Weekly Plan 11/27/22

The End of Bear Market

Hi traders-

For last 15 trading days or so, the market has been range bound between the 2 key levels that I shared in this Substack in one of my weekly plans, earlier in November. This after having come off about 500 handles or roughly 15% from the local low at 3550 that I called about 2 months ago, again here in this Substack. I noted back in September that further excursions below 3500-3550 will be hard to come by, at least for what remains of this this year and anticipated a rally back to 4000-4050.

We have arrived here, and have been drifting sideways now for about 3 weeks , so close to this paramount and important 4050 level. Due to the holidays there has been low liquidity and choppy conditions which I expect to resolve soon. This week is going to be very event risk heavy with Powell set to speak on Wednesday, the PCE indicator out on Thursday , followed by the non-farm payrolls (NFP) on Friday.

The recent choppiness begs the question: we have had a large rally. Risk-on stocks like AMD, NVDA etc have been on a tear, again having come up about 30-40% off the local lows called in this newsletter many months ago. Can this good run continue? Can we see new highs in the stocks any time soon now?

I will try and answer this in this weekly newsletter.

There are two other things I want to cover today, one of them being quite educational in nature:

1. My personal style is based on momentum and I like to search for and develop new strategies that can measure and trade momentum. I back tested one of my momentum strategies on intraday time frames like one-hour bars and wanted to share some results which I thought were very interesting. I will share the back test results as well as describe the strategy design and assumptions. A majority of trading, up to 70% on many indices is now algorithmic which is all based on rule based strategies. Do not miss this if you are interested in swing time frame momentum strategies!

2. Share some names I am bullish on next few weeks to months + weekly time frame levels and scenarios for the S&P500 Emini.

The #1 above is simply describing how I will approach any technical analysis or strategy a little bit more quantitively rather than just “feel” it thru chart patterns. When we back test any strategy, I think the back test alone should have few of the below characteristics:

1. Large enough sample size (20 or more trades). Anything less than that I think can be prone to random errors.

2. Large enough time line (minimum 6 months to 1 year of back testing) . Anything longer than this I think may also be an overkill as market attributes do tend to change over a year due to fundamentals, macro or even volatility.

3. Should account for cost of trading, slippage etc . I would say $4 per lot per round trip is a decent cost of trade for emini S&P500.

There are few strategy assumptions which are very important:

1. The strategy assumes the limit order will always get filled in all conditions. Based on market conditions, this may not always be true.

2. The trade can be closed either a) when the session closes or b) when the exit conditions are met. I ran the backtest under both of these conditions.

3. Since the general trend has been down this year, I ran the backtest on the bearish side. It can be easily coded to run a backtest on the bullish side but I did not do it in this version (may be later). I will be sharing similar strategies with folks when it makes sense for them, depending on the underlying conditions.

4. I think further optimizations can be added like not to run the strategy when the volatility completely dies down to avoid chop, for instance, using an ADX indicator that only runs the strategy when the ADX is above 20 or more. ADX can be a good proxy for VIX as well when the real time data may not be available for VIX. I did not make any other optimizations other than a simple trend following filter. Covered more in detail below.

Strategy Basics and rationale

The strategy itself relies on leveraging the longer term trend to measure momentum and uses a shorter time frame to enter and manage risk. Here are some results on running the back test on this strategy on Emini S&P500 for last one year.

Note these are based on one hour time frames and do not take into account closing the trade at session close. Strategy can run on longer time frames as well, like Daily closes but the number of trades will be quite less. For Emini S&P500, only one contract size was used as default. For stocks like SPY in the back test, only one share was used but the results can be similar for 100 shares.

Everyone has the same data now a days. What matters is what you do with this data. Successful trading is all about finding a unique edge and exploring it. This newsletter is based on OrderFlow and is a result of watching Level 2 data. Whenever I come across an interesting idea, I make sure I share it with the folks, like your self. If you like this preview so far, consider subscribing for up to 5 similar posts every week.

Strategy construction:

Here are the technical indicators I used to construct this strategy. This is purely a technical approach and does not consider any other variable like the related markets or current macro.