My approach to entering and exiting a position (4-2-2010)

(EDIT note: Since I am no longer always going long, I realized that I needed to change the title after I posted.)

This is the second iteration of my approach to buying stocks. (For purposes of comparison, you can check out the first version here (entry), or here (exit).)

This might be a little presumptuous, but over the Easter weekend break I thought it would be good to try and spell this out. I am making some major changes in my approach to trading, and I think formalizing the changes is a good exercise. (Much of this is my interpretation of FNG's approach, the basis of which may be found here.)

As is evident in my personal and publically available win/loss record, this is by no means a recommendation of what to do.

Principal 1:

The market is always moving. Some of the moves are small, and some of the moves are big. Market movement cannot be predicted, but it can be recognized, and it can be followed.

Short and simple - not to imply that this is easy to implement. By no means. When it comes to the stock market I am my own worse enemy.

Practical application:

I am using several platforms at the moment: StrategyDesk (SD), Ninja Trader (NT), and Trader Work Station (TWS). (This is somewhat tedious and I hope to get things slimmed down.) At this point:

SD is used for Level 1 screens. Once a week I filter all of the NASDAQ and NYSE for minimum criteria (30-day EMA daily volume >= 500000, and last close >= $5) and paste these results into a daily screener that checks for daily high and low spread (the larger the intra-day movement, the higher the probability of capturing some) and daily volume. The screener highlights new daily highs and lows and acceptable bid/ask spreads and is sorted by day's volume / daily 30-day EMA volume. I link a 5-minute chart to the screener for candidate screening.

If the candidate looks good, I move it to NT's market analyzer which is linked to two charts. The market analyzer serves to keep track of candidates, allowing for quick reviews. One of the charts is a 5 minute candle and volume chart (with FNG's recommended 17 and 7 period EMAs) and the second is a 4 period TEMA based Heiken-Ashi displayed on a 3 minute interval. The Heiken-Ashi aids in establishing trends and changes in trends. If you are keeping track, this is in lieu of FNG's 15 minute candle (and the only reason I am still clinging to NT... the jury is still out on this). I also track QQQQ on two NT charts, same 5 minute and 3 minute setup.

When the market is moving, the screener and QQQQ chart let me know about it. QQQQ seems to start the move, and new highs/lows light up in confirmation.

TWS is only used to enter and exit orders. Orders are placed at market (with no confirmation) by clicking on the current inside bid and ask in 500 share lots. (Note to self: ALWAYS check to make sure I am clicking on the correct side of the entry.)  Exits are accomplished with a ctrl+left click on the position column (confirmation required).

Seeing as this is still relatively new, I expect the practical application to change a lot. But this should be a closer representation of what I am doing for the time being.

Selling Strategy (2-10-2010)

Last month's losses served to stress the importance of establishing a better basis for profit/loss points. Stretching my profits points worked out very well the first part of the month, but the lack of a good stop loss ended up costing the account a lot of money.

And now, a week and a half into February, and a couple of mistakes later, the account value is down another ~5k.

Two factors - the stop loss and, perhaps an even bigger factor - the psychological: buying outside of the tested strategy, getting carried away with big profits, and the lack of a proper perspective for the trade profit/loss calculation interval - combined for some very poor decisions.

I have been analyzing the data that I have been collecting on the stocks that have passed screener criteria. Unfortunately, almost all of the metrics that I have saved, - or thought of calculating - have pretty much washed out in terms of predictive value. I haven't been able to establish any type of relationship between collected/calculated on the day of purchase to future price - everything resulted in uniform scatter plots with an occasional outlier.

