What drives your profits?
If you look at your trading screen at any moment on any day, you’ll see green and red and hopefully the total of all the trading instruments adds up to a green number and you’re ahead for the day so far. What precisely created that change in equity? Was it the FED’s actions? Was is some economic number that came out that morning? Was it that breakout from that bullish triangle? NO to all of those questions.
The reason that your portfolio is up or down for the period is that PRICES MOVED! Nothing else. If you are long a stock and the price is up, you made money. If it is down, your equity moves down. Nothing else affected your equity but that simple concept.
So, as a trader starts to puzzle over what he or she will create when designing a new trading strategy, they should design whatever they come up with to stay as close to price as possible. Don’t look at interest rates, GDP growth, fundamentals or the news. They are not what most directly affects your equity.
An example:
Say you have a strategy that lays out like this: If the interest rates are declining according to the 30 vs the 100 day moving average of Treasury Bonds, and if my target stock is breaking out of a 20 day Donchian (price) channel to the upside, buy the stock. With this logic, you’ve include a filter (Treasuries moving up) to your price indicator ( breaking out of the Donchian channel).
What will happen sooner or later, and I’ve been doing this almost 50 years, the filter will lock you out of a nice bull move with your price indicators breaking out all over the place and you can’t act on any of these breakouts by your designed strategy.
A more practical solution:
In the example above, the strategy is complicated away from that which affects the portfolio: price. Eliminate that filter of the interest rates and go with every breakout with that stock and you will never miss out on a big move that you can let run and produce the profits you seek. If the breakout doesn’t carry very far, cut your losses quickly with a stop in place, free up your equity, and move on to your next trade.
Doing this ensures that you never get out of step with what the market is doing and drastically reduces the potential for the stress of being completely out of step with what is happening with prices and your equity curve.
The Latest Bull Move:
Clearly the stock market has had a nice run during the first half of 2023. The S&P is close to highs at the time I’m writing this. Did I foresee this? Absolutely not. My look at the economy is that the FED has waited way too long to clamp down on inflation, and will likely over-react trying to stop it. Meanwhile social programs are on their way to bankruptcy, debt is off the charts, the economy is struggling along, inflation on some household goods is hurting many and we have scandals in government coming to light every day. I would have predicted that we would be in an extended bear market right now, if that is how I traded. Instead, I got a lot of price-based breakouts, went long 30 of 30 sectors in my ETF Timing strategy and have been enjoying that ride indeed.
I completely ignore all my logical thinking when trading. These are two very different areas of thought. As a citizen of the US and the world we live in, I can have all sorts of thoughts and beliefs about what is going on, but in my trading, I can look at price and go with it blindly. Some of my best trades over my lifetime have been when I look at the trade and shake my head, saying, “This trade ought to have a rough time.” The breakout ends up surprising me and everyone else who were predicting something else.
If you want to stay in sync with what is happening in the markets and you want to maximize the correlation of your profits and equity curve to what the markets are giving you the opportunity to exploit, concentrate on what prices are doing, not all the other financial and economics news out there. That’s interesting information, but it shouldn’t have a place in your trading plan. Enjoy the ride!
I have researched numerous volume included indicators and have found nothing I felt comfortable using. I figure when a trade is done, there’s a buyer and seller and both accept the deal or the trade does not happen. I rate that trade as neutral, not bullish or bearish. I therefore ignore volume.
Excellent advice