Tuesday 30 December 2008

New High Breakout Over 21 days

A popular trading strategy among stock traders is to look for some sort of price breakout from current ranges or limits. For example, if a stock has been trading in between clearly defined resistance and support levels for the last few weeks and then it breaks through and close above the resistance level traders might buy or take a ‘long’ position in the stock, as illustrated in the chart below (click to enlarge).



Another way, which is easier, to determine price breakout is to look at the previous ‘n’ periods (for example 21 days) and wait for the price to make a new high within this period. When this happens, it is generally believed that there is renewed strength in the stock, and so traders would look to take a long position in the stock.

Once a long position has been taken, we could set the initial ‘stop loss’ level using the Average True Range indicator. The good thing about this indicator is that we could also use it to ‘trail’ the position as it starts to make a profit, and it also provide clear exit points for the position should the price start to come back down again. The chart below explains what I am trying to say in a much clearer way (click to enlarge).


Note that the ATR Trailing Stop indicator has 2 parameters which need to be defined (i) the time period and (ii) the multiplier. In this example, I have used 21 days as the time period and a multiplier of 2; I will refer to this indicator as ATR[21,2x].

Our system entry and exit rules are as follows.

System Rules for New High Breakout over 21 days:
  • Open a long position in a stock when its price makes a new high over the last 21 trading days.
  • Exit position in a stock when its price closes below the ATR[21,2x] trailing stop.

There are multiple parameters that could be varied in this system, including:
  • Time period ‘n’ for measuring the breakout range (e.g. 10, 21, 50, 100, 200, etc.)
  • Time frame of the chart: intraday, daily, weekly, monthly, quarterly or yearly
  • The 2 parameters of the ATR Trailing Stop indicator
Instead of using the ATR indicator as the trailing stop, we could have used any other trailing stop indicator, such as other volatility-based stop loss, Count Back Lines, and Bear Range Exit just to name a few.

Changing any of these parameters could significantly affect the performance of the system. Therefore, it is important to determine the effects that each parameter have on the system in order to achieve the optimal performance.

I will discuss the performance of this particular system in a future post. Stay tuned!

Friday 19 December 2008

The Rule of 72 and Various Rate of Returns

The following table demonstrates the rule of 72, which gives a good guide to how long it would take for your investments to double in value.

The starting investment value in this example is $10,000 in January 2009. As can be seen below, the rate of return on investments significantly affects performance over a long term period of, say, 15 years.


The Australian stock market has managed to achieve an average rate of return of 13.9% over the last 30 years (with dividends reinvested). If you can achieve the same rate of return over over 15 years, you could have turn $10,000 into nearly $80,000 as your investment value would double every 5.2 years (72/13.9 = 5.2) at this rate.

However, many professional traders out there can probably earn about 20% or more consistently over the long term (without gearing). So, if you could achieve this rate of return, you could have turn $10,000 into more than $160,000 in about 15 years because your investment would double every 3.6 years (72/20 = 3.6).

I have tested multiple stock market trading strategies combined with gearing, and have been able to achieve an average return of 38% over a 20 year testing period. This would mean my investment (or trading account) would double every 1.9 years (72/38 = 1.9) if I could achieve this rate of return consistently, which I believe is possible. So, $10,000 could have turn into $2.56 million in just 15 years.

All this is possible due to the powers of compounding interest and gearing.

What is gearing? It's simply borrowing money to invest or trade, and it can be achieved through Margin Lending or Contracts for Difference (CFD), which are readily available to traders in Australia.

Wednesday 17 December 2008

The Rule of 72

This post is written by Andrew Page from Trading Tutors Newsletter Issue #288 12 December 2008.

We all know that the share market can be a very scary place in the short term, in fact given the past 12 months we should now understand this very well indeed. But that doesn’t alter the fact that the market offers amazingly attractive returns over the long term. So as long as you can afford a longer time frame and ride out any short term volatility, your investment dollar is well placed.

With dividends reinvested, the average total investment return for the Australian market is 13.9%pa. That might not seem like much, but over time it can yield phenomenal results. This is due to the power of compounding, and although we usually associate this with savings accounts, it applies to any investment where your income returns are reinvested.

Chart 1 is the Long term performance of the Australian share market. Represented by the All Ordinaries Accumulation Index 1979 – 2008. Logarithmic Scale.


click chart for more detail
Chart 1 - click to enlarge


To gauge just how powerful compounding is we can apply what is known as the “rule of 72”. This provides a reasonable estimate of how long it takes your investment to double given a certain rate of return; all you do is divide 72 by the annual investment return. So assuming that the long term rate of return on the market stays close to 13.9%, we can expect an investment in the market to double in just over 5 years (72/13.9 = 5.18). Of course in reality, it’s not likely that you will experience a nice even rate of return from one year to the next, but over the long term it provides us with a very reasonable estimate.

