Trading Systems Can Bounce With The Market

trading system

trading systemThe main idea behind the construction of most of these systems is to make money when the market is going up and then either protect those profits or go short when the market is going down. The result of this approach is that when the general market has a good week, this post is super positive and we make money. Then, when the market has a down week, we get very defensive and analyze how the systems go about protecting themselves.

Sometime, trading can feel like a spring that bounces back and forth between the good weeks and the bad weeks. It’s important to remember not to get too excited about the good weeks and not to get too depressed about the bad weeks.

This was one of the good weeks. The general market has been showing very positive action for the past two weeks. Because of that, many of our systems have broken back into positive territory. During weeks like this, it is important to keep in mind that the market can turn on a dime tomorrow. We need to make sure that we have proper defense mechanisms in place to protect our capital in the event of a sharp decline.

Comparing Our Systems

trading systemsWe currently have eight systems in positive territory and six systems showing losses. System 2B continues to be our leader, but each of the long term systems improved this week to the point where they might start providing some competition.

It is interesting to note that System 5 seems to have very little correlation to the long-term trend. It doesn’t seem to be affected either way when the market makes big moves. That lack of correlation is hurting System 5 right now while the other systems are passing it up in the standings. However, it will benefit the system when the market eventually heads down and those other systems give back some of their gains.

It is also worth noting that the bottom three systems are all there because of their short components. These systems all got smacked on Monday and Tuesday. It will be interesting to see if the short component is able to make up for these shortcomings when the market eventually begins to trend downward.

System 1 – Buy & Hold

Overall Return: +0.70%

Last Week: -1.25%

trading systemsSystem 1 posted a big gain this week, bringing it back into positive territory for the first time since the beginning of August. The market took off running on Monday, then gapped up even higher on Tuesday, and didn’t look back for the rest of the week. This makes two straight positive weeks for the buy and hope investors!

As we say every week, the big problem with System 1 is that it has no method of protecting itself if the market crashes. It has no plan to ever get out, only to hold on and hope that any losses are recovered quickly.

System 2 – IBD Market Calls

Overall Return: A: -1.10%, B: +0.88%, C: -3.31%, D: -0.95%

Last Week: A: -1.38%, B: +0.61%, C: -0.94%, D: +0.24%

trading systemsDespite the fact that we did not have a Follow-Through Day, after the Nasdaq broke into new high ground on Monday IBD switched their outlook to Confirmed Uptrend. According to them, there is a precedent for uptrends that resume without a Follow-Through Day.

This means that each of the four versions of System 2 went long the SPY at Tuesday’s closing price of 168.87. Here is a reminder about how each version trades:

  • System 2A – Long on Confirmed Uptrend, Cash on Market In Correction
  • System 2B – Long on Confirmed Uptrend, Cash on Uptrend Under Pressure
  • System 2C – Long on Confirmed Uptrend, Short on Market In Correction
  • System 2D – Long on Confirmed Uptrend, Cash on Uptrend Under Pressure, Short on Market In Correction

It was a bummer that versions A and B misses out on the big moves Monday and Tuesday. Versions C and D were actually hurt by those moves because they were holding short positions. While it sucks to miss out on that action, that is the nature of trend following. We want to catch the big chunks in the middle of a trend, not time the tops and bottoms.

Now that each of these versions is long the SPY, we will be watching for IBD to change their outlook. A change to Uptrend Under Pressure would move versions B and D to cash, and a subsequent move to Market in Correction would move versions A and C to cash and push versions B and D to short positions. Because IBD uses distribution days to track uptrends and monitor for changes in the market, that is what we will want to keep an eye on. There are currently three distribution days that have been logged on each of the major indexes.

System 3 – 10/100 Moving Average Crossover System

Overall Return: +0.69%

Last Week: -1.25%

trading systemsSystem 3 jumped back into positive returns this week, moving to an overall return of 0.69%. After almost losing its 100-day line just two weeks ago, the chart has bounced back and is looking very strong. It is now trading well above both of the moving average lines and the 10-day line is pulling back up and distancing itself from the 100-day line.

One of the first interesting developments of this experiment has been watching how each system reacts to a potential downtrend without actually knowing what will happen next. So far, System 3 appears to be more likely to sit through the short term price swings in favor of riding the longer term trend. After the big up week we just witnessed, that seems to be the correct strategy right now.

It is pretty unlikely that the price of the SPY will tank enough in the coming week to pull the 10-day line below the 100-day line. Therefore, it is very unlikely that System 3 will make any moves at all. It is perfectly content to just sit and ride the current trend.

System 4 – 89/13 Breakout System

Overall Return: -1.97%

Last Week: -1.97%

trading systemsUnfortunately for System 4, it was the Nasdaq that led the way this week and not the S&P 500. The SPY has not yet overtaken the high it set in early August. It closed the week at 169.33, just shy of its 89-day high at 170.97. Because there was not a new high this week, System 4 stayed on the sideline again.

If the market continues higher this week, the SPY will break that new high and establish a new long position for System 4. If the market falls back and consolidates for a bit, then the system will continue to sit in cash.

While it is incredibly frustrating to see a system that is down almost 2% sitting on the sideline while the market is having a good week, we have to remember that these types of situations are going to be common. Missing a small rally could prove to be a great move if the bottom falls out of this market tomorrow.

System 5 – 3 Day High/Low Mean Reversion System

Overall Return: +0.5%

Last Week: +0.5%

trading systemBig up weeks like the one we just saw don’t offer up many opportunities for System 5. Because we are in an uptrend, we are looking for the SPY to close with lower highs and lower lows three days in a row and also close below its 5-day moving average. Since we only recorded one red day this week, there were simply no opportunities to be had for System 5 this week.

In the coming week, it is certainly not out of the question that we could see the SPY pull back and set up a trade for System 5. While there is a decent chance we see a pullback, with the market as strong as it has been recently the chances of logging three down days in a row are not good.

System 6 – Simple Moving Average Systems

Overall Return: A: +0.70%, B: +0.70%, C: -2.85%, D: +0.70%, E: +0.70%, F: -6.33%

Last Week: A: -1.25%, B: -1.25%, C: -1.58%, D: -1.25%, E: -1.25%, F: -1.26%

trading systemsHere is a quick reminder about the six different versions of System 6:

  • System 6A – Long above 200 day SMA, Cash below 200 day SMA
  • System 6B – Long above 100 day SMA, Cash below 100 day SMA
  • System 6C – Long above 50 day SMA, Cash below 50 day SMA
  • System 6D – Long above 200 day SMA, Short below 200 day SMA
  • System 6E – Long above 100 day SMA, Short below 100 day SMA
  • System 6F – Long above 50 day SMA, Short below 50 day SMA

Because versions A, B, D, and E were all long heading into last week, they were all able to benefit from the big up days Monday and Tuesday. Versions C and F were not so fortunate. Version C completely missed out on the big move, and version F took a big hit by being short.

It is beginning to look like using the 50-day moving average is making versions C and F a little bit too short-term. It will be interesting to see if this is just a product of the current market conditions, or if it will persist long-term. Either way, it is going to be very hard for version F to crawl out of the hole it has dug for itself.