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This article is the sixth in a series summarizing and updating an ETF momentum trading strategy called "Hot Hands" by Courtney Smith. Not the blonde screen actress, Courtney is a trader, author, money manager, educator and trading advocate. He is unique in having a high ranked mutual fund, stock picking newsletter, futures newsletter and a hedge fund. Courtney has authored seven books, appeared on countless TV shows and spoken at hundreds of events.

Hot Hands aims to select and invest in the strongest performing ETFs and is traded monthly. Momentum traders seek to enter the market at the start of large market moves to the upside (or downside). The Hot Hands trading method is accomplished in three steps.

Hot Hands in Three Steps

Step One

Select ETFs for purchase by going here. In the "Performance" sector (found in the upper left of the front page of ETF Screen main page) you will find a list of ETFs.

Use filters atop the ETF Performance list to include short funds and, if you so choose, leveraged funds. Leveraged funds are optional to multiply potential rewards and risks in a fund by two or three times. Use the volume filter to choose funds trading in volumes over one million or over five hundred thousand shares. Be sure to click to update the page after you adjust the filters.

Click the downward pointing arrow on the column labeled Rtn-1mo at the top of the Performance list of ETFs and ETNs. This action will find the strongest performing exchange traded funds ranked from high to low by last month's returns. After generating the list, cull VIX funds, unintelligible titles, and funds with similar assets to create a well-diversified list.

The VIX Index is a measure of expected market volatility and since it is a range trading index and does not trend, it is not appropriate for momentum trading. If you don't understand the title of the fund, discard it, and also funds with underlying assets identical or similar to a fund already chosen, gold or silver, for example.

In articles I & II you were advised to "discard all entries with a relative strength factor (RSf) less than 90%". Clarification from Courtney advises that relative strength is based on annual returns. Since this strategy deals with one month returns, the RSf is not relevant.
The lists below are examples of charts of 10 ETFs from here, ranked high to low, sorted by one month returns as of 8/12/11; 9/2/11; 9/30/11; 11/1/11; 12/1/11; 1/12/12.


Click to enlarge.

Step Two

Determine how much to invest and how many selected ETFs to buy. Using a conservative $5,000 or $10,000 invested in the ten funds selected in the previous article as of November 1, the example below reports results from buying an even number of shares costing closest to $500 or $1000 for each of the ten selected exchange traded funds. The broker is acknowledged with a commission of $10 per trade deducted from every transaction to reveal net income in the scenarios below. Courtney recommends investing no more than 1% of your total investment portfolio in any one Hot Hand ETF or ETN.

Step Three

Wait one month before selling the selected funds in favor of a newly selected incoming group of stronger performing funds as ranked by monthly returns reported on the ETF Screen website. In less volatile markets, the funds can linger in the top ten for several months. There are four examples of such lingering funds in the December charts below. Set buy stops at $.10 above 55 day historic high for each fund selected and set sell stops at $.10 below 20 day historic lows for each. Or trade based on trend analysis, setting stops based on recent swing highs and swing lows in price using the same $.10 high/low margin for trade stops.

Conclusion Using Market Order Methodology in December

Preferred trading frequency is monthly. However, when one ETF is running strong, it is best to let profits run. The following chart shows price gains (losses) for the top ten from $500 or $1000 invested in each December 2 and sold as a group January 10 at market close. There were just 4 profitable trades in this group for the period. Those trades could not offset the six substantial losers. Thus a $5000 investment resulted in a net loss of ($280.92) or (5.62%). Similarly, the $10,000 investment did no better, but managed to cover a bigger portion of the broker fees resulting in a net loss of ($361.85) or (3.62%).


Click to enlarge.

Conclusion Using Trend Analysis Methodology

Thursday, December 1, the ETF Screen website provided the following list of ten new high performer ETFs. As trades were placed on the dates indicated below, sell stops were placed at $.10 below recent swing lows for each for risk protection. Gains/losses from those selections are now reviewed and new Hot Hands ETF selections for January are reported.

December Trades

The following results can now be reported from the December list.

