Frank Berreth's Blog

Forex Trading Systems

2011-12-10T21:45:00.000-08:00

I was shocked recently when I visited www.myfxbook.com. Let me explain: myfxbook is used to 'show off' automated trading systems. The website tries to verify the trades done by the trading system and that the account is not fake. It also has a search facility for finding those systems and shows if the system was a real account (real money at risk), a demo account (virtual money) or simply a back-test!

I was shocked by how readily people jump on new systems with a real account (or demo account) that shows a history of maybe 3 months of data. Sure, the profits these systems produced were enormous - but that alone should be a warning sign! These systems are highly optimize for a single currency pair and have 'expires soon' written on them. When they fail, they fail BIG.

Now I am no expert on trading systems but from the back-testing that I have done I can tell you that no system always works and the more they are optimized the harder they fail. The markets do change ... Take for example a simple moving average system that gives you buy/sell signals (take any methodology). You will discover that

It will not work on all currency pairs and shows huge losses on some (hint: this is how the system behaves when it does not work well)
If it works great on one currency pair, it will not work on all time frames (weekly, daily, 60min, 15min, 5min, 1min charts)

When you see the system fail miserably you need to ask yourself: How can I design the system so it fails gracefully or reduces losses when 'out of sync'. Since a simple system like that (and I think any system) does fail on many currency pairs and time frames, optimizing this for a single currency pair & time frame makes it look stellar on paper (you get a real smooth profit line) but makes the system less robust because eventually the market will change. Think for example of the stop-loss the system may be using - it may simply be too tight in the near future. Or maybe it has no stop-loss and hopes for the better :)

Be careful!

Europe

2011-11-12T15:01:00.000-08:00

The market did surprise me this past week quite a bit. Given the dire news that came from Europe about Greece and Italy, the market stayed very strong. Here is an update on the last graph I posted.

It seems like the 30diff broke the resistance line. The 30CLX also is showing great strength.

The 30CLXpp is also showing great strength. Yes, they all seem to be on the upper bound, but if you compare that to previous bull market advances this by no means indicates a pullback must come.

On the sentiment front the 2CS is doing great as well. Plenty room for it to go down and mark a top.

Short term sentiment may be a little high (taking AAII sentiment).

We never get a perfect picture I guess. My feeling is if we ever get I will be way too scared to actually buy :)

Longer term sentiment as measured by asset allocation also shows that we are not at a top nor bottom. Since we 'just' came from a bottom I would imagine a meaningful top being make here before another multiyear market decline. It doesn't look this way - in face, I do like the high cash % and bond %!

So, what do I think happens? I go with the flow. Looks to me that we may break out to make new highs next week, so I simply use a buy stop which gets me in on further strength.
I expect news from Europe to keep everyone scared while the market does what its going to do - whatever that is.

Out of the woods?

2011-10-28T15:47:00.000-07:00

In my last post I presented the possibility of a slide, taking out the market lows. The Dow took out the market lows only intraday significantly and closed slightly lower. Other indexes like the Russell 2000 lost some more, but the market quickly recovered.

I showed the divergences in the CLX and here is an update. Despite the quick advance of the market in the last weeks, the 30 CLX and diff chart did not take out the downtrend line. It's right at the top though.

Time will tell how this resolves. The 10 day CLX of course shot up since it is much more sensitive to market moves of a couple days (did this in 2008 decline too). Given this chart though I am hesitant to declare that we are out of the woods. The market is very news driven and news from Europe can bring it back down quickly ...

PS: Sorry for not updating the Dow in the graph above.

Oops

2011-09-09T17:35:00.000-07:00

I noticed that the link to my web site was broken. I fixed it up now :)

A slide ahead?

2011-09-09T11:19:00.000-07:00

I am posting some CLX charts here so you can see how the CLX compares to 2008 time period. Some interesting divergences developed. Now does that mean that we will follow the 2008-2009 track? I don't know. My guess is probably not. As Buffet said - this is not 2008.

Notice the divergence between the CLX and price (red lines). The same developed in 2008. This also developed in late 2009 - early 2010 (not in red) but the resulting price decline caused a wash-out in the CLX. We are not quite that low but we also don't have to get there ... my guess is though that if we take out the price lows that we will slide fast.

Same story here.

This chart is my own indicator that combines the P/C with volume. The spikes usually occur at market bottoms but in late 2008 this was actually not enough and the market continued to slide while the P/C declined.

The last chart for your amusement. You can see the divergence developed in the cumulative DIFF but not in the cumulative CLX as it did in 2008.

Sentiment

2011-06-22T11:19:00.000-07:00

Looks like the 2CS did its thing and the market reached a bottom. There may be short term weakness left but longer term I think the worst is over. It's also interesting to see how AAII or II sentiment (bulls/bears) softened during this decline which really wasn't that bad.

New computer model

2011-06-22T11:16:00.000-07:00

I added a new computer model called "performance" to my web site (link on the right). It has back tested data in it though. The reason for it is that I experimented with a new set of ETFs and many of them (like GLD) had only a couple years of history, so I had to use data to train the model that reaches beyond 1/1/2007 (this is where I let the models start so its easier for comparison).

New computer model

2011-05-19T12:29:00.000-07:00

I updated my website "Long Term ETF Investing" with a new computer model. This model has about the same performance than the sector model but with less trades

I also added some statistics about the max draw down for both models. Please post comments/suggestions for the site here. It is a work in progress ...

Short-term Sentiment

2011-05-11T11:52:00.000-07:00

For the short-term Sentiment I watch mostly the 2CS. The 2CS can be a little early (1-2 weeks) but usually signals some tradeable market correction or bottom.

Here is the 2CS chart:

You can see that the 2CS just put in a low while the market continued sideways. I think there will be some short term correction (<3 months) but the longer term sentiment indicates that after that we should be good for further advances.

