How Trading Systems React To Uncertainty

trading systems

trading systemsThis was an up and down week for the general market that looked incredibly bad on Monday and Wednesday, only to recoup all of those losses and then some on Thursday and Friday. We are starting to see some differences in our six systems, however those differences have been mostly minor at this point.

For the most part, we are just witnessing how the systems protect themselves (or don’t) from a market that may or may not be topping out. What is making this experiment interesting is that fact that it is happening right before our eyes. Backtesting systems is great for getting the raw numbers, but this live experiment offers something completely different. We are able to observe how systems react to uncertainty when even we don’t know what the long term outcome is going to be.

There wasn’t a whole lot of action from System 3 or System 4 this week. System 5 made a profitable trade, and System 6 experienced its first whipsaw. Probably the biggest takeaway from this experiment so far has been what a good job System 2 did of getting itself out of the market at the right time.

Let’s take a deeper look at what each of the systems did this week.

System 1 – Buy & Hold

Overall Return: -0.91%

trading systemsAfter two big losing weeks in a row, things didn’t look good for System 1 coming into this week. Then things got even work over the first three days as the SPY fell even further. However everything changed on Thursday as the market jumped and then continued even higher on Friday. The SPY closed slightly higher for the week, which bumped the overall return for System 1 from -1.38% to -0.91%.

One of the things that is going to make this experiment even more interesting is the fact that we are just getting it started as markets are near their all-time highs. Since System 1 has no method to protect itself from a crash, it is probably going to suffer tremendously from an eventual downturn. It will be interesting to note how the random mid-year start of this experiment might reflect he results.

In a similar real-life situation, my mother and her husband recently sold their rental home. Since they suddenly had a big chunk of money, they did what Americans are supposed to do, they invested it in what I would imagine (I’m trying really hard to stay out of their financial business!) is some sort of index based mutual fund or annuity. It will be interesting to see the real life impact on their nest egg.

They could be investing at the top of the biggest stock market bubble of all-time, or they could be getting in on the ground floor of the next great bull market. I don’t know which one is more limey, and they don’t either. The only thing that we know for sure is that they have no plan to protect themselves from the next black swan.

System 2 – IBD Market Calls

Overall Return: A: -1.38%, B: +0.61%, C: -1.13%, D: +0.05%

There were no changes in the IBD Market Calls this week. We have been in a correction since last Thursday.

Here is a quick reminder about the four variations of System 2:

  • 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

trading systems

Systems 2A and 2B both sat in cash all week. This seemed like a great idea on Monday and Wednesday, but it also led to these systems missing out on the rally days Thursday and Friday. Of course, there was no need for them to partake in the rally days since they didn’t lose out on the down days earlier in the week.

Systems 2C and 2D both came into the week short the SPY. Obviously, this looked great on Wednesday evening, but not so good on Friday night. On the week, both systems took losses.

Heading into the coming week, each of the four systems is looking for a Follow-Through Day. This would be a buy signal that would put each of the systems into long positions. If we don’t get a Follow-Through Day, then Systems 2A and 2B will remain in cash and Systems 2C and 2D will profit from any move further down.

System 3 – 10/100 Moving Average Crossover System

Overall Return: -0.91%

trading systemsSince System 3 was still long coming into this week, it mirrored the performance of System 1. Just like System 1, things looked bad for System 3 early in the week, but then turned around Thursday and Friday. While the price action later in the week did get the price back up to the 10 day line, it has yet to retake that line. The 10 day line is certainly coming closer to the 100 day line in recent weeks.

In the coming week, if the price moves higher, System 3 will benefit by already being long. If the price heads south, it will get the system closer to an exit signal.

System 4 – 89/13 Breakout System

Overall Return: -1.97%

trading sytemsSystem 4 came into the week in cash, looking for a new 89 day high or low to initiate a position. The action of the week took the price closer to the 89 day average than it did to an 89 day high or low, so this system didn’t do anything all week but sit and watch from the sideline.

Moving forward, System 4 is still slightly closer to its 89 day high than its 89 day low. However, that could change in a hurry if the bottom were to fall out of this market. Either way, this system is safe from taking a huge loss right now because it is sitting in cash.

System 5 – 3 Day High/Low Mean Reversion System

Overall Return: +0.25%

trading systemsThe first trade that System 5 made earlier this month had me worried that the lag of waiting to buy the following day would make this system unprofitable. That lagged worked in favor of the trade the system made this week though.

Friday’s close was the third day in a row of lower highs and lower lows. It was also below the 5 day line and above the 200 day line. This triggered a long signal in System 5 that was executed at Monday’s close, which was actually much lower than Friday’s close. The system then signaled to exit the position when the SPY retook its 5 day line on Thursday. Once again, executing at the close of the following day helped the position.

This week’s trade purchased the SPY at 164.77 and then sold it at 166.62. This represents a profit of 1.85 per share, or 1.12%. Of course, we aren’t factoring in the brokerage commission, which would have eaten a big chunk of our profit.

Moving forward, System 5 is going to look to make the exact same trade over and over again as long as the SPY is above its 200 day moving average. If the price loses its 5 day line and closes with lower highs and lower lows for three days in a row, we will establish another long position.

System 6 – Simple Moving Average Systems

Overall Return: A: -0.88%, B: -0.88%, C: -0.75%, D: -0.88%, E: -0.88%, F: -0.72%

Here is a quick reminder about the different variations 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

trading systems

Systems 6A, 6B, 6D, and 6E are all still holding long positions because the price has not broken the 100 or 200 day lines. The SPY did break its 50 day line this week though, so there was some action in Systems 6C and 6F.

System 6C went to cash on Tuesday after the SPY broke its 50 day line on Monday. It then reestablished its long position on Friday after the SPY retook its 50 day line on Thursday. System 6F did the exact same trades but went short instead of going to cash. Because the timeframe was so small, and there wasn’t much movement, both systems suffered similar small losses.

Moving forward, there is a good chance we continue to see more of this whipsaw action in Systems 6C and 6F because the price is trading right at the 50 day line. This is one of the negatives we expected to get from the shorter time frame of the 50 day line.