The ACD Method

[SteveM]

Slightly off topic in regards to random walk, but for a while I was trading ACD by looking at stocks which were highly profitable last month using ACD and trading them this month - I found this strategy did not work to well and my stops were constantly getting hit. I'm sure that a lengthier backtest would reveal stocks in which ACD consistently produces above average returns vs the universe, but simply taking good a ups on last month's hot hand doesn't really work so well, at least in my experience trying to make money intraday so far.

What I have been doing more of lately is incorporating "surprises" with ACD, and I've found the results are promising so far. Soros said:

"Markets are constantly in a state of uncertainty and flux and money is made by discounting the obvious and betting on the unexpected."

The revelation I've had lately is that if I am going to make money daily using ACD, then I need to find situations were others feel that they must act quickly due to unexpected news, earnings, etc. An example would be an oil driller where 30% of the float is short and the stock is 70% off its 52 week high, just blew analyst estimates out of the water with their earnings released before market open - taking a good A up is a much higher probability setup than just trying to play last months hot hand like I was previously.

Another nice thing about surprises is there are derivatives here too - for example, Valeant has spread a lot of toxicity around the entire pharma industry - stocks are reacting violently based off earnings and particularly guidance. - Endo phramaceuticals released earnings last week that in a normal environment would have only driven the stock down 5% or so - however on the conference call management expressed the dreaded "pricing concerns" lingo, and the stock immediately traded down 40% the next day - why? Because people associated it with the problems at Valeant and ran for the hills. This type of stuff cannot be backtested in Tradestation either.

Mav, when you were actively trading intraday did you find value in incorporating surprises into your methods? Thanks.

 

[wappler]

Hi Koolaid,

Just thought I would give you my 2c on this, and explain the stage that I am currently at in my own studies.

With the number lines it seems hard at least in my own experience to detract from the fact that a number line is in no way similar to moving averages etc. You should think of the number line moreover as a scorecard for price action. If a number line is strong it doesn't mean that you would buy the instrument, it should be clarifying what you already know, is the product is acting strong or weak. Think of looking at number lines like looking at a league table in football etc i.e You can tell who the strong teams are but that still doesn't mean they are going to win the next game.

Personally I was never happy with the way that a confirm works, my reason for this being that you cannot trade Apple in the same way as you would trade Natty. The problem I see with the original Fisher version of the number line, is that for example Natty may confirm faster than Apple since they are both unique products. Its unlikely that one setting will work seamlessly with two separate products. If you watch a lot of different instruments, you can see that by the time you get a confirmation the meat of the move has already occurred. As Mav & running_bare have pointed out, you really want to identify moves before other participants do and avoid rush hour. Another thing I would like to point out on this is as Mav says, the number line is only a foundation to build from. But the foundation Fish has given us is rock solid, especially for relative analysis and identifying marginal change.

So I have been looking at a way of speeding up the confirmation process, there are two possible ways I can see of doing this. The first is as Wappler and co mentioned in this post, by optimising your number line confirmations on a product by product basis.The second is as Mav has mentioned by using ACD derivatives.

From my own analysis I like Mavs idea of using ACD derivatives. The 30 day indicator is excellent for gauging the strength of the trend. Because it is over a larger timeframe, it is much smoother than shorter timeframe ACD indicators such as the 5 day. What this means is that the 30 day is far less susceptible to noise. If you follow a 30 day over a long enough period of time you will see what I mean.

What I am currently working on is distinguishing the difference from what may be just a bump on the 30 day line to what might actually be a change in trend. The best way I can see of doing this is measuring the slope of the 30 day, then ascertaining the direction of the trend(slope +-), strength of trend(slope steepness), trend transitions(slope changing from pos to neg). This in itself is a lot of useful information and should be a great aid in identifying when the market is experiencing regime shifts. This is still all work in progress but looks highly promising thus far.

Something I used to ignore on this thread was the other posters saying that you really must make ACD your own. The more and more ACD grows on me, the more I seem to be using this advice and the greater confidence I have in applying it to my trading.

Hope this helps and apologies for repeating, what Mav or others may have already written.

Redbaron,
Check your PM, I've replied to your TSSB question. Cheers!

 

[wappler]

Defense stocks are your fire. LMT, NOC, RTN have all broken the monthly A Up.

 

[justrading]

OK, that didn't turn out so well. Baron changed the format so highlighting your text doesn't work that well, I'll post my response here that follows in order your questions.

"justrading, post: 4280063, member: 262807"]I actually believed it was quite the opposite, the hypotheses that is. Since markets are efficient, price cannot but describe a random walk, given there is no reason to do otherwise."