Sentiment

2011-05-11T07:19:00.000-07:00

So, I have been wondering about sentiment since the stock market did some good sized advance since early 2009. Have a look below:

The first chart shows short term sentiment of AAII bulls-bears readings. You can see even though sentiment relaxed (10 week bulls-bears) that the stock market held up. A correction like in July 2010 is not impossible though.

The second chart shows long term sentiment over more than 20 years. Sentiment cannot really be used for market timing as you can see in the 2005-2007 years but it could be used for getting cautious. Anyways, this long term chart also shows no concern.

The last chart shows the asset allocation. Although the cash level is getting a little bit low, this is of no concern due to a high bond allocation. The high bond allocation though makes me think we will see continued weakness in bonds.

This shows in no way that there couldn't be a sizeable correction coming like for example in Apr-Jul 2010, but the chances for a big market decline a'la 2008-2009 or 2000-2003 are probably quite low.

I'll post a short term sentiment chart soon (the 2CS).

Algorithmic Trading

2011-05-07T21:20:00.000-07:00

I have been working on computer generated trades (or algorithmic trading). I put up a website with some info (work in progress) and where the trading decisions from the 'robot' are posted. Here is the link!

The spreadsheet in there is what gets updated automatically. A new entry at the bottom means that a new trading decision was taken. Currently the algorithm is invested in XLE.

Happy Thoughts

2009-04-06T11:31:00.001-07:00

Well, I was watching Peter Pan too often ... my happy market thoughts are these today:

Despite the recent rally in March (>20%), investors are moving more into cash. Nice :) Although news may be positive for a bit like they were recently, I am sure the media will pick up on the doom stuff again.

And also the more long term CLX chart I am watching showed some progress. The CLX summation pushed through the lower trendline and the CLXpp is about to do so:

There are very nice divergences that you can see in the MACD and other indicators between the Nov low and March low. All these things are my happy market thoughts today :)

Market thoughts

2009-03-26T12:56:00.001-07:00

Recently, the news is quite positive about the market. Nasdaq erasing '09 losses. Dow reaching 8000. Is it too late to buy? etc. This rally may continue to go on, but I think a pause is in place about here (EOD Friday to be precise). The reaction to this will tell us if the market has strength to continue.
As someone who watches the CLX I have my eyes in this chart:

It shows that the cumulative diff (of CLX & CLXpp) and the cumulative CLX is reaching a downward trendline. If it pushes through I think we have a change in market behaviour.

Historical CLX

2009-02-24T16:18:00.000-08:00

I follow the CLX data every day. You can read up on the CLX here.
I keep several charts around that I find useful. Below is a summary of the charts as they appeared on the 2001 or 2003 market bottom. I post charts about this market bottom not because I think the current market should be compared to it but because I don't have data reaching further back than about 2000.
One of the charts is also a 2CS chart. The 2CS was invented by Tom Drake.

Fork in the road

2009-02-19T11:47:00.000-08:00

Today (Feb 19th) we are at a junction again. We have a tidal low supposedly but there is some sentiment like the P/C ratio that is not quite bullish yet. Also, the VIX is very sleepy today for the market to make a low today. These are some concerns that I have that would make me not trust a potential rally. But lows are never perfect - there are always some indicators that won't 'fit'. We'll see how the market plays it.

Looking at the Dow action, recent daily action from Oct on closing basis looks almost like the Jul-Sep '08 move in the Dow. The fear here of course is that the market may replay the Oct '08 collapse and take out the recent lows. There are a lot of people that are looking at a S&P500 730 buy or 720 buy. If the Oct '08 collapse repeats itself it will go much lower. I for myself hope that it does not get that low ...

In case you are still fully invested and experienced a 50% decline in portfolio value (just to give a number), a further decline in the markets to replay say 1929-1932 would make it decrease to some 13% for a total of 87% decline - that would be S&P500 at about 190 or so? Going from 50% to 75% may not sound so bad, but it means your portfolio gets halfed again. Something to keep in mind ... It would get halfed again, after being halfed twice, for a 87.5% decline. Interestingly, there are sectors that already declined more than 75%, for example metals & mining (XME) or finance (XLF) or steel (SLX) etc.

Market Thoughts

2009-01-21T17:04:00.000-08:00

The P/C * Vol chart below did a good job of finding the highs/low. It showed on the Nov decline a divergence also which is very interesting (the P/C chart without volume did not show this divergence). We are currently again in an area for a turn. Tuesday may have been the low, it also coincides with a tide turn (not shown here).

Another chart I am watching is the CLX summation chart. My hopes got up when the CLX diff summation broke out of the downtrend shown below, but recently got back into the channel. I don't know if that means further weakness ahead but I will be more cautious short term.

The survey data form AAII is useful for sentiment charts like these below. The AAII sentiment is now at about the same level as on the '90 crash.

Better yet is the asset allocation chart whose cash percentage is at an all time high. This shows how investors are currently scared of the market - but looking at the chart you can see 'cash' percentage to go up and spike at market bottoms. If anything, your asset allocation should probably do the opposite ...

Options P/C Ratio Improved

2008-11-10T13:41:00.000-08:00

The contrarian will use the options P/C ratio to detect highs and lows in the market. The following chart illustrates my point:

You can see that the equity options P/C ratio results into the best signals. The signals can be marginally improved by multiplying the P/C ratio with the options volume. You will get this chart:

Notice how the P/C * Vol drifts upward. This is due to increased options activity over time. To eliminate this drift, you could have a formula like this: options P/C ratio * (vol / avg. vol over 90 days). The following chart represents the graph with this formula. It takes out the guessing work a little bit more than a simple options P/C ratio chart in my opinion.