Systematic Momentum and Pullback Swing Trading

[spn1305]

First thread on traderji, looking forward to interacting with you all. On this thread, I'll describe some systems that we can use to trade. I've been in the markets since about 4 years now, started when I was 15. I'm not a fully automated/quant trader, rather a market participant who likes to objectify trading setups and execute correctly, following a process. There can be aspects of it which are discretionary, but I place a strong focus on ensuring that whatever we are doing is repeatable. Trading needs to be process based and consistent.

I invest for the long term as well. While that has mainly been discretionary, I'm looking to change that and have incorporated some objectivity into investments as well. We'll get into that too.

A summary of trading systems that I plan on covering (this can change):
1. A swing high inside bar system that looks to long after a breakout from a consolidation zone. These zones are defined objectively.
2. A 21MA pullback system based on swing highs and inside bars.
3. A positional trading momentum system that looks to buy after signs of strength are shown post-pullback.

Rather than describe the three systems separately and confuse you all, let me try to show you the essence of one system first, and we can start looking at setups in the live market.

-Smeet

 

[spn1305]

Swing High Inside Bar System

Here's a quick description of a swing high and an inside bar, for those of you unfamiliar.
A swing high is a candle with a lower high before it and a lower high after it.

Here's a random chart. Candle 2 is a swing high because the candle before that (1) has a lower high, and the candle after that (3) has a lower high.
Now let's look at inside bars.

An inside bar is formed when the range of the candle is within its preceding candle. In the picture above, the green candle is an inside bar.

Now let's look at a swing high inside bar. This is basically an inside bar that forms after a swing high. Using our pictures, if candle 3 in the first image was an inside bar, that is what I would call a swing high inside bar. Have a look:

Candle 2 is a swing high, and candle 3 is an inside bar. Is that simple enough to understand?

Now our setup is not to buy a breakout of a swing high inside bar (SHIB?). Rather, after a SHIB has been formed, we wait for a couple of candles to be formed whose low does not breach the low of candle 2. Have a look at what I would consider a valid setup:

I'd posted this Cipla setup on my blog too. Candle 2 was a swing high as confirmed by the formation of candle 3 which had a lower high, and candle 3 was also an inside bar. Now for the next two candles, we do not want it to breach the low of candle 2. Candle 4 doesn't, neither does Candle 5. The setup is complete and we look to buy at a break of the high of candle 2.

It may seem complicated in a written form, but have a look at it on charts, it's quite simple and intuitive.

You'll notice that the Cipla trade above is about to hit the stop loss. I could have easily cherry picked a setup that worked, but by starting off with a losing trade I want to convey some relevant info about this setup. We'll most likely have a win rate of less than 50% with this setup, but because of decent risk reward opportunities and strong money management, we can have a positive expectancy. My next post is going to be about position sizing.

Don't just look at this as a setup to speculate. There are plenty of ways you can make use of it. For example, one way I've begun using it is to observe the names that show up in our screens everyday and form sectoral views. These views can be used to adjust your sectoral allocations in your long term portfolio. If one of our holdings' names show up in the screen, we can trade around a core position. There's so much you can do.

I've only recently begun testing this on Indian equities, I trade a similar variant of the setup on currencies too.

-Smeet

 

[spn1305]

Position Sizing and Money Management

I follow Van Tharp's methodology for position sizing and the use of R multiples. It's quite simple and works like this.
Let's say you have Rs. 100,000 in your account, and you wish to risk 2% per trade. That means you're risking Rs. 2,000 for a trade. Now let's say you find a setup in Reliance, trading at Rs. 1000 a share. You've determined your stop loss to be at Rs. 900. This means that your risk per share is Rs. 100. The number of shares you should buy (your position size)= 2000/100= 20 shares.
Simple?

Now coming to R multiples. It's just a simpler way of expressing risk reward ratios. In the same example as above, If Reliance reaches Rs. 1100, your unrealized profit is 1R. It's the same thing as a 1:1 risk reward ratio because your entry price is 1000, SL is 900. Thus 1R is 1100, 2R is 1200, and so on.

For SHIB trades, I sell 25% of my position when it reaches 1R, and keep trailing the stop loss at every 1R level from there on, for the rest 75% of my position. For example, when Reliance touches Rs. 1300, it's a 3R trade for me and I'd trail my stop loss at Rs. 1200, the 2R level.

Feel free to ask questions.

