how to avoid black swans with point & figure charts · how to avoid black swans with point...
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How to avoid Black Swans with Point & Figure charts
IFTA Conference 2014
Cyril Baudrillart, CFTe, MFTA – [email protected]
Main topics
Introduction: The daily job of technical analysts and what to expect from them.
What is a Black Swan?
Why are trend following tools good to deal with Extreme Events?
Case studies on Point & Figure chart strategies
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Don’t try to be a hero!! Introduction
Preliminary talks about some popular market mantras
Financial markets “discount everything”. Don’t try to be too smart!
“Most successful traders are contrarian investors”. It may be true for
aggressive traders but not for long-only asset managers.
“Don’t try to anticipate Black Swans”. It is not possible to do so. It depends
what you call a Black Swan!
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Financial markets are great leading indicators! Introduction
Stockmarket prices are included in most leading indicators
Markets DO ANTICIPATE most economic turning points
They are amazingly accurate to forecast bankruptcies and major market
disruptions
“Wall Street indexes predicted nine out of the last five recessions”, Paul Samuelson
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Stockmarkets even anticipate interruptions! Introduction
25 interruptions mostly in the
1930s and WWII
Only four cases since the
1960s (Egypt in 1962,
Argentina in 1965, Chile in
1971 and Portugal in 1974).
Source: Philippe Jorion, William N. Goetzmann
Performance of real stock prices a year before interruptions
-20% on average in 12 months before an interruption
“ Global Stock Markets in the Twentieth Century”, P. Jorion and W. N. Goetzmann
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The daily work of a sell-side technical analyst Introduction
What should I recommend to my clients today?
We need a routine, a methodology, a roadmap!
Typical questions from investors:
In a bull trend:
• Do you think it is time to sell? Don’t you think it is overbought?
• How high do you think the market can go?
In a downtrend:
• Is the market oversold?
• Should I buy now?
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Contrarian against trend-following thinking Introduction
A lot of people spend a significant amount of time trying to anticipate inflexion points
Overbought markets can continue to rise and oversold markets will often continue to
decline much longer than what most people think…
Contrarian thinking is good but ….
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How can technicians add value to your trading? Introduction
They listen to the markets (what people are doing, not what they are saying)
They help to characterize trends: up / down or sideways?
When you ask advice to a technician, please DO SELECT YOUR TIME FRAME
or at least your favourite investment period
Don’t expect too much from technical analysts!
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The strength of trend following methods Introduction
How can you make money in financial markets in the long run?
Buy & Hold … and Pray
Be an insider
Be a genius (but you will also have to work hard…)
Be disciplined! (not so easy)
If you are not Warren Buffet and don’t want to go to jail, trend following is what
you need
Keep losses small (and hopefully avoid Negative Black Swans)
Avoid taking profits too early (to benefit from Positive Black Swans)
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Statistical explanation of a Black Swan Black Swans
Probability curve
Trend following helps to capture abnormally
high returns
Trend following helps to avoid bankruptcies
and abnormally low returns
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What is a Black Swan? Black Swans
A few examples of Negative Black Swans
Fukushima
1929 & 1987 crashes
LTCM or Lehman failure
World Trade Center attacks
Positive Black Swans also exist!
Penicillin
Post-it
Velcro
Marc Zuckerberg
Steve Jobs
An “extreme” event that cannot be forecasted!
Copyright Cyril Baudrillart
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Warning! Trend following is not Holy Grail! Trend following
You will lose money in trading ranges
Markets are trending around 20-30% of the time so it is important not to miss
strong trends
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Next step: which trend following tools should we choose? Trend following
Moving averages (simple, exponential…)
Oscillators like MACD
Trendlines & chartist analysis
Parabolic or other trailing stop methods
Ichimoku charts
Point & Figures
There are plenty of techniques available!
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Why I like 3-box reversal Point & Figure charts Trend following
Objective interpretation of patterns (unlike chartist analysis)
Clear targets
«Low-pass filter»
Reduced lag compared to simple moving averages
Automatic detection of trends with 45° trendlines (just 1 point needed!)
They do help to reduce psychological biases
A lot of people criticize the subjectivity of technical analysis. They are right!
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Explanation of P&F charts as an asymmetric filter Trend following
15 x x
14 x O x
13 x O x
12 x O
11 x
10 x
Point & Figure 1x3
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The power of 3 box size reversal P&F charts Trend following
Objective vertical & horizontal targets
45° trend lines define « the trend »
Source: Jeremy du Plessis
Jeremy du Plessis: « The Definitive Guide to Point & Figure charts »
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How to use 3-box reversal P&F charts Trend following
Contrarian ideas
High risk -> be reactive and use tight stop losses
Preferably use high reward-to-risk ratios
Trend-following ideas
You can put loose stops
Trades are “less risky” so high reward-to-risk ratio not needed
They do help to categorize your trades
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Which box size should we choose? Trend following
Depends on the volatility of the asset studied
Depends on the investment time frame and portfolio turnover allowed
My favourite settings on equities and indices:
Semi-log scales for daily charts (usually 0.5% / 1% / 2%)
Linear scales for intraday charts
Don’t use weekly or monthly prices for Point & Figure charts!