I decided to take the stochastic approach and examine performance of the stocks that passed screener criteria by way of the difference between a day's high and the close of the stock on day of purchase. Day 1 of ownership was the most consistent. The figure below plots the difference between the high of the first day of ownership and the close on day of purchase, with the day of purchase (Day 0) on the x-axis:

Pretty cool huh? Some crazy variance on the DOW's down days, but it is pretty easy to see that the majority of stocks have a high that is higher than the close on the day of purchase.  Here is a histogram of the day 1 data:

Using some statistical analysis, I fit the total Day 1 data to a distribution and calculated values at 50% probability and 75% probability and came up with gain values of approximately $0.20 and $0.04 respectively. Filtering the Day 1 gain for positive only yielded approximately $0.20 and $0.09 respectively. For those who may be interested, the unfiltered data was fit to a Burr (4p) and the filtered data was fit to a Pareto distribution, with respectable goodness of fit tests:

 

I next filtered the Day 1 gain data for negative values only, and checked the corresponding difference between the high gain on Day 2 versus the close on Day 1. The value for a 75% probability was approximately $0.01, indicating that for the most part - it is best to sell the losers on the first day as well.

All of this lends itself to the formation of a new strategy - set a profit point at about $0.20 above Day 0's close, and close all positions at end of Day 1.

Easier said then done. Take Monday and Tuesday of this week for example. Monday was a losing day. I did not sell at end of day, deciding to wait until the morning of Day 2 (Tuesday) (I did however enter two new positions). On Tuesday the market saw a lot of bullish action and I postponed the sale,and ended up reaping a decent return for my trouble - on all but one stock (which I sold today at an even greater loss). The psychological factor - at one point during the day I was up just under $300 on that stock, but still down overall. Why is it so difficult to keep the day's gains in perspective??

I want to be mechanical about my trading - I think that is best probably. But - it seems there has to be room for interpretation - everything was down on Day 1, so itI thought that it was probably was best to wait until Day 2's morning to sell. Futures indicated a strong opening and I held on, which happened to be the correct thing to do. But - what if they wouldn't have - e.g., week three last January?

After the steep loss on January 22, a lot of people were trying to guess at what the market was going to do the next day. I don't think it was at all possible to have any confidence in anyone's opinion on what was going to happen. What if I find myself in that position again? I think if there is any doubt I need to sell. Chances are that I will be wrong sometimes. Cost of doing business.

So that is my stop loss - hold on to the position for a day. If everything is down, wait till the next morning, then try to gauge market sentiment; if the futures market is mixed, sell right at open.

And the last thought - I have been tuning into Don Miller's blog which I have found offers a lot of practical advice. He talks about the idea of outliers and how those will be the big reward days. My implementation of this will be the lowering of the sell point during normal trading hours, but prepped for the possible gap open by bumping up the sell during extended hours. Slow and steady with the occasional home run. That's me.

Lets see what happens.

My selling strategy (1-04-2010)

At this stage in my day trading experience, I find the question of when to sell out of a position pretty complicated - and constantly evolving. For whichever reasons, I have already decided to buy, and for better or for worse, I am invested; now the day's gains and my prevailing mood depend on the whims of other traders. How many times have I sold only to later realize that I sold at the low for day, or at the start of the rally? How many times have I not sold, only to watch the price spiral down out of control while I sit on my thumbs and shut my eyes to all of the bright red on StrategyDesk? I am guessing that both have occurred with equal frequency. There are huge emotional and psychological elements to day trading - and personally I feel like they all come to a head in the sale - an essential pronouncement of judgment on my decision to buy and everything in between. Now it is done - the profit or loss are locked in and realized.

So... how do I sell?

This is about as un-scientific and un-technical as it gets. And which, as I sat down to write this, really, really bugged me.

I shoot for daily targets - from $150 to $200 per trade, gross. I usually buy in units of 500 or 1000 shares, so that means setting the sell anywhere from $0.15 to $0.40 on top of the buy point. All sells are limited, GTC + ext. If I don't sell the first day by close, I bump the price up for extended hours and possible gap open. I don't set stop losses.

Yup... I have tried a bunch of approaches and nothing seems to work very well - except this: shoot for so much a day. When it comes to selling at a loss, I feel like I am pretty mcuh flying by the seat of my pants.

The thing is, I am not at all sure that it is possible to be rigorous in one's approach to selling (and buying for that matter). But I keep collecting data to see if I can't figure something out.