EVIDENCE BASED TRADING; LETTING PROFITS RUN November 27, 2009
Posted by Marlowe Cassetti in Blogroll.trackback
US stocks follow world markets lower on concerns Dubai debt problems may hurt economic rebound
This was the sideswipe investors had feared.
The stock market is in the middle of one of the great rallies of a generation, but for weeks there has been a nagging fear that bad news was never far off. The news came from Dubai, a wealthy Middle Eastern city-state that many Americans probably couldn’t find on a map. Concerns that a government-backed investment company risked defaulting on $60 billion in debt ripped through world markets and served as a reminder of how fragile the financial system remains a year after it nearly collapsed. (courtesy of AP Business)
I have been working on one of the items high up in priority on my “job jar” list. The thing that has been nagging me for some time now has to do with the pros and cons of using a profit target. Pick up any book, or go to any seminar on trading and most likely you will find the following imperative “always have a profit target before entering a trade”. On the other hand there are others that promote letting your profits run. An intermediate strategy is to use an alternative trailing stop. I’m homing in on utilizing a modified trailing stop. It works this way…Upon entering the trade you enter a stop loss at the prescribed level of 0.9 Nx. Next place an alert at profit target of 2.0 Nx. After the alert is hit you enter a trailing stop of 0.3 Nx. I will be firming up these numbers after my investigation is finished. Okay, so what can we expect from RSI after these modifications? The following chart shows the histogram of 230 simulated closed trades spanning 2 1/2 years using our standard $1,000 (1% portfolio) risk. Winning trades peak at $1,800 while the losers peak at $1,000. Notice there are over twice as many wining trades as losers. These two peaks are determined by the 0.9 Nx and 2.0 -0.3 Nx factors. Using this modified trailing stop gives more opportunities for profits to move to the right of the peak. It allows profits to run.
So now you see what evidence based trading is all about. You develop a model, a simulation if you will, of your trading system and then test various strategies. Then you evaluate the objective results. Instead of operating on hope or intuition or guesswork or hearsay you utilize hard evidence, just like on CSI. For years I used the 8% stop loss recommended by IBD. Now I have evidence to go a different path. This is still a work in progress and the numbers are only examples. I will update the status of this investigation as it works into the operational system.
There are many caveats associated with this analysis. The important point is there are simulated results are not the results of real world trades. In a future blogs I will discuss some of the shortcomings of simulated trading.
Okay, with all this heavy stuff out of the way I need to report that RSI has no picks today. So have a great weekend and I’ll catch you after the market close next Monday.
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