Special Short-Term Situations
History does repeat itself, just not with precision.
It is time to develop a checklist of possible short-term trading opportunities, we can accept or reject each month. You can do this yourself by gleaning out of my trading opportunities that appeal to you. To give you a feel for doing this, I devote this chapter to setting up specific trades you should be looking for each month. These trades are based on times of the month and holiday
The time-of-the-month trade is hardly a new idea. As noted earlier the concept has been known for years. Here are my improvements and adaptions to a long-standing market truism: stock prices rally around the first of the month. The light I shed on this play was to find out that Bond prices experience this same monthly uplift as demonstrated earlier. We will develop a winning strategy based on these insights.
Month-End Trading in Stock Indexes
There are now several vehicles speculators can use to catch these savings. The S&P 500 stock index has been the kingpin of trading stock market moves but lately, the lower margin S&P minicontract has been
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Figure 10.1 S&P 500 buying first day of each month.
grabbing smaller investors' attention. The newcomer in this group, though, is the Dow Jones 30 index, a futures contract that mimics the world-famous Dow Jones Average. I expect this to become an even more important index to trade in the future.
The strategies discussed here are based on the S&P 500 for one simple reason; we have more data because this stock index began trading in 1982, the Dow 30 in 1997. But, the strategies can be applied to all the stock indices; just alter your stop based on margin, contract size, and current volatility.
I went back to 1982 and tested buying the S&P 500 index on the open of the first trade day of every month with an exit on the first profitable opening. The stop I chose was only $1,500, but was not used on the day of entry; however, after the entry day it was in place at all times. There have been 129 trades making a net gain of $73,437, about $7,000 a year for trading only once a month. The numbers of this system are excellent; the accuracy is 85 percent, average profit per trade (that's net gain, winners minus losers, divided by total trades). Drawdown came in at $3,325, less than 5 percent of total gains. This is good stuff (see Figure 10.1).
Target Months
If you are getting the hang of this game, you may have already asked yourself if some months do better than others. The answer is yes, as the following printouts show. The story they tell is that the worst months, in the past 16 years, have been January, February, and October. These should be your target months to avoid or be cautious of seasonal trading. I suggest you study the month-by-month recaps presented in Table 10.1.
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Making It Better
Although some of our speculative competitors are aware of this repetitive pattern, most do not consistently take advantage of it nor have they figured out about skipping some months. That is a big improvement, but we can do even better.
How? By only taking these first-of-the-month trades when Bonds are in an uptrend. As I demonstrated earlier, an uptrend in Bonds is conducive to stock market rallies. A pretty good rule, and easy to follow, is to only buy on the first of a month, any month-if Bonds have closed higher the day prior to our anticipated entry than 30 days ago. This is evidence Bonds should be supportive of a stock market rally.
Month-End Trading in the Bond Market
Next, let's look at buying the first trading day of every month in the Bonds, as we did in the S&P 500. The results are quite profitable based on the rules of using an $1,100 stop and exiting on the first profitable opening. This approach to trading comes close to 70 percent accuracy and has a very large average profit per trade considering that we are in for only one day on average (see Figure 10.2).
We can dramatically improve these results by simply by-passing the poorer performing months which, as shown in Table 10.2, are January, February, April, and October, with December being a question mark.
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Figure 10.2 Bonds buying first day of each month.
As mentioned, the month-end up move in stocks has been written about for years; all I have done is figure out how to better qualify trades for this time period. Until now, the tendency for Bonds to rally at this same time has been known by only a few of my students. My research and actual trading over the years show this is also an excellent time for short-term swing moves in Bonds and Bills.
Figures 10.3 and 10.4 should give you an overall view of this technique's strength. Figure 10.3 shows the growth in an account that would have
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Figure 10.3 End-of-month T-Bonds system (U.S. T-Bonds day session 1983-1996).
Figure 10.4 End-of-month S&P 500 (1983-1996).
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bought one contract of T-Bonds on the third to the last trading day of each month and held for six trading sessions, exiting at that time or taking a loss of $1,500 with a protective stop. This chart, from one of the Bond market's best students Mike Stock, offers convincing proof of the phenomenon. The same opportunity presents itself in the S&P 500 as well as Figure 10.4 shows.