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Identifying the primary trend with Point & Figure charts Case Studies on P&F charts
Case study on Alcatel-Lucent: is this a bear trend?
Alcatel-Lucent between 1997 & 2014
2%x3 daily close Point & Figure chart
2000 2002 2004 2009 2012
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Identifying the primary trend with Point & Figure charts Case Studies on P&F charts
C a s e s t u d y o n A l c a t e l - L u c e n t ( 2 % x 3 ) : 4 5 ° l i n e s h e l p t o d e f i n e “ t h e p r i m a r y t r e n d ”
Alcatel-Lucent between 1997 & 2014
2%x3 daily close Point & Figure chart
with 45° trendlines
2000 2002 2004 2009 2012
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A basic trading strategy based on Point & Figure charts Case Studies on P&F charts
Favour long strategies when a market is above its ascending 45° support line
Stay in cash when a market is below its declining 45° support line
Rules of TRADING MODEL #1 :
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A basic trading strategy based on Point & Figure charts Case Studies on P&F charts
TRADING MODEL #1 on Alcatel, 2%x3 Point & Figure chart:
Buy & Hold: -89%
Long-only strategy: +74%
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Another French stock with a similar bearish chart: Alstom! Case Studies on P&F charts
Case study on Alstom (2%x3)
• Alstom between 1998 & 2014
• 2%x3 daily close Point & Figure chart with 45° trendlines
1998 2001 2003 2004 2008 2011
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Why are results mixed on Alstom? Case Studies on P&F charts
Case study on Alstom (Trading model #1, 2%x3 Point & Figure chart)
Buy & Hold: -89%
Long-only strategy: -45%
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Now have a look at a leading French stock! Case Studies on P&F charts
Case study on Air Liquide(1%x3)
Too much whipsaws!
• Air Liquide between 1999 & 2014
• 1%x3 daily close Point & Figure chart with 45° trendlines
1998 2001 2003 2004 2007 2009 2011
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Basic trading strategy on Air Liquide Case Studies on P&F charts
Case study on Air Liquide (trading model #1, 1%x3): difficult to beat buy & hold
Buy & Hold: +374% since 1998
Long-only trading strategy: +21%!
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First conclusions on Point & Figure as a trading tool Case Studies on P&F charts
Better results on trending markets with high volatility
Help to be in cash during bear markets
Help to stay long during sustained bull markets
Main risks:
Lot of false signals when volatility is low (reduce the box size!)
You will lose money during trading ranges
Trend reversal signals will come too late after exponential moves
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Euro STOXX 50: 1%x3 PF chart since 1987 Case Studies on P&F charts
2000 2007
2009
2011
2012
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Trading Model #1 applied to Euro STOXX 50 (1%x3) Case Studies on P&F charts
Buy & Hold since
1987: +257%
Long only strategy:
+298%
Only 5 winning trades
out of 20!! But…
Average gain : +46%
Average loss: -1.8%
-50%
-25%
-66%
-62%
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Trading Model #1 with short selling allowed
Rules of TRADING MODEL #2:
Favour long strategies when a market is above its ascending 45° support line
Go short when a market is below its declining 45° support line
Case Studies on P&F charts
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Trading Model #2 applied to Euro STOXX 50 (1%x3) Case Studies on P&F charts
Buy & Hold: 257%
Long-short model: +266%
Average gain: +30%
Average loss: -2.5%
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Next step: improving reactivity of P&F model Case Studies on P&F charts
What can we do to reduce drawdown after exponential moves like in 2000 and
2007?
