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Stock Trading Questions - Ask the Pro

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Live Trading Scenario

questioning your trading strategyIn a live trading scenario, is there ever a time when fundamentals or macro events would cause you to step in and override your systems?

I would say that if I was to override a system it’s not because of any macro or any fundamental view, it’s because of an emotional input. Have I done it? Yeah, of course I have. Even though I have been trading for thirty years there’s always that time where you think, “Oh this is not going to be good.”, but that rarely happens –very rarely. It certainly does happen to less experienced traders quite regularly. It will tend to happen more to people who doubt their strategy. But if you have complete confidence in your strategy then you’re just going to stand up to the plate, swing that bat, and put your trades in. That’s the bottom line.

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To what extent is your systematic trading approach automated?

dollar signsTo give an example, our U.S. mean reversion strategy is fully automated, we literally push a button and it will generate the buy and sell signals.

I put my account balance in my software, and I push the button, and it will generate the orders for me. It will do all the position sizing, generate the orders for me and then what we do is upload that via an API to my broker. Push another button and it will place those orders –it doesn’t matter if it’s one order or a hundred orders. It will place those orders instantly at the push of a button, and then that API will manage the positions during the night.

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Survivorship Bias

design trading systemsSurvivorship bias refers to stocks that have survived. So for example, Microsoft is in the S&P 500 these days, and it was in the S&P 500 back in 1998. Enron is not in the S&P 500 these days because it’s now bankrupt, but it was back in the S&P 500 back in 1998. So Enron has not survived. Microsoft has survived.

What we want to do when we test our strategies is we want to do two things. We want to test those stocks that are delisted to make sure our strategy has worked on those, because those stocks are now gone. But we also want to ensure that we’re trading the same universe today, as we would have traded back in 1998. For example, using a historical constituent list, we can see what stocks were in the S&P 500 back in 1998 and make sure we’re trading those stocks. If I have a universe which I trade, which I do –the S&P 500, I want to know that the S&P 500 I’m testing on back in 1998 was the actual 500 stocks in that list back then. Including all the ones that delisted.

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What defines a robust system?

Robust SystemI can’t stress this enough; You need to have a robust system.

What is a robust system? A robust system is a trading system that has been validated, that works reasonably well over various markets and that the end user, the trader, can implement on an ongoing basis.

The first question I ask people is, why does your strategy make money? If you don’t understand why your strategy makes money, you’re going to find it very difficult to stay with your strategy when it goes a little bit pear shaped –which every strategy will at times. If we go back to the easy version of the momentum or trend following strategy, we make money because we cut our losses and let the winners run. You create a positive expectancy because you make a lot more money on the trades that win, than you lose when you have a losing trade.

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Why I don’t trade on the short side?

money blogI only trade the Australian and U.S. markets on the long side. I don’t trade short.

I use to trade short but I stopped in 2009. There’s a couple of reasons. First of all, I’ve never really come across a strategy I’m 100% happy with. I can find strategies that make a profit trading on the short side but the risk adjusted return is such that is really doesn’t appeal to me. The second reason and probably the most important reason is back in 2008 the Australian regulators banned short selling. What’s the point of having a strategy to trade on the short side and when you need it the most you’re not allowed to trade it? So I just focused on the long side.

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