Dr. Kris has been under the weather for the past quarter-moon which is why I’m not at the birthday party of an acquaintance at a Moroccan restaurant replete with full bar and belly dancers. Feeling a bit better than yesterday at least, Dr. Kris (aka moi) has updated the Channeling Stocks Portfolio. As mentioned in Wednesday’s blog, I covered all of my short positions at their closing prices. The chart below reflects that.

As I also said, I don’t have time until my talk at the LA Traders Expo on June 4th at the Pasadena Convention Center to contribute more to this portfolio. The only two positions open are the two longs—HNP and OSIP.

But, as I mentioned at the start, this was a strategy that I’ve never traded before as an entire portfolio and it would be a learning experience for both of us. I’ve traded a few channeling stocks and index tracking stocks on occasion and made an overall profit on them. At the time, there weren’t nearly the amount of fundamental nor technical tools available as today (for better or for worse!), nor was the market so ambiguous. Running this experiment today has been an eye-opener for me

What I’ve learned from paper-trading Channeling Stocks
Here are some of the more notable things that I’ve learned from this experiment:

1. In markets that have been trending in one direction for a long time, trying to fade (go against) the market in the majority of picks was not optimum, even though the entry (short) signals were triggered.

Although it might be tough to discern market direction, when the market headed south at the beginning of March and the VIX didn’t follow was a signal that something was up, either good or bad. But once the market began rising and the VIX concurrently falling was a time to limit taking on short positions.

2. There’s always been a debate between those who think you should put all of your eggs in one basket (e.g. shorting stocks like I did at market down-turns) and balancing your total amount between long and short positions.

3. Unknown factors can be detrimental in any portfolio, such as short-holding Pepsi-America (PAS) which was covered right after the take-over announcement by Pepsi-Co. Unless you have insider info, there’s virtually no way you can spot this action. You might expect it if other companies in the sector are cash-flush and hurting for cash flow, e.g., new product.

4. Holding over an earnings release can be detrimental, especially if the release is in sync with current market direction that is opposite to your holding. Take Fiserv (FISV) who reported good earnings after the bell on April 30th. Good thing I chose to cash out of my short positions on April 29th based on other criteria, because my position would have suffered a bit: the stock opened on May 1 (after the good earnings announcement) at $37.58. Had I covered my short at that time, my loss would be -6.3% instead of -4.8%.

Summary
Even the most experienced traders in the business can be unprofitable if they’re novices in regards to a new strategy. That’s why I’m going to shout the following: PLEASE PAPER-TRADE ANY STRATEGY BEFORE EXECUTING IT! That’s how you learn the intracacies that you may never have thought of due to changing market conditions. Your failure does not make the strategy invalid; you just need to learn it.

Many people will tell you that trading the market is easy; if you’re new to trading and have good luck, you might agree with them, but after a while your luck can (and probably will) run out. That’s when you might consider giving up, but that’s exactly the time when you should examine your trades and learn more about why you succeeded and also why you didn’t.

Which leads me to the second point: KEEP A JOURNAL!

You’re only a failure if you keep repeating your losses.

End of lesson.

Channeling Stocks Portfolio:

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There is no new additions or subtractions to the MANDA portfolio.

Here’s the updated holdings in the Channeling Stock Portfolio.

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Below is the current holdings in the Channeling Stocks portfolio. This reflects the past week’s additions and subtractions. I did forget to mention that on 4/2 the Ultrashort Financial ETF, the SKF, violated its lower channel forcing a sell. My apologies.

As I mentioned in the MANDA update, please note that the realized return is based on a total portfolio value equal to exactly that of the current holdings (where each holding is of equal dollar value). If a static portfolio value is assumed, the realized return will be a different number (either more or less). There’s no one correct way to calculate the theoretical total return. I prefer the former method for a couple of reasons: it’s easier to calculate and easier to demonstrate, i.e., the reader can see exactly how each trade performed.

I decided in this portfolio to compare the dynamic realized return to a “static” return. To calculate the static return, I began with a portfolio of $500,000 with each position set at $10,000. ($10 commissions and 4.5% margin interest computed monthly are also assumed.) You can see that the difference between these two returns is quite dramatic: -11.5% for the dynamic portfolio versus only -2.4% for the static one. Obviously, this is because there’s a lot of cash in the latter portfolio as opposed to none in the former which cushions the drawdown.

Click on table to enlarge.

Here’s the new Channeling Stocks portfolio. There are nineteen short stocks, and one long (the ultrashort financial ETF). Stop loss prices are determined by adding or subtracting the average true range to the cost basis, depending upon whether the position is a short or a long one.

Equal dollar amounts are assumed. Commissions are $10 per trade and the margin interest rate is 4.5%. There’s no account interest.

The market is up as of Tuesday morning. I hope I don’t get stopped out of these!

[Click on table to enlarge.]

Last week I promised to introduce a couple of new portfolios, and today I’ll be honoring that by introducing a new portfolio based on Recipe #3: Chocolate Channeling Bars. Before we start, I want you to know that I do test out each recipe either by back-testing (if appropriate), paper-trading, and/or real-time trading. I’ve played channeling stocks before and have done well with them, but I’ve never quantified my results. So, I thought I’d put my (paper) money where my mouth is and see how well I could do in real-time.

The strategy
To that end, I’ve designed the Channeling Stocks Portfolio according to Recipe #3. Basically, the strategy is a simple one: Identify stocks that “channel” between a lower support level and an upper resistance level and then enter a long position when the stock begins to bounce off of its low and sell when it reaches its high (or close to it). A short position can also be taken when the stock begins to roll off its high and covered when it nears support.

The set-up
The portfolio will be constructed according to the following guidelines:

1. Equal dollar amounts of stock will be used. This prevents overweighting in higher priced issues.

2.End-of-day prices will be used for simplicity, although better results may be obtained by using intra-day prices.

3.Stop losses will be set at 1 N (where N = average true range) below support levels and 1 N above resistance levels. This is an arbitrary figure but in general this approach limits losses to between 7% and 10%.

4.Short positions in stocks above $5 will be taken when indicated. This assumes a margin account and I’ll be using 4.5% as the margin interest rate which is appropriate for accounts between $250,000 and $500,000 in size. An initial portfolio of $500,000 will be assumed. Note that account interest rates are effectively zero (about 0.05%) and are not worth bothering with.

5.A flat commission fee of $10 per trade will assumed no matter how many shares are traded. For computational purposes, each trade will be sized at $10,000 each. There will be no portfolio compounding.

6. Options strategies will not be used for now.

The portfolio
One good thing about this current market is that a lot of stocks have been stuck in trading channels, giving me no shortage of viable candidates. In fact, I’ve found 24 that fit the bill and later this evening I’ll be collecting them into a table along with their entry, target, and stop loss prices. Each day at the end of my blog, I’ll update you as to new portfolio additions or subtractions. An updated table including the transactions for the week will be posted each weekend. This way you can follow along in the fun and hopefully this will be an instructive lesson for both of us.