SPY 10/27/08 to 2/12/09
Let’s go back to October 27 (2008). On that day the SPY closed at 83.95. Today, it closed at 83.66. Net change in three and a half months has been -.3%. The range, from high to low, over that period of time has been 25.81 points, or 30.9% based on today’s close. So, we have a wide range, with little or no change. The market is “range trading”. It is choppy and flailing wildly depending on the news of the moment. Every statement by a public official, every economic report, every speculation is driving the market into a frenzy. However, after all is said and done, little has changed.
This is the perfect market to drive system traders crazy. And how have you been faring over these recent months?
Basically, most trading systems require trending - either up or down, and when a market isn’t trending, and individual stocks or stock groups aren’t trending, it’s extremely difficult to make money.
All systems have some sort of filter, some way of preventing relentless whipsaws. A simple system that buys when price moves above a moving average and sells when price drops below that moving average, allows prices to move up and down as long as the moving average isn’t crossed. Once the average is crossed, an action is taken - either buy, or sell.
So, systems such as the above will always catch a trend, but never buy at the exact low, nor sell at the exact high. There is always a period of lag. These systems catch the middle portion of the trend. This is the basis of almost all trend following systems.
Now, what happens if the trend is short, if price turns down soon after a buy signal is generated? Well, the answer is that losses will occur.
In a basically trendless market, a trend following system won’t - can’t make money. One must look for those few stocks, or futures, that have some sort of trend, then attempt to trade them, either long or short, depending on trend direction.
When a profitable system breaks down, and stops making money, it is usually because the market is no longer trending, no longer behaving in a manner that the system is designed to handle. These periods are when drawdown occurs.
Today’s market was all too typical of recent market action. The market closed with an uptrend yesterday, then opened to the downside with a gap - so if you were long anything going into the open you had immediate losses. Depending on the type of system, stops were hit and long positions were closed out. Short positions were opened. Then, the market rallied strongly into the middle of the day, then crashed to new lows, then rallied almost vertically on yet another news announcement.
Is this type of market tradeable? Are you fast enough to react to the minute by minute movement? What do you do if you have to leave your computer screen? Can your system handle the volatility?
And, what can you do with months like this?
You can use this period of time to improve your system with additional rules - do this, or don’t do this based on the open, the last hour etc. You can backtest your stocks, one by one, to see which ones are working in this environment, and then you can delete the stocks that have been losers. You can get out entirely. You can get “small” - that is, keep trading, but reduce your position size, or you can just trade a couple of stocks.
In times like this I have learned to stay in the market but to get “small”. I prune my stock list to just the ones that have been making money in recent months. I reduce my position size. But, I keep trading. Why? Because it’s how learning happens. It’s how systems are improved.
To repeat my subtitle, “It all seems easy when you’re making money”. However, when times get tough, when you’re losing money, that’s when the learning takes place. That’s when you look at your system and the market, and test new rules and new strategies. If you can survive the tough times, you’ll be stronger and better when the good times return.
And, there will always be tough times, and there will always be good times.
SPY 2_12_09 30min Bars
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