The Active Trend Trading System: Pillar 5 Expectations
Pillar 5: What are the expectations?
There are many systems available that do trend following or swing trading or long term trading, but few that provide a system that works regardless of market condition. Additionally, almost every system requires a huge outlay of time and effort to learn the basic, the patterns, pages of rules that govern the system. For someone like me who worked 10-15 hours a day in a job, learning technical analysis and the right system took discipline, commitment and even though I studied hard acting on what was learned was challenging because pieces seemed to be missing. The Active Trend Trading System addresses each of these issues successfully. I will not use the term easy to learn and use, but I will say that it is simple, objective and straight forward to learn and execute.
As I studied various systems it became clear that all successful systems are built on 5 primary pillars. If one of these pillars is weak or not understood completely the success of the trader using the system will be impacted negatively! Every good trading or investing system provides the following 5 pillars which tell us:
- What to trade
- When to buy: Objective Entry Action Points
- When to sell: Objective Exit Action Points
- What strategy to use
- What are the expectations
These Pillars support the system and ultimately the trading campaign as depicted below.
Over the course of this book each of these pillars will be covered in detail so that the attentive reader will be able to learn and apply the lessons quickly and with confidence.
Pillar 5 Model
It seems to be popular these days to start at the end and work back to the beginning. We see this approach all the time on current television shows where the final scenes of a story are told upfront and then the writers move the story to the events leading up to the conclusion to fill in the blanks. With that in mind, I’ll start with Pillar 5 and briefly discuss what the expectations are for a sound trend trading systems.
In Dr. Thomas Carr’s book, Trend Trading for a Living he says that one can expect an annual return on a sound system of approximately 40% per year, with a win/loss ratio of 60%. Based on his research, I’ll let this be the benchmark to measure the ideal returns we can expect from the Active Trend Trading System.
To establish a model of the Active Trend Trading System using a benchmark entity was paramount. The SPY ETF was chosen because it emulates the Standard and Poor’s 500, better known as the S&P 500 and tends to have returns in line with the DOW and a bit less volatile than the Nasdaq and Russell Indexes.
Testing the Active Trend Trading System on the SPY from 2004 through 2013 covered the Bear Market of 2008 and the sideways Market of 2004 & 2011. For the Active Trend Trading System there was an average of 16.7 total entries per year resulting in an average holding period of 17.2 days, with an average return of 31.75% (not compounded) and a win/loss ratio 71.86%. During this same period a buy and hold strategy on the SPY would have yielded an average return of 6.95%. On a compounded basis the model generated a 140.02% average return compared to the S&P’s average compounded return of 9.46%.
The Active Trend Trading System was profitable every year, while the S&P was profitable only 8 out of the 10 years. With the System, only long bullish traders were entered based on objective Entry Action Points which will be covered in the section on Pillar 2 and all exits were based on objective Exit Action Points that will be clearly explained in the section on Pillar 3.
Based on the benchmark set by Dr. Carr’s research, the Active Trend Trading system meets and exceeds expectations for a sound trend trading system.
I remind you that these are backtesting results and not a claim that similar results be achieved by all traders. No backtesting can ever totally incorporate all the variables present in the Market and human factors in following trading rules. Backtesting is intended to test the viability of the system only.
The results of this model are provided in the tables below.
One of the findings that surprised me a bit on reviewing the data was the distribution of the types of entries and exits. This unexpected finding helps provide additional focus for what entries deserve the most attention when learning the patterns and specifics of designing entry criteria. Clear details will be provided in the sections covering Pillars 2 and 3.
Follow-on Modeling: After completing the initial research on the total Active Trend Trading System it became apparent that while the returns were very good, perhaps the basic system still needed simplification on the entry and exit Action Points. The Basic System if it tested successfully would serve as the initial training module for learning the total system.
We went back to our backtesting using only two simple objective triggers for trade entries and exits. The basic system removes the use of candlestick patterns and support/resistance bounces for triggering Actions Points for entries or exits which had provided refining characteristics in the full system. We again used the SPY for backtesting purposes and arrived and the results shown in the following table reflect the first 5 years of backtesting.
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We will complete the full 10 years of backtesting going forward, but initial indications are that the Basic System performs better that the “Buy & Hold” strategy with the SPY.
With the Basic System rules refined and simplified I began wondering how the Basic System would perform on stocks. I wanted to avoid cherry picking stocks that I knew did well for a particular year and introduce some randomness into the selection of a few stocks to track. Since we’ve been tracking the first IBD 50 list that appears each year going back to 2007, I decided to pick the first stock that appeared on the list every year starting in 2007 through 2013.
Starting in 2007 the first stock on the list was AXR and actually was a very poor performer for the year. AXR completed 2007 down -74.38% and showed a lot of the characteristics of a strong growth stock that is no longer in favor. Backtesting using the Basic System resulted in a gain of 8.36% for the year. Over the year there were five entry Action Points to open a position in the stock, with 3 of these trades being successful. The following table provides the results of backtesting the first stock from the first IBD 50 for each year. The model only considered bullish trades and the starting test account balance was $10,000.
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The Basic System results show that even in the years where the over return for the selected stock was negative, the system generated a positive return. The Winning Trade percentage of 65.82% is within the parameters of what is expected from a sound trend trading system. The variability in yearly return is reflective of overall Market conditions and characteristic variables associate with each of the stocks.
As a reminder: These are backtesting results and not a claim that similar results be achieved by all traders. No backtesting can ever totally incorporate all the variables present in the Market and human factors in following trading rules. Backtesting is intended to test the viability of the system only.