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Market Efficiency
Portfolio
July 14, 2007
by
Van K. Tharp
In the next few articles on the portfolio, I�m going to look at why the portfolio was not as profitable as I would have liked. For example, our earlier studies of the efficiency portfolio in 2001 worked very well, even in a bear market. I simply stopped that portfolio because there were no positive efficiency stocks in the worst part of the bear market in 2002.
When I started this portfolio, I thought a hedged long and short portfolio would work. Thus, the first major change I made to this portfolio was to have both long and short stocks based upon what percentage of the portfolio was long or short. That obviously didn�t work as most of our short positions were a disaster. As a result, in this issue, I�m going to look at what would have happened if we had followed our old rules of having a long-only portfolio with a simple 25% trailing stop. That was what we did before with a few additional exits.
Next month, in an August issue, I�ll take a look at the short portfolio and why that might have given us so much trouble. And in a September issue, I�ll take a look at some of the top performing stocks during the period from July 06 through June 07 and see why we didn�t catch them. It might have been a simple issue such as �there were too many positive efficiency stocks to select from,� but there are a number of possibilities that I want to explore.
This examination of the portfolio will probably result in a revision of the portfolio rules. If there is enough interest, I�ll continue the portfolio with the new rules in place. Please, let us know through your comments in the feedback section below if you would like me to continue the portfolio with these changes. I�ll need a strong positive response from you to go in that direction.
Our closing portfolio values were shown in Table 1 of the June issue. The portfolio was up $4140 (not including the commissions of selling) but the closed out positions were down by a similar amount. The net result was basically a scratch result over the 11 months, which I�m not happy with.
During the 11 months we had 44 positions. Since we charged ourselves $15 for both entry and exit, that amounted to a total cost of $1320 for commissions over the 11 months. That amounted to 6.7% of the value of the starting portfolio. In addition, I made one major mistake (breaking my rules) when I bought PLRO and had to immediately sell it out for a $414 loss. Thus, this portfolio needed to make almost 10% just to break even and that�s about what we did. I point this out, because these are the basic costs of trading. You probably have to make 10% or more just to cover your very BASIC costs of trading a small portfolio. And this is one of the real disadvantages of trading a small account. Many traders try to make it with much less than the $20,000 that we began this portfolio with. To illustrate this point, if we resume the portfolio testing we�ll do so with a $100,000 portfolio so that our costs will be a much smaller portion of the portfolio.
The first question we need to ask ourselves is �How far against us did our long positions go?� Table 1 shows all of our long positions with the Maximum Adverse Excursion (in terms of R). By the way, John Sweeney introduced the Maximum Adverse Excursion in his great book Campaign Trading. However, the real strength of the concept is to use it in terms of R, which I�ve never heard anyone else do except for me. It�s one of the best tests I�ve ever seen about your initial stop. In Table 1, we are comparing all of our initial long positions against a 25% stop as 1R.
