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And I don't own it。 I define a good stork。as。one whose share price goes。up while I do own it。 The winners。select themselves。by going up and staying in the top part of the ranking list。 Simple though this。system is； it works。very。well。 I have not found a universe of markets。or stocks。on which it does。not work； even though the volatility of different universes。varies widely。
Trading Rules
We now need to devise trading rules。to get us。in and out of our selected positions。 I have not invented any new indicators。 I did not invent the wheel either。 It seemed to be there when I needed it and I use the ones。on my car because they work。well。 It is。the same with indicators。 We learn through back…testing that many indicators。work。well some of the time。 A few work。well a lot of the time。 None work。well all of the time。
In a leptokurtic。distribution prices。will spend about a third of the time in a narrow range； and about a third of the time each in an uptrend and a downtrend。 Each situation requires。three sets。of indicators。 What my method values。most highly is。not a range trade but a strong absolute and relative trend。 We use the indicators。（like RSI； MACD； OBV； Bollinger bands； and others） that are set up as。standard defaults。on the Bloomberg Professional…service。 They are more than adequate for our needs。 There is。of course a built…in bark…test facility。
Once the appropriate indicators。have put us。into the positions； we simply hold on until one of the prices。drops。enough to hit a stop…loss。level。 We then sell out and buy the next stock。or market that has。now been promoted up our ranking table。 We always。remain invested until the index itself gives。a sell signal； by hitting its。own stop…loss。
This。level is。a trailing percent behind the rising price。 We do not use a fixed percentage trail but one that varies。with the market or stock。and is。proportional to the volatility that is。normal for that item。 I call this。the volatility。signature； or sometimes I call it beta with bells。on。 For example； the number for the FTSE index is。7 percent （see Figure 10。9）。 In a bull market this。index almost never has。a setback。bigger than 7 percent。 Trailing up this。much below the rising market index will keep you in a bull till virtually the end。 However； a stock。like BP is。inherently more volatile； and the signature works。out at 13 percent。 The price regularly swings。that amount while still in an uptrend。 The signature for an index like the BSE Sensex （India） is。18 percent。
It is。delusional to think that we can get away with very tight stop…losses。and never lose money。 As。Figure 10。10 shows； if the stop is。too tight； you will overtrade and make nothing。 If you do not risk。anything； you will not make anything。 We can see that； over time； the more volatility we can accept； the more money we will make； within reason。
Of course； we do have to survive in the game。 Figure 10。11 shows。how much we need to make to win back what might be lost on a very volatile swing。 If we lose； say； 5 percent； we need to make just over 5 percent to get back。onside。 If we lose 10 percent； we need to make only 11 percent to be all square。 If we go down 30 percent； we need 43 percent； a rather less probable oute； at 50 percent we need to double just to get back。onside。 If we were ever to allow a drawdown much bigger than that； we would need to shoot the lights。out just to get level。 In other words； we would be eliminated from the game。 In practice it is worth tolerating volatilities。and the acpanying losses。tip to 25 percent for slightly greater profits。 Our stops。are normally taken within the range of 10 percent to 25 percent。 The lower figure applies。to big blue…chip situations。and the higher one to smaller market capitalizations； either stocks。or market indexes。
The next trading rule is。to make sure the size of each investment unit is。proportional to the capital available。 Even using the ranking system and the correct stop…loss； it is。possible to make wildly different amounts。of money for a given amount of risk。 There are essentially。three ways。to work。this。 One is。to have equal…size units。all of the time； or unit position sizing； the second is。to use a martingale； and the third and best one is。to use an anti…martingale。
A martingale strategy is。when a man playing roulette always。bets。on red。 He knows。red will eventually e up。 Further； every time he loses； he doubles。his。investment。 When red es up； he gets。all his。losses。back。plus one。 Unfortunately； if the wheel has。a run against him； he will soon find that he is。betting his。whole wad just for the chance of getting a one…chip win。 It simply is。not worth it； and he risks。getting blown away。
An anti…martingale is。a better system。 It works。in reverse。 The unit size is。increased only if the position is。winning。 The unit is。not actually a constant； but a constant proportion of the capital now available。 If the positions。are losing； the unit size is。reduced accordingly。 In this。way downturns。are survived and uptrends。are more fully exploited。 Figure 10。12 shows that； using identical stock。selection and entry and exit rules； a reasonable return can be transformed into an extraordinary performance with the help of an anti…martingale。
We can bine our analytics。and trading rules。to build a mechanical trading system that a puter expert would identify as。a rules…based expert system。 This。means we can write algorithms。for each part of the system。 There are not that many rules。and they are all simple； but their application leads to a sophisticated answer。 They can all be back…tested； and we can put numbers。on the probability of being right。 We have an edge； and we know what it is。 There is。of course no such thing as。absolute certainty。 It is。more like having a form book。at a horse race。 Heavily backed odds…on favorites。do not always。win； but it is。the way to bet。 For example； the normal seasonal setback in September to make a low in October is。a 70/30 bet。 It did not work。in 2006。 It did not work。in 1986 either。 On that occasion we had to wait until late in 1987 for a setback。that then took。the form of a crash。 You do not have to be in this。business。very long before you will be wrong about something。 Nobody knows。w