This is not true. You can make money in an efficient market. In fact everyone can. Efficient is referring to excess return. Random walk is referring to an unknown return. This might make it easier. Say you wanted to open a pizza joint. You do some research and you find out there are tons of them where you want to have yours but despite that competition, the avg pizza joint owner enjoys a 20% return on his money. You investigate this further and find that pretty much all of them are close to this mean, meaning that the distribution of returns seems to indicate that no one really is going to make much more or much less. So if you open up the nicest place in town, you might make a slightly higher yield but not much more. This is what we would call an efficient market. Marginal revenue = marginal cost in economics world. All firms are price takers and customers set the price which equals demand. We'll call this yield Y* as the equilibrium yield you will earn if you enter the market which is the same as the yield as everyone else earns. Now even though this market is highly efficient, you will actually earn some nice bank. Efficiency does NOT mean you don't make money. Some of the highest earning professions in the world are efficient.

Now let's say instead of this market being efficient, it's completely random. Meaning, we have no idea how much you expect to earn if you open a pizza joint. Your best guess is simply yesterday's earnings which should be completely random and independent. Would you enter this business now? Of course not. In this world, if you open the nicest joint in town you could randomly go broke. There is no reason why anyone would succeed or fail, it would be left to chance and therefore no one would enter the market.

When you invest or trade, you also get an equilibrium return. For very simplistic purposes let's call this R*. And let's for arguments sake keep it simple and say R* is 7.5% a year which is the long term return of the S&P 500. If you choose to enter the market, like the pizza business, you will make money. And pretty good money too. Not only will you make money, but you have a positive expectancy. You can't have a positive expectancy with a random walk by definition. The question really is, can I do better then 7.5%? And this is precisely the question the pizza owner has. If I put in 20 flat screen tv's to watch sporting events, can I increase my yield greater then 20%? If I stare at charts 15 hours a day, can I increase my yield to greater then 7.5%? This speaks to efficiency. It does NOT speak to randomness.

"Doesn't the Random Walk Hypothesis posit that the past movement of a stock price (and such) cannot be used to predict the future price movement of the instrument? That price takes a random and unpredictable path?"

Yes and no. Depending on how strict of a random walk once chooses to believe. Common random walk theory does not subscribe to past prices can't be used to predict future prices. It simply states it cannot be done consistently. There is a distinction there.

Isn't it based on the idea that since price movement is random, it is not possible to beat the market without taking on additional risk?

This is also wrong. If markets are random leverage does not matter. Where leverage matters is in the above examples where we knew we had a positive expected return. For example, the pizza owner could earn more then a 20% yield if say he were to borrow lots of money and open 10 places. The trader can earn a 15% yield in the S&P if he doubles his exposure. If you add leverage to a random walk, in theory, and by definition, it should not increase your expected return because your expected return is simply today's price.

"Yet, the very existence of trends means the market can be beaten without taking on additional risk. Buffett epitomises that. Edit: not epitomising trends, but that the market can be beaten and hence price is not random. Sorry, should have made this clear, he isn't a Turtle Trader."

Again, random walks have trends. Random walks have a zero mean expectation but not a zero variance. This means that in a random walk model, price increases with variance in proportion to time. Now let's talk about trends as they refer to efficiency. All a trend means is, if they exist, everyone is offered it. A more detailed and structured approach to efficiency says, say you are a long only trader and all you do is buy stocks. What efficiency means is that you are now in this sub group of people who will benefit from any upside trends as a result of your strategy. This means EVERYONE gets this benefit in your group. The efficient market argument would say you can't do better then those in your "group" without adding more leverage or risk to what your group is doing.


"If price were truly random, none of us would be here. We all profit when price moves from A to B and we ride that movement. If it were otherwise, then let's just do what Surf advocates, toss a coin, enter, and manage the position."

Again you are confusing random with efficient. And you are implying markets are always random or always efficient whichever one you choose to believe, you can't really believe both. Markets can be random most of the time meaning there is a noise effect in any market. There might be meaningful information there, but the question is can you consistently extract the signal from the noise without adding leverage or risk?

"I didn't mention leverage, so please let's not complicate things."

Leverage has to be included because it's almost the sole source of alpha on wall street and hedge funds. This can be proven empirically by examining the excess returns that are earned in terms of units of risk. Many funds have beaten the S&P for years in terms of absolute returns but not in terms of units of risk. Implying that the sole source of their out performance is not alpha, but leverage. I'm sorry, we have to include this.



My answers are above in bold. I honestly think you are hung up on terminology and trying to apply a very strict orthodoxy to the meaning of these words.

Appreciate the depth of your response.

My basic problem with the random walk hypothesis is I see everything happening within the overarching imperative of the economic cycle. Governments, central banks and businesses act, providing fundamental drivers for the markets. From all this, we see trends. There is always something trending. Identifying that and riding the trend provides returns that beat the index.

I remember reading a paper by Andrew Lo on this very subject, the existence of trends. Malkiel dismisses both fundamental and technical analysis as worthless. Lo has evaluated TA and found it can be used profitably. As for FA, markets do not always react immediately, but there is no denying long term value when the fundamentals are strong, or that prices will go down when the outlook is poor.

So, on this one we will have to agree to disagree.

 

[Maverick74]

Slightly off topic in regards to random walk, but for a while I was trading ACD by looking at stocks which were highly profitable last month using ACD and trading them this month - I found this strategy did not work to well and my stops were constantly getting hit. I'm sure that a lengthier backtest would reveal stocks in which ACD consistently produces above average returns vs the universe, but simply taking good a ups on last month's hot hand doesn't really work so well, at least in my experience trying to make money intraday so far.

