Take Advantage of Quick Down Moves In An Up Market
January 2015 – Implementing A New Strategy – RS27
When I first got interested in the Stock Market, I was always looking for new stocks to trade. I’d follow newspaper and magazine tips and trawl through what internet forums were around back then. Nowadays, I’m still looking for ideas, but not ideas of what stocks to trade but ideas of how to trades those stocks.
I am a system trader. I use technical analysis and a set of rules to find trades, enter them and exit them. Many systems or strategies could be 100% operated automatically but I also like to use just that little bit of discretion.
So what I have done over the last few weeks is gather a set of rules to create a new strategy that I can start trading immediately.
Whenever I introduce a new strategy, I do some back-testing to get a feel for how it performs before I put money on the line.
Once I’m pretty happy with the results from back-testing, it’s ready to trade live. What I plan to do now is document the trades as I take them so we can all see how this strategy (and me as an operator) performs in real time.
Be sure to keep watch on this blog as I share my future entries and exits for this strategy I am naming RS27.
I plan to trade and test this strategy over the next six months and then give a detailed analysis of the results.
Designing a Strategy – Where Do I Start?
Beliefs:
We all have beliefs about life. As traders, we all have beliefs about the markets. In fact, I think we trade our beliefs about the markets. So step one of designing a new strategy is making sure it’s inline with your beliefs.
My main belief relevant to this strategy is:
- Whether we are in a Bull or Bear market, there are still opportunities to profit from short-selling.
If you had a belief that the best way to make money was to find a stock with sound fundamentals, buy it and hold it for the long term, then you probably wouldn’t be suited to a short term short-selling strategy like the one that I am going to design.
I am only touching on the subject of beliefs here but I hope you get the general idea that designing a strategy must be designed around your own personality and in line with your beliefs.
Objectives:
This is a really important one.
Before I even think about the technical side of designing a strategy, I will sit down with a pen and paper and write out what I want from trading this new strategy.
So here are some of the main objectives I outlined for this strategy:
- I want to trade stocks on the U.S markets
- I want to find trades during the market closed period
- Entries, stop losses and profit taking will all be executed automatically at pre-determined levels (selected during the market closed period)
- Selecting trades that meet my rules will be done using screening software within a matter of seconds
- I want plenty of opportunity. For example, I want to be in the markets the majority of the time with a choice of trades. Not a strategy that only triggers a handful of trades per year.
- I want trades to be open on average between a couple of days to no longer than a few weeks.
So from this list of my objectives you can see that if you’re the type of trader that likes buying and selling a few different stocks within the same day then the strategy I design really wouldn’t be suited to you.
Selecting My Tools:
Before randomly selecting technical indicators and oscillators to build my strategy around, I want an idea of how the strategy will work and why it will give me an edge. Having that all-important edge means that after a large enough number of trades, you will be profitable.
Yes, there will be winners and losers but after all the losses are subtracted from the winnings, you will come out profitable.
The general rules for my RS27 strategy are based around the ideas that:
- I look for downtrending stocks (the main trend)
- Then I select downtrending stocks that have recently risen or rallied and become overbought
- I sell short the stock into the rally
- When the stock reasserts it’s downtrend I take profit, when it becomes oversold
Essentially i’m going to need 3 main tools here. The first to identify a stock that is in a downtrend. The second to identify when it becomes overbought to give the entry trigger and the third to identify when the stock becomes oversold and gives to trigger to take profits.
I will actually use the same tool to trigger the overbought entry and the oversold exit. This being the good old Relative Strength Index or RSI. This is one of my favourite oscillators and a tool I have used loads in both short-selling and buying strategies.
In this image above I have shown you an example of how this strategy works:
- We see a Downtrending stock
- The stock then has a Small rally
- We see RSI has become Overbought which is where we Enter our Short sell
- We wait until RSI becomes Oversold where we Exit taking profits.
The dotted horizontal lines shows the price decline that we captured and profited from within a few days.
In this introduction I’m not going to lay out the exact rules to trade this strategy. That’s for another blog post and maybe a video walk through.
Follow My Trades
I have the rules and I am ready to begin testing my RS27 strategy. Be sure to check for regular updates of trades I take and read my observations as the weeks go by.
If you have any questions then you can email me at jarrod@thetransparenttrader.com or leave a comment below. Thanks, as always for reading.
Jarrod
Featured image by Marco Chiesa via Flickr.com