To put this into dollar terms, imagine you invest $2000 into a mix of quality blue chip shares when your child is born, and you reinvest all the dividends. By the time the child reaches 21, they will be sitting on a portfolio worth over $27,000. Still not impressed? Well, what if you decided to contribute an additional $1000 per annum (that’s less than $20 per week)? Again, based on the long term historical average return of the market, your child would receive for their 21st a portfolio worth over $105,000! Furthermore, the portfolio would be generating thousands of dollars in dividends each year (not to mention the tax benefits of franking credits). It really is the gift that keeps on giving.

Chart 2 illustrates $2000 invested in 2008, with dividends reinvested and $1000 added each year. Based on an average annual return of 13.9%


click chart for more detail
Chart 2 - click to enlarge

So if you are struggling to think of presents for the children or grandchildren (or even yourself), why not consider putting some money into the market? The DividendKey program specifically focuses on building substantial wealth through conservative long term income investing, and is perfect for those wanting to generate these kinds of returns. (www.dividendkey.com)

Ask yourself what your child or grandchild would prefer for their 21st birthday - an engraved pewter, or a portfolio worth close to a hundred thousand dollars...?

Tuesday 16 December 2008

Moving Average Crossover - SMA[100] & SMA[200]

Stock Market trading systems are usually constructed from one or more technical indicators and are used in such a way that gives clear signals to the trader or investor regarding the entry and exit points of a trade.

By far, the most well known and used technical indicator in the stock market is the moving average (MA). So, a good starting point in reviewing trading systems is to look at something that involves using the moving average(s) in some way.

In fact, the 100-day simple moving average (SMA-100) and 200-day simple moving average (SMA-200) crossover system will be discussed here. Why use the 100-day and 200-day periods? I believe that’s an excellent question, and it is the sort of questions that traders should be asking themselves all the time. But for now, the answer is because they are widely used by everyone out there including traders, investors and analysts.

Our system entry and exit rules are as follows.

System Rules for Moving Average Crossover - SMA[100] & SMA[200]:
  • Open a long position in a stock when its MA-100 indicator crosses over its MA-200 indicator.
  • Exit position in a stock when its MA-100 indicator crosses under its MA-200 indicator.

This is illustrated by the chart below (click to enlarge):



There are multiple parameters that could be varied in this system, including:
  • Method of calculating MA: simple, exponential, weighted, etc.
  • Period of the shorter (faster) MA
  • Period of the longer (slower) MA
  • Chart timeframe: intraday, daily, weekly, monthly, quarterly or yearly
  • The exit condition could also be altered, such as using a trailing stop loss to lock in profits

Changing any of these parameters could significantly affect the performance of the system. Therefore, it is important to determine the effects that each parameter have on the system in order to achieve optimal performance.

I will discuss the performance of this particular system in a future post. Stay tuned!

Monday 15 December 2008

About Me

Hello World!

As this is the first of what I hope to be many long, happy and profitable postings, I think it's a good idea to start off by breaking the ice, so to speak, and introduce myself, my ambitions and talk a bit about the aim of this blog.

Well, where do I start? OK, I live in the land of Oz (that's Australia), and I am an electrical engineer by profession. Have been working for a few years now after finishing Uni and basically getting paid peanuts.

I am a bit short on cash, and can't afford to buy things like a house, my future BMW or that trip around the world. "But you're an electrical engineer, how can you be short on cash?!?" I hear you ask. Let explain...

I've been doing a bit of trading over the last year and a half and, to put it mildly, haven't been doing too well... Alright, I'll admit it, I got burnt like a house on fire and lost a lot of money.

The last 18 months have been one of the most volatile times in the stock market's history. You are either laughing all the way to the bank or feeling sorry for yourself if you are a trader. I know for a fact that most people are feeling sorry for themselves in these times. There is only 1 person that I personally know of that is making a massive amount of money from the markets. I'll tell you more about him in future posts.

My great ambition in life is not to work until I reach retirement age. I want to retire young with a couple of million dollars in my pocket. Then I can do the things that I really enjoy doing, such as spending time with family and friends, make a positive difference to the community, and travel around the world.

Life, to me, is too short to spend around 1/3 of it at work. When you also consider the fact that most of us also spend 1/3 of it sleeping, we only have the remaining 1/3 to do things that really matters to us.

I have decided that working from 9-5 for the next 40 years will not allow me to achieve my ambitions. If I were to make a lot of money and retire young, I would have to create a another stream of income.

After trying out a few business ventures, it seems the best option for me is to make money in the stock market. Although, I've gotten off to a false start, I genuinely believe that a lot of money could be made in the stock market.

So finally, the purpose of this blog is to record and share the strategies I use in the stock market and discuss the back-testing results of these strategies; I'll also publish my actual trading portfolio and activities on the blog, as well as any other useful information relating to making money in the market.

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