Much has been written on similarities between trading/investing and poker. Both are gambling activities (and yes, any trading/investing is gambling by definition); and in both cases while you can certainly have ‘bad beats’ and losing streaks short term, in the long run skill certainly dominates over luck. In both cases you have to have the chips/capital in the portfolio to bet aggressively when a great trading opportunity/poker hand presents itself/dealt to you. It’s important to have the discipline to not trade iffy setups (or play marginal hands with little or no edge), to preserve the capital and not get chopped up. While it’s obviously important financially, psychological impact of ‘getting chopped up’ is perhaps much more profound. After many losing trades/hands one can be easily driven off his or her ‘A game’ and start playing either overly tight, missing out on excellent opportunities out of fear of losing even more of his bankroll or – even worse – start playing overly aggressive, chasing after losses, which inevitably leads to throwing good money after bad and – sooner or later – more losses.

So how do we recognize the opportunities to be aggressive? There are many setups and opportunities, depending on your style of trading and I wanted to share just one of them, something I came across while reading Dow-award-winning paper ‘Plains, trains and automobiles. A Study of Various Market Thrust Measures’ by Wayne Whaley.

As with other research on the topic of ‘breadth thrust’, Whaley concludes/confirms that large market moves start with a huge increase (thrust) in either the number of traded issues, positive volume of issues, or, alternatively, just a sharp jolt higher in an index over several days.

I decided to put Whaley’s theory to the test with last 3 years of data and track performance of SPY, IWM and TNA 3, 6 and 12 months from the time of purchase. In the table below you’ll find  instances of issues or volume thrust (per Whaley’s definition) with values over 70% (I removed signals occurring within a few days of the initial one, although one could use them as confirmation and add to long positions at that time). I have not had the time to calculate maximum drawdowns from the purchase points, which is an important system parameter, something that’s still on my ‘To do’ list.

To be fair to the spirit of Whaley’s research, only signals on 7/13/2010 and 7/1/2011 ) dark green in the table) would be the ones he would consider, however other buy points in the table appear to have fared very well.

What struck me as odd is poor performance of a couple of instances, specifically 12/7/2010 and 7/1/2011 (especially surprising as this fit the definition of the ‘true signal’ per Whaley). Once I’ve added another parameter to the table – ‘% off 52wk high’ it became rather clear. It appears that market thrusts near the recent top of the market could be viewed as a warning sign of a blow-off top, exactly what happened in July of 2011. The most recent signal actually occurred on 3/13/2012, at the new 52wk high on SPX, and at this point SPX is 1.76% lower, supporting the thesis of a market issuing a warning sign when such market thrusts occur near the recent top.

So what about the results of these signals? Let’s take a look at the 6-months (126 days) performance for TNA, which is a vehicle I’d be employing to take advantage of the signals. If we exclude the signals that occurred too close to a recent market top, at this point we have results on 9 data points.

Min gain – 20.43%, Max gain – 114.34%, Average gain – 49.9%.

At this point all  of the 6-month trades are winning ones, although as you can see there are some drawdowns on the 3-month timeframe.

While these signals didn’t pinpoint absolute bottom (understandably so as they key off market upward thrusts), they did do a good job of catching the next significant move higher and an astute investor equipped with this information could benefit quite significantly by betting aggressively at the correct time.

Bottom line is – know when you have an edge that fits your trading style and personality and pursue it aggressively (obviously that’s not a reason to completely throw caution in the wind, risk management should always be of utmost importance). Aces don’t come around all that often, so make sure to take advantage of that opportunity and don’t gamble on seven deuce offsuit. Market breadth studies will often tell you where the market is heading, are you listening?

I BET IT ALL

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