Getting Specific
The rally usually begins in Bonds prior to the first of the month as evidenced by the next set of printouts. Figure 10.5 shows the results of buying Bonds on the opening of TDM 18 with a $1,500 stop and exiting on the close 3 days after entry. The 139 trades, since 1986 netted $34,875 with a comfortable average profit per trade of $2 50. This is tradeable, despite the $8,62 5 drawdown.
We can do better, however, by bringing a subset of the trend of the Gold market to filter out bad or marginal trades. As described in the works of such major contributors to our understanding of the markets as Marty Zweig or John Murphy (whose books are must reading), Gold exerts a great impact on Bonds. When Gold is in an uptrend, it acts as an impediment to Bond market rallies, conversely, when Gold is in a downtrend, Bonds are more apt to rally.
Figure 10.6 reveals the power of filtering trades with Gold. In this case, trades were taken at the same time period with the same stop and exit as before. The difference is that trades were only taken if Gold was in a downtrend (i.e., the close of Gold on the day prior to entry was less than 24 days ago).
Figure 10.5 Buying bonds on TDM 18.
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Figure 10.6 Bond TDM 18 buy signals backed by gold.
Although total profits dip $2,000, the accuracy slightly increases while our "all important" average profit per trade jumps up over $100 per trade and drawdown improves substantially by being cut almost in half!
Better and Better
We can do even better than the preceding results by delaying our entry until TDM 22. There are a lot less trades as the Figure 10.7 shows, only 50, but a
Figure 10.7 Bond TDM 22 buy signals.
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Figure 10.8 Bond TDM 22 buy signals backed by gold.
higher accuracy, 76 percent, an amazing $496 average profit per trade, and very livable drawdown of a little over $4,500.
I know, I know, you want to know what happens when we back this trading opportunity with the trend of Gold. Well, Figure 10.8 shows the answers and they are very impressive, $20,156 of profits. Again, the trend criteria is that Gold close lower than 24 days ago, same stop and exit as in the previous results.
Although our drawdown has a major improvement, crashing all the way down to $1,500, the accuracy skyrockets to 89 percent and average profit literally zooms to $719 per trade.
This is an exceptional trading opportunity; the problem is not many months have a TDM 22, but when they do, I will be buying. Check out the string of winners with the Gold filter, 17 winners in a row, whereas without the filter, we only had 5 winners in a row.
A Time to Sell as Well
Bonds have also dipped around mid-month most of the time, as Figure 10.9 reveals. The rules called for selling on the open of TDM 12 with our usual 3-day exit and $1,400 stop. From 1986 to the middle of 1998, this dip has been profitable to trade 76 percent of the time with an average profit per trade of $133 on the 152 trades. Drawdown is acceptable at $6,093, but larger than the ideal ratio of profits to drawdown.
Ideally, drawdown should be no more than 15 percent of the profits of $20,281. In this case, the drawdown was 20 percent profits. So, although we are certainly onto something here, I would like a shot at making it better.
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Figure 10.9 Bond sells TDM 12.
Whereas traditional commodity market analysts would try to filter this trading opportunity with technical "junk" like the trend, oscillators, or momentum flows, I would rather go back to what matters;
fundamental relationships, that of Gold to Bonds. After all, charts and oscillators do not move the market, underlying conditions do.
In addition to now having a real way to trade this mid-month dip, we are also able to again see the power of fundamentals in Figure 10.10. The trade entry and exit rules are exactly as in the previous clip, the only difference-and what a difference it makes-is that trades were only taken when Gold had closed greater
Figure 10.10 Bond sells TDM backed by gold.
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than the close 10 days ago. In other words, Gold was in an uptrend, which suggests to us that sell signals should be more effective in this monetary environment. The average profit per trade more than doubles, profits get bumped up $6,000, accuracy goes from 76 percent to 78 percent, no big deal, but our drawdown to profit percentage is just about halved from 20.9 percent to 11 percent. Perhaps best of all the average profit per trade jumps to $359 from $133.
Here we have a very tradable opportunity. All one need do is have the patience to wait for the mid-month time periods when Gold has been in an uptrend: that is the fundamental setup that created these results.
Patience seems to be the one commodity commodity traders have in short supply. Most people must like to trade for the heck of it, I guess. I want to wager or speculate only when I have a distinct advantage in the game. If it is not there you know where I will be ... on the sidelines . where I belong. I hope you will be there with me!