How to research and verify trading ideas

[oraclewizard77]

Please note that I have been deleting some messages that violate ET policy.

Stop acting like children, if you want to act like a baby, please post your remarks in the chit chat forum.

Please note that we do see your ip, if the person with the 1 post remarks wants to keep posting here, stop now, or I will report you to admin to have you banned.

For those that like this forum, please ignore the trolls that are trying to ruin it, I will delete their posts when I have time, but I sometimes like to go outside and take a walk or jog, and don't spend my life on the internet like the trolls who can't trade and have no life.

 

[beginnerjohn]

Hi Talon
Yes very wise words indeed. You and Maestro seem to be the two voices on here that make the most sense to me.

Well done and thanks.

All the Best

John

Quote from talontrading:

one more thought on big picture before we jump into the volatility stuff in more depth.

i made the claim that the market was mostly random in response to jack's claim that the market was orderly and predictable. someone responded that they disagreed with my word 'random' but he thought the market was unpredictable. fine, we're both saying the same thing there. i think if i elaborate on this statement a little further it will help the newer guys (and ladies... unless i've gotten some pm's from dudes with interesting handles lol) orient themselves.

as i said before, i think the basic mental trick of all trading is just thinking in probabilities. any one trade is more or less a coin flip... may work out or may not. this, incidentally, is why it's important to be consistent in your execution and how much risk you assume on each trade. you don't know which trades are going to be the good ones so you have to treat them all the same. what is your responsibility as the trader? to put the trade on and manage it correctly. you have no responsibility for the ultimate outcome of the trade... if it doesn't work out you just move on to the next trade. it's that simple.

but it's only that simple IF you have an edge. this can come from a high probability setup (which, btw, usually means 60%... so it ain't actually all that high) or from a setup that has a low probability of winning but wins much larger than losers. (here right away you see why people who focus only on win ratio are simple wrong.) if you know you have that edge, then you just work within the calculus of the probabilities and put the trades on... at the end of the day, week, month the cards will almost always fall in your favor.

i don't mean to trivialize this process because finding these edges and monitoring their performance (sometimes things do stop working or sometimes things only work well in certain environments) is a lot of work. in addition, monitoring your emotions and performance as a trader is key. it doesn't feel good to be wrong 80% of the time on a particular setup, but if your wins are 10 times your losers you have to keep sitting at the table and paying the ante.

as for the question about calling the market in advance, in my experience and in my framework that's ludicrous. 85% of the time if you ask me about any market my answer is "i have no clue." in those times, i have no edge and no reason for being involved. all i am doing if i take a position in those times is guessing... because i have trading skills i probably won't lose money (but other people without these skills will) but i am assuming unneeded risk. for instance, what if i'm screwing around shorting some POS biotech in the middle of the day then they halt the stock to announce they found the cure for cancer? Sh*t happens all the time but if it happens to me when i'm in a position i have no business being in, well that's a major mistake.

However... 15% of the time I think I have a clue. Now, I'll be wrong a lot of the time anyway, but here's the point of this post: The key is identifying what I think the most likely outcome is (based on my intuition or a specific trading edge I have identified) and... here's the key... knowing where I'm wrong. It can be as simple as saying "this 30.15 level should hold, if I see 30.14 I'm out" or it can be much more complex... but whatever... that's the key and that's how I teach the people I have worked with to think. It's not about some complicated magic formula and it's certainly not about knowing the future. It's about knowing where the probabilities lie and knowing what "should" happen and knowing what would have to happen to make me wrong.

This relates primarily to discretionary trading, but I think it's a framework that underlies all my thinking... so I thought it was important to get it out.

Ok... let's dig into volatility next.

 

[xburbx]

any thoughts on what calculations to use for volatility according to different time frames?

example

i wouldnt use the same strat on an 8 week swing as i would an intraday trade correct?

trying to figure stocks to filter

 

[Spydertrader]

Quote from xburbx:

any thoughts on what calculations to use for volatility according to different time frames?

You might choose to rank (descending highest to lowest) all equities by ADR. Focus on the upper portion of this list. Over time, those equities which no longer 'measure up' will fall off the list as new players move into the top positions.

Quote from xburbx:

trying to figure stocks to filter

Begin with narrowing down the entire Universe of Equities by culling for quality first. Then, focus on those equities which move (have the highest ADR).

Culling criteria:

1. Price $10.00 - $50.00
2. Volume: Greater than 400,000 shares traded daily
3. Float: 5 million to 60 million shares (daily)
4. Positive Earnings
5. Insider Owned Shares > 5%
6. Institutional Owned Shares > 5%

You could narrow the list further by choosing to focus on equities which show a cycle of 20% (or more) Price improvement over a period of 6 to 8 days a minimum of five times in the previous six months.

HTH.

- Spydertrader

 

[xburbx]

interesting. i will have a look at that today. thanks.

Quote from Spydertrader:

You might choose to rank (descending highest to lowest) all equities by ADR. Focus on the upper portion of this list. Over time, those equities which no longer 'measure up' will fall off the list as new players move into the top positions.



Begin with narrowing down the entire Universe of Equities by culling for quality first. Then, focus on those equities which move (have the highest ADR).

Culling criteria:

1. Price $10.00 - $50.00
2. Volume: Greater than 400,000 shares traded daily
3. Float: 5 million to 60 million shares (daily)
4. Positive Earnings
5. Insider Owned Shares > 5%
6. Institutional Owned Shares > 5%

You could narrow the list further by choosing to focus on equities which show a cycle of 20% (or more) Price improvement over a period of 6 to 8 days a minimum of five times in the previous six months.

