|Weekly Newsletter 05/21/10|
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Intraday-Reversal: A Short Term Bottom?
In volatile trading, the markets reversed at least twice on Friday to deliver gains of over 1% for each of the major indexes and accumulation days for the DJI and S&P 500. An intraday reversal is considered a possible signal of a market bottom so we may see the bounce continuing into next week. Another positive sign is that the index closed above its 200 day average.
The day's low occurred shortly after the open and coincided closely with the May 6 Flash Crash low.
The sharp fall and quick recovery that day was almost certainly the result of a program trading feedback loop so today's sharp recovery from that day's low may also be the result of program trading. If so, it shows how difficult it is for the retail investor, not glued to their monitor, to play in this market. Our CwH backtest simulator (more below) shows that when our market trend signal is down, which it currently is for the NASDAQ and Russell 2000, it is best not to enter any new positions.
Volatility has been pronounced lately due to the European debt situation and also uncertainty about financial regulation at home. Although not resolved, the European situation has possibly stabilized now that the German parliament has endorsed the bailout package. Additionally, although the Senate and House finance bills have to reconciled, the broad outlines of the new regulatory environment are now known (see this NY Times article for a useful summary of what's in the legislation - too bad reinstatement of Glass-Steagall was not included).
Against this background, the short term outlook is for reduced volatility and a recovery from the present oversold condition but as long as the debt problem overhangs Europe and the US, which is likely to be for a long time to come, the long term trend may be downwards.
|New Features this Week||Additional Value that we added this week|
No new features this week.
|This Week's Top Tip||Tips for getting the most out of our site|
Optimum Hold Days for Cup-with-Handle Breakouts
Last week we discussed the optimum target gain % for cup-with-handle breakouts. By optimum target % we meant at level should we take profits and move on to our next breakout opportunity. If we take profits too soon, we miss out on some extra gains but if we get too greedy and hold out for more gain, we pay an opportunity cost because we missed buying a better performing breakout. You will recall that our conclusion was that the optimum target % was 25%. This was assuming that we selected breakouts which met our target criteria (see Factors Affecting Performance After Breakout).
The question we answer this week is "how long should I hold onto a breakout before taking profits?".
This question arises because just as holding on for a higher percentage gain can create an opportunity cost, so can holding on too long. Clearly, the gain a stock will make is related to how long we hold it, so we need to find the optimum combination of hold days and target %.
To find this sweet spot we ran our simulation for hold periods from 10 to 360 days in 10 day increments and target gains of 10% to 75%. Other parameters were held constant. Our complete set of parameters were:
The results surprised us!
We found that the optimum hold days was just 20 and the optimum target gain% had moved up to 55% with a compound gain of over 1600% (compared to over 900% with a 180 day hold and 25% target).
Here is the strategy output as of Friday, May 21, 2010.
This also proves to be a very low risk strategy. The detailed results show that the maximum drawdown was only 4.4%. So at no time during the 4 1/2 years of the strategy backtest had we lost more than 4.4% of our portfolio value and this was during one of the most extreme bear markets in memory. We we've highlighted the important statistics in the table of results.
We can now state our recommended cup-with-handle strategy:
Backtest Data Considerations
|Market Summary||Overview of market direction and industry rotation|
|Weekly Breakout Report||How confirmed breakouts performed this week|
2This represents the return if each stock were bought at its breakout price and sold at its intraday high.
3This represents the return if each stock were bought at its breakout price and sold at the most recent close.
|Top Breakout Choices||Stocks on our Cup-and-Handle list with best expected gain if they breakout|
|Top Second Chances||Stocks that broke out this week and are still in buyable range|
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