Well its been exactly a year now since we tried to answer the question of "Can you time the market using nothing but Moon Cycles?" The answer continues to look like a 'yes' as the system has made another $2263.50 the past year using a flat $50k buying power per trade for the SPY despite taking quite the hit in January. I've updated all the performance reports below:
Many moons ago....(see what I did there) when I was in my infancy as a trader, I was a regular in a chat room of what used to be pivotfarm where they had a free tool in beta testing that was basically an audio "tape reader." It would make popcorn sounds when big selling pressure was hitting the tape, and crickets when big buying pressure was hitting the tape...anyways there was quite the assortment of traders in the room, & I learned a great deal from many of them. Perhaps one of the greatest lessons that I learned in that room, that I can unequivocally say is one of the few truths of making a living via the markets, is that there is no "right or wrong" way to extract money from the markets. I see it all the time on twitter and elsewhere where traders or money managers think that there is only 1 way to make money in the market, which couldn't be further from the truth. One of the classic debates is the merits of fundamental analysis vs. technical analysis....both camps can argue to the death that one is fubar, and the other is the "only correct way to make money"...but there are tons of guys on both sides that have done just fine for themselves.
So to circle back to the chat room, I remember there was this one trader in there (her name escapes me) but I witnessed her extract money from the markets at an amazing clip, in real time, using nothing but time cycles & moon cycles, all of which are considered nonsense by a large group of traders and investors. She certainly made a believer out of me (keep in mind this was 2008), so I decided to go back and test if there was in fact an edge to be had in trading moon cycles or if my eyes had been deceiving me all those years ago.
Theory: From what I had remembered, the main thesis was to buy a full moon, & sell on the following new moon. So lets see what that looks like in an equity curve....for testing, we will use a flat 50k of buying power per trade rounded down to the nearest 50 shares. We will be testing this idea on the SPY for the last 20 years, I'm not including any slippage or commissions as this is just a thought experiment & not a complete trading system. One last note is that my coding is not exactly perfect, as when I go back and manually review the trades, they are off by 1 day about once a year...even though the moon is almost in a perfect circular orbit, it is not quite perfect....and depending what hemisphere your in (because of the angle you are viewing it from) the phase might appear a tiny bit different. So for this test we are assuming that we are in the northern hemisphere in the eastern standard time zone, and even though the date will sometimes be off by a day, it's close enough so that we can get a general idea of the effect. So without further ado, lets see what it looks like:
So that certainly doesn't suck (keep in mind there are no other filters, no stops, and no profit target of any kind). Assuming you start out with a $25k trading account, the return on initial capital is almost the exact same as buy and hold the last 20 years (284% vs 287%), yet this system is only in the market 50% of the time, & the max drawdown (24.77%) is way less then what buy & hold produces. A couple of interesting notes about the initial test are that when the markets have experienced "bubbles" aka the lead up to the dot com bubble, and our current bubble, this sweet and simple methodology has really done well. It certainly floundered around in the 2000's, but since the bottom in 2009, has really outperformed buy and hold with zero other filters (and no stops). One other big thing I look at to see if something like this is random or might have an edge is simply the percent winners. If the moon cycle theory was totally random, we should expect to see a winning percent of around 50% (or less), but the study comes back at a pretty impressive 65% winners. Taking these things into consideration at least at first glance, its hard to not conclude there is something to the moon cycle and its relationship to the SPY. Lets try to add a simple filter or profit target to see if that improves the results and equity curve.
First lets try adding a simple moving average to define a bull or bear market on the SPY daily chart. We'll test from a 10 SMA-200 SMA in increments of 10 (price must be ABOVE the moving average for the trade to trigger) to see if that improves the moon cycle idea.
So as you can see, pretty mixed results. Using a 170 simple moving average is what tested as best, but we lose a lot of net profit, even though the profit factor is increased. So I wouldn't use this particular filter just because it really doesn't improve the results.
Lets quickly reverse the filter to only take trades in a bear market (or under the moving average) and see what we get. We'll run the same test, 10 SMA - 200 SMA in increments of 10.
Kind of the same story, the efficiency of the idea improves as we get a better profit factor, and bigger average trade for the top results, but comes at the expense of losing a ton of net profit, even at the most optimized values which appear to be outliers.
Lets see if adding a profit target of some kind can improve the idea. We'll test a profit target ranging from 1000-8000 in increments of 500.
