Monday, February 11, 2008

When to keep out of the market

When developing a system based on a bullish trend following one needs to make sure the system doesn't trade in a bearish market. This will help minimize the false trades which are bound to happen in opposite trends. To overcome this problem I needed to identify the market direction. My idea was to use one of the indexes as a gauge. Since the main market I trade (although the system performed well in other markets as well) I tried to use the Nasdaq composite (^IXIC) and its SMA to determine if we are in a bearish or bullish period. If the index moved under its SMA I would stop buying until the index moved back above its SMA. I also checked whether I should also close all my position when the market is turning bearish but that turned to be wrong and this is why I am keeping my current positions. The results were outstanding. The system's total profit for the test period improved by 100%. (the simulated period last between November 2002 and November 2007). I was trying to further improve the result by using the QQQQ instead of ^IXIC which turned out to be a good bet as you can see from a previous blog.

I was looking at historical data for the QQQQ to see how long did it stay under its SMA using my current system settings for the SMA period. In the crisis of 2000 the QQQQ had stayed below its SMA from September 2000 to November 2001, went up for 2 months and then dived for another 10 months. That's a long period were you're not buying anything and hopping you wont need to sell anything due to stop loss. But one cannot argue with historical data and statistics.

I hope the current recession will not hold that long but if it does  I will have to find something else to do with my spare time (as if trading on a weekly basis takes too much of my time).

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