A New Approach

It was too nice a weekend to sit and update the old BLog so I hope you all did something special with family and friends as did I.

But while I was enjoying the weather and continuing my quest to get my veggie garden ready I came up with a new idea.

Some months ago I showed you all a filter that captured stocks when the MACD first crossed below the 0 line rather than waiting for it to reappear in positive territory. I suggested at that time that by the time you caught the MACD on the upswing most of the move was probably done and you would only be getting the leavings.

This filter is much the same except I'm using the linear regression slope (LRS) coupled with an RSI(2). Again my preference for filters is to use indicators that are as close to real-time as I can get them and the linear regression slope is one of those critters. Also the RSI(2) is about as close to real-time as you can get and still have an indicator of some kind.

Instead of picking a single point in time for either of the indicators I'm looking for a process - I want the RSI(2) to be descending and I don't care what the values are and I want the linear regression slope to be ascending with the only caveat that it was less than zero 5 days ago. In other words the stock is showing some momentum slowdown (RSI) but at the same time it is reversing its course (LRS). As readers of this log know - stocks slow down and stop before they reverse course - in both directions.

The LRS takes a bit to move it - it is a large boat and large boats require a lot of time and water to turn around. The RSI on the other hand is a speedster and it moves pretty quickly up and down. Here is the filter -

Show stocks where close is between 15 and 35
and Average Volume(90) is above 500000
and rsi(2) has been decreasing over the last 1 week
and linear regression slope(45) has been increasing over the last 1 week
and linear regression slope(45) < 0 5 days ago
and draw cma(pp,4)

The line regarding the cma(pp,4) can be ignored for now - it is just something else that I'm working on. Generally speaking from observation only it can be used to enter the stock (close > custom moving average(pp,4)) and as an exit method - (close < cma(pp,4). I didn't test that, I only observed it.

A typical selection looks like this -


It back tests nicely as a good swing trade selector - short term it is merely adequate. The numbers were 61% win ratio, 1.52 reward/risk and 39.11% ROI short term. But where it excelled was in the 30 day region where it returned a 6.94% net and that is fantastic.

So if you are looking for a filter that finds depressed stocks that are on the mend - this is it. It doesn't pick very many - about 1 every other day or so - but those it selects are generally green at the end of a week.

BOB - A Reprise

Bullish Jim mentioned that he made a little yesterday during lunch time playing QID and so I went to take a look. And indeed QID was in the BOB formation. That is annotated on this chart. And I’m repeating the methodology here both for any new readers and as an update for some of my old readers who may have forgotten the pattern.



Now that is the only way a BOB is defined. If you look at the three candles just before the three I used to describe it you can see a similar but not quite the same pattern. That is not a BOB - only similar - and you can see that the stock continued to go down. Only the real BOB has a 68% probability of a rebound. Of course this BOB had a bit more than that because of the fact that it had descended through the second support level.



That lends a whole new amount of probability to the possibility of a rebound (probability and possibility in the same sentence - what a weasel worder).

Then the third piece of goodness associated with this particular BOB was the fact that the RSI(2) was less than 2 and had been for awhile. That is indicated by the purple color of the candles. I set up Quote Tracker to color them purple when the RSI(2) was less than 2.

So here is a BOB that is supported by other pieces of technical analysis and if you saw it and didn't trade it you lost an amazing opportunity to make some cash.

One other point I'd like to make - BOB isn't TA - it is a "trader's observation" and there is a difference. Technical analysis is based on price manipulations in some manner such as RSI or Pivot Points or Moving Averages of whatever kind - the "BOB" on the other hand uses price in the raw as it is happening now. BOB then is more up to date than is most TA. When BOB is coupled with TA it becomes extremely powerful.

RSI ATR - A Practical Example

Revisiting that filter I spoke about yesterday here is a good example of what I was talking about. This is IMCL and you can see quite clearly that there were two occasions in the last month and a half when you could have taken this stock off the RSI/ATR set-up.



And at least one occasion when you shouldn't have. You can see on that occasion what I was talking about yesterday when I said that you had to wait for both conditions to be met to be able to say that the stock is bottoming with about a 65% assurance. If you had just taken this stock from the RSI(2) < 2 flag you would have been two days early.

Note that on both of the true flags the stock went on to post a blow-off bottom and that is just one more indicator to watch for - it isn't required but it makes for a good confirmation.

