Saturday, July 11, 2009

Basic Trading 101

For me, trading is not a hobby, not a game of chance not some intellectual odyssey filled with clashing egos and chest pounding pissing contests. No, for me, trading is a way to make a living, doing something I love and am good at. So my approach is a little different then some of you may be used to.

Yet every so often a communication from one you impacts me with frustration and dismay. By now I would think that if you have been with me for six months, or a year, or longer, you would be making money trading, using some ideas and techniques that I have described over the months and years of writing AllAllan. But I hear something else from these communications, I hear that many of you are not getting it.

Today I am going to present to you three ways to trade using the simplest of strategies based on end of day prices and a minimal of necessary hardware or software. I am going to use an unleveraged ETF and remove all of my more sophisticated (read: expensive) tools, using only Market Club Triangles and 3 Line Break Point charts, both very similar in their construction and entirely objective in their application.

You can trade this going forward on XLF and probably not need anything else to be successful month to month, quarter to quarter and year to year. But it is my hope you will instead, glean from this the very basic premise of a simple rule-based system that can be applied and tweaked to any number of tradables, a simple trend following trading system from which anything is possible if you only have the discipline and desire to make it work.

XLF - Market Club Triangles -Daily Chart

Their are actually two systems shown on the chart:

(1) Enter trades on appearance of WEEKLY TRIANGLES and exit on appearance of reversing DAILY TRIANGLES. If flat, RE-ENTER on appearance of DAILY TRIANGLE in direction of most recent WEEKLY TRIANGLE;

(2) ENTER/EXIT on appearance of WEEKLY TRIANGLES (disregard DAILY TRIANGLES).

The third system is based on the 3 Line Point Break chart and nothing else.

Here is the chart:

XLF 3 Line Point Break - Daily

This strategy is simply to ENTER LONG OR SHORT in concert with 3 Line Point Break Chart. I've annotated the four trades, year-to-date, on the above chart.

All of the signals generated on the three trading systems are summarized and analyzed in the table below:

Trade Summary

This table lists each trade going back year-to date. The most complicated of the systems, first described above, returned 45.64% (no leverage) in six months. It's sister system, trading only Weekly Triangles, returned 54.62% in the same six months. Finally, the 3 Line Point Break System, the simplest of the three (come on, all you have to do is look at a chart), returned 55.15% for the period, yes, the simplest technique had the best return.

I am well aware of the shortcomings inherent in such a small sample size, so feel free to spend hours back testing these over the course of decades, if that is what it takes to build some confidence in these matters. This is what the market and the XLF is doing NOW and it is working NOW.

That's it. Your introduction to successful trading in it's rawest form. Scoff at it's simplicity, but if you find anything that works as well and that doesn't cost and arm and a leg or is knee deep in esoteric bullshit interpretations and/or indicators, bring it on. We'll make that our advanced course, Basic Trading 102.



Anonymous said...

Allan, Thanks for sharing with those of us still holding down daily jobs, but aspiring to be at least part time traders!

Sandy said...

You are a thick skinned guy, one needs to be - most successful people are - obstinate, stubborn and relentless. Typical traits of not just a good trader but simply a successful person.

Failure, doubt, aspersion is simply another step in that gilded staircase. Keep at it - best wishes

Joann said...

Hi Allan,

I've been following you for a few months and just want to thank you for all the insights you share here. I am fairly new to trading and I find it hard to learn when most people either try to sell me something or have some crazy system that I can't understand. Anyway, just want to say thanks.

Richard168 said...

Hi Allan,

I have been following your site for a couple of weeks and I find that you have simple but great trading approaches - such as the 3 Line Point Break system. I'm definitely going to look more into it. Thanks again for sharing your ideas with us.


Anonymous said...

John W. Meriwether (his LTCM - shut down with a 90% loss of original 4 billion $ capital and, next his JWM Partners shut down with a loss of 44% of 2 billion $ of fresh new capital)could use a really good friend like you, Allan. Glad I found you first! Warmest regards from NYC, Joe

Anonymous said...

Alla, so you are saying that NNVC is going to be up more than 10,000 % within 5 Years..Do I read that right?

Anonymous said...

Hmmmmmmm Almighty Alla? I meant Allan...

Rob said...

Allan, I am new to this but have been following your blog for about a month. Are there any books or other materials that explain the 3 Line Point Break System more thoroughly? Thank you for you education.

bob said...

Allan. An old man once taught me the principle of KISS, Keep It Simple Stupid. I've practiced life using it and searched diligently for someone who might be using the same principle in the markets. Thanks for your careful, thoughtful words to us all. Your making it very easy and very enjoyable.

rob g said...

allan after learning how to trade the market club system how does one figure out the best trade opportunities when there are so many weeky and monthly trade triangles each day? what are some of the things you look for? do you stick with a hot sector?

rob g

Anonymous said...

Allan, thanks for all your insights, it helps me alot, I am wondering if you can also compare Renko with them, it seems to me that Renko charts is very clear on up/down indication (no wave, just up or down), so not sure if it can at least beat 3 line point

Anonymous said...

Thanks Allan,
everything is fine perhaps my question is very trivial but how i know at which level a certain triangle is going to appear (matket club)?

Allan said...

Re: Comments

Reading all of your comments this morning, I can't begin to tell you how gratified I am by your response. Thanks all, for commenting, for caring, for being out there.

Re: Research on 3 Line Break

Google it.

Re: Picking trades for triangles

Start with your favorite ETF's, when you find a few that have the right feel, graduate to individual stocks. Do the work, put up the charts and triangles and then write down each signal. Add them up, some generate much better results then others. I picked XLF because I trade it.