Table 1: Maximum Adverse Excursion of Our Short Stocks with 25% Initial Stop
| Date Bought | Stock | Entry Price | Date Sold | Exit Price | Date of Lowest | MAE | 1R | MAE as % of R |
| 16-Jul-06 | OGE | $35.97 | 8-Sep-06 | $35.58 | 12-Jun-07 | ($2.20) | 8.99 | 0.24 |
| 16-Jul-06 | AETH (NEXC) | $6.05 | 15-Aug-06 | $5.65 | 8-Aug-06 | ($0.70) | 1.51 | 0.46 |
| 15-Aug-06 | AYE | $40.55 | 8-Sep-06 | $40.00 | 19-Sep-06 | ($1.54) | 10.14 | 0.15 |
| 15-Aug-06 | CG | $58.21 | 8-Sep-06 | $57.13 | 26-Sep-06 | ($4.79) | 14.55 | 0.33 |
| 11-Sep-06 | VTR | $39.95 | 11-Oct-06 | $37.96 | 8-Nov-06 | ($3.45) | 9.99 | 0.35 |
| 11-Sep-06 | SYX | $13.25 | 12-Oct-06 | $14.38 | 25-Oct-06 | ($3.32) | 3.31 | 1 |
| 11-Sep-06 | LQU | $54.05 | 15-Jun-07 | $72.82 | 5-Oct-06 | ($2.05) | 13.51 | 0.15 |
| 11-Oct-06 | CPY | $48.85 | 13-Nov-06 | $42.01 | 19-Dec-06 | ($8.39) | 12.21 | 0.69 |
| 11-Oct-06 | OMG | $53.17 | 13-Nov-06 | $49.03 | 12-Mar-07 | ($13.16) | 13.29 | 0.99 |
| 11-Oct-06 | ENR | $75.00 | 13-Nov-06 | $71.14 | 28-Nov-06 | ($9.58) | 18.75 | 0.51 |
| 13-Nov-06 | MWP | $35.54 | 15-Jun-07 | $57.28 | 13-Nov-06 | ($0.23) | 8.89 | 0.03 |
| 13-Nov-06 | EWP | $52.12 | 9-May-07 | $57.28 | 5-Mar-07 | ($0.95) | 13.03 | 0.07 |
| 13-Nov-06 | NU | $26.52 | 15-Jun-07 | $28.88 | 14-Nov-06 | ($0.37) | 6.63 | 0.06 |
| 13-Nov-06 | CHL | $42.32 | 9-May-07 | $46.16 | 8-Dec-06 | ($3.12) | 10.58 | 0.29 |
| 16-Jan-07 | LFL | $57.80 | 15-Jun-07 | $81.90 | 23-Jan-07 | ($0.80) | 14.45 | 0.06 |
| 13-Feb-07 | SGF | $18.75 | 9-May-07 | $16.92 | 14-Mar-07 | ($3.74) | 4.69 | 0.8 |
| 9-May-07 | DRYS | $37.00 | 15-Jun-07 | $36.94 | 12-Jun-07 | ($2.45) | 9.25 | 0.26 |
| 9-May-07 | MFW | $62.25 | 15-Jun-07 | $68.69 | 18-May-07 | ($5.34) | 15.56 | 0.34 |
| 9-May-07 | ENR | $100.01 | 15-Jun-07 | $98.25 | 8-Jun-07 | ($5.85) | 25 | 0.23 |
| Stocks that split while held | ||||||||
| 11-Sep-06 | CXW | $42.33 | 15-Jun-07 | $64.90 | 28-Sep-06 | $0.01 | 10.58 | 0 |
| 13-Nov-06 | PBCT | $44.62 | 16-Jan-07 | $44.18 | 8-Jun-07 | ($4.30) | 11.16 | 0.39 |
| 18-Dec-06 | ALB | $71.55 | 9-May-07 | $83.88 | 8-Jan-07 | ($3.51) | 17.89 | 0.2 |
| 9-May-07 | NRG | $83.80 | 15-Jun-07 | $91.40 | 16-May-07 | ($2.20) | 20.95 | 0.11 |
| Special Situations | ||||||||
| 16-Jul-06 | FAL | $54.25 | $55.02 | 13.56 | ||||
| 15-Feb-07 | PLRO | $4.55 | 18-Feb-07 | $3.33 | 16-May-07 | 1.14 | ||
I�ve divided the stocks into three groups. Most of the stocks are in the first group because nothing unusual happened. The second group of stocks all split (in fact CXW split twice). The third group of stocks are special situations that I�m calling mistakes. I bought PLRO and it didn�t really meet my entry criteria (it was just very efficient in the short term and it was also a penny stock that had taken off). And I probably should not have purchased FAL, because it was a buyout stock and was near the buyout price when we bought it.
The last column shows the most important data for us; it expresses the MAE as a percentage of R. We have 23 stocks, not counting the last two, and only two of them show a MAE near 1.0. Neither of those stocks reached a 1R loss on a closing basis, but both did so intraday on the lowest price day. But what this says is that had we used a 25% initial stop on a closing basis, we would not have been stopped out of ANY of our stocks. In fact, only five of the 23 had a loss bigger than 0.5R (which would have been a 12.5% trailing stop).
