Appendix I: System 1 Details
System Name: RLCO/SQC/New HOD-LOD.
System Objectives: SQN of at least 4; average R multiples of 2R/day, 5R/week, and 20R/month; generates 4-10 trades per day with holding periods of 10-60 minutes; functions in all longer-term market types, but may not perform as well in quiet sideways markets.
Position Sizing Objectives: Make at least 100% per year with a 5% chance of having a maximum 25% peak to trough drawdown during one month. What is important to me is attaining a balance between ensuring that I don’t have my worst-case loss at the end of the year and maximizing the chances of meeting my goal.
System Description: RLCO/SQC/New HOD-LOD actually consists of three different systems (SQC, RLCO 10/30, and New HOD/LOD), which are described under one general “category” of day trading systems that use Dr. Ken Long’s Regression Line Crossover (RLCO) “lens” to view the market and frame trades. They consist of four different entry types, but the exits are all the same and the “RLCO lens” applies to them all. The objective is to be positioned to take advantage of a price signal in my favor if I can frame the trade with a favorable reward:risk (R:R) ratio. In terms of trading rules, I like to describe them as a series of systems that are in the same family (i.e. discretionary day-trading systems) that I plan to use interchangeably throughout the day using the same trading account, which is why they appear in the same system description appendix. However, for the purposes of determining system quality, I will test and evaluate the three different entries as three separate systems.
SQN: I have not calculated SQNs for these three systems in production yet. However, I have calculated a combined SQN (including all three systems) on 285 trades of the symbol TNA using a simulator. In that simulation, I obtained an SQN (normalized to 100 trades) of 6.7. See the attached Excel spreadsheet for a list of the R-multiples, system expectancy, R standard deviation, win rate, SQN, and an R-multiple histogram.
System Type: Rules-based discretionary day trading systems consisting of a combination of band trading, short-term trend following, and chart pattern trading systems.
Market Types: These systems should work in all market types, but will probably not perform as well in quiet, flat markets. For these market conditions, I would need to maintain very tight stops.
System Edges: Frequent trading opportunities, low risk ideas, ability to cut losses short (sometimes less than 1R), a greater ability to trade in flow with the markets than a pure mechanical system because I am looking at price actions in several different periods on one chart, very low correlation to my other systems. These systems also favor a direction-neutral frame of mind, which removes the pressure to be right about price direction.
Key Beliefs:
• Regression lines and Bollinger Bands combine the insights of moving averages, the discipline of descriptive statistics, and a framework to pinpoint important critical states in different timeframes.
• Critical states are moments when the market is under tension and ready to make a larger than normal move in either direction.
• A change of trend may be imminent when the 30-period regression line crosses over (or under) the 10-period regression line outside of what Ken calls “the river” (i.e., the +/- 1 Standard Deviation of the 30-period Bollinger Band). This is the key belief behind the RLCO 10/30 system.
• A price breakout of a sideways quiet channel (SQC) can be a signal of price momentum in either direction. This is the key belief behind the SQC system.
• A new High of Day (HOD) or new Low of Day (LOD) can be a signal of price momentum and institutions expressing buying/selling interest. This is the key belief behind the new HOD/LOD system.
• These are not mechanical systems. I must be able to stalk, trade, monitor, and take profits (or abort trades) for one or more stocks/ETFs during the day session (9:30 AM to 4:00 PM ET). While it is possible to have a successful setup, entry, and exit occur in an hour or less, I should be prepared to spend several hours in front of the screen each day that I choose to execute these systems.
• These systems will likely provide several trading opportunities per day.
• Trading experience and market intuition are key factors in the successful execution of these strategies. In other words “Trader Quality Number (TQN)” (as compared to the System Quality Number or SQN) is extremely important to the success of these systems.
• I must always remember that exits matter much more to the overall profitability of these systems than entries.
• I want to see price moving in my direction before I commit, so I look for evidence that a turning point is in place. Evidence of price moving in my direction is a key belief for these systems. Without that evidence, I am just guessing that my entry is the turning point I am looking for. Like the first mouse that tries to eat the cheese in a mousetrap, I risk being caught if price continues in the same direction. I prefer to be like the second mouse and wait for evidence of price moving in my direction. The second mouse that attempts to eat the cheese often walks away with it (i.e., profits), when the trap has been sprung by the first mouse.
• I want the best return in the shortest time period and hope for a 2:1 reward to risk ratio in less than 60 minutes. Ken has often exited with a profit in less than 30 minutes.
• I assume that institutional money will come into the trade at perceived points of value (support) during the day, and I should not be surprised to see that my stock/ETF does not hesitate at the first logical tactical resistance level, but continues to forge right ahead past a previous intraday “swing” high.
• These systems can go either long or short. Although my belief is that stocks and the market have a bias to the long side in the long term, since these are short term systems, that bias will have little to no effect. After all, the market must breathe in, then out, then in…
• I believe I can improve my edge by being able to recognize a few chart patterns that recur regularly throughout the day in many stocks and ETFs.
• These are intraday strategies. I expect to be in a position measured in terms of minutes from entry to exit. Trades that last 30 to 60 minutes are common. I want to move my stops to “no lose” (or breakeven) within the first 20 to 30 minutes, if possible. Otherwise, my belief is that the turning point and rally (or breakdown) I was anticipating is not going to happen, and I am better off preserving my capital for another opportunity.
