Interesting fade self-contrarian double-cross coin toss

Discussion in 'Trading' started by infolode, Aug 18, 2006.

    Why It's So Easy To Lose Money In The Markets
    Friday August 18, 10:16 am ET
    By TradingMarkets Research

    The TAZ Trader Blog recently posted "10 rules for losing one's money quickly". I also responded to a recent reader's question and addressed the topic of why it is so easy to lose money in the markets. Both of these posts underscore an important point: Doing what comes naturally is not what makes you money as a trader. "If it's obvious," market guru Joseph Granville used to say, "it's obviously wrong."

    Let's take a simple example of this idea, courtesy of the Barchart site. Barchart tracks the performance of various stocks according to technical trading systems. By using ETFs as the stocks, we can see how technical systems performed for entire sectors and for the market as a whole. Almost all of these systems tracked by Barchart reflect a momentum/trend based style, in which the trader sells signs of weakness and buys signs of strength. In other words, the trader does what comes naturally.

    For instance, one system tracks the 40-day Commodity Channel Index (CCI) and has the trader selling dips below -100 and buying rises above +100. Exits occur on a re-crossing of those thresholds . Since August, 2004 in the S&P 500 Index (SPY), we've had 49 trades with this system, with each trade averaging a holding period of 7 days. Of these 49 trades, 8 were profitable. Yes, you got that right. The trading system was wrong about 84% of the time.

    But maybe the problem is the indicator or the time frame, you think. Well, Barchart follows other indicators and time frames--a total of 12 technical trading systems in all. For SPY over the past two years, only one of the twelve made money. Seven of the systems lost more than 15 SPY points (the equivalent of 150 points in the ES futures) during that time: a period of rising prices.

    No, the problem is not with time frame or indicator. Quite simply, strength has led to weakness and weakness has led to strength, making these trading systems excellent contrary indicators. In fact, if one could simply create a filter to eliminate periods of high momentum, you could develop a rather good trading system by fading the ones tracked by Barchart. Which is another way of saying, you could fade human nature.

    Brett N. Steenbarger, Ph.D. is Associate Clinical Professor of Psychiatry and Behavioral Sciences at SUNY Upstate Medical University in Syracuse, NY and author of "The Psychology of Trading" (Wiley, 2003). As Director of Trader Development for Kingstree Trading, LLC in Chicago, he has mentored numerous professional traders and coordinated a training program for traders. An active trader of the stock indexes, Brett utilizes statistically-based pattern recognition for intraday trading.