Monday, April 02, 2007

Do - Do Not Do

Just finished reading Trader Mistakes Avoid At All Costs and found it to be flawed.

Good grief, Charlie Brown - if you need 10 rules go back to school - you only need one rule and he even includes it in his list -
Listening to rumors: Forget the talking heads, rumors and tips as they are nothing but garbage and a sure way to substantial losses

Which is just another way of saying Rule 1 - Nobody Knows Nothing - including me (and probably Chris Perruna too).

But where I find the biggest problem in his list of rules is -
Buying 52-week lows: Don’t be afraid to buy stocks making new highs. The garbage sits at the bottom along with weakness and downward momentum. Buy strength and the momentum moving higher.

As has been proven on this site over and over again there is more money to be made in buying low than buying high. I'll prove it again.

I wrote a simple filter -
show stocks where close is between 1 and 500
and stock reached a new 52 week low

And back tested it. Then I reversed it to 52 week high and back tested that one. The results were:

52 week lo - 48% win, 1.14 Reward/Risk ratio and 29% ROI - pretty bad.
52 week hi - 58% win, .86 Reward/Risk ratio and -17% ROI - pretty awful.

My goodness - Chris is correct - you get far more winners with the 52 week high method than you do with the 52 week low - the problem - you don't make any money. And last I looked that's why we're doing this.

I tried a different tactic - I went back in time to February 27th - you remember that day - market meltdown? - sound familiar? Anyway what I did was run the two filters and pull out the top 10 selections of both in two categories from that day.

The 52 week high filter found 80 candidates! and the 52 week low found 163 candidates. The two 10 stock categories were top 10 by price and top 10 by volume.

Then I discovered their change-to-date and summed it for each set -

52 week high - top 10 by price = -5.57%
52 week high - top 10 by vol = 1.43%
52 week low - top 10 by price = 16.15%
52 week low - top 10 by vol = 13.45%

Now those are totally random selections based on a two line filter - i.e. absolutely no effort was made to select good from the bad - and blindfolded dart-throwing selections from the bottom of the barrel beat the top of the barrel hands down. I don't know about you but I'd rather have some real crappy stocks and 16% profit than really great stocks and a -5% loss.

I'm not saying that there is never a time that a high-flying stock won't fly higher but the odds of your finding it are worse than finding a winner from the bottom of the deck - And that is all that this is about - probability and odds. There are only so many hours in the day - should we spend them looking for a diamond among brilliance or in the coal dust? I think they're easier to find when they're mixed in with the dust.

Rant on - the problem with many of these slick BLOGs is simple - they make unsubstantiated statements of fact and some newby comes along and says - oh yeah - that's right - that's what I want to be when I grow up. Then most of them just repeat one another so the next thing you know the trash is everywhere and there is no hope of cleaning it up. Then when they run out of crap to post they start posting BS lists of rules which are also repeated and promulgated throughout the net.

You will never see more than Rule 1 on this site. If you need more than Rule 1 - keep your money in nice safe CDs because you ain't going to make it in the Bigs. You don't need rules - rules are useless. You will never make money with rules.

What you need are processes - working, productive processes - they aren't a set of rules - they are an instruction manual for making money. And an instruction manual doesn't contain rules - it contains Alarms, Warnings, Alerts, and Steps. You don't get "rules" in Marlyn's place - you get processes. Rant off.


Anonymous said...

Amen (Corner).


Matt V. said...

Spoken like an engineer!

Marlyn Trades said...

Thank you - financial engineering - the study of phynance - is fast becoming part of the core curriculum of many Colleges and Universities.

While I'm an old guy I believe in the methods and think you can do best with a process. At least with a process you know when you are screwing the pooch.

Bullish Jim said...

I took his "don't buy 52 week lows" rule as basically the same thing as "don't try to guess a bottom" or "don't try to catch a falling knife" and I tend to agree with him. I love to buy a bounce off the 52 week low (like a BOB for instance) but I won't buy if I'm not sure if it has stopped falling yet. That bounce off the low is what gets you 90% ROI on BOBs and only 29% on buying the 52 week low without waiting for a bounce.

And for the record, I disagree with it being OK to buy 52 week highs. Be patient and you'll get a pullback off that high most of the time. Don't you think?

Marlyn Trades said...

I agree that you shouldn't try to catch a falling knife and that's what trader observations are all about. And absolutely - the pull-back from the 52 week high is a great method IMO. In fact I'm thinking of a filter even as I type - I think I know how to do it.

Bullish Jim said...

Hey Marlyn- this conversation inspired me to do a little analysis as well. I just did a post about whether the ROI of breakouts is impacted by how close the stock is to its 52 week high. I would love your feedback on the post when you have a few minutes. Unless I'm crazy, it appears that it matters how close the stock is to its 52 week high.

Chris said...

It’s great to see opposition to my list but what I don’t understand is how you disregard another system of trading without success of trading it yourself. I, as a trader, understand that thousands of successful methods exist to trade and many of them won’t fit my personality so they won’t work for me. Buying low priced stocks can and does work for some. Buying higher does work for me and has since 1998 (very successful since 2003). If you took a few seconds to read the blog further, you would understand that I do buy stocks making new highs in strong bull markets but spend 85% of my time buying stocks near new highs (within 15% of new highs) or stocks gaining support along the 200-day moving average. My bread and butter is along the 200-day moving average.

Anyway, thanks for the conversation but I must dismiss your opinion for lack of real-life experience trading it. I don’t trade lower priced stocks but I know it can work but the probabilities are against you. Stick to your back-testing, I’ll continue to trade real money. Don’t be so generic with back testing, only wannabe traders do this to prove a point, their point.