Wednesday, May 25, 2011

Trading Algorithm

The goal of any trader is to make money consistently. In order to do this, one must accept the fact that markets are not 100% predictable. Moreover, they are even less predictable than the experts on TV believe. If this were not true then all of the star fund managers would not be trying to beat the market by few percentage points, let alone making average yearly gains of 20+%.

Therefore, I realized that in order to be successful one needs to do the following:
1. Identify trend change potential
2. Decipher trend
3. Stay with trend
4. Minimize loss
5. Maximize profit
6. Systematic entry and exits.

Consequently, the following trading plan was put in place and is available for your reference.

Stock Market Analysis - Part 2

What a huge difference a few days can make.

On Thursday, when Market Barometer was analyzed, we were seeing a very bullish tilt. This was primarily because we were in a long-term uptrend with near-term market action being neutral. This combination led to a situation, where buying the dips made sense near the low indicated by the Inflection Point Model. At the same time, we had certain sentiment readings which were also pessimistic. Collectively, it was a good buying opportunity.

However, over the past two days market has declined sharply. Invalidating the ending diagonal pattern and bringing the bearish pattern to the top of the list. This decline has also led to the fulfillment of the proprietary 8/4 rule, converting me into a seller of rallies from a buyer of dips. As a further testament to the strength of this decline, unlike the last 5 bottoms which occurred during the "Turn Window," predicted by the Inflection Point Model, this decline did not stop there. Further, the pessimism which was cropping up in the market, has suddenly disappeared.  This suggests the recent decline has further to go. Hence, until unless we can solidly close above 1340, I will not be going long this market till the end of June.

Over the next few weeks, I will share my trade algorithm to better understand the risk-reward ratios involved in trading.

Sunday, May 22, 2011

Stock Market Analysis - Part 1

There are three possible scenarios according to the Elliott Wave analysis of the stock market. Since the stock market rise has been overlapping and choppy since mid March,two scenarios point to  higher prices, while one scenario exhibits potential of lower prices. In this post, I will discuss all of the three possible scenarios through the lens of Elliott Wave.

Ending Diagonal

Ending diagonal pattern is a termination pattern, and leads to the end of a prevalent trend. In our case, it could result in a significant decline for SP500, as the market completes its third wave up. 
If this scenario is to play out, market (SP500 cash) cannot exceed 1400. Otherwise, 3rd wave would become the shortest wave, which is not allowed according to the Elliott Wave principles. There are strong fib relationships around 1370 level.
However, keeping in mind the current sentiment level (which is not very optimistic), a terminating move is not likely. Furthermore, other indices like financials and real estate are also not exhibiting similar patterns. In fact, financials (XLF) sport a triangle pattern, with excessive pessimism towards financial stocks. This pattern normally results in a sharp move in the prior direction. Therefore, if the financials do rally, they would take the entire market higher. 

Finally, the recent correction has lasted for around 3 weeks. This is a reasonably long time for a correction, in comparison with the ending diagonal pattern. This is the same duration of correction that we saw in Jan and Feb of 2010, August 2010, November 2010 and Feb/March 2011. All of these instances resulted in a sharp rally. Thus, it suggests that we might not be dealing with an ending diagonal rather a different wave sequence. Moreover, last low was made during the "Turn Window" of the inflection point model, which gives credence to the fact that we have put in some form of bottom

I will discuss this sequence in the next post related to the Elliott Wave analysis. 
        Ending Diagonal     SP500 
        Max Upside:              1400 
        Invalidation below:      1319

"That was the reasoning about Us, which We gave to Abraham (to use) against his people: We raise whom We will, degree after degree: for thy Lord is full of wisdom and knowledge. We gave him Isaac and Jacob: all (three) guided: and before him, We guided Noah, and among his progeny, David, Solomon, Job, Joseph, Moses, and Aaron: thus do We reward those who do good."
—Qur'an, sura 6 Al-An'am, ayah 83-84

Thursday, May 19, 2011

Novel Market Barometer

Every one wants a one line answer after going over 1000s of indicators, techniques and methodologies, to predict the market's next move. Although there is no holy grail, I have tried to combine my Market Matrix analysis with the probabilistic modelling to come with a neat way of summarizing and quickly evaluating the inherent nature of the market.  
         As a result, Market Barometer came into being. It is an algorithmic combination of the following strategies and analytical techniques, using Market Matrix. 

