have changed enough that some modification of your system might be of benefit in the current environment. 

Here is what I have been using with good success.  I run a smoothed 5 period RSI on the daily chart of the stocks selected by the basic system.  I do not buy the two stocks down the most on the day of analysis.  Instead I do the following: 
 
1.  I track the stocks until they meet the criteria based on the 5 period RSI.
2.  The RSI must fall below 15.  Ideally in the 8 to 15 range.
3.  The 5 period RSI must then rise above 20.
4.  I buy near the close on the day that the RSI rises above 20.
5.  I just pass on the trade if the 5 period RSI does not get below 20.
 
Let me illustrate with an example.
 
AGIL was a basic system pick on 2/20/02 at 9.75 and the 5 period RSI was at 15.84.  I do not buy the stock on that day but instead follow it until the RSI goes above 20.  This happened on 2/22  so I buy near the close with the RSI at  25.80 and the price at $10.01.  Two days later the stock opened at  $11.09.

This has prevented buying into stocks that continue to decline after the official buy point of the system.  I have avoided some of the really big hits using this method.
 
I am a full time trader and so I have incorporated some different trade management concepts into the system.  Suffice it to say I sell partial positions as the stock rises and stay in the trade longer than the two days of the basic system.  I also use an initial stop of no more than 10% and move the stop up quickly based on intra day charts and the action of the stock.

I use the daily charts from  Real Tick which has the closing RSI available

Jim Bennet

 

Comments from STTA Consulting
Ii is a very interesting concept. The author of the letter (Jim Bennet) allows any members to ask him any questions about his system. Write us (service@stta-consulting.com) and we will forward your letter to Jim.

Some questions from our members and Jim Bennet's answers

Questions:

How he "smoothes" the 5 period RSI?

On the line numbered 2 of his discussion page write-up,  should the first sentence: "The RSI must fall below 15" read ". . . fall below 20?"

 How long he is willing to track a stock waiting for the RSI to go back above 20.

 If he uses a similar system for short trades.  If so, what does it look like?

Answers

 I use Real Tick and you just check a box on the menu to smooth the 5 day RSI.  I don't know what charting software he uses but I would think most would have this feature.
 
 The line he refers to is right as written.  I like to see the 5 day RSI fall to at least 15 before going back above 20.  Many of the stocks on the list go much lower than that.  Many get down as low as 2 or 3.  This is just a criteria I use.  Some of the stocks I am sure go up without falling below 20.
 
 I haven't used this on short trades but it is an idea that could be looked into.

I track the stocks for several days at least.  No exact time but if list starts to get to long I take a few of them off tracking list.


 

 

 

Selling short strategy in 2000
From STTA Consulting

We have received many questions about performance of selling short strategy in 2000 based on the list of potentially bearish stocks. For the period from January 2000 to November 2000 we calculated the average returns of stocks from the bearish list. We start selling short these stocks at the morning of day #1 (the next day after the day of analysis) and close the position at the market closing of day #4 or #5.

For the full picture we will present the average returns (negative returns are good for selling short) in cases if we close the short positions at the opening of day #2 (o2), at the closing of day#2 (c2), etc. All stocks from the list have been analyzed. We have also calculated the risk/return ratios. They are negative. The closer the ratios to zero, the better.

The returns have been calculated as

R(c1)= (P(c1)/P(o1) -1) * 100%

R(o2)= (P(o2)/P(o1) -1) * 100%

and so on. Have a look at the graphs:

 selling_short.gif (4563 bytes)

One can see that closing position at clo4 is optimal. The risk/return ratio is the best. However, closing positions at clo3 or even at clo3 is also good.


 

 

 

New method of dividing trading capital
The basic strategy calls for the investment portfolio to be equally invested in all trades in terms of dollars (i.e. Trading Capital split into 3 for recurring three day trading window, Daily Capital split equally between 2 trades).

Has STTA ever evaluated the potential to increase return (maybe some increased risk as well) by investing more in stocks with a higher initial day decline? For example, the Low Risk 1 includes stocks with Day 1 Decline >5% (Low Risk 2 >10%).

If on Day 1 there were 2 trades indicated, Trade 1 having a 12% drop, and Trade 2 a 6% drop, would returns be increased by investing 2 dollars in Trade 1 for every dollar in Trade 2?

Example

Trade 1: 12% decline on Day 1
Trade 2: 6% decline on Day 1

$12,000 to invest on Day 1.

