Monday, 8 September 2014

testing trading strategies : methodologies and risks

Testing your trading strategies is one of the best ways to gain confidence before you begin real time trading. I recently came across a great website called Market watch which allows you to test your trading strategies by creating your games. You can basically create a few different games, and test different strategies consecutively to figure out which works for you the best. The question now arises, as to how you would formulate your testing strategy.

I will take an example of explaining a simple testing strategy that I recently tested, by testing it on a dummy account first. Here is the link to my dummy test :

I named the game minetrades. They provide you with a starting amount of $100,000 to test your strategy. Henceforth I will refer to the strategies that I used in this game with reference to the name of the game aka 'minetrades'.

Earnings season is always the focal point of day traders who want to make a few quick bucks. If you are one of the traders who want to make good use of the upheavals in the stock market during earnings season, a very good website to follow is the is the official site of Real Earnings Expectations, Whisper Numbers, Earnings Estimates, Earnings News, and Individual Investor Market Sentiment according to the website. Whisper Numbers are basically like analyst ratings of a stock, they are basically the forecasted earnings or unofficial earnings that circulate among professional traders in wall street.

Whispers list the earnings per share forecast days before the actual earnings announcement, thereby enabling trade enthusiasts to gauge the ability of a stock to go up in the near future. As a rule, market works on sentiment, and therefore these whispers even though not 100% accurate drive stock prices. our trading strategy during earnings season needs to focus on the strength of the following points not necessarily in sequence:
1. the financial stability of the stock & company
2. the past earnings of the stock, and whether the stock has been performing consistently well in the past few quarters
3.the analyst ratings of the stock
4. the overall market value of the stock
5. the 1-day reactions and the 5-day reactions of the stock in the previous earnings
6.any recent market news associated with the stock

Since market go up by sentiments, usually the biggest move in the market for a particular stock is before the earnings announcement.

In my game minetrade, I will take the example of A - Agilent technologies. When I brought Agilent, it had a projected Zacks rating of 1, and a positive whisper number. If see Agilent's chart, the major move in the stock occurred in between August 12 to August 18. The earnings were announced on August 14, and Agilent reached it's peak in 4 days. So the stock rose in anticipation for 3 days up-to $3 per share, and then after the mixed earnings reviews pulled down the stock shortly after. Sometimes, if the earnings are as per expectation but there are mixed reviews from analysts, like in the case of Agilent  where the guidance for fourth quarter fell well below analyst Zack's expectations, the bulls for the stock, kept the stock going up for a few more days based on the positive earnings report. On August 18, the stock tends to be more or less flat, and on August 19th the stock starts sliding down. This is aptly the right time to sell the stock. if the stock has been going up for a while based on market news and sentiment, and then eventually stalls and starts to slide, that is the right time to slide out of the stock. remember, sometimes, the slide maybe sudden, and you must be extremely careful , not allow your potential gains to become your potential losses eventually. as in the scenario above, make a sell anytime soon after august 18th is the wisest decision to made here for this stock. For those who want to invest, there are different strategies that must be applied. the strategy I explained here is for people who are interested in short term trading.

With positive news around the beginning of September, the stock seems to be rallying again, however, there is different strategy that works for trading stocks based simply on market sentiments minus the earnings data.