1. To take all of the guess-work out of trading, and
2. To tip the odds in my favor in as many ways as possible.

In his book “Way of the Turtle”, Curtis Faith talks about trading with an edge. An edge is something about your system that gives you an advantage, or tips the odds in your favor. The first edge a system can give you is a stock selection process that beats a simple random selection, or the ‘dart board’ approach. This initial edge comes directly from the set-up filter. One way to measure an edge of this sort is to measure the Maximum Adverse Excursion (MAE) and the Maximum Favorable Excursion (MFE). Mr. Faith discusses these terms in Chapter 5 of his book. The MAE is the maximum move a stock makes in the direction against you, whereas the MFE is the maximum move the stock makes in the direction favorable to you. Obviously, you want the MFE to exceed the MAE, and the larger the ratio of MFE/MAE, the more the odds are being tipped in your favor.

Currently, I use a set-up filter to find stocks for the High Energy Watch List. However, I don’t include all of the stocks that satisfy the filter. I look through the charts and hand-pick the ones that look good to me. But this is not the way that a good mechanical system should work. Singling out the ones that “look good” adds my own personal bias to the stock selection process. How does my mind decide which ones look good? Does the current state of my emotions dictate how I pick the stocks? Do I later say “I should have,” or “I shouldn’t have,” picked particular stocks that performed well, or performed poorly? These questions ultimately lead to hesitation, second-guessing, and self-doubt. In the long run, this is not a desirable situation.

What would happen if I didn’t hand-pick the stocks? What if I purchased them all? I performed a series of simple tests to see how this initial High Energy Watch List filter would have performed over the last two years, on its own merit. To start with, I ran a test to see how all of the selected stocks performed one week after they were purchased. I measured MEA, MFA, final return after 1 week (RTN%), success percentage (WIN%), and annual Return on Investment (ROI%). I did the same thing for a two week holding period, and a one month holding period. The results are shown in the following table:

Existing High Energy Watch List Filter

As you can see, the performance of this filter over the last two years has been a losing proposition, without considering triggers, sell strategies, and money management procedures. The Maximum Favorable Excursions do exceed the Maximum Adverse Excursions, which is positive. You want the stocks to move up more than they move down. But the final outcomes of the trades are not so positive. Selling all stocks after 5 days results in an average trade of -0.89%, and an annual ROI of -43.79%. Holding all stocks for one month results in a annual ROI of -16.21%, but each trade lost an average of -1.31%. So even though the MFE/MAE ratio is tipping in our favor, the final results for all three holding periods are tipping against us - obviously not a good starting point for a winning system.

So over the past few days I have been working on an improved filter. This new filter is more selective, and keys on new 60-day highs on greatly increased volume. I used the tools at www.stockfetcher.com to build my filter, and Trade 4 Cash Pro members who currently use stockfetcher.com can see my actual filter in the Trade 4 Cash Pro member forum. The results of this filter, using the same holding periods, are shown below:

New Set-Up Filter

In all cases, the MFE/MAE ratio is increased, the success percentage is increased, and the annual returns are positive instead of negative. The 5-day holding period gives the best ROI and success percentage, at 42.95% and 49.88%, respectively. In other words, with this new set-up filter, simply selling all stocks after 5 days would have resulted in an annual return of 43% over the past two years, with half of the selected stocks finishing positive. A much better way to start a system. But can this be improved even more? I’ll continue looking at this over the next few days.