Riding The market
We all ride the same market – but we have very different results. Research shows that between 70% and 90% of traders lose money – you have to wonder: why do we do it?
In his book, Best Loser Wins, Tom Hougaard, has some fascinating statistics. He cites a study of 25,000 people who traded currencies daily, and over 15 months they executed 43 million trades – a very decent sample size! They found that 62% of the trades made a profit, which is a good hit rate. So, these traders made money, right?
No, unfortunately. Why not? Because when they won, they made an average of 43 pips. When they lost they lost an average of 83 pips, twice as much. You don’t have to be a mathematician to work out that they are not going to last very long.
Which brings me to the ITM strategy. What it is doing is not catching every wave and riding it from beginning to end. The only way you can do that is in hindsight, which is how I think a lot of trading books are written! Instead, it is getting into relatively safe trades, and getting out before any large moves down.
Flipping the Switch
I have been thinking about and testing new strategies – one that was a spectacular failure was ‘flipping the switch’. My reasoning was that after getting out of a bull trade, why not ‘flip the switch’ and enter a bear trade. After all, if you are not bullish doesn’t that mean you are bearish?
Actually, no. Not a good idea.
There is a time for sitting on the sidelines, as the results of this proved. Using various parameters for the SMAs, I examined the results: all were bad.
Here’s the results for the last 10 years for the commonly used 10/50 SMA.
You can see that using the bull strategy, even though you made more losses than gains, you would still win overall because your wins were double your losses. But adding in the bear traders was disastrous: although you made slightly more on a winning trade your percentage of winning trades was very small – you would crash your account quite swiftly.
And here are our results using the 10/200 ITM strategy:
You can see that although we had an equal number of wins and losses because the size of our wins is 5 times bigger than our losses then it wins overall. And this is without leverage.
Choosing your options
A few posts ago we looked at why options were expensive, and concluded that it was the effect of interest rates, not volatility. It makes selecting suitable options for the ITM strategy more difficult, but let’s have a look.
We can see that getting an effective price less than 1% above the current price is difficult if we are looking a year out. Buying an option with a closer expiry is a solution, the only real downside being that you will have to roll out more often. There are several January 24 options that work, with 50 – 60% leverage some February, with 50 – 58% leverage and one in March with 50% leverage.
Of course, you have to consider whether it is a good time to get into the market. Let’s review the charts.
The morning star from last week didn’t work out – as is the way of many candlestick patterns. I am sure that authors who write about predicting the market using candlesticks with perfect accuracy are definitely using hindsight!
Last week was dismal, and our SMAs looked as though they were going to cross – but on Friday we had a lovely big green cancel on relatively high volume which was encouraging. I was hoping for a better week this week – but the news out of the middle east is worrying.
Anyway, now we don’t have to worry about support at the $416 level, as it is now below our 200 SMA and we will have had a death cross before we get there.
A similar candlestick pattern to SPY, with the morning star failing – but the good thing was that it didn’t trade much lower than last week, seeming to find support at the $59 level. Another encouraging sign was the fact that Friday’s candle took SPYG back up to where it gapped down.
I have drawn in a green dashed rectangle, showing the gap. Traders watch gaps closely. If the gap is closed next week then that will be a bullish sign, alternatively if it treats the gap as a resistance then it is bearish. Definitely been in consolidation for three weeks now.
Why is SPYG not as dismal as SPY? Well, all will be explained when we look at the QQQ chart
You can see that the QQQ chart is similar to SPYG, and for good reason: there is a significant overlap in the stocks that they hold. SPYG is the S&P 500 ‘growth’ Index, holding 240 stocks, and QQQ has come to be associated with tech stocks, which are heavily represented in SPYG. Hence the similarity between QQQ and SPYG.
The VIX was flattening off, but who knows the effect that the middle east crisis will have on the market? If we look at the effect of the war in Ukraine we will get some idea.
The week ahead
The futures do not look good at this stage. To be expected, of course. Looking back at the most recent international situation, the invasion of Ukraine, we can see that it was at the start of a bear market. Did it cause the bear market? Who knows? Will the Hamas strike on Israel cause another bear market? Again, who knows?
But don’t you just want everything to settle down? We seem to be lurching from crisis to crisis. Bit of a depressing note to end on, I am afraid.