So this is a bit more interesting. As you can see, any profit target above 6000 makes no difference, but using a profit target of 1000 seems to be quite helpful. Using the 1000 profit target, you improve the profit factor, cut the max drawdown in almost half, and the equity curve GREATLY improves. You do lose about 4k in net profit, and their is certainly the potential that it is a slight outlier with further testing needed to draw a better conclusion, but at least in this initial test, it is very helpful. Lets quickly test if a stop will help the performance.....it has been my experience that stops on swing trading systems almost always hurt the performance, but lets see if one will help the max drawdown again or improve the profit factor. Here are the results for testing a stop loss between 1000-8000 in increments of 500 (profit target has been removed).
Yep, every single stop hurts the performance.
One other idea I wanted to test was a day of the week filter. The overall market has shown day of the week tendencies previously, so lets see if combining the moon phase tendency with the day of the week tendencies will improve the results. In Tradestation, 1=Monday, 2=Tuesday, 3=Wednesday, 4=Thursday, 5=Friday....also keep in mind that full moons that occur on Saturday or Sunday will be triggered on the following Monday or Tuesday.
Now this is very interesting....Moon cycle trades that occur on Tuesday (2) or Wednesday (3) do very, very well. They both have profit factors over 2, and much larger average net trades. All of the days of the week are profitable, but Friday seems to be the weak link. This filter actually lines up with know performance by the day of the week, as Tuesday and Wednesday are the most positive historically anyways. Here is what the equity curve looks like if you only take the moon cycle trades that fall on Tuesday or Wednesday:
You still get a pretty nasty drawdown in 2008, but the equity curve is certainly better, and a profit factor of 2.11 is certainly an improvement.
Lastly, just for fun, lets see what it looks like if we only take the moon cycle trade on Mon, Tues, Wed, or Thurs and use a 1000 profit target. (Below I've zeroed in on the profit target testing from 500-2000 in increments of 100, and as you can see, 1000 does not appear to be an outlier, as anything from 600-1500 is fairly stable.
Not to shabby....the equity curve really looks pretty good, we improved the profit factor, we greatly improved the max drawdown, and we didn't lose a ton of net profit. So in conclusion, I certainly think there is something to the moon cycle and its effect on the markets. If you really think about it, it's not a stretch to come to the conclusion in the first place since the gravity of the moon effects every living thing on this planet, so why would it NOT effect the markets might be a better question?? There are a TON of other things that could be tested on this theory, and remember this was simply a thought experiment and NOT a complete trading system. But I'm certainly intrigued, and intend to do more testing of my own....if you have any ideas, please share them with me @TRUmav, and I'll share any results, also if you would like the code and workspace, just send me an email at email@example.com.
NOBODY WANTS TO BE THE LAST SOLIDER TO DIE IN WAR, THINGS TO LOOK FOR IN A MARKET TOP PART 2 (Part 1 is below)
(Originally posted 5/15/2013)
"The greatest point of market opportunity is when you feel alone."-James Dalton
"If you can keep your head when all about you
Are losing theirs and blaming it on you;
If you can trust yourself when all men doubt you
But make allowance for their doubting too;
If you can wait and not be tired by waiting..." -Rudyard Kipling
This is part 2 on my series on what to look for in a market top. In this post I'm really going to dig into the details of what to look for and hopefully you will know when the time is right to fade this market, & also (probably more importantly) when the time is not right.
First & foremost, you must first realize that markets very very rarely go straight from bull to bear, or bear to bull. The vast majority of the time, we will go from bull, to balance, to bear, or vice a versa. So basically us traders almost always have some amount of time on our side to realize that the paradigm is about to shift. You don't have to try to short the high tick on longer time frames, its just not necessary. But we have all seen someone the past month desperately trying to justify a failed short in this market. The human mind is hardwired to seek concrete answers. Our tendency is to acknowledge only those answers that support our predisposed beliefs, which can lead to tunnel vision, shortsightedness, & in the end, losing positions (also known as confirmation bias.... here is a great link on cognitive biases that I know you will relate to http://io9.com/5974468/the-most-common-cognitive-biases-that-prevent-you-from-being-rational). We've all seen someone the past month stuck in a short, "Earnings were terrible for this quarter, unemployment is still way to high, our President is running the country into the ground, the Fed cant print money forever!" and so on & so forth. Humans will use any data point or argument (no matter how vague) to justify whatever our belief is, especially when money is on the line!
