Stock Exchange: Have You Ever Tried To Design A Trading System?

The Stock Exchange is all about trading. Each week we do the following:

  • Discuss an important issue for traders;
  • highlight several technical trading methods, including current ideas;
  • feature advice from top traders and writers; and,
  • provide a few (minority) reactions from fundamental analysts.

We also have some fun. We welcome comments, links, and ideas to help us improve this resource for traders. If you have some ideas, please join in!

Review: Do You Start The Day With A Trading Plan?

Our previous Stock Exchange asked the question: Do You Start The Day With A Trading Plan? but went on to explain that changing market conditions can quickly make your plan ineffective. However, being able to calibrate to dynamic market conditions can make the difference between winning and losing. A glance at your newsfeed will show that particular lesson remains relevant week after week.

This Week: Have You Ever Tried To Design A Trading System?

Having success as a trader is invigorating. But have you ever tried to design your own system to consistently and repeatedly generate real trading profits? We have learned a variety of important lessons in this endeavor. And we’d like to share a dozen of those lessons, with the help of seven valuable trading articles, from real life trader experiences.

Lessons one through six come from an oldie-but-a-goodie article from way back in 2007. The article tells the story of the last man standing from a group of trading class cohorts. The article is called Another One Down, and the important lessons are as follows:

  1. It takes time to make it as a trader,
  2. It takes money to make money.
  3. Don’t be fooled by early successes.
  4. Treat trading as a business.
  5. Even the best prepared, the smartest, the best researched traders can fail, at least temporarily.
  6. The people that get press coverage, write exciting books and live glamorous trading lives do so because they took inordinate risks which paid off.

It’s easy to quickly list these lessons, but they’re based on real life experience, and for more context, the article is worth a read.

Lesson number seven is from a Jeff Miller article called Building your own trading system, and it is also from way back in 2007. One of the lessons from this article is:

7. Making powerful software simple to use and data more readily available just makes it easier for non-experts to lose a lot of money.

Lesson numbers eight and nine are both related to backtesting and they come from articles titled Developing a Trading System: Be Careful and Test!andHow Some Academics Misguide Traders And Hedge Funds.

8. The difficulty arises because the novice system developer takes all of the available data and back fits some trading system.

9. Most strategies fail due to changes in market conditions.

Lesson number 10 is from a new article this week called The Future for Factor Investing May Be Different Than its Backtested Past, and the article explains how:

10. Data mining is a huge risk with factor-based investment strategies.

The next lesson is from an article that explains “Why Momentum Investing Is A Contrarian Approach.” It explains how the biggest errors in a bull market are usually errors of omission:

11. Not buying a stock because it is up too much too fast or not buying a stock because you sold it at a lower price recently.

This can be a very important lesson, particularly in strong market conditions like we’re having right now.

Lesson 12 comes from a fascinating Morningstar article published this week titled “What Computer Chess Suggests About Investing.” The article explains how artificial intelligence allows chess playing programs to teach themselves to perfection, but that doesn’t work in the markets yet because…

12. Even as artificial intelligence learns to teach itself, all the factors that may affect security prices cannot be placed on a single sheet, as can all the ways in which chess pieces can be moved.

If you’re going to endeavor to design your own trading system, heed these important lessons. Learning them can save you very real time and money.

Model Performance:

Per reader feedback, we’re continuing to share the performance of our trading models, as shown in the following table:

We find that blending a trend-following / momentum model (Athena) with a mean reversion / dip-buying model (Holmes) provides two strategies, effective in their own right, that are not correlated with each other or with the overall market. By combining the two, we can get more diversity, lower risk, and a smoother string of returns.

And for these reasons, I am changing the “Trade with Jeff” offer at Seeking Alpha to include a 50-50 split between Holmes and Athena. Current participants have already agreed to this. Since our costs on Athena are lower, we have also lowered the fees for the combination.

If you have been thinking about giving it a try, click through at the bottom of this post for more information. Also, readers are invited to write to main at newarc dot com for our free, brief description of how we created the Stock Exchange models.

Expert Picks From The Models:

This week’s Stock Exchange is being edited by Blue Harbinger; (Blue Harbinger is a source for independent investment ideas).

Road Runner: This week I purchased JB Hunt Transport Services (JBHT). Have your hear of this company?

Blue Harbinger: Yes—in fact I see trucks with the JB Hunt logo on them frequently when I’m driving down the highway. Why’d you buy this stock, d Runner?

Road Runner: For the same general reason I enter all of my trades. JBHT was in the lower end of a rising channel. You can see what I am talking about in the following chart.

