“Bounce” Trading System An RLCO-based System for Low Volatility Markets By Kim Andersson

Presentation Overview What everyone needs to know in order to be able to trade someone else’s system: Beliefs Mental Strategies Mental States Bounce System Description Bounce System Rules Sample Trades Results of 197 live trades Position Sizing Analysis Using “Know Your System” Importance of Rigid Risk Management Questions?

What Dr. Van Tharp Says: “You can’t effectively trade another person’s system if you don’t know that person’s key beliefs, mental strategies, and mental states.”

Key Beliefs About the Markets It is more difficult (but not impossible) to day trade a low volatility market. The markets have been fairly quiet during the last four years, because they’ve spent most of that time in bull mode. Large ETFs (like SPY, DIA, and TLT) have a tendency to “bounce” off of key indicators such as Bollinger Bands. Large ETFs (like SPY, DIA, and TLT) are more likely to revert to the mean than individual stocks. Large ETFs (like SPY DIA, and TLT) are less “trendy” than individual stocks, but that does not mean that they don’t trend. Large ETFs (like SPY, DIA, and TLT) often move within relatively tight bands and are less volatile than individual stocks.

SPX vs. VIX from 2011 - 2015

Key Beliefs About Myself as a Trader I am impatient – I like to see profits quickly, hence I prefer shorter timeframes (1, 3, and 5 minute charts). I like a fair amount of action; therefore, I seek a system that provides me with lots of trading opportunities per day. I hate to lose! I have difficulty letting my profits run; therefore, I need to design a system that deals specifically with this weakness. I don’t like to program and I’m not a good programmer, hence I don’t like and don’t use purely computerized/mechanized trading systems. I believe that discretion adds value to a mechanical rule-set. I believe that the market offers tradable opportunities every second of the day that it is open. (So far, I have no proof of the validity of this statement, but it doesn’t stop me from believing it!)

Key Beliefs About Good Trading Anything can happen. You don’t need to know what is going to happen next in order to make money. There is a random distribution between wins and losses for any given set of variables that define an edge. An edge is nothing more than an indication of a higher probability of one thing happening over another. Every moment in the market is unique. I must act on my edges without reservation or hesitation. I should pay myself as the market makes money available to me. I must continually monitor my susceptibility for making errors.

Key Beliefs About the Bounce System Regression lines and Bollinger Bands combine the insights of moving averages, the discipline of descriptive statistics, and a framework to pinpoint important critical states in different timeframes. This is not a mechanical system. This system will likely provide at least a dozen trading opportunities per day depending on the timeframe used. Trading experience and market intuition are key factors in the successful execution of this strategy. In other words “Trader Quality Number (TQN)” is extremely important to the success of this system. I must always remember that exits matter much more to the overall profitability of this system than entries. Keeping losses very small (i.e., no larger than -0.5R) is very important in improving the SQN of this system.

Key Beliefs About the Bounce System (continued) I don’t need to see price moving in my direction before I commit; I only look for a reasonably sized pullback which gives me enough evidence that a good reward:risk ratio exists. I want the best return in the shortest time period and hope for a 2:1 reward to risk ratio in less than 30 minutes. I assume that institutional money will come into the trade at perceived points of value (support) during the day. This system can go either long or short; however, I will (generally) only take trades that are in the direction of the overall trend as measured by the 5 minute charts and the 30 period Bollinger Bands. The recent trends in the ETF (daily and hourly) are useful in identifying the direction that I should be trading in and what I can reasonably expect in terms of price action.

Mental Strategies Key decision making strategy for day trading: Recognize it as familiar. See a pattern. Feel good about it. Act.

Mental State Zero state (zen) is key for effective day trading:

Bounce System Description Discretionary rules-based day trading system for low volatility markets that uses Dr. Ken Long’s Regression Line Crossover (RLCO) “lens” to view the market and frame trades. It takes advantage of “bounces” off of the Bollinger Bands, as well as the 30 period regression line, to capture small moves in the direction of the trend, which is determined by the slope of the 30 period +/-1 standard deviation Bollinger Bands. It is essentially a micro trend following system that takes advantage of pullbacks to and bounces off of bands.

Quick Illustration of Bounce Concept

Quick Illustration of Bounce Concept (continued)

Set-up Rules Price must be at key support or resistance levels: Bollinger Band Bounce: price is approaching the +/-1 or +/-3 SD BB. I also want to generally only take trades that are in the direction of the slope of the Bollinger Bands. The only exception to this rule is after a strong move, such as a full range stat move or more. RLCO (Regression Line Crossover) 10/30 Bounce: 10 period RL crosses the 30 period RL line outside of the river (i.e., +/-1SD 30-period Bollinger Band) and is moving towards or into the “river”. HOD/LOD (high of day/low of day) Bounce: Look for support/resistance at previous HOD or LOD.

Entry Rules If the setup is valid and Reward:Risk is greater than or equal to 2:1, then enter when: For Bollinger Band bounces two entries are possible as follows: Enter as price pulls back or up to the +/-1 standard deviation Bollinger Band (SD BB); enter in the direction of the trend in accordance with the 5-minute chart and the slope of the BB. Enter as price touches the +/-3 SD BB on the 5-minute chart; enter in the direction of the BB mean. For RL 30 Bounces: Enter after RLCO P1 and price bounces off of the RL30 (essentially entering on a local double bottom). For HOD/LOD bounces: Enter when price touches the HOD/LOD or previous day’s HOD/LOD; enter in the direction of the BB mean.

Exit Rules Market stops you out: Initial Stop is hit – iStop is never more than -0.5R. Trailing Stop is hit. Trailing Stops: Move the stop to “no lose” once I have +0.5R in hand. Now, I can monitor/manage the trade knowing I have nothing to lose. Ratchet the stop up in 0.5R increments. Zeno Stops: Tighten stop aggressively when price is approaching the top or bottom of a band.

Sample Trades Bollinger Band Bounce (5 min chart):

Sample Trades RLCO 10/30 Bounce (3 min - very similar to RLCO P1):

Sample Trades HOD Bounce (5 min chart):

Sample Trades LOD Bounce (5 min chart):

System Results Total trades 197 Max R 3 Min R -0.575 % R Wins 109 55% 0.68 Scratches 46 23% 0.00 Losses 42 21% -0.49 R Stan Dev 0.58 Expectancy 0.27 SQN(197) 6.46 SQN(100) 4.60

Position Sizing Analysis At 1% risk per position, I would have high confidence of seeing a return greater than 200% on just 500 trades with a negligible chance of hitting a 10% drawdown.  It’s likely that at 1,000 trades and 0.5% risk, I could meet my objectives with even lower drawdowns.

The Importance of Rigid Risk Management I recently experimented with using a tighter iStop (-0.5R vice -1R). Below are results in terms of cumulative R. Note the vast improvement after 1000 trades when I started tightening the iStop.

Questions?