Change in Methodology

BarroMetrics Views:  Change in Methodology

Two readers have raised important questions about the change in methodology and timeframe.

The questions will take up a couple of blogs.

I’ll take Joe’s question because that will also answer Peter’s. Joe asks: “I assume that you are now trading with much shorter time frames with more frequent entries and exit( hence more opportunities) in order to generate the income to meet your target.

My question is has your methodology changed- setup, etc , been modified to trade these shorter time frames?

If so in what way have they changed?”

Before I talk about the change in methodology, I need first to address what I believe may be an erroneous assumption.

The first part of Joe’s question seems to associate the shorter timeframe with more opportunity and therefore more profit. But more opportunities can also mean more opportunity for loss. The key question is whether the trader can utilize the opportunities to increase his Expectancy Return [(Avg$Win x Wrate) – (Avg#Loss x Lrate)].

And that brings me to the nub of the problem that has been facing since last year.

I’ll use the S&P as an example but the problem runs the gamut of the instruments.

Figure 1 shows the S&P weekly since the March 2009 lows.  I’d have liked to have used the daily chart but it was far too compressed to illustrate what I wanted to show.

Notice the areas in red, the market was climbing without support of the volume and range studies I adopt. Moreover, if you bring up a Barros Swing chart (Figure 2), you’ll note that the 18-day has not had even a 5-d pull back in the move up since February 2010. Now in a strong market, that’s not a problem. I would treat it as an R2/3 (see Nature of Trends) and I have tools to deal with that type of trend.

But in this case, since the Volume and Range were not confirming the price move, I could not classify it as an R2/3.

So the S&P represented the first problem: where the ‘internals’ I use were not confirming the price structure. A lack of internals usually means a lack of swing structures,  and I use swing structures not only to identify the trend but also to provide change in trend patterns, setups etc.

The second problem was the failure of trades to reach their normal targets – too often, my trades were retracing  before they hit the profit target.

The end result was my Expectancy Return moved below the minimum $0.80 of my Expectancy Return range. I have been here before. The last time was ended around 1999-2000 when for 3-years, I was unable to return a profitable return.

When markets adopt this environment, I have a two-fold problem:

  •  My normal approach fails to identify the change in direction early enough to enter to provide an adequate return when the market changes direction and
  • My stops are too far away so that the profit targets become more than the market is willing to give.

Those were the problems. Tomorrow I’ll deal with the generic solutions.

f-t-sp-2010-04-16-mktvol.jpg

FIGURE 1 Weekly S&P

f-t-sp-2010-04-16-18d.jpg

FIGURE 2 S&P 18-day Swing

1 thought on “Change in Methodology”

  1. Hi Ray
    I empathize with the need to change methodology.
    Glen Neely describes the phases that a market goes through. That I found enlightening, if it is true.
    My style of option trading is statistically based. Both swings and ATR based, with strong emphasis on reversion to mean. This does’t suit all market personalities. Throwing out the statistical outliers is fine, but when they happen, its a killer. Point in case this current S&P, grinding pullback free rally. Not only does it not fit my methodology, it is not apparent until it is doing damage. Makes me feel very amateurish.
    I feel an addendum to my trading plan on the short horizon.

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