So lets get into the real nuts & bolts of what to look for when a trend is starting to grow tired. As I mentioned in part 1, market structure is key when assessing risk of any position, & the greatest factor in market structure is balance areas & there relationship to each other.
Clue #1: "The stronger the trend, the greater the distance between successive balance areas. As the auction ages, this distance decreases. In the last stages of the trend, price may continue to rise, but the next balance area will often be resting on top of or within the prior, lower balance area." -James Dalton MIP
And just so you know, the following examples were not cherry picked, AAPL & GMCR were literally the first two stocks on an old watch-list I had.
As you can see in the above example of AAPL, from Sept 2011 through Jan 2012, she created a nice balance area between approx 363-425. At the start of Feb 2012, AAPL broke out of the balance area & proceeded to trend almost 100 handles straight up. She then balanced again between approx 550 to 626, in Aug 2012 she broke out of balance higher again, but here was the shot across the bow to the longs, she trended up only 17 points as compared to the previous breakout of 100 points. AAPL continued to balance just above the old balance area, another shot. The final warning was on 10/8 & 10/9 2012 when AAPL dropped back into the previous balance area (circled in white) & accepted price back in the old balance area. This was a drop dead give away that the longer term bullish trend in AAPL had most likely come to an end. Also on a side note, guess what, you didnt have to short 700 to get a great short trade out of AAPL, you could have simply waited for the 3rd & final shot across the bow & got a nice 250 handle short out of it, no guessing or dart throwing involved!
Clue #2: "Trends that are growing "tired" will begin to exhibit increases volatility w/o producing much further directional progress. Additionally, volume will begin to decrease &, in some cases, auctions that are in the direction of the trend will be accompanied by less volume than on days the market auctions against the trend......Another sign that the upward trend has aged is provided by observing the counter-trend auctions-auctions that, in many cases, were stronger than those that occurred with the trend" -James Dalton MIP
So in the above example in GMCR, she had been in a monster uptrend for quite some time, & had continued to double its share prices over & over. The bottom indicator is just the ATR, average true range, & as you can see where I've draw a white line was the day volatility pretty much doubled overnight for GMCR and the ATR stayed up for almost a full two months before the price went from the all time high at 116 all the way down to 17 bucks & change just a year later. This is a really nice example of a product exhibiting increased volatility w/o producing much further directional progress, a key hint that almost always signals a longer term trend is coming to an end. Also if you note again, ya didnt have to catch the high tick to get a great short out of it, it gave traders almost 2 full months of shots across the bow before she finally broke.
This is the same chart of GMCR in the 2 month period of increased volatility when it made its all time high at 117. Notice that 8 of the 10 biggest volume days were DOWN days, while she is hovering just under all time highs, another shot across the bow.
"There always has to be a scapegoat, so everyone can externalize their angst & anger. After all, it would be too esoteric to blame the market's decline on "weak structure." It cant be said often enough: you must develop a holistic understanding based on the market's real-time structure in order to separate yourself from the pack & become a truly competitive money manager."-James Dalton MIP
Can you image how many traders & money manager made excuses & came up with scapegoats for GMCR going from 116 all the way back down to 17, & every clue they needed was right in front of there eyes, even the market structure was very poor to go along w/ EVERYTHING in clue #2.
Clue #3: "If the market is attracting new buyers & had any real underlying strength, an upside breakout to new all time highs should exceed the upper end of the volume range. Investors often lament that "No one rings a bell at the top of the market." But in a sense, the low volume that accompanies an upside breakout is that bell." -James Dalton MIP
Same example from GMCR, the day she made the all time high at 115.98, the volume was approx 3.5 million, but the 20 day average for GMCR was just over 3 million! If GMCR's higher prices had really been bringing in more new buyers, (the day should have finished green, vpoc should have been at a new all time high as well) the volume for this day should have been well above 3 million, not just marginally above it.