Click to enlarge.

UCO (Crude Oil 2X Bull) No trade made.
December 2: Buy stop set @ $45.05 ($.10 above 55 day high) with closing price at $43.19. Buy stop never triggered. No trade made.

BZQ (Brazilian Market 2X Bear) No trade made.
December 2: Buy stop set @ $22.61 ($.10 above 21 day high) with closing price at $17.93. Buy stop never triggered. No trade made.

ITB (US Home Construction Bull) Buy stop triggered. Bought 85 shares December 5 at $11.80 =$1003.00. Trade remains open.
Sell stop at $11.39. January 12 closing price was $13.29.
December 2: Buy stop set @ $11.80 ($.10 above 55 day high) with closing price at $11.55.
December 5 new 21 day high set @ $11.94 close. Buy stop triggered at $11.80. Bought 85 shares =$1003.00. Sell stop set at $10.28 ($.10 below recent swing low $10.38 on November 23.)
December 7 new 55 day high set at $12.06
January 3 new 55 day high set at $12.36. Moved sell stop to $11.39 ($.10 below swing low $11.49 set December 28).
Remains open. January 12 Closing price at $13.29

DRR (Euro Double Short Bear) Buy stop triggered. Bought 23 shares December 12 at $43.92 =$1010.16. Trade remains open. Sell stop at $44.65. January 12 closing price was $46.43.
December 2: Buy stop set @ $43.92 ($.10 above 21 day high) with closing price at $42.55.
December 12: New 21 day high set @ $44.08. Buy stop triggered at $43.92. Bought 23 shares =$1010.16. Sell stop set at $41.78 ($.10 below recent swing low $41.88 on December 1.)
December 29: New 55 day high set at $46.04. Sell stop reset at $44.15 ($.10 below swing low of $44.25 December 20).
January 11: New 55 day high set at $47.65. Sell stop reset to $44.65 ($.10 below swing low of $44.75 January 3).
Remains open. January 12 Closing price at $46.43

ZSL (Silver Ultra Short) Buy stop triggered. Bought 70 shares December 14 at $14.25 =$997.50. Sold 70 shares January 3 as sell stop was triggered at $14.27. $1.40 gain did not cover $20 buy/sell broker fee. Net loss = ($18.60)
December 2: Buy stop set @ $14.25 ($.10 above 21 day high) with closing price at $12.32.
December 14: New 20 day high set @ $15.72. Buy stop triggered at $14.25. Bought 70 shares =$997.50. Sell stop set at $11.56 ($.10 below recent swing low $11.66 on December 1.)
December 28: New 55 day high set at $17.65. Sell stop reset to $14.27 ($.10 below swing low of $14.37 December 16).
January 3: Sell stop triggered as market price slid to $13.69 low. Sold 70 shares at $14.27 = $998.90. $1.40 gain did not cover $20 buy/sell broker fee. Net loss = ($18.60)

IHE (US Pharmaceuticals Bull) Buy stop triggered. Bought 13 shares December 6 at $74.52 =$968.76. Sold 13 shares January 3 as sell stop was triggered at $75.60. $14.04 gain did not cover $20 buy/sell broker fee. Net loss = ($5.96)
December 2: Buy stop set @ $74.52 ($.10 above 55 day high of $74.42) with closing price at $73.58.
December 6: New 55 day high set at $74.53. Buy stop triggered at $74.52. Bought 13 shares = $968.76. Sell stop set at $68.42 ($.10 below recent swing low $68.52 on November 25.)
January 3: New 55 day high set at $77.67. Sell stop reset to $75.60 ($.10 below swing low of $75.70 December 29).
January 5: Sell stop triggered as market price slid to $75.38 low. Sold 13 shares at $75.60 = $982.80. $14.04 gain did not cover $20 buy/sell broker fee. Net loss = ($5.96).

