In this blog, we’ve often mentioned the many pitfalls traders face from trading blindly with chart setups and trend line strategies without the benefit of quantitative analysis from proper backtesting. Experiencing some of those pitfalls firsthand, the hard way, was the main inspiration behind the creation of the TVO system. System trading, however, is not without its challenges, especially when the trade doesn’t go your way.
Back in January when it looked like we had a tradeable bottom in place, TVO sunk down to a low of -7.3 and reversed. In that range, it normally indicates strong sentiment that the tides in volume, and thus price, are about to turn. That factor along with the general atmosphere around town that we’ve all had just about enough of this correction, caused us to increase our risk exposure, and at the same also caused us to break two important rules of the system: 1. Only add once to the trade and, more importantly, 2. Having 2 days in a row of the same oscillator value negates the signal.
You often hear lots of credible folks say it’s ok to break your rules 10-15% of the time, but we’ve seen that even one occasion of going with intuition over a backtested quantitative model can be costly. Fortunately in this case the added damage to the loss was limited.
On Friday there was a similar kind of scenario brewing with the Heat Gauge. At -10 with a sizable drop in overall volume (-21%), it’s pretty safe to say the big institutions are sitting on the sidelines waiting for things to play out. So that means we should go short, right? Again let’s re-emphasize the importance of sticking to the system rules… The line in the sand to go short with HG is when the number dips below -10. That level would assure us that buyers are exhausted and sellers will now start to take control. But now we’re right at the line, so what do we do? In the interest of preserving capital, we too will be staying put (not buying puts) on the other side of the line and will remain in cash for the time being. -MD
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