Clue #4: Poor structure & poor volume distribution among the daily profiles. This is really kind of a more abstract & dynamic clue that a trend is weak. James Dalton defines poor structure as the following, & I really cant think of a better way: "Market-generated information (MGI) that comprises poor structure are as follows: accumulating poor highs or lows, wide points of control (VPOC's) that are not revisited, accumulating anomalous, or non symmetrical profiles over time, strung out profiles that are asymmetrical in shape showing no healthy elongation, daily bar charts that are strung out & show no balancing-no 'elevator stops' that reflect healthy balancing as a market trends up or down. This is to say that as more suspect MGI develops, the structure is worsening at an increasing rate & factors into our market perspective accordingly." So basically poor highs & lows, ugly looking daily profiles, & moving straight up or down w/ no balancing are the major things were looking for in clue #4. I could probably do an entire blog post on just clue #4, but I'm already getting long winded so we'll leave that for another day.
So to recap, days in the direction of the auction time frame you are trading should result in better volume, stronger auctions, progressive VPOC migration in the direction of the trend, balanced profiles followed by elongated profiles, not added volatility w/o continuing in the direction of the trend, not overlapping balance ranges, & not bigger volume on counter trend rotations if your looking for a trend to stay in tact. Or to put it simply, for an uptrend like we are in now, you want to see higher prices bringing in MORE buyers w/ good structure, which is all I've seen for quite some time. But stay nimble my bullish friends, someone ALWAYS has to be the last man to die in war.......
This is simply a re-posting of my favorite blog post I ever did 2 years ago. I simply look at the key tells for a market top (any market) and take the guess work and dart throwing out of the equation.
(Originally Posted 5/14/2013)
"The greatest point of market opportunity is when you feel alone."-James Dalton
With the S&P at life of contract highs, I suppose its only natural that I've seen a ton of traders trying to fade the new highs (or what really looks to my eyes as pure & simple guessing/dart throwing). Look, nobody wants to be the last solider killed in a war just to see it end the next day (think about the poor soul of James Arwood at White Sulphur Springs, North Carolina....the last solider (Union to boot) killed east of the Mississippi during the Civil War, on May, 6 1865, almost a full month AFTER Lee surrendered; nobody also wants to buy the all time high of any market to realize they also just bought a market top. These are very logical & primal human emotions & thought processes.
So w/ that said, I thought this would be a very timely two part post to: 1. Review how tops are formed & what to look for, & 2. How to stay out of your own head. If your looking for an actual top call, well, this post is not for you. Leave the top calling to guys like Doug Kass who called a market top some 200 S&P points ago (hope that gun isnt still to his head :)
A lot of what I'm about to write is pulled straight from James Dalton 2nd book, Markets in Profile. You can find tons of other great stuff on his website, JamesDaltonTrading.com.
So basically market structure is the key to assessing risk of any position, long or short. Balance areas & their relationship to each other are probably the #1 way I evaluate market structure. For those unversed in Market Profile, balance areas are simply trading ranges, brackets, consolidation, congestion areas/ranges. They define price ranges in the market that are containing trade (also sometimes referred to as channels), simple enough right? The S&P's had a very nice example of what I would call a balance area on the daily & hourly chart right before we got NFP on May 3rd.
So as you can see from the above chart, the S&P had formed a really picture perfect balance area between 1530-1593ish (noted by the red lines). On May 3rd, we got a positive NFP report & finally broke higher out of balance above 1593ish (circled in white). So one of two things was going to happen on the breakout above 1593 & I intended to make one of the following trades: 1. The market breaks out higher & is met by aggressive sellers, & prices fail to be accepted above the breakout. In this case I would have faded the probe failure, & looked for a target around the opposite end of the balance area at 1530. 2. The market explores to the upside, not only are higher prices not bringing in sellers, its actually bringing in even more buyers. Higher prices are being accepted & the breakout is successful. In this case (the one that played out) we went w/ the price acceptance in the direction of the breakout. The actual way I played it was to sell /ES 1600 & 1610 puts.
So this brings me to a point I seem to always be preaching about fading breakouts & how to guard you, from your "bad" trading self. Just because a product is moving higher DOES NOT mean "Its just a better price to short it at." This was the disconnect that I saw TONS of traders making after May 3rds breakout to new all time highs. What these traders were failing to realize is that the higher prices were bringing in MORE BUYERS, not cutting them off. So your brain is telling you the higher price is a better short then it was pre-breakout of 1593, but in reality, its the exact OPPOSITE....its really one of the worst trades you can take.
This is part 1 of 2, part 2 will discuss what to look for when market structure is becoming weak & clues to look for when a trend is coming to an end.