Q&A
Since You Asked| Confused about some aspect of trading? Professionaltrader Don Bright of Bright Trading (www.stocktrading.com), an equity tradingcorporation, answers a few of your questions. |  Don Bright of Bright Trading |
IMPROVING A TRADING SYSTEMDon, what you think about a simple system like a moving averagecrossover system? I've played with different combinations (50/200, 30/100,and so on) in different markets (NASDAQ, Standard & Poor's 500, andothers) with equities only. I got very good results with 30/100 in NASDAQwith money management, investing about 3% per trade. My profitable tradesare somewhere between 40% and 50%. What you think about the system, andhow do you think I should improve the trading system with additional indicators?Thanks. -- Sudhir Cheda
Moving average trading systems are one of the oldest and most basicstill being used today. But looking for return on investment is one thing,actively trading is another. Since many fund managers utilize moving averageand moving average convergence/divergence (MACD) techniques and generallyreturn about the same long-term return as the overall market (actually,most underperform the S&P 500), I would have to say that relying onthis type of system alone would not be the best way to extract money fromthe market.
Most top traders I know tend to use multiple indicators and numerousfactors in their algorithmic trading, rather than relying on any singlefactor of technical analysis. Since most systems are "if/then"basedin their programming, the more pertinent data you can combine, the better,in my opinion.
So sure, moving average techniques can work by themselves, but I suggestadding complete fundamental analysis, trend-following, sector relativestrength, and other criteria to your model.
PRICE TO BOOK VALUEI am hard at work studying for the series 7 test. Hopefully, I'llpass the first time through, but I have my doubts. I am targeting the Octoberboot camp. Question: How do you determine whether a company has a low priceto book value? -- Chris Garzon
First, to find book value (http://finance.yahoo.com), click on key statistics.For example, GE book value is $11.37, stock is trading around $40 or so,40/11.37 = 3.5 price to book ratio, approximately. Yahoo! Finance has theprice to book already for each stock. The lower the number, the betterthe stock, as far as this valuation is concerned. You really need to check"price to tangible book value" as well. The tangible book value has thingslike goodwill, intellectual property, and other intangible assets takenout of the balance sheet valuations. Good luck!
BENCHMARK COMPARISONSIs there a benchmark number you look for before making a trade?Or is it based on a comparison to another stock, like GE/HON? Or averageoverall market? -- Chris Garzon
Not really. We compare two "peers" to develop a long and a short forour pairs trading, based on their overall fundamentals. Generally, we endup long in value stocks and short in growth stocks, and trade them togetherbased on trading ranges.
POSITION DOUBLINGI have a question about position doubling. One of my trading buddiestrades using the Murray math technique in simulated trading and doublespositions on the Russell 2000 and S&P 500 eminis every two points thetrade goes against him (start with one contract on entry, then two, four,eight,16, 32, and so on). Of course, that allows him to escape bad tradeswith at least breakeven. In the end, he ends up with zero losses and dailygains.
I'd like to have some feedback from experienced traders aboutthe long-term viability of this way of trading when he goes live usingthis strategy (personally, I believe he will tank his account, becausein simulated trading, you can double forever, but not so in live trading).--Gabriel
One of the biggest reasons for trader failures is adding to losing positions.That said, let's chat for a second.
I have played hundreds of hours of a modified Martingale system witha (nearly) 50/50 game (baccarat), and if we take into consideration gettingour costly comps (trips, rooms, shows), we can justify the overall negativeexpectation -- to a point. Without the fringe benefits and when dealingwith something like the market that is not a 50/50 game, it makes no sense.
The reason for adding or taking off a position is based on what themarket is doing. As traders, we are responding to market conditions, andputting on positions based on these conditions. To simply double down isnot a valid premise in the market, in my opinion.
If, for example, you're trading eminis, you're long at 1480 and it breaksa support level, are you not better off closing and possibly reversingthe position compared with adding to the losing trade? We have to takeinto consideration things like the VIX (CBOE volatility index), recentprice and market movements, premium/discount to fair value, and many otherfactors.
New traders would more often than not be better off closing a positionvs. adding to the losers. Treat each entry/exit as its own event, basedon the overall reading of the market. (I could go on and on, but I'll spareyou -- just an overview from my perch!)
E-mail your questions for Bright to Editor@Traders.com, with the subject line direct to "Don Bright Question."
Originally published in the October 2007 issue of Technical Analysisof STOCKS & COMMODITIES magazine. All rights reserved. © Copyright2007, Technical Analysis, Inc.
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