And confirmation is the most important thing of all - on this chart to the left you can see one more spot where the criteria were met but the stock didn't turn. Remember this business is all about confirmation and without confirmation we don't do anything foolish. No confirmation - no trade. It did finally confirm but didn't follow through - that's why you use a stop loss. On the next flag it followed through and then some.

In a previous post this morning the one about the past being prologue I said we needed to wait for the ATR to turn around and come down before we could be sure that the index had bottomed. This is not inconsistent with how I use the ATR as a proxy for volatility. In the ATR/RSI filter I am using it to look for low volatility because low volatility begets high volatility and if the stock is at the bottom then it should go up when volatility goes up. But both tops and bottoms are marked by volatility changes. If it is high it will go low if it is low it will go high.

For those of you not in possession of a capability such as being able to draw a moving average of the ATR note here's a tip. Just look and see where the ATR is in relation to its recent past and price bottoms. If it is anywhere near where it was the last time the stock turned and went up then it is probably at a bottom.

And finally - this chart is a screen print of stockfetcher.com's new charting interface, SF2 and it is a beauty. It is still in Beta but when they get it finished it will be a joy to behold.

I don't get anything from them for the endorsement so it doesn't bother me if you don't want to improve your trading ability.

Relative Strength Index

We've done testing using the Relative Strength Index on this site before and have been all over the block with it - from RSI(8) to RSI(2). Most recently we have pretty much settled on RSI(2) < 5 as being the killer app for trading purposes and I've made a few coins using the selections generated by that filter. Not randomly but by watching them and their price over price relationships on 4-minute and 15-minute charts. This is the filter that I am currently using for this purpose -

show stocks where close is between 15 and 35
and average volume(90) < 500000
and rsi(2) < 5
and volume 1 day ago > volume 2 days ago
and volume > volume 1 day ago

Some time ago I included the volume relationship criteria because it just made sense to me that it was needed. The test results for this filter are somewhat impressive too = 72% win rate, 3.6 Risk/Reward and 161.22% ROI.

Without the volume criteria the results are good but a little less = 70% win rate, 2.85 Risk/Reward and a 119.4% ROI. These as I said are good but less.

Once again though as a sanity check I reversed the premise of the filter shown above and changed RSI < 5 to RSI > 5. Now the results changed appreciably = 64% win rate, 1.23 Risk/Reward and 36.34% ROI. That kind of proves that the RSI(2) less than 5 is a pretty potent beast.

But what is the RSI? I'm not going to go into the details here because you can find them in many technical analysis books, all over the internet and also here - my favorite quick reference.

RSI Revisited

A number of trading posts talk about the RSI(2) as a means to quick profit and for all practical purposes I believe it to be so. I did a post some time back that got good results from an RSI(8) but I think that if you adapt to the techniques that other traders are using you are probably better off in the long run. This is because you can exploit their weaknesses - and that is what you want to do.

This morning I read an article published by Trading Markets and reprinted in Yahoo Finance regarding several ways that they select stocks for trading.

One of these was using the RSI(2) and I quote - 2-Period RSI Below 2: These are stocks that have a 2-period RSI reading below 2 and are trading above their 200-day moving average. Our research shows that stocks trading above their 200-day moving with a 2-period RSI reading below 2 have shown positive returns, on average, 1-day, 2-days and 1-week later. Historically, these stocks have provided traders with a significant edge.

Needless to say in my never ending quest to rid the world of Simple Moving Averages this one caught my eye. I said - well - I have to test this theory out - so I wrote a filter.

It's a simple filter as filters go -

show stocks where close is between 15 and 85
and average volume(90) < 500000
and rsi(2) < 2


And I back tested it. I got some pretty nice results - 68% win percentage and 129.73 ROI. This is not too shabby.

Then I modified the filter to add a line - and close > ma(200) and back tested that. My results were 64% win percentage and 51% ROI. Wow - talk about a fall off in profit potential.

I modified it once more to change the line to close > ema(90) - the results were even worse - 55% win percentage, 44% ROI.

One more modification to close < ma(200). This time the results were almost the same as they were with no moving averages involved at all - 68 and 131 (a little improvement in the ROI).

A final modification just to close the loop to close < ema(90) and that improved the ema results to 66% and 127% ROI.

Bottom line - the moving average doesn't matter - RSI(2) < 2 with a play on the highest volume output that day is a good short term winner without considering a moving average. But if you are going to use a moving average of any kind - go low not high - in other words - below is better than above. Which just serves to reinforce our common refrain - distressed stocks do better than high flyer's in the short term.