Basic Strategy: $6,000 for Trade 1; $6,000 for Trade 2
Revised Basic Strategy: $8,000 for Trade 1; $4,000 for Trade 2

Comments from STTA Consulting
This is a very good idea. Your potential return will be higher and risk will be lower because you will buy more stocks with potentially higher return and lower risk. We do not describe this method in our Text Level-1 and Level-2 just because it takes time to do more calculations during the last minutes of the trading day.


 


Stock Options and Trading Strategies
Has the use of options ever been considered for increasing leverage and ultimate return?

Comments from STTA Consulting
We receive many questions about using stock options to follow ideas of Basic or Low Risk Trading Strategies. We have not finished the full return/risk analysis of various option strategies. Let us show the PRELIMINARY results.

What is bad
-Many brokerage firms do not allow inexperienced traders to buy and sell options. It is related to higher risk of option trading.
- Commissions to buy and sell options are higher.
- A trader should learn complicated option terminology, ticker system, rules, strategies.
- Bid-ask spreads (in %) are higher.
- A trader should remember about option expiration date.
- Not all stocks have options.
- Once again: the risk is higher. There is a high probability of  loosing the whole capital if a trader puts all money in options.

What is good
- The return can be much higher than return of stock trading.
- Options are cheap and a trader needs smaller capital to play this game.

Consider our Low Risk-1 Strategy for trading stocks. The average return  per trade (without transaction cost) is equal to 4.7%. The average transaction cost (commissions and bid-ask spread) is close to 1.5%. Therefore, this strategy is profitable.

For options the transaction cost is much higher. We calculated the average bid-ask spread for 17,000 options and it is equal to

BID-ASK SPREAD = 19% St. Dev. = 31.3%     (ALL OPTIONS)

Options > $2
BID-ASK SPREAD = 7.8%   St. Dev. = 4.4%

Options > $4
BID-ASK SPREAD = 6.1%   St. Dev. = 3.2%

Options > $6
BID-ASK SPREAD = 5.4%   St. Dev. = 2.8%

The options > $2 are usually "in money", i.e. their strike prices are lower than stock prices (for calls). These options have reasonable bead-ask spreads and their prices follow closely to stock prices. It is not true for low priced options which are usually "out of money"   and their prices change little for small price change of corresponding stocks. We think that a trader should use "in money" options to follow our stock trading strategies.

Our selected stocks have an average price about $20. For $4 options the stock price change of 4.7% produces change of option price about 25% what is much larger than transaction costs if a trader buys significant amount of option contracts to reduce the influence of brokerage commissions.

Preliminary conclusion:
using stock options (buying "in money" calls) can be very profitable if a traders selects stocks with high growth probabilities.The return is higher than return of stock trading but the risk of option trading is very high. A trader MUST use a small amount of trading capital for trading options.

 


Buying stocks using LIMIT orders
We receive many questions from our members about buying stocks from the list of potentially bullish stock list if they drop more than 10-15% in the middle of day #1. Some of our members made a very good profit (much better than the Basic Strategy) using this method. We have performed the statistical analysis of this strategy:

Strategy: A trader buys stocks from the bullish list during day #1 using LIMIT orders.  Stocks should be sold at SALE_TIME.

N is number of stocks found during the period from January 1996  to March 2000   (1045 trading days)

RR is the risk to return ratio

LIMIT       SALE_TIME       RETURN      RR         N
=========================================

10%        CLO1                    0.51%            18.2       1521

10%        OPE2                    1.39%             7.5         1521

10%        CLO2                    2.39%              5.3        1521

10%       OPE3                       4.13%             3.4         1521

10%       CLO3                       4.04%             3.7         1521

10%       OPE4                       4.95%              3.15       1521

=========================================

8%      OPE4                     4.17                 3.44      2396

10%    OPE4                     4.95                 3.15     1521

12%    OPE4                     5.63                2.94      1002

14%    OPE4                    5.5                    3.27       667   

=================================

For this period:

RR (one trade) for the Basic Trading Strategy = 3.2  RETURN = 3.48% N = 2090

RR (one trade) for the LOW RISK-1 Trading Strategy = 2.6  RETURN = 4.76% N = 1066

Conclusion: The strategy ( buying with LIMIT = 10 - 12% during day #1 and selling at OPE4) is very profitable but it is more risky than our main strategies.


