For many investors and traders January triggers new aspirations, charged up after some well deserved holiday time, and most significantly, makes them eager and ready to trade! The million dollar question is… how to start off the new year with profitable trades?
Experienced traders know that during the first 2 weeks of the year, volumes are low and caution is required. This is not just true of markets, but many businesses are closed for holidays and don’t resume until after the first 1-2 weeks. This sleepy period means productivity is slower than normal and most people understand this. You could even call it a ‘rebooting’ of the country.
Analysts and financial journalists are looking for signs of where the markets are headed. A quick google search or look into any financial website and you will be flooded with market predications/projections for Index and individual stocks alike. Right now the 6000 level seems to be the consensus around town regarding the ASX200 Index performance for 2014. I guess we will have to wait around until next year and see who was right!
However as traders, we need not worry ourselves with grand projections and illusions of predictive power, but instead trade the opportunities that are in front of us now.
As an analyst/trader for the last 10yrs, one of my preferred plays to start off the year is patiently waiting out the first two weeks, taking note of the highs and lows of this period, and using this range as a breakout strategy to define for me, the likely direction for the coming 8 weeks or so (approx 2 months).
I have found that during this time of year, most directional investors in the markets are usually waiting for others to make the first move. Then, as direction begins to be seen, the remainder of the market slowly follows suit, and we get a new trend.
But can such a simple strategy like this really work?
I ran the figures for the last 10yrs, knowing that past performance is no reliable indication of future performance of course, but to test the validity of such an approach. The results were surprising!
This was not a points test to show how profitable trading index futures or Index CFD’s would have been, but instead highlighted whether there was any positive expectancy available. Simply put, did the breakout of the range of the first 2 weeks of the year, provide any real edge over the market? If not, we would probably expect to see about 50% right / 50% wrong. But if so, well then we have a game plan to work with.
Let’s take a look at a buy and a sell example to demonstrate
Here is the bullish break of 2013 using a weekly chart to highlight the 2 week range, plus the 8 week window for trading.
The first two weeks had a range of 4644 to 4750. The 3rd weekly candle of the year we had he confirmed breakout the upside and the market continued on to a high of 5135, 8.29% in the direction of the breakout. As the market during this year did not look back following the breakout, the worst case scenario for this breakout was recorded as breakeven or 0pts.
In 2009, we saw a breakdown, signalling a bias adding bearish strategies to your portfolio for the fist 10 weeks of the year.
For the first 2 weeks, the range was a low of 3572 and a high of 3817. The lows were broken again in the third week, and we saw a continued decline throughout the following 8 weeks. The best case scenario for the bears that followed this breakout was a 448pt decline or 12.54%. The worst case was a 30pt move above the break point, which works out to be 0.84% against the signal direction.
The above chart shows each year and the extent of the max favourable move, verses the max unfavourable move using the breakout to select direction.
In 9 of the 10 years since 2004, using the breakout direction provided a larger favourable move, in the direction of the breakout, than against it. On average, the favourable move was a 6.32% during the 8 weeks after the breakout. In fact this was as high as 12.54% in 2009 as shown above. On the flip side, there was an average of only 1.4% moves against the direction of the breakout.
Over the 10 years, 7 of the breakouts were bullish and 3 bearish (2008-2010), and interestingly it was the years of bearish breakouts saw more significantly moves, averaging max declines of 10.98% within the 8 week window. There was only 1 year (2011), where the max movement against the breakout (-3.58%) exceeded the max favourable move (3.03%).
The conclusion of this study is to have a plan, to understand the seasonable influences and to trade what the markets are showing you now. With this study in mind, and coming into the end of the first two weeks of the Jan, we now have our plan. Do you have yours?
We will look at the high/low range, and once we get a bullish or bearish signal, we will use that signal to help define trades over the next 8 weeks. Not just on the Index, but across the overall markets as our start of 2014 top down filter.