BH: Yes, I see what you’re talking about, Road Runner. Here is the 1-year chart too if that is helpful.

Road Runner: Thanks, but I typically hold my positions for only 4-week, so that view is a little long for me.

BH: How about fundamentals, Road Runner? For example, the following Fast Graph has data going back to 2011, and gives earnings estimates out to 2020.

Road Runner: 2020? I will have completed many trades before 2020.

BH: Well based on the earlier performance table, your returns have been positive over the last year, but your still lagging behind the other traders. Maybe you should start considering more fundamentals.

Road Runner: I’ll stick to my disciplined process, thank you very much. I realize that different styles work better under different market conditions. In fact that’s one of the beauties of Jeff’s system—he takes a blended approach among more than one model in order to keep aggregate returns higher and risks lower.

BH: Alrighty then. How about you, Felix? I noticed you put up some really good performance over the last week. Did you place any trades?

Felix: No trades, but I was holding RH (RH) this week, and the shares are up around 39% in the last 5 days, and 79% this year. If you recall, I typically hold my positions for about 66-weeks. And this isn’t the first time we’ve done extremely well with RH. Despite a little trash talking from our readers, we also owned RH last September and November when it also put up big gains. You can read about that here: Despite Fundamentals, We Nailed RH, Again.

BH: Nice job, Felix. That is impressive. Do you have anything else to share this week?

Felix: Yes, I ran the NASDAQ 100 through my model, and I’ve ranked the top 20 for you in the following list:

BH: Thanks Felix. I know you are a momentum trader, and I see plenty of momentum names on that list. Much appreciated.

Athena: This week I bought Applied Optoelectronics (AAOI).

BH: Interesting small cap pick, Athena. They make optical equipment for cable TV, wireless and fiber-to-the-home. Why do you like this stock, Athena?

Athena: As you know, I am a momentum trader, and AAOI looks attractive over the next 17-weeks, which is my typical holding period.

BH: Athena, this stock is way below its highs, although I can see it has a little momentum over the last couple months. Have you even considered the fundamentals? Here is the FastGraph for you to consider, and as you can see EPS is expected to rise.

Athena: Thanks for that info, but I am a trader, and I’ll exit this position long before those future earnings announcements are released. I’ll exit my position when either my price target or stop price hits.

BH: Thanks Athena. How about you, Oscar—any trades this week?

Oscar: No trades to share, but I did rank the Comprehensive & Diverse ETFs universe. Here are the top 20.

BH: Interesting, Oscar. I realize you are also a momentum trader, and you usually rotate to a new sector after about 6-weeks. Thanks for this list.


There are a lot of different considerations that go into building a trading system. And there are a lot of mistakes that can be avoided along the way. If you’re going to give it a shot, you’d be wise to avoid as many mistakes as possible, such as the dozen listed earlier in this article. Also, if you email us at newarc dot com, we can offer a copy of our brief paper by Vince (our Research Director) with more information about his methods.

Background On The Stock Exchange:

Each week, Felix and Oscar host a poker game for some of their friends. Since they are all traders, they love to discuss their best current ideas before the game starts. They like to call this their “Stock Exchange.” (Check out Background on the Stock Exchange for more background). Their methods are excellent, as you know if you have been following the series. Since the time frames and risk profiles differ, so do the stock ideas. You get to be a fly on the wall from my report. I am usually the only human present and the only one using any fundamental analysis.

The result? Several expert ideas each week from traders, and a brief comment on the fundamentals from the human investor. The models are named to make it easy to remember their trading personalities.

Stock Exchange Character Guide:

Character Universe Style Average Holding Period Exit Method Risk Control
Felix NewArc Stocks Momentum 66 weeks Price target Macro and stops
Oscar “Empirical” Sectors Momentum Six weeks Rotation Stops
Athena NewArc Stocks Momentum 17 weeks Price target Stops
Holmes NewArc Stocks Dip-buying Mean reversion Six weeks Price target Macro and stops
RoadRunner NewArc Stocks Stocks at bottom of rising range Four weeks Time Time
Jeff Everything Value Long term Risk signals Recession risk, financial stress, Macro

Getting Updates:

Readers are welcome to suggest individual stocks and/or ETFs to be added to our model lists. We keep a running list of all securities our readers recommend, and we share the results within this weekly “Stock Exchange” series when feasible. Send your ideas to “etf at newarc dot com.” Also, we will share additional information about the models, including test data, with those interested in investing. Suggestions and comments about this weekly “Stock Exchange” report are welcome.

Trade Alongside Jeff Miller: Learn More.

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