Table 2: Our Results with Buying Our Positive Efficiency Stock with 25% Trailing Stop
| Date Bought | Stock | Entry | 1R | High | Trailing Stop | Jul 13 Price | Stop or Jul13 price | P or L | P or L in R |
| 16-Jul-06 | OGE | $35.97 | 8.99 | $41.30 | $30.98 | $36.57 | $36.57 | $0.60 | 0.07 |
| 16-Jul-06 | AETH (NEXC) | $6.05 | 1.51 | $13.80 | $10.35 | $11.01 | $11.01 | $4.96 | 3.28 |
| 15-Aug-06 | AYE | $40.55 | 10.14 | $56.58 | $42.44 | $57.87 | $57.87 | $17.32 | 1.71 |
| 15-Aug-06 | CG | $58.21 | 14.55 | $81.02 | $60.77 | $80.25 | $80.25 | $22.04 | 1.51 |
| 11-Sep-06 | VTR | $39.95 | 9.99 | $47.97 | $35.98 | $37.75 | $37.75 | ($2.20) | -0.22 |
| 11-Sep-06 | SYX | $13.25 | 3.58 | $31.16 | $23.37 | $21.90 | $23.37 | $10.12 | 2.83 |
| 11-Sep-06 | LQU | $54.05 | 13.51 | $78.09 | $58.57 | $77.46 | $77.46 | $23.41 | 1.73 |
| 11-Oct-06 | CPY | $48.85 | 12.21 | $87.19 | $65.39 | $68.64 | $68.64 | $19.79 | 1.62 |
| 11-Oct-06 | OMG | $53.17 | 13.29 | $59.75 | $44.81 | $55.89 | $44.81 | ($8.36) | -0.63 |
| 11-Oct-06 | ENR | $75.00 | 18.75 | $114.17 | $85.63 | $107.67 | $107.67 | $32.67 | 1.74 |
| 13-Nov-06 | MWP | $35.54 | 8.89 | $64.47 | $48.35 | $58.47 | $58.47 | $22.93 | 2.58 |
| 13-Nov-06 | EWP | $52.12 | 13.03 | $60.80 | $45.60 | $60.58 | $60.58 | $8.46 | 0.65 |
| 13-Nov-06 | NU | $26.52 | 6.63 | $33.62 | $25.22 | $29.33 | $29.33 | $2.81 | 0.42 |
| 13-Nov-06 | CHL | $42.32 | 10.58 | $58.84 | $44.13 | $58.69 | $58.69 | $16.37 | 1.55 |
| 16-Jan-07 | LFL | $57.80 | 14.45 | $86.32 | $64.74 | $83.96 | $83.96 | $26.16 | 1.81 |
| 13-Feb-07 | SGF | $18.75 | 4.69 | $19.47 | $14.60 | $18.93 | $18.93 | $0.18 | 0.04 |
| 9-May-07 | DRYS | $37.00 | 9.25 | $55.85 | $41.89 | $54.36 | $54.36 | $17.36 | 1.88 |
| 9-May-07 | MFW | $62.25 | 15.56 | $69.70 | $52.28 | $67.75 | $67.75 | $5.50 | 0.35 |
| 9-May-07 | ENR | $100.01 | 25 | $114.17 | $85.63 | $107.67 | $107.67 | $7.66 | 0.31 |
| Stocks that split while held | |||||||||
| 11-Sep-06 | CXW | $42.33 | 10.58 | $66.80 | $50.10 | $63.16 | $63.16 | $20.83 | 1.97 |
| 13-Nov-06 | PBCT | $44.62 | 11.16 | $47.91 | $35.93 | $37.99 | $37.99 | ($6.63) | -0.59 |
| 18-Dec-06 | ALB | $71.55 | 17.89 | $89.62 | $67.22 | $85.12 | $85.12 | $13.57 | 0.76 |
| 9-May-07 | NRG | $83.80 | 20.95 | $91.89 | $68.92 | $88.00 | $88.00 | $4.20 | 0.2 |
| Special Situations (Mistakes) | |||||||||
| 16-Jul-06 | FAL | $54.25 | 13.56 | $40.69 | $55.02 | $55.02 | $0.77 | 0.06 | |
| 15-Feb-07 | PLRO | $4.55 | 1.14 | $3.41 | $3.33 | $3.33 | ($1.22) | -1.07 | |
| Sum = | 24.55R | ||||||||
| Expectancy = | 0.98 | ||||||||
| Standard Deviation | 1.15 | ||||||||
Table 2 now shows the same stocks with a 25% trailing stop (calculated from the intraday high, although I could have used the closing high). It also shows the closing price on July 13, had we kept them that long. Notice what happened to our portfolio. We now have an expectancy of nearly 1 and very low variability in our R-multiples (just over 1). Suddenly, we have a tremendous system and it is all on the same stocks.
