“Cry In The Dojo, Laugh On The Battlefield.” Samurai Wisdom
Some readers are aware that I am a competitive cyclist. It’s kind of odd when I call myself an athlete, now that I’m in my late 50’s. But I’ve been an amateur athlete since my 20’s, and a competitive cyclist since my early 30’s. In fact, my original post-secondary education was in Phys-Ed – which lead me to own a serious training gym when I was in my mid-20’s. Always the entrepreneur.
Right around the time I started racing bicycles, I also got involved in the investment business (I was 29). When I first got into this business in 1990, I did what every uninformed Financial Advisor does. I bought mutual funds for clients. But, by 1994, I began trading stocks – albeit in a less-informed manner than I do now. It was around that point that I began studying Technical Analysis, and attained my CMT. Over time, the structured training and systematic approach I had learned from bike racing began to influence the structure of how I would formulate today’s ValueTrend Equity Platform. I learned the discipline of Technical Analysis. I formulated a structured trading routine – just like I had formed a structured training plan for bike racing.
Race training is different than training for fitness. It’s far more structured, and frankly, involves far more pain and suffering than one endures in the pursuit of a healthy level of fitness. Race training (if you want to win) is about pushing your body and mind to its limits. When you need to respond to “attacks” by your competitors on the hills late in the race, and you feel exhausted, you’re ready. You’re never comfortable with it, but you’ve trained to deal with it.
Trading is similar. You need to familiarize yourself with the pain of taking losses. You need to harden your mind to the uncertainty that is the stock market. Do you place this trade today? But what about (fill in the current market worries here…Iran war, Trade wars, US debt, Brexit…)? You need to employ a structured approach that gets you out if the trade sours. You need to accept that a stop loss strategy might result in getting out, to then watch the stock move back higher. You need to accept that you missed the winning trade. You need to embrace taking a loss, or making less of a gain than you could have. You need to feel comfortable that, despite all of these downsides, you will still come out ahead over time if you adhere to your disciplined structure.
For all of this to happen, you need to make your mistakes through back-testing a trading system. And then, you need to make some mistakes in real time.
You need to cry in the dojo, so you can laugh on the battlefield.
Testing Your Trading Strategy
Here are a few of my thoughts regarding how to test a trading strategy. This is not a computerized approach. It’s for those readers who prefer an old fashioned chart-eyeballing strategy.
Note: I am using a very simplified system to illustrate the principle of back-testing. I am not suggesting that you adapt this very simple series of trading rules. In fact, this illustration isn’t dynamic enough for most investors. But it will illustrate how a back-testing regime works. You can read my book, Sideways , for a more comprehensive look at how to create buy & sell trading rules for yourself.
Let’s make your strategy look like the following. Again, this is NOT a recommended set of trading rules. It’s an illustration.
Let’s say that you want to buy after a stock or ETF has tested a particular price (technical resistance) several times over the past 3 months, and then broken out.
- You want to buy on a move above the 200 day (40 week) Simple Moving Average (SMA) in combination with a minimum of 1 week of the stock remaining above that sideways pattern breakout price.
- You want to avoid stocks trading at an RSI of over 70. RSI is a technical momentum indicator found on most charting services.
- You will sell on a break of the 200 day SMA by more than one week.
Back-testing Steps
Step 1:
You want to do your testing on a few security types that you might typically trade. For example, at ValueTrend, we mostly trade country ETFs, NA sector ETFs, commodity ETFs and individual mid-large cap stocks.
For each chart, go back in time and start at your furthest back period. For illustrative purposes, I have chosen the S&P 500 chart (SPX) beginning in 2012 and ending in the fall of 2016. Charts courtesy of stockcharts.com.
Step 2:
Move the chart forward, bar by bar, and spot possible trade setups according to your rules. On the SPX 1 chart above, you will see that the SPX was contained below a level of 2100 from June 2015 to June 2016. Then the market broke that lid in July 2016. It was above the 200 day SMA. That lasted for more than a week (one bar).
Step 3:
When you find a trade setup based on your trading strategy and rules, pretend you entered it. In this case (SPX 1), we have a breakout from a consolidation that lasted over three months. We have a move above the 200 day SMA. RSI is not overbought. Support at the breakout point of 2100 is holding. So you enter the trade. Make note of the date, position size, and price of “entry”.
Step 4:
Now, move the chart forward in the trade’s history. Your sell rules must be adhered to as you note your actions. Note on the SPX 2 chart that the SPX retraced to the breakout point in a classic test that November. You wait a week. After a brief move below 2100 that lasted less than a week, the SPX looks to be holding above 2100 and its 200 day SMA. No need to stop out of the position yet. Keep holding the SPX until your rules say to sell–whether it’s a loss or a gain.
Step 5:
Keep scrolling forward on the chart. Enter a sell if your sell rule kicks in. I’ll skip ahead to 2018. On the SPX3 chart, note the break of the 200 day SMA in the last week of September of 2018. That’s a sell signal if it lasts for more than a week. You wait a week. The SPX remains below its 200 day SMA. You sell in the mid-2600 area. You’ve made 23% from your entry in June 2016 to your exit in October 2018. The market falls further. But you are now in cash, and await another buy signal based on your system. Make notes of your exit conditions, and your profit or loss on that trade.
That’s about it. The above steps should be followed using historic charts on several stocks or ETF’s that might represent typical instruments you invest in. After testing at least 10-12 securities over many years of set-ups, you should have an idea if your buy/sell discipline is profitable. Again, I encourage you to read my book Sideways for a more comprehensive guide to creating your own buy & sell trading rules. Best of luck in your findings!
If you have questions about the technical analysis of stock trends for individual stocks, be sure to phone in with your questions for Keith during the show.
Call Toll-Free 1-855-326-6266
Or email your questions ahead of time (specify they are for Keith) to marketcall@bnnbloomberg.ca
Keith Richards, President & Chief Portfolio Manager of ValueTrend Wealth Mgmt., can be contacted at krichards@valuetrend.ca.
Keith Richards may hold positions in the securities mentioned. The information provided is general in nature and does not represent investment advice. It is subject to change without notice and is based on the perspectives and opinions of the writer only. It may also contain projections or other “forward-looking statements.” There is significant risk that forward looking statements will not prove to be accurate and actual results, performance, or achievements could differ materially from any future results, performance, or achievements that may be expressed or implied by such forward-looking statements and you will not unduly rely on such forward-looking statements. Every effort has been made to compile this material from reliable sources; however, no warranty can be made as to its accuracy or completeness. Before acting on any of the above, please consult an appropriate professional regarding your particular circumstances.