Market Matrix provides an overall overview of the stock market's internal strength, future projections, trend analysis and rally potential, in one chart. This overview is then run through a combinatorial algorithm based on probability distribution of historical trends, which generates a Market Barometer reading.
          In all respects, this is a proprietary algorithm based on historical analysis of various technical analysis techniques. Furthermore, the combinatorial algorithm will be continuously improved as data dictates. There might be flaws in this model. In this regard, I would appreciate your input to make this tool more useful.
Goal: To identify strong moves (rally or decline), pre-define risk, ride the trend, reduce positions near turn points, re-position using TPAP (Turn Point Action Plan) and identify major psychological changes.

Market Bottom? - May 19, 2011 - Before Bell

"Whoever keeps his affairs in order with God (follows His orders sincerely), God will also put his affairs with men in order; whoever makes arrangements for salvation, the Lord will arrange his worldly affairs; whoever advises his own self, God will also protect him." Hazrat Ali (A.S.)

Based on current sentiment readings, historical perspective, indicator's analysis and Elliott Wave structure, it seems that we are approaching an inflection point. Therefore, one should be ready to buy the market. This observation is in agreement with the Inflection Point Model. Market Matrix is given below. 

There are many green lights. With very good risk-reward ratio. It appears that we are nearing a bottom, within a primary uptrend. This bottom  will be confirmed by a break above 1345(closing). It is a good time to buy with cycles bottoming, technical improving, sentiment  neutral to pessimistic  and  waves complete.  We will wait until verification from the trading model before going long.

Various supporting wave structures will be discussed in next post, while the cycle turn dates have already been discussed in the last blog update. In Elliott Wave terms there are two potentials:

1- Ending Diagonal: Up potential 1390
2- Sequence of 1,2 and 1,2 up: Very high potential
3- Sequence of 1,2 and 1,2 down: Low potential 

These supporting wave structures will be discussed in the next post with appropriate market levels. 

Even with all of this analysis, one should always remember that only price pays. Therefore, one should always trade in the direction of the primary trend and have a comprehensive risk-management strategy. 

Thus, in terms of Risk-Management the market is currently buy-able as long as it does not close below 1319. Furthermore, uptrend will be re-confirmed on a close above 1345 (SP500).

Wednesday, May 18, 2011

Market Bottom? - Inflection Point Model

In the name of God, who granted me insight, knowledge and wisdom to walk through the confusing financial markets. On April 18, 2011, it was stated that the inflection point models were suggesting a bottom in the financial markets around April 18, 2011 (+/- 4 days). By the grace of God, it turned out that even in the midst of US debt downgrade by S&P on Monday (April 18, 2011), stock market bottomed on the same day, and zoomed 5.8% higher over the next two weeks. 

Since then the market has chopped around without exceeding the May 1st 2011 highs. Although I have been out of the market during this chop fest, I am keenly watching the unfolding socioeconomic situation, Elliott Wave pattern, sentiment gyrations and the Inflection Point Model. 

Model 1 and Model 2 first produced the mid May turn date in April 2011In order to further refine the projections, the two Inflection Point Models were re-run and following conclusions were achieved. 

Model 1 and model 2 are both suggesting that the next market turn date should be around May 16, 2011 (+/- 4 days). Therefore, we can have a turn window from May 11 to May 20. This means that it is possible that we might have seen the bottom today i.e. on May 17, 2011 @ 1319 (SP500). Furthermore, this level also sports various support levels and the week of May 16 is also the options expirations week - many times market turns during options expiration week. 

I will further analyze the market from the following perspectives to better understand the future market trajectory:

1- Sentiment
2- Elliott Wave structure of Indices, US Dollar and Commodities 
3- Technical Indicators

These will be discussed in an upcoming Market Matrix post. In short, we might be nearing a significant bottom or might have already bottomed. Therefore, one should be vigilant for potential long opportunities. If market closes below 1312 then one should become much more careful, as this would suggest that market has larger downside potential. 

P.S. During the last month I was busy with my finals, and that is why blog posts were very infrequent.