Trading Systems Are Security Guards for Your Capital


system tradingAnother down week for the market gives us another chance to analyze how our systems protect capital in the midst of uncertainty. The most important thing a system can do is make sure that we don’t lose money. The best systems operate much like security guards for our finances. They identify potential threats and maneuver us to avoid them.

With the current issues in Syria, those threats are beginning to pile up all around us. This is a great opportunity to demonstrate that the ultimate value of a trading system is not in the returns it produces, but the risks it eliminates. Of course, the systems that get our money to safety the fastest are also producing the best returns right now.

The bottom line is that no one knows what the market is going to do in the coming weeks, and certainly not in the coming months or years. We can’t predict the future, so the best thing we can do is prepare ourselves to take advantage of whatever happens.

Comparing Our Systems

system tradingWith the SPY posting another bad week, we are getting front row seats to witness how these systems react to a market that is falling apart in front of our eyes. Because of our unlucky start date of July 15, all but three of our trading systems are currently sitting in negative territory. As you can see in the ranking chart, the top two systems are the IBD market call systems that got out on August 7 when IBD changed their outlook to Uptrend Under Pressure.

The current clubhouse leader is System 2D, which not only got out on August 7, but also went short the SPY on August 16 after IBD changed their outlook to Market in Correction. Since then, this system has profited from the continued decline of the general market.

It is also interesting to note that System 5 has been largely unaffected by the recent market decline. Since it is a mean reversion system and not a trend following system, it will not suffer from a correction the way the rest of our systems have.

While it is fun to talk about the best performing systems, we should remember that the worst performing systems are not all created equal. There is a big difference from the long term trend following systems like System 3 or System 6A and the buy and hope approach of System 1. These differences should work themselves out over time. Remember, we are still not even two months into this experiment.

System 1 – Buy & Hold

Overall Return: -2.68%

Last Week: -0.91%

trading systemSystem 1 took a big hit this week. Monday felt like a pretty significant loss, but it was quickly dwarfed by Tuesday’s huge gap down loss. There was a meager bounce back rally on Wednesday and Thursday, but most of those gains were given back on Friday. The system started the week with an overall loss of just under one percent, but by the end of the week it had bumped that loss up to 2.68%.

As I say every week, the problem with System 1 is that it has no safeguards in place to protect itself when the bottom falls out of the market. It is very possible that we are right in the middle of the market demonstrating exactly that for us.

One could argue that we simply picked a lousy time to start trading this system. If we had started trading at the beginning of the year, we would still be sitting on a healthy profit for the year. We could also cherry pick a number of different starting dates to distort the results. Baseball announcers are famous for doing this with player stats. The bottom line is that we had to start somewhere, and July 15th was when I started tracking these systems.

System 2 – IBD Market Calls

Overall Return: A: -1.38%, B: +0.61%, C: -0.23%, D: +0.97%

Last Week: A: -1.38%, B: +0.61%, C: -1.13%, D: +0.05%

trading systemEach version of System 2 did its job this week by either staying out of the market altogether or profiting from short positions. Here’s a quick reminder about the different versions:

  • 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

Since versions 2A and 2B stay in cash during corrections, they both remained unchanged this week. While they didn’t make money, they didn’t lose money like System 1 did. We are still dealing with an incredibly small sample size, but System 2 appears to be outperforming System 1 by a widening margin.

Versions 2C and 2D were both short the SPY coming into this week, so they were able to profit from the awful week. By getting out early and then going short, these variations are performing very nicely. However, they are also at risk to lose money if we see a bounce back.

Moving forward, all four versions of System 4 will go long the SPY as soon as IBD calls a Follow-Through Day. It will be interesting to see how much versions 2C and 2D give back if that happens.

System 3 – 10/100 Moving Average Crossover

Overall Return: -2.68%

Last Week: -0.91%

system tradingAfter Tuesday’s gap down, the SPY spent the rest of the week trading right at its 100 day line. The losses of the past few weeks have really pulled down the 10 day line. The two moving average lines are now trading very close to each other, but they have not crossed yet.

System 3 is showing a pretty significant loss right now, but we should keep in mind that we did start trading in the middle of the current trend. If we had started trading when the current trend was signaled, we would be giving back a portion of our profits instead of showing a loss. However, as we discussed with System 1, we could manipulate the start date to say all kinds of things, but it is what it is.

In the coming week, if the SPY continues to post losses, we will likely see a cross. At that point, System 3 will exit its current long position and either go short or stay in cash.

System 4 – 89/13 Breakout System

Overall Return: -1.97%

Last Week: -1.97%

system tradingSystem 4 came into the week with no position and didn’t generate any signals. Nothing happened.

After this week’s trading, the SPY is now trading right at its 89 day moving average. This makes it just about equally far from an 89 day high or low. Because of that, it isn’t likely that this system is going to generate a signal either way anytime soon. It would take a tremendous move for the SPY to break into a new high or low in the coming week.

System 5 – 3 Day High/Low Mean Reversion System

Overall Return: +0.25%

Last Week: +0.25%

trading systemThe huge losses on Monday and Tuesday looked like they were setting up another quick trade for System 5, but the small bounce back on Wednesday ruined that setup. Even though the SPY spent the rest of the week trading under its 5 day line, we didn’t get the three day signal, so we just sat and watched.

Since Friday closed the week with another big loss that took the price below its 5 day line, all we need in the coming week is two more down days on Monday and Tuesday to signal a long position. If that happens, we will go long until the price retakes the 5 day line. If not, we will stay in cash.

System 6 – Simple Moving Average Systems

Overall Return: A: -2.68%, B: -2.68%, C: -1.58%, D: -2.68%, E: -2.68%, F: -0.91%

Last Week: A: -0.88%, B: -0.88%, C: -0.75%, D: -0.88%, E: -0.88%, F: -0.72%

trading systemHere is the 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

Despite the losses posted by the SPY this week, it is still trading above its 100 and 200 day moving averages. This means that versions 6A, 6B, 6D, and 6E are still long and all took pretty significant losses this week. The same starting point excuses that we made for System 3 can be made here, but once again, we had to start somewhere.

With the price crashing back down through the 50 day line this week, it was interesting to see that version 6C was able to get into cash and protect itself from further damage. System 6F took that one step further and went to a short position, which actually made a small profit by the end of the week. While it is great to see these systems trading well this week, by trading more frequently they will both be exposed to more whipsaw trades.

The price is currently sitting right at the 100 day line, which means we could see some activity from versions 6B and 6E this week. Losing the 100 day line would also be a strong confirmation signal that versions 6C and 6F are on the correct side of the market.