Saturday, November 25, 2006

Blind Squirrel Finds Acorn

Sometimes you just stumble across things. There's no "eureka" moment - it just happens - it happens. Earlier I mentioned that I was working on an idea regarding an exponential moving average crossing a simple moving average. I thought that might make for a nice swing trade idea. It didn't work.

Since then I read something that Jim Cramer said the other day regarding speculative stocks. He said if you speculate you should remain between $2 and $10 as that was where you would find the best bets. I'm paraphrasing - Jim always calls it "investing" but we know what he really means don't we gang - wink-wink-nudge-nudge (second time today).

Anyway I tried "EMA 21 crosses MA 20" filter for stocks in the $2 to $10 range and I started getting some good hits. I added a volume requirement (90 day average .5 million shares) to weed out the weak sisters and then added the fact that they should be below the EMA 90 at least 4 days ago (based on swing trading findings from earlier). After looking at the results of the scans over several days in the past (another stockfetcher capability) I dropped the value requirement from $10 to $7 and began to backtest.

I set up a simple enough test using several variations. First - stop loss, second - number of days held, third - number of stocks bought daily, and fourth number of stocks held in the portfolio.

After many runs I settled on stop loss = 10%, no profit exit, sell after 4 days (or stop loss hit), buy only 1 stock per day and never have more than 4 in the portfolio at any given time. The no profit exit option was selected because I decided that I didn't want to cut off my profit potential since I was only holding 4 days.

Result of the test - in 77 days out of 77 stocks purchased and held 4 days only 7 were stopped out - the rest were sold after 4 days or on the last day of the test. Bottom line - using a $100K account - the filter racked up a whopping plus $43727. The maximum loss was $3417.00 and that occurred early in the process.

Now I'm not saying that you can make this kind of money from such a simple system nor am I saying that I can but here's the bottom line. I changed the dollar requirement from 2 to 7 to 20 to 70 with a commensurate increase in the volume requirement and the return was $560.00. So given slippage and the need to buy several thousand shares of cheap stocks as well as find a buyer for same 4 days later you probably can cut the 43K in half and make it a more reasonable 20K. But you don't have to cut that 560 bucks in half - you will probably get that whole amount.

Point being a simple filter can return remarkable results if the venue is correct. Something like this can work on cheap stocks because you only need a dime or a quarter to make some money off them whereas on the more expensive stocks you need a lot bigger move.

Anyway past performance is never a good judge of future performance and keep in mind that the test period selected was also the period of recent market gains as a whole.

I'm going to be looking at the day(s) after a spectacular gap up and rise in a future post. Stay tuned.

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