-Smeet

 

[TracerBullet]

Hello,
Did you backtest this in code? It seems simple enough to be testable. Once you add taxes and execution costs, you might get a decent estimate of whether there is an edge and what you can expect in terms of returns, drawdowns etc

Assuming you plan to trade this on Daily Equities, one possible thing to check is whether a decent proportion of your trades execute on open. I don't have first hand experience but i would guess that you will often not get the price printing as open. So there will be slippages and your system must be able to tolerate it. Generally i prefer to take the bar closing price ( so say 1m/5m closing price of open bar) in my backtests to mitigate this issue in testing breakouts. Maybe will also need to test behaviour after gaps and whether its ok to pay the price and get in.

 

[spn1305]

Hi @TracerBullet ,
I’m unable to backtest at this point of time because I don’t have access to my uni’s Reuters terminal due to the lockdown. I don’t know how to code yet.
There are a few more nuances to it though. The idea isn’t to use this entirely on its own as a system, but to have a setup on our watch lists for potential sectoral plays, trades around core long term positions etc.

About the opening price/gaps issue, yes it happens often in equities. Check out Granules India, a setup was formed, and it gapped above the trigger price. If I see that it hasn’t reached 1R yet, I place a buy limit, else look for alternative breakouts.

From what I’ve been seeing, it is better to take a fresh entry on a breakout later rather than paying the price and getting in after the gap.

 

[spn1305]

An aggressive and alternative approach to enter stocks that have gapped up beyond our trigger price, is to enter on a break of the 1R level. You're feeding into your fomo then but it can be rewarding.

I use chartink for screening. Here are all the names that screened according to this criteria after Thursday's market close (30/4/2020):

How do we choose the ones we use to trade? This is where there is some discretion involved, and there are some ways you can minimize the extent of it. The first thing you could do is add volume or market cap filters. You could also use a top down approach and play certain sectors through the names that come up on the screen. I prefer playing the sectors, while trying to stick to stocks on a long and intermediate term uptrend.

The ones I find interesting are Minda Corp, Britannia, Tata Elxsi, and Page Industries. As I described above, we buy once it crosses the swing high, thus our buy triggers for these stocks would be active at the following levels:
Minda Corp: Buy above 73.4, SL 67.5
Britannia: Buy above 3290, SL 3160
Tata Elxsi: Buy above 860, SL 810
Page Industries: Buy above 18920, SL 18000
Do try and have a look at daily charts and confirm the trigger prices. I'll be watching these over the week.

Amongst the names on Wednesday (29/4), the ones I added to my watchlist were: Reliance, Vedanta
Tuesday (28/4): HDFC Bank, TCS, Muthoot Finance
Monday (27/4): Cipla, Granules India, Divis Labs, Petronet LNG.

Of these, HDFC Bank, TCS, Cipla, Petronet, Granules, and Muthoot have triggered. Vedanta and Infy would have been triggered had we entered post the 1R level.

HDFC Bank, TCS, and Petronet have reached 1R. Cipla almost reached 1R but reversed. Vedanta would have been a huge gainer. Granules reversed on the downside. Let's keep a watch.

 

[spn1305]

Solutions to a few nuances:

1. Sometimes, we will have trades that almost reach 1R and then reverse. While we certainly miss out on realized profit for a part of our position when that happens, we can avoid such situations by moving our trailing stop close to breakeven. For example, if you buy a share at Rs. 100, with a SL of Rs. 90, your 1R level is 110. Let's say it reaches to 108 but then starts reversing. In such a case, moving your stop up to Rs. 98 would be a prudent choice rather than letting your position reverse against you completely.

2. Avoid trades with very wide stops, or take majority of profits at 1R in such cases.

3. Adjust position sizes and 1st sell amounts depending on market conditions and the timeframe you trade on. I use this setup for shorter term and intraday plays too, but with a few changes, which I will get to if I see some interest building. Intraday stops are smaller and moves can be quite huge, hence it makes sense to sell only 25% of your position at 1R and hold the rest to lock in a larger gain in case of a trend. But moves on the daily chart are not so huge, hence it may not be a bad idea to sell a greater % of your position at 1R on the daily charts, and a further % at 2R. In short, practice scaling out while trading longer term charts.

-Smeet

 

[spn1305]

By the way, would you find it helpful if I posted the link to the chartink screen? What are the forum rules for links to other websites in posts?

 

[siddhant4u]

By the way, would you find it helpful if I posted the link to the chartink screen? What are the forum rules for links to other websites in posts?

any link related to trading, investing or news etc are allowed. It should not be advertisement or directing traffic for personal gains.

 

[TracerBullet]

Intraday stops are smaller and moves can be quite huge, hence it makes sense to sell only 25% of your position at 1R and hold the rest to lock in a larger gain in case of a trend.

Intraday costs and slippages can be high too. That alone makes short term edges less useful.
I am guessing that your take profit level would have to be beyond 1R in intraday for it to be useful. That has been my experience so far, but best is for market to tell you what to do anyway ...