And notice what I did. I simply went back to the original concept, which I knew worked as long as there were some positive efficiency stocks. I eliminated everything that was complex.
We exited on the closing price on every stock except for SYX (at nearly a 3R profit), OMG, which was stopped out at a loss even though it eventually closed above our entry price and our two �special situation� stocks. In addition, we lost the most on PBCT, which was a very unusual stock that had a 10 for 21 reverse split that really upset the shareholders.
Notice that we only lost money in three stocks (plus our mistake). Those were VTR, OMG and PBCT. It�s interesting that a lot of people said, �Why are you trading this crazy concept that doesn�t work?� However, I�d already proven to my satisfaction that the efficiency concept worked. What we changed was (1) having the longs and the shorts as hedges; (2) having too many exits; and (3) not being patient with our stocks.
The results also suggest that we could have used an initial 15% stop and then switched to a 25% trailing stop when it produced a more favorable price. This would have caused us to be stopped out if we�d used a 15% initial stop and then used a 25% trailing stop as our profit taking exit, we would have been stopped out of two stocks (SYX and CPY) both of which produced nice profits (4.45R). We would have also been stopped out of OMG (which showed an eventual loss) and SGF (which was a scratch trade). Our other winners would have produced much bigger R-multiples (about 1.67 times bigger).
Table 3 shows this conversion. The losses were all assumed to be about 1R (those that we later stopped out like PCBT must be measured against a smaller initial R) and the R-multiple gains were all multiplied by 1.67 to reflect or decrease in the initial stop or R. One might think that this would make a better system and indeed the expectancy does rise from 0.98R to 1.25R. But the standard deviation almost doubles and those of you who�ve taken my advanced courses know how that will affect your position sizing. In addition, the reliability drops from 84% winners to 72% winners.
Thus, my conclusion is that the original efficiency system, which just uses a simple 25% trailing stop and only buys long positions, worked very well during the past 12 months. (See Table 3).
Yes, I haven�t looked at position sizing and the cost of trading in this analysis. But the cost of trading would be very small on a $100,000 portfolio and the results are a dramatic enough change to convince me that this method works.
This situation on the short side was much different. In fact, when I looked for the best performing stocks over the last 12 months DLX was the only one of them. That stock was one we shorted in our portfolio and it went on to be one of the 25 best performing stocks of the 12 month period. As a result, next month, we�ll look at what happened on the short side. Until then, this is Van Tharp.