What I have been doing more of lately is incorporating "surprises" with ACD, and I've found the results are promising so far. Soros said:

"Markets are constantly in a state of uncertainty and flux and money is made by discounting the obvious and betting on the unexpected."

The revelation I've had lately is that if I am going to make money daily using ACD, then I need to find situations were others feel that they must act quickly due to unexpected news, earnings, etc. An example would be an oil driller where 30% of the float is short and the stock is 70% off its 52 week high, just blew analyst estimates out of the water with their earnings released before market open - taking a good A up is a much higher probability setup than just trying to play last months hot hand like I was previously.

Another nice thing about surprises is there are derivatives here too - for example, Valeant has spread a lot of toxicity around the entire pharma industry - stocks are reacting violently based off earnings and particularly guidance. - Endo phramaceuticals released earnings last week that in a normal environment would have only driven the stock down 5% or so - however on the conference call management expressed the dreaded "pricing concerns" lingo, and the stock immediately traded down 40% the next day - why? Because people associated it with the problems at Valeant and ran for the hills. This type of stuff cannot be backtested in Tradestation either.

Mav, when you were actively trading intraday did you find value in incorporating surprises into your methods? Thanks.

Back in my Worldco days all we did was trade surprises. Earnings, earnings revisions, and major news that impacted earnings. Usually in a related name, not in the name itself.

 

[Maverick74]

Appreciate the depth of your response.

My basic problem with the random walk hypothesis is I see everything happening within the overarching imperative of the economic cycle. Governments, central banks and businesses act, providing fundamental drivers for the markets. From all this, we see trends. There is always something trending. Identifying that and riding the trend provides returns that beat the index.

I remember reading a paper by Andrew Lo on this very subject, the existence of trends. Malkiel dismisses both fundamental and technical analysis as worthless. Lo has evaluated TA and found it can be used profitably. As for FA, markets do not always react immediately, but there is no denying long term value when the fundamentals are strong, or that prices will go down when the outlook is poor.

So, on this one we will have to agree to disagree.

Yes but back to the random walk. And this is something I need to maybe put more emphasis on. Let me try to explain this better then I did last time. So efficiency relates to forward expectations. In the pizza example we had a forward expected value of the 20% yield. In the S&P 500 we have a forward expectation of 7.5%. So what efficiency would say to your above comment is that if the government is doing this and that, then EVERYONE is going to build that into their forward expectations. THAT is why you see trends. A trend happens when there is a meeting of the minds and we all agree that plaid shirts are cool, or we all hate the new android phone, or we all love that one movie, that is what begets trends. The problem is, the market is listening. If well benefit from it, how do you benefit more? For example in the last 6 years the s&p has been on fire. So all index holders benefit equally. The question here is, do you think you can benefit more? Now obviously you do or you would just be long the index.

The random walk is the path the market takes towards that forward expectation. It zigs and zags in unpredictable ways but ultimately moves towards that final destination which is the forward expected value. I don't think we disagree on anything. I believe the markets are very efficient and the fact that most traders don't make money seems to prove that out. The goal obviously is to be an outlier. That rare person who can separate the signal from the noise. I believe ACD does help with that. I've often said that the best thing ACD ever does for you is keep you out of the market. It's trying to keep you away from the noise. I believe in the concept of rarity which I've stated on this board 100 times. You need to be patient. You need to be picky. You can't swat at everything that moves. Pick your spots. Look for the signal. It does not mean the markets are not efficient and it does not mean they are not mostly random.

On the vastness of data...

"You know, there are four hundred billion stars out there, just in our galaxy alone. If only one out of a million of those had planets, and just one of out of a million of those had life, and just one out of a million of those had intelligent life; there would be literally millions of civilizations out there."

Carl Sagan

 

[koolaid]

Hey guys,

I don't have much experience with coding but would like to have a program where I can just put in the ticker and it will shoot out a 30 NL score. Any idea on how I could even get this started or if you could point me in the right direction. Thanks all.

 

[DT3]

Seeing lots of chop with no clear direction. My Nasdaq NL has been confirmed negative for over a week, S&P getting close but not there yet. Any tells in currency land?

 

[wow12]

Seeing lots of chop with no clear direction. My Nasdaq NL has been confirmed negative for over a week, S&P getting close but not there yet. Any tells in currency land?

Im little confused at the moment difficult to read i guess , US dollar has lost some strenght and canadian dollar has picked up some strenght . if US dollar weakens further we could potentially see some strenght in S&P but dont quote me on tht , im pretty confused at the moment.

 

[Maverick74]

Im little confused at the moment difficult to read i guess , US dollar has lost some strenght and canadian dollar has picked up some strenght . if US dollar weakens further we could potentially see some strenght in S&P but dont quote me on tht , im pretty confused at the moment.

Instead of looking at "what" the dollar is doing, try more to focus on "why". It's the causes that are more important then the price.