Q&A
Since You Asked
Confused about some aspect of trading? Professional trader Don Bright of Bright Trading (www.stocktrading.com), an equity trading corporation, answers a few of your questions.

Don Bright of Bright Trading



IMPROVING A TRADING SYSTEM

Don, what you think about a simple system like a moving average crossover system? I've played with different combinations (50/200, 30/100, and so on) in different markets (NASDAQ, Standard & Poor's 500, and others) with equities only. I got very good results with 30/100 in NASDAQ with money management, investing about 3% per trade. My profitable trades are somewhere between 40% and 50%. What you think about the system, and how do you think I should improve the trading system with additional indicators? Thanks. -- Sudhir Cheda

Moving average trading systems are one of the oldest and most basic still being used today. But looking for return on investment is one thing, actively trading is another. Since many fund managers utilize moving average and moving average convergence/divergence (MACD) techniques and generally return about the same long-term return as the overall market (actually, most underperform the S&P 500), I would have to say that relying on this type of system alone would not be the best way to extract money from the market.

Most top traders I know tend to use multiple indicators and numerous factors in their algorithmic trading, rather than relying on any single factor of technical analysis. Since most systems are "if/then"­based in their programming, the more pertinent data you can combine, the better, in my opinion.

So sure, moving average techniques can work by themselves, but I suggest adding complete fundamental analysis, trend-following, sector relative strength, and other criteria to your model.



PRICE TO BOOK VALUE

I am hard at work studying for the series 7 test. Hopefully, I'll pass the first time through, but I have my doubts. I am targeting the October boot camp. Question: How do you determine whether a company has a low price to book value? -- Chris Garzon

First, to find book value (https://finance.yahoo.com), click on key statistics. For example, GE book value is $11.37, stock is trading around $40 or so, 40/11.37 = 3.5 price to book ratio, approximately. Yahoo! Finance has the price to book already for each stock. The lower the number, the better the stock, as far as this valuation is concerned. You really need to check "price to tangible book value" as well. The tangible book value has things like goodwill, intellectual property, and other intangible assets taken out of the balance sheet valuations. Good luck!



BENCHMARK COMPARISONS

Is there a benchmark number you look for before making a trade? Or is it based on a comparison to another stock, like GE/HON? Or average overall market? -- Chris Garzon

Not really. We compare two "peers" to develop a long and a short for our pairs trading, based on their overall fundamentals. Generally, we end up long in value stocks and short in growth stocks, and trade them together based on trading ranges.



POSITION DOUBLING

I have a question about position doubling. One of my trading buddies trades using the Murray math technique in simulated trading and doubles positions on the Russell 2000 and S&P 500 eminis every two points the trade goes against him (start with one contract on entry, then two, four, eight,16, 32, and so on). Of course, that allows him to escape bad trades with at least breakeven. In the end, he ends up with zero losses and daily gains.

I'd like to have some feedback from experienced traders about the long-term viability of this way of trading when he goes live using this strategy (personally, I believe he will tank his account, because in simulated trading, you can double forever, but not so in live trading). --Gabriel

One of the biggest reasons for trader failures is adding to losing positions. That said, let's chat for a second.

I have played hundreds of hours of a modified Martingale system with a (nearly) 50/50 game (baccarat), and if we take into consideration getting our costly comps (trips, rooms, shows), we can justify the overall negative expectation -- to a point. Without the fringe benefits and when dealing with something like the market that is not a 50/50 game, it makes no sense.

The reason for adding or taking off a position is based on what the market is doing. As traders, we are responding to market conditions, and putting on positions based on these conditions. To simply double down is not a valid premise in the market, in my opinion.

If, for example, you're trading eminis, you're long at 1480 and it breaks a support level, are you not better off closing and possibly reversing the position compared with adding to the losing trade? We have to take into consideration things like the VIX (CBOE volatility index), recent price and market movements, premium/discount to fair value, and many other factors.

New traders would more often than not be better off closing a position vs. adding to the losers. Treat each entry/exit as its own event, based on the overall reading of the market. (I could go on and on, but I'll spare you -- just an overview from my perch!)


E-mail your questions for Bright to Editor@Traders.com, with the subject line direct to "Don Bright Question."

Originally published in the October 2007 issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright 2007, Technical Analysis, Inc.



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