The Weekly Update

The beginning of the week was scaring. On Tuesday all major indexes lost more than 1.5%. By the end of the week the US indexes have recovered all the loses and some more. The emerging markets were down. The biggest winner was the US REIT ETF. Here is the state of the positions we follow:

Asset	Symbol	Position	Date In	Gain
Nasdaq 100	^NDX	Long	2010-09-03	12.51%
Emerging Markets	EEM	Long	2010-07-23	11.86%
US REIT	VNQ	Long	2010-07-23	11.27%
S&P 500	^GSPC	Long	2010-09-30	3.67%

The last closing price of all the positions is well above the corresponding moving average, thus, the likelihood of triggering a sell is very low. For instance, the current 20-week EMA for the Nasdaq 100 is at 8.54% above it’s EMA, which, according to another recent post of mine, means that the index needs to shed more than 8.54% in a week in order to trigger a sell signal at the end of the next week.

Certainly according to the position of the indexes with respect to their EMAs continues indicate a severely overbought market.

Peeking Ahead at an EMA

When using a daily average, the maximum loss one can incur, is the maximum the market can lose on any single day. However unlikely this is, one should keep in mind that the biggest single day loss in Dow history is about 27%! Even 27% is significant, but consider for a moment you used double or triple leveraged ETFs – one would have been wiped in a single day!

Where I am getting is that stop losses are a must. The need of them is even more obvious when one is trading using longer term periods, for example, weekly or monthly.

Let’s assume we are using a 10-month EMA. One way to compute a stop loss, is to predict the end month value whether we would have sold, then (optionally) add a penetration cushion before this predicted price. Once the daily price goes below cushioned price, we sell.

How do we predict the ending month value? It requires a little bit of math, but in general it’s as simple as solving an equation with a single unknown.

Computing the Closing Price that Would Trigger a Sell

In other words, a sell signal at the end of the current month will be triggered if the closing price for the current month is below the EMA computed at the end of the previous month.

As an example, at the end of September (the last full month at the time of this post, today is October 17th), the closing price was $1141.20 and the EMA was $1089.64. Thus, there will be a sell signal at the end of October if the closing price for October is below $1089.64. If we want to add some cushion, we can subtract another 1% from $1089.64 and arrive at a sell stop of $1078.74.

Similar tactics can be used to get into the market ahead of the period end – if the intra-period price penetrates and stays above the end period price.

The Weekly Update

Not much going on lately, the markets have been trending for a while now (up), making trend following strategies look awesome. All positions mentioned lately have been doing well:

Asset	Symbol	Position	Date In	Gain
Emerging Markets	EEM	Long	2010-07-23	13.53%
Nasdaq 100	^NDX	Long	2010-09-03	12.15%
US REIT	VNQ	Long	2010-07-23	8.91%
S&P 500	^GSPC	Long	2010-09-30	3.06%

In the column field, I use the Yahoo Finance Symbol. Symbols starting with “^” are indexes, not a particular trading instrument.

Another new detail is that I have started using the closing day date instead of the opening of the next day. For long term trend following systems that change should be irrelevant, however, it is certainly better for short-term contrarian systems and is widely used (just check the volume of the last hour on any trading day). For the ones interested in similar strategies, there is plenty of information on the web, certainly the MarketSci Blog articles and research on RSI(2) systems is a good place to start.

One last point – the markets seem overbought here. Especially the Nasdaq 100. On the other hand, with all the money pumping noone knows what’s going to happen.

A Nice Visual Backtesting for MA Strategies

Recently I found the ETFReplay.com site, which offers, among other things, a nice visual interface for backtesting strategies based on moving averages! Select the S&P 500 (SPY), 10 month moving average and see the performance for the past 10 years.

Long S&P 500

For the S&P 500, I am using the 10-month EMA. At the end of September it became a buy once again. The last trade turned out to be a severe whipsaw, resulting in an above average lose. However, that could be a positive that the market is finally taking a direction.