TMF (20 yr Treasuries 3x Bull) Buy stop triggered. Bought 13 shares December 19 at $75.10 =$1010.16. Trade remains open. Sell stop at $62.78. January 12 closing price was $68.71.
December 2: Buy stop set @ $75.10 ($.10 above 21 day high) with closing price at $67.56.
December 19: new 55 day high set at $76.18. Buy stop triggered at $75.10. Bought 13 shares = $978.30. Sell stop set at $62.78 ($.10 below recent swing low $62.88 on December 1.)
Remains open. January 12 Closing price at $68.71
THD (Thailand Market Index) Buy stop triggered. Bought 16 shares December 6 at $62.67 =$1002.72. Trade remains open. Sell stop at $56.46. January 12 closing price was $68.71.
December 2 Buy stop set @ $62.67 ($.10 above 21 day high) with closing price at $61.65.
December 6: New 55 day high set at $63.05. Buy stop triggered at $62.67. Bought 16 shares = $1002.72. Sell stop set at $56.46 ($.10 below recent swing low $56.56 on November 21.)
Remains open. January 12 Closing price at $61.40

NUGT (Gold Miners 2X Bull) No trade made.
December 2 Buy stop set @ $38.15 ($.10 above 21 day high) with closing price at $30.26. Buy stop never triggered. No trade made.

FAZ (Financial 3X Bear) No trade made.
December 2 Buy stop set @ $55.04 ($.10 above 21 day high) with closing price at $40.62. Buy stop never triggered. No trade made.

December Trend Trade Summary

Here are the net returns from December 1 to January 12 using trend analysis trading technique. An even number of shares were bought, costing closest to $1000 for any of the above ten selected exchange traded funds (ETFs) when triggered by buy stops set $.10 above recent swing highs. Results showed a ($24.56) net LOSS (.0246%) on $1000 invested. There were NO winning (net profit) trades, TWO losing (net loss) trades, FOUR trades not taken, and FOUR trades continuing into next month's report.

Conclusion

The primary lesson demonstrated this month is the disadvantage of dumb luck in accidentally timing six losing trades in the market order strategy while six buy stops were activated (for a small loss) using trend analysis. The market order strategy with no stops lost ($361.85) or (3.62%) for the month on $10,000 invested while the trend analysis method placing stops $.10 below the recent swing lows lost just ($23.75) on two trades for (.0246%) for the month. Four open trades could bring profits com February. We'll see.

Year End Summary

An accounting for previously reported trading activities from the first six monthly 2011 Hot Hands reports is available in a separate Seeking Alpha article: Momentum Trading Strategies VII: 2011 Hot Hands ETF Summary.

January Trades

The following trades are now pending with results to be reported in February. Since four trades remain open from December, only the top six Hot Hands selections are set up with buy stops as of 1/13/12.

Click to enlarge.

FAS (Financial Bull)
January 13: Buy stop set @ $77.73 ($.10 above 20 day high) with closing price at $75.25.

RUSL (Russia 3X Bull)
January 13: Buy stop set @ $36.87 ($.10 above 20 day high) with closing price at $35.08.

SOXL (Semiconductor 3X Bull)
January 13: Buy stop set @ $32.42 ($.10 above 20 day high) with closing price at $30.12.

FBT (Biotech Index)
January 13: Place Open Market Order with 55 Day High set today at $37.17 with closing price at $37.12.

UYM (Ultra Basic Materials)
January 13: Buy stop set @ $37.76 ($.10 above 20 day high) with closing price at $36.80.

TAN (Global Solar Energy)
January 13: Buy stop set @ $37.76 ($.10 above 20 day high) with closing price at $36.80.

February's report will include an accounting for open trading activities left over from the December Hot Hands list:ITB; DRR; TMF; THD.

Disclaimer: This article is for informational and educational purposes only and shall not be construed to constitute investment advice. Nothing contained herein shall constitute a solicitation, recommendation or endorsement to buy or sell any security. Prices and returns on equities in this article are listed (except where noted) without consideration of fees, commissions, taxes, penalties, or interest payable due to purchasing, holding or selling same.

Source: Momentum Trading Strategies Part VI: Hot Hands ETFs Seek Direction In December