Table 3: R-multiples Change with 15% Initial Stop
| Stock | Old R-Multiple | New R Multiple |
| OGE | 0.07 | 0.11 |
| AETH (NEXC) | 3.28 | 5.48 |
| AYE | 1.71 | 2.85 |
| CG | 1.51 | 2.53 |
| VTR | -0.22 | -0.37 |
| SYX | 2.83 | -1 |
| LQU | 1.73 | 2.89 |
| CPY | 1.62 | -1 |
| OMG | -0.63 | -1 |
| ENR | 1.74 | 2.91 |
| MWP | 2.58 | 4.31 |
| EWP | 0.65 | 1.08 |
| NU | 0.42 | 0.71 |
| CHL | 1.55 | 2.58 |
| LFL | 1.81 | 3.02 |
| SGF | 0.04 | -1 |
| DRYS | 1.88 | 3.13 |
| MFW | 0.35 | 0.59 |
| ENR | 0.31 | 0.51 |
| CXW | 1.97 | 3.29 |
| PBCT | -0.59 | -1 |
| ALB | 0.76 | 1.27 |
| NRG | 0.2 | 0.33 |
| FAL | 0.06 | 0.09 |
| PLRO | -1.07 | -1 |
| Mean | 0.98 | 1.25 |
| Standard Dev | 1.148332404 | 1.906913657 |
About Van Tharp: Trading coach, and author Dr. Van K. Tharp, is widely recognized for his best-selling book Trade Your Way to Financial Fre-edom and his outstanding Peak Performance Home Study program - a highly regarded classic that is suitable for all levels of traders and investors. You can learn more about Van Tharp at www.iitm.com.
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Proven
Day Trading Strategies
September 15-16-17 |
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Swing Trading Techniques One-Day Add-On September 18 |
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Some Help for Day Traders (and others): The Uptick Rule is Dead!
By D.R. Barton, Jr.
We�ll
take a short one-week break from our no-cost Internet sites series
to go over a BIG regulatory change that has received very little
fanfare.
Very few people noticed the recent death of the infamous short selling uptick rule. Let�s look at the short selling restrictions and then some implications that the removal of these restrictions are having for traders like you and me.
On July 6th, the SEC eliminated a 73-year-old rule that required an uptick in stock price before a stock could be sold short. In SEC language, they have removed the �price test restrictions� on short sales, and prohibited any other organizations from imposing price tests (local exchanges, for example).
An �uptick� is the common name given to Rule 10a-1, under the Securities Exchange Act of 1934. This rule allowed short selling only following a trade where the traded price was higher than the previously traded price (called an uptick).
This uptick rule was the enemy of many a trader who tried to short a stock only to be �unable� on their fill or to get a much worse price than desired. It was one of the rules that made stock trading tilted to the favor of the long side. And it was especially difficult for day traders who wanted to trade NYSE or AMEX stocks.
What the Elimination of the Uptick Rule Means for Traders and Investors
This �quiet� rule change may turn out to have some interesting effects. Let�s look at how it impacts certain groups:
- Individual
Traders and Investors.
Longer term investors, especially those that only buy or
go long will see little change in their activities.
For anyone involved in short selling, there won�t be
much change for NASDAQ stocks (earlier changes allowed legal
workarounds for NASDAQ traders).
But for anyone shorting NYSE or AMEX stocks, the change
could have a significant impact on the ease of getting those
short sales filled, since they will no longer have to wait for
an uptick
- Institutions
and Funds. A
common practice for �big money� on Wall Street was to put in
a significant amount of buy orders to move a stock to an uptick
and then put in their real short sale order.
Short selling will now be a more efficient endeavor for
these institutions and funds.
The elimination of this practice may already be affecting
the Tick Index. (Thanks
to Jason Goepfert for insights into changes that appear to be
affecting the Tick Index already.)
- The Tick Index. The NYSE Tick Index gives the number of stocks on the NYSE that are trading on an uptick minus those that are trading on a downtick. This is a broadly watched index, especially among short and intermediate term traders. Since the uptick rule has gone into effect, many traders and commentators have noticed that the maximum tick reading of the day has been depressed. And this is easily seen mathematically: the average high tick of the day was 25% higher for the seven days before July 6th than the seven days since. This has happened despite the market�s move up, including the extremely strong move on July 12th. In fact, the 7-day moving average of the high tick of the day is at its lowest value since the sell-off that occurred in May 2006.
The bottom line is that traders and investors who use the Tick Index in their analysis need to be aware and wary of the skew in the index that is occurring. Monitor the Tick Index over the next couple of weeks to see if the this trend continues, and adjust your analysis accordingly.