HTH.

- Spydertrader

 

[jtrader33]

While the basics are being addressed, I wanted to ask one additional question regarding data quality. I've spent the last two weeks questioning every data provider I could find (~15 or so) on their methodology for adjusting for cash dividends (for the most part, splits and stock divs are handled consistently across providers).

My thinking was that there is only one correct way to do it - adjust for all cash dividends (special and quarterly) in the following manner:

1. Calculate an adjustment factor on the day prior to the ex-date ---> AF = (Close - Div)/Close, then
2. Multiply all prices prior to the ex-date by the AF

Do others agree?

It was surprising to see that adjusting this way was only an option at two providers. The most common answer was that only special cash dividends are adjusted for (using the steps above), but ordinary quarterly cash dividends are not. That seems inconsistent at best.

After some more digging, it appears that this is the format in which the exchanges distribute the data. Most providers seem to filter for bad ticks but then pass it on as-is without further dividend adjustments.

Anyhow, a number of times when asking these questions, the representative did not know the answer without consulting their tech people - I guess they're not questions that they get asked often...also surprising. So since Talon previously emphasized the importance of using accurate data, I figured this might be worth highlighting here. Hope its not too far off-topic.

 

[charts]

Isn't it ... (?):
Expectancy = (Probability of Win * Average Win) - (Probability of Loss * Average Loss)

Also ..., in my opinion, your trading shouldn't be "very closely related" to gambling.

Quote from talontrading:

... In trading and gambling (which, be clear, are very closely related) we think a lot about expectancy. Expectancy is defined as the payoff of an outcome * the probability of that outcome. If you have multiple possibilities, it works like this:

(payoff of outcome1 * prob of outcome 1) + (payoff of outcome2 * prob of outcome2) + ... etc

 

[talontrading]

Your expectancy formula is correct, and I know many trading books give this formula the way you wrote it. However, that's not the most useful way to think of this if your goal is to build intuition. For instance, one way to think about this is to imagine there are 5 outcomes when you get in a trade: big win, big loss, small win, small loss, breakeven. You roughly assign probabilities to those scenarios and, after doing this a long time, begin to build some intuition about the expectancy of the overall situation. That's just one situation, but don't simplify this to the formula you gave below.

Trading has much more to do with gambling than you might think. Why do you think it shouldn't be closely related?

Quote from charts:

Isn't it ... (?):
Expectancy = (Probability of Win * Average Win) - (Probability of Loss * Average Loss)

Also ..., in my opinion, your trading shouldn't be "very closely related" to gambling.

 

[talontrading]

I'm not sure about Spydertrader's answer, but I dont think it answers the question you're asking... perhaps I misunderstand the question you're asking though.

To generalize, there are probably two volatility calculations you should be aware of.
1. Average true range. I think everyone already understands this one?
2. Statistical (or historical) volatility. This is the standard deviation of the returns, usually annualized. Note carefully that this calculation works on RETURNS not raw CLOSES. You may use percentage returns or continuously compounded returns without much difference.

I would interpret these two measures slightly differently:
1. shows you the average range the market is likely to cover in a single bar. That one's easy.
2. Is probably less intuitive: when this number is correctly annualized, it tells you what a 1 standard deviation price change would be one year from now, assuming normality. It is clearly a measure of close to close volatility, which can be very different than ATR.

You should play with these numbers a lot until they make sense. For instance, does it seem right to you that a stock can be bouncing around in a $5 range from 45 - 50, then viciously drop from 50 - 20 in two weeks, and the volatility would actually decrease as that happens? That's a very possible outcome under #2 if the breakdown happens in a straight line (think how closely the closing prices cluster around a best fit line drawn over a fairly short lookback period. Not the same measure, but a useful way to think about it.)

Blindly applying these measures will get you in trouble. The behavior of volatility is actually one of the most fascinating aspects of market analysis... and some of the most reliable profits come from systems designed to trade volatility. This is not a topic we can cover adequately in this thread, but it will reward deep study.

There are also other volatility measures... many more. For instance, you can calculate measure #2 using the C to O return to study overnight gaps, using L to H return to look at intraday volatility, can look at residuals from a regression line on closes... etc etc etc, but what is more important is what they are measuring rather than how.

Quote from xburbx:

any thoughts on what calculations to use for volatility according to different time frames?

example

i wouldnt use the same strat on an 8 week swing as i would an intraday trade correct?

trying to figure stocks to filter

 

[talontrading]

FWIW, I disagree with a lot of these criteria, but it depends on what yo're trying to accomplish with the screen.... daytrading? swing trading? investing? longs only? shorts only?

Quote from Spydertrader:

You might choose to rank (descending highest to lowest) all equities by ADR. Focus on the upper portion of this list. Over time, those equities which no longer 'measure up' will fall off the list as new players move into the top positions.



Begin with narrowing down the entire Universe of Equities by culling for quality first. Then, focus on those equities which move (have the highest ADR).

Culling criteria:

1. Price $10.00 - $50.00
2. Volume: Greater than 400,000 shares traded daily
3. Float: 5 million to 60 million shares (daily)
4. Positive Earnings
5. Insider Owned Shares > 5%
6. Institutional Owned Shares > 5%

You could narrow the list further by choosing to focus on equities which show a cycle of 20% (or more) Price improvement over a period of 6 to 8 days a minimum of five times in the previous six months.

HTH.

- Spydertrader