Wednesday, October 17, 2007

Volatility Breakout System Using the IBD 100

Perhaps the most difficult aspect of William O'Neil's Canslim method of buying stocks is that it is usually difficult to determine the proper buy points. Furthermore, for the average investor, it is almost impossible to always be on top of the market, which is what is required if one hopes to buy on those high-volume breakout days.

As I said in a previous post, I have been working on a more systematic way to trade the high momentum IBD stocks. Here are the results of a backtest of one year. Notice the excellent winning percentage and the gain/loss ratio. The three plots are of the buy and hold of the IBD 100, the equity line, and the number of stocks in a buy mode. While the strategy underperforms the buy and hold, what it does do is control the risk of a serious downturn. Say, for instance, that the correction of this summer turned into a bear market, my strategy would have been mostly in cash during the entire hypothetical bear market, thus protecting capital.

The system is basically a volitility based breakout system. I include requirements of volume and making new highs. Selling requires large volume breakdowns. What is especially nice is that this system only requires that someone buys or sells the open after a signal is given. Such a system doesn't require someone to constantly watch the market. All one would have to due is to place their orders the night of the signal.

Out of all the stocks on the IBD 100 I picked out six at random and looked to see how they fared during this last correction. I also wanted to see how close an IBD based buy point lined up with my system's buy point. I think you will be amazed my how well the two lined up. On the six charts I show the IBD buy points and where my system would have made a buy. The green up arrows are my buys, with the grey shaded areas being times when the trade is on. The red down arrows are sells.

I should say some more about the indicators on the charts. The moving average envelopes are just 9 period exponential moving averages of the highs and lows, displaced by one standard deviation of the price. The colors of the averages are turned on and off using the TD Average I rules that can be found in Tom DeMark's "New Market Timing Techniques".

I have some older IBD 100 lists and will be performing some test on them, trying to figure out how well losers are rejected from the system and how well new leaders are included. Look for more posts soon.

1 comment:

Anonymous said...

Did you ever follow up on this? I'm interested in any success you had.