Re: Renko comparison

I omitted Renko because unlike the others, the user has to make a subjective decision as to size of Renko box. I was going for no-brainer trading here, Renko didn't make that cut.

But since you asked, using a 0.50 size box, Renko had 7 trades for same period, 5 wins 2 losses, total points +7.36 for a six month return of 64%.

How did I know to use 0.50 box? I tested half a dozen sized boxes and the 0.50 box came closest to others in length and look of other systems. Curve fitting, data mining? Yep. Two weaknesses not in other 3 systems in initial blog.

Re: Market Club Triangles logic

Three period (daily, weekly, monthly, quarterly and soon to be intra-day according to MC) new highs/lows.


Yes, that's the plan, an over $100 share stock within 5 years, based on their pipeline, management, ongoing research and development.

I had planned an update blog on NNVC for today, but, just got some tickets for the Diamondback-Marlin game this afternoon and unless I write it through my iphone from the game (unlikely) it will have to wait another day.

Re: Joe/NYC

.....and I am glad you are out there, my friend.


C2Vettes said...

I have been reading your blog daily for a year now. Becuase I am learning through books and a few GOOD Blogs,I have not done a whole lot of trading.Following your thoughts and comments puts more confidents in my decission to trade. Through the support of your knowledge I plan on doing a lot more trading.

Thousand Thanks!

Anonymous said...

Allan, thank you for your post. That you take the time to do posts like this is much appreciated. Many people aren't interested in helping new traders.

I will say this. The triangles are good. Damn good. It is so easy to dismiss them due to their simplicity and seeming mindlessness. There really isn't much testing one needs to do with them, as long as the market in question is moving in one direction or another you will make money. I think one would need a very powerful edge in order to swing trade better than the triangles.

The triangles are much better than most TA indicators and chart patterns, most of which are BS in my opinion. I was reading some issues of Stocks & Commodities magazine that were given to me and I came across an interview with Alex who used to post here. A quote I really liked was I've been studying the markets for 10 years, and people always ask me if I'm more convinced or less convinced that technical analysis works. Honestly, I'd have to say both. When I read my first technical book, it was filled with so many profitable examples that I thought any of those methods would make me a million dollars in a short time. But after I did many, many, rigorous tests, I realized that most of those methods were going to land me, and anybody who actually went for them, in the poorhouse. Sums up my experience when I first discovered TA materials, and my experiences in testing the methods presented in them.

He goes on to say So in one sense I've become less convinced, but in another sense I've also become more convinced because there are a few methods or basic concepts that have proved to be profitable after rigorous testing. I think the triangles are one of those basic concepts that works.

Anonymous said...

Allan, this is one of your best and most important postings. Thank you for it. However, a good system is only part of successful trading.

If you extended your simulation back just another couple of months, the results would have started quite differently. For example a .50 renko block would have whipsawed you back and forth generating a 1.00 loss each time.

If someone is convinced that these systems will work and starts today to use one of them, just dumb luck will play into it. If the next couple of months turn out like Nov.-Dec. the system will initially generate drawdowns that will be a disaster for a small account. A new trader will become disillusioned quickly, panic, and quit with losses before the system turns profitable.


Anonymous said...

Regarding the backtesting over decades comment. I happen to think backtesting is very important. I have read studies that say most traders have not thoroughly tested the systems they trade and often end up blindsided when the system throws some unexpected results at them. Everything works until it doesn't.

I know someone who purchased a trading system from his financial advisors which worked great for years. It had occasional drawdowns but it always made them back and became profitable again. Until last year when it completely blew up, decimating his account.

I doubt the triangles would ever decimate an account because of their stop/reverse logic, but they can still generate substantial losses from time to time, which as was mentioned above can be devastating to a small account especially if the trader doesn't understand bet sizing or diversification. I will always subject any trading system I consider using to rigorous testing across a variety of different market types. Even if I know the system "works" I still want to know what I need to be mentally prepared for.

Not trying to criticize your excellent post. Just saying I think testing is very important.

Anonymous said...

I like back testing too, but I also think people take back testing to an extreme in a quest for safety in a profession where there is no safety.

I don't really care how my systems would have performed 100 years ago, and dwelling too much on older data reminds me of the buy and hold acolytes who blew their clients' accounts out while smugly citing decades of statistics.

If you agree that markets change over time, then your most important backtesting will involve the most recent data. Don't we use exponential moving averages under the assumption that the more recent data is more reliable/persuasive? I'm more interested in what works NOW, than in what worked in the 1950s.


PS: Great post

Anonymous said...

>>> a quest for safety in a profession where there is no safety

That makes me think of Van Tharp's observation that most traders are overly obsessed with entry signals.

You get a sense of control with entry signals because the point at which you enter the market is the point at which the market is doing exactly what you want it to do. As a result, you feel like you have some control over the market. Unfortunately, once you are in a position, the market is going to do whatever it wants to do - you no longer have any control over anything except your exits.

I have this quote posted next to my computer.

I suppose we all have to find a way of dealing with the anxiety associated with having no control over the environment in which we must exist.

Anonymous said...

Right. Too many indicators are deadly. You can shut off the TV set so you aren't influenced by CNBC, you can shutter yourself in and stop reading the pop business news, but that's not going to keep out the irrational if you clutter your desktop with too many indicators. Too many indicators can become your substitute friends, and like real friends, they can mislead you when they tell you what you already want to hear.

It's better to keep things simple and just try to interpret what the market is doing now. That's what traders are, interpreters. The market babbles in many tongues, and we try to make sense of it all in the here and now, while avoiding too much guess work on what it is going to say.