Several methods can help to solve this issue:
Internal trendlines
Track Point & Figure patterns
Use contrarian oscillators to buy the dips during bull trends / sell strength
in a downtrend
Use moving averages or MACD on Point & Figure charts
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How can we reduce drawdowns? Case Studies on P&F charts
1/ Use internal trend lines and patterns: case study on the year 2000 top
2000 2003
Fulcrum top Euro STOXX 50 between 1990 & 2014
1%x3 daily close Point & Figure chart with
45° trend lines
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How can we reduce drawdowns? Case Studies on P&F charts
1/ Use internal trend lines and patterns: case study on the year 2007 top
2009 2007 2003
Fulcrum top Euro STOXX 50 between 2003 & 2011
1%x3 daily close Point & Figure chart with
45° trend lines
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A text-book breakdown! Case Studies on P&F charts
1/ Use internal trend lines and patterns
Euro STOXX 50 between 2009 & 2014
1%x3 daily close Point & Figure chart with 45° trend lines
2009 2011 2012
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Case Studies on P&F charts Trading Model #1 with buy & sell signals in an uptrend
Rules of TRADING MODEL #3:
When the market is above its ascending 45° support line:
Buy when the index completes a double-top breakout
Close long on a double-bottom breakdown
Stay in cash when the market is below its declining 45° support line
15 x
14 x O x O
13 x O x O
12 x O O
11 x O
10 x
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Results of a P&F strategy #3 on Euro STOXX 50 (1%x3) Case Studies on P&F charts
Disappointing results since 2010 because of whipsaws
-33%
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Results of a P&F strategy #3 on S&P 500 (1%x3) Case Studies on P&F charts
Much better results on the S&P 500! Model is long since December 2011
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Results of a P&F strategy #3 in a bear market applied to Euro STOXX 50 Case Studies on P&F charts
Short strategies are less rewarding than bullish ones (Model #3 in bear markets)
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Ideas of other trading models using Point & Figure charts Case Studies on P&F charts
There are no limits!
Filtering RSI signals with 45° trend lines
Applying MACD to Point & Figure charts
Using moving averages on Point & Figure chart to filter double-top and double-
bottom signals
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A smart model combining RSI and P&F trendlines! Case Studies on P&F charts
Rising 45° support line
Declining 45° resistance line Rules in a bull trend:
RSI is overbought when >80
RSI is oversold when <40
Rules in a bear trend:
RSI is overbought when >60
RSI is oversold when <20
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MACD applied to Point & Figure charts Case Studies on P&F charts
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Moving average applied to Point & Figure charts (8 periods) Case Studies on P&F charts
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And now, Ladies and Gentlemen…. Case Studies on P&F charts
Point & Figure charts applied to
Negative Black-Swan Events
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Point & Figure charts and Extreme Events: 1987 CRASH Case Studies on P&F charts
• First warning on 8 October (double-bottom breakdown)
• Triple-bottom breakdown at the open on 19th October 1987
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Strategy #3 applied to Dow Jones index in 1987-1990 (1%x3) Case Studies on P&F charts
-40%
-23%
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Case study on 1987 crash Case Studies on P&F charts
Fine-tuning with 0.5%x3 box size on Dow Jones Industrials
• First double bottom breakdown on 16 September
• Second bottom breakdown on 9 October, 6 sessions
before the crash!
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Strategy #3 on Dow with a 0.5%x3 box size in 1987-1990 Case Studies on P&F charts
-40%
-24%
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The 1987 crash was a non event on Point & Figure charts! Case Studies on P&F charts
45° degree support line
No “trend reversal” in 1987 (1%x3 box size)!
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1982
1987
2000
Line broken in September 2002
The main ascending 45°support line was support during 20 years (1%x3)! Case Studies on P&F charts
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What about 1929? Case Studies on P&F charts
The crash was not a “major event”. What happened a year later was more bearish…
1903 1907 1914 1918 1921
1929
• Double-bottom sell signal on 21 October, a week before the crash
• Vertical downside target at 242.88 broken on 28 October
Main 45° support line broken in October 1930
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The 1931-13932 bear market could have been avoided Case Studies on P&F charts
T h e e x i t s i g n a l w a s t h e b r e a k b e l o w t h e m a i n 4 5 ° s u p p o r t l i n e ( s t r a t e g y # 1 )
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Strategy #3 applied to Dow between 2012 and 1946 (1%x3) Case Studies on P&F charts
-48%
-33%
-89%
-47%
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Case study on the 1929 crash Case Studies on P&F charts
The 0.5%x3 Point & Figure was even clearer
• Two consecutive double bottom sell signals
• Huge downside target at 243 validated on 21 October 1929
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Now let’s have a look at Greece! Case Studies on P&F charts
The 2008-2013 bear market could have been avoided
1998 1999 2003 2007 2009 2012
Main 45° resistance line broken
in October 2013
Main 45° support line broken
in September 2008
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Flat on Greek stocks since 2000! Case Studies on P&F charts
Trading model #1 applied to Greek stocks(1%x3)
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Double top/bottom bottom strategy on Greek stocks Case Studies on P&F charts
2014 is worst performance in 14 years on trading model #3!
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What about Russian stocks? Case Studies on P&F charts
Lot of whipsaws over the last three years!
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Not so bad given difficult market conditions on trading model #3
Double top / bottom breakouts on Russian stockmarket Case Studies on P&F charts
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Thank you for your attention!
Why I like 3-box reversal Point & Figure charts
Conclusion
Objectivity
Improve discipline and reduce the disastrous psychological bias on your trading
You will spend less time trying to anticipate turning points and will sleep much better!