 

Price drop during the day of the analysis
Our members asked us about the influence of the large price drops during the day of the analysis (day #0) on the average returns per trade.

We have performed calculations of the returns for the stocks selected for the Basic Trading Strategy as a function of price drops during the day of the analysis. Let us show the plot of returns versus price drops:

return and price gaps.GIF (4503 bytes)

Statistics for the period from October 1995 to March 2000.

One can see the positive effect: the larger price drop during the day of the analysis, the larger the average return per trade.


 

New Idea about BPTS

Our users asked us to publish the full SORTED list of stocks (not only two stocks) for Busy People Trading Strategy. Some people want to have a possibility to watch three or more stocks (not only two) with maximal price drops during the last trading day. It increases the probability of buying stocks and can increase the quarterly returns.
Starting January 22, 2000  we begin publishing the list.

 


Low Risk Trading Strategy

I would like to employ the low risk strategy-1 but cannot watch the market at 4 pm. Could you evaluate the strategy when one selects stocks picked for the low risk strategy-1 during DAY-1 and place LIMIT=100% on the next trading day.

What are the average returns, risk to return ratio and probability of buying stocks in this case? Also, if possible to evaluate how would this strategy fare during those mini bear markets? Is it any better or worse than BPTS? Alternatively, can one utilize the idea of the low risk strategy-1 but buy stocks at 1-2 pm rather than at the market close?

 

Comments from STTA Consulting

This idea can not bring a good return. The probability of overnight positive moves for stocks with CLO1 < 0.95*CLO0 (Low Risk Strategy-1) is very high and a trader will miss these moves. Look at statistics (1996 - 2000):

Probability to find such stocks = 38%

Pure Average Return per trade = 2.5%

Risk to Return Ratio = 3.65

Probability of positive return = 62%

These characteristics are worse than the characteristics of the Low Risk Strategy-1 and the Busy People Trading Strategy.

 


Extra Money

If the BPTS is confined to buying only in the case of a 95% (or less) cost relative to the Day 0 analysis, why do you say that money is divided into 3 parts and will be used to buy stocks every day? What if neither stock meets the 95% condition, which, as you point out, is a common occurrance in the low-risk strategies?

 

Comments from STTA Consulting

A trader can divide the capital into 2 parts if the probability of finding stocks is substantially less than 100%. This is often the case for the Low Risk Strategies and the BPTS. The quartely returns can be much larger.

However, we would never do that because  the risk to lose a large portion of the trading capital in one trade is very high. It can kill your courage to trade further.


 

Stock Selection

I am extremely enthusiastic about the system (especially the Low Risk-1) system, and its reward and risk characteristics.

Also, I would like to commend you on your complete documentation of how you select stocks, something which I think is probably unprecedented in a subscriber-based system. The complete technical, yet understandable, documentation leads a subscriber to have confidence in the system.

In implementing your system, I have not always selected the stocks with the most percentage decrease in price. Sometimes I look at the profile of the company (i.e., sometimes I avoid nets or recent IPOs) and its P/E ratio (or lack thereof) to try to pick companies that have good value on the traditional value benchmarks. I may have lost out on a couple highflyers this way, but I feel more comfortable with the stocks I buy.

The one other statistic that I do track on the day of buying stocks is whether the volume for that day is significantly above the average daily volume of the last X days. (I do this using Yahoo! Finance. I'm not exactly sure what X is.). An extremeIy high volume for very oversold stocks that decline in price that day, usually indicates panic selling, and can be what's called "capitulation" selling. After this "capitulation" selling, typically everyone who wants to get out of the stock for whatever reason (including forced selling due to margin calls), has gotten out and the price may bounce over the short term.

I think that this may be an important additional criteria for stock selection, and can increase the average return and probability of success.

I was wondering if any of your studies actually analyzed whether the average returns are better for stocks that had a very high volume compared to average daily volume on the day of selection.

Comments from STTA Consulting

This method of trading is very reasonable. It is more save. The average return can be less (because the number of trades is less) but the risk can be smaller. The problem is: 90% of our selected stocks have bad fundamentals. Our trading methods are based on the reverse market reaction.

We have studied the price-volume patterns but we did not find any significant correlation between increasing volume for oversold stocks and the probability of growth.

 

 
Wish you understand all of this discussion on the stock market? Getting an economics degree could give you a better understanding of the stock market. There are graduate school classes that focus on stocks, and they are a great option for those wishing to further their college educations.