In September, Brad Martin and I are teaching our only Day Trading course of the year (plus a one-day Swing Trading workshop). In times past we talked about workarounds for the uptick rule and avoiding certain types of stock on the short side. But no more! This rule change is one that (finally!) helps traders, especially short term traders. We�d love to see you at this great workshop.
Next week, we�ll dig back into our series on no-cost Internet sites.
Keep sending in your favorite sites to drbarton@iitm.com. And let me know if you�ve found this discussion useful! Until next week�
Great Trading!
D. R.
About D. R. Barton: A passion for the systematic approach to the markets and lifelong love of teaching and learning have propelled D.R. Barton, Jr. to the top of the investment and trading arena where he is one of the most widely read and followed traders and analysts in the world.
He is a regularly featured guest analyst on both Report on Business TV, and WTOP News Radio in Washington, D. C., and has been a guest analyst on Bloomberg Radio. His articles have appeared on SmartMoney.com and Financial Advisor magazine.
Flat Mel
by Melita Hunt
Take a look at today�s picture and meet my twin (or is that alter ego?)�Flat Mel.
I was wondering what to call the article and the words �Double Trouble� and �Being in Two Places at Once� came to mind, but basically it�s all about Flat Mel. "Who�s that?" you may ask�
Two weeks ago, before I headed off to London I was invited to a �white dress party� and to a fund raiser, but due to my flight and work schedule I was unable to attend either event. My friends told me that I would be sorely missed so we hatched up a plan to take me along anyway and give everyone a laugh. They proceeded to take a photo of me dressed in white; it was blown up to full size, put onto a board with a stand and Flat Mel was born. I was told that she was quite a hit at the parties, and she both shocked and entertained quite a few people as she was propped up on stools, tables and countertops. I have no idea what she was up to in the two weeks that I was away, and I�m curious to see the photos�but I�m sure it was all in good fun.
In the meantime, the real me was having a wonderful time in London at our two workshops (more below). I also got to spend time with one of my sisters and her family, and I re-connected with friends that I had not seen in 15 years, although it felt like we had seen each other only yesterday. That�s the joy of being a social butterfly (or should that be flutterby?), I flutter in and out of people�s lives around the world and always feel so welcomed.
This brings me to our workshops�
When I do the initial introductions and say �HI� to everyone who is attending I always mention that by the end of the event (or by the end of that day) they will be best of friends. Sometimes I get smiles and other times I get the �Huh? What is she talking about? I�m here to learn trading, not to make friends� look. However, the networking at our events ALWAYS seems to be one of the highlights and I think that this is because we are all human and, whether we consciously think of it or not, we like to be around people that are similar to us and have the same interests.
As soon as we start to share, talk and learn from Van and from one another, the familiarity kicks in and the desire to talk about our experiences and ask questions about one another creates a great networking environment. This extends into group work and ultimately socializing at lunchtime and evenings during our three-day events. Many people stay in touch with their new found trading buddies and it is always fun to watch the transformation. We have a very global audience and being in London we had clients from Europe, Dubai, Ireland, New Zealand, India and even the US (among many others).
For our final night get together on Sunday, we found an unusual bar in London, the Absolut Below Zero Ice Bar. It is completely made of ice, including the bar, the tables, chairs, glasses and even a telephone booth. There is a 45 minute limit (so that you don�t freeze) and everyone is given gloves and a special coat to wear (you can click on the link below to see pictures including Van looking like a silver Santa Claus). We had a really fun time and it is certainly going to be hard to beat that in North Carolina! However, we do often have dinner at Van and Kala�s house whenever we have workshops here, which everyone seems to enjoy as well.
So, rather than writing anything particularly inspirational this week, I just wanted to have some fun and hopefully put a smile on your face. Laughing and having new experiences are definitely things that I enjoy, whether it�s the real Mel or the infamous Flat Mel.
Although there were only 12 of us left in London on the final night, I hope that you enjoy the pictures.
You can contact Melita at mel@iitm.com
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