• If the trade is not going to work, it’s not unusual for my initial stop to be hit within 5 to 10 minutes, thus taking me out of the trade and giving me a -1R loss (or a fractional R loss). If the trade doesn’t move up to at least +1R or hit my initial stop in the first 60 minutes, then I should (probably) exit the trade, depending on what SPY/the market is doing. By cutting my losses short (and not waiting for them to hit my initial stops to ensure full -1R losses), I can improve my results as measured by my R-multiple distribution, expectancy, and TQN.
• Context is important. The action in SPY and the recent trend in the stock or ETF (daily and hourly) are useful in identifying which stocks/ETFs to trade and what I can reasonably expect in terms of price action. For example, if SPY is in a bull market and a stock breaks to a new high, it may find little resistance to continuing the rally to higher highs on an intraday basis. With a strong trending stock in a bull market, Ken has found that +5R to +10R returns are possible intraday. On the other hand, if I am trading a stock/ETF that has been in a multiday tight trading range, I should be prepared to enter at support levels and proactively exit at resistance levels. With a stock in a tight trading range, Ken has found that +1R or +2R returns are as much as one can expect to walk away with in these market conditions.
System logic, concepts, and definitions:
• “The market” is SPY, which is the ETF representing the S&P500 index. It is highly correlated to my target trading population, and I believe that my target stocks/ETFs often move in the same direction.
• “Short term” means intraday moves that are typically less than 60 minutes and often less than 30 minutes. I generally use a 3-minute (3”) intraday chart with candlesticks showing the price action. Other time frames (e.g., 1, 5, or 15 minutes) can be used as well, but I like the 3-minute charts for equities and 15-minute charts for forex.
• Entry – see below for when and how to enter trades.
• Initial Stop (istop) is the initial amount I put at risk and is the price between my entry price and my initial stop or exit price. Typically, it is $0.10 – $0.20 below (or above) my entry price or $0.01 below a recent low (or high) on the 3 minute chart.
• Reward:Risk Ratio is calculated as:
(Target Price – Entry Price) / (Entry Price – Initial Stop Price)
• Profit Targets:
o The first profit target is the 30 period Bollinger Band mean.
o The second profit target is the +/- 1 Standard Deviation of the 30 period Bollinger Band.
o The recent highs (or recent lows) on a 3 minute chart or other logical points of resistance or support (e.g., resistance level from 60 minute or daily chart).
o The VWAP (Volume Weighted Average Price).
• I want the best return in the shortest time period and would love to see a 2 to 1 return in 30 minutes or less. I will respect the power of whatever caused such a price change though, and remember that the aftershocks may not yet be over.
Trading population:
• Large cap U.S. stocks (minimum 1M shares per day): Dow 30 Industrials, S&P100, Nasdaq100, S&P500, S&P400 (midcaps). However, in recent testing that I performed, I have reason to believe that SQC may work in the forex markets (see attached spreadsheet for details on SQN, expectancy, and R-multiple distribution, as well as an R-multiple distribution histogram).
• Large liquid ETFs (minimum 100K shares per day).
• I prefer stocks and ETFs with prices in the range of $10 to $50 per share, although prices up to $75 per share are acceptable.
• A key consideration in the selection of which stocks/ETFs to stalk is the intraday volatility and the instrument’s signal to noise ratio consistency, which Ken calls the Frog Quality Number (FQN). A high FQN means the instrument has demonstrated consistent and high average range within the last 30 days. I want sufficient volatility for there to be one or more opportunities for successful trades with a 2:1 reward to risk ratio. At the same time, I want to keep my initial stops to $0.10 if possible, although $0.20 or $0.30 is reasonable for higher priced stocks with higher FQNs. I will choose my initial stop based on the instrument’s Frog Standard Deviation (SD), which, according to Ken Long, is a good measurement of the instrument’s “noise”. Ken Long publishes the calculations of FQNs and Frog SDs in his chat room on a daily basis.
• Examples of ETFs and stocks that fit this profile include KO, AA, GE, CAT, MRK, JNJ, HD, PG, INTC, IWM, UWM, QLD, VXX, UVXY, TNA, etc. Some of the best targets are the slow moving “cows” that have huge liquidity and intraday volatility large enough to provide one or more moves of $0.20 to $1.00 from intraday low to intraday high. They tend to cycle between oversold and overbought along with the market (SPY). They also tend to move in an orderly way and have tight bid/ask spreads, which makes market orders (vs. limit orders) acceptable for entry and exit.
Finding targets:
The following lists some examples of how to find targets:
• Find broad sectors or instruments that are the most oversold on a 10-day basis. They have the potential to turnaround.
• Any instrument that shows up on Ken Long’s daily report as a swing trade set-up is a good candidate for these systems.
• Any instrument that has a high FQN (3.0 or above) and high volatility that appears on Ken Long’s daily report.
Setup rules:
For the setups, I want to see SPY (the market) supporting my entry with price action that is moving in my direction on the theory that most of my trades will be highly correlated with the market. I also want to generally only take trades that are in the direction of the slope of the Bollinger Bands. The only exception to this rule is after a strong move, which usually entails three “legs” of movement between which price consolidates or a mild retracement occurs. After a strong three leg move, there is a higher possibility of a trend reversal.
• RLCO (Regression Line Crossover) 10/30: The following must occur for this set-up to be valid:
o The 10 period regression line crosses the 30 period regression line outside of the +/-1SD 30-period Bollinger Band and is moving towards or into the “river”.
o The 30 period regression line is starting to curl up (when going long), or roll over (when going short).
• SQC (Sideways Quiet Channel): The following must occur for this set-up to be valid: