Over the past 34 years, this strategy not only beat buy and hold, but it did so with over 50% less drawdown of capital. The largest losing trade was 11%, and there were only two separate periods of five consecutive losing trades.

There was one trade that generated statistically outsized gains: the trade that led to the blowoff of the Nasdaq bull market in 1999 and 2000. This single trade was responsible for 1,756 of the 3,933 total points earned from this strategy. It's never good to have all your profits from just a few trades, however, even if we take away this one trade (which was one out of 117), the strategy still outperforms buy and hold.

A strategy of buying and selling the Nasdaq based on its relationship with the 10-week SMA can be made more effective by adding two protective stop losses. The first is designed to protect your capital: If price moves greater than 2.5% against your entry position, you exit the trade. The second is designed to protect your profits -- it's a trailing stop loss so that you will never lose more than 8% of your profits.

Why did I choose a 2.5% protective stop loss? In my original no stop-loss strategy, over 95% of the winning trades never went lower than 2.5% from the entry price. In other words, if a trade moved more than 2.5% against the entry price, it was likely to be a loser.

The performance results for such a strategy are shown in Table 2 under the column labeled system #2. By adding two protective stops, the strategy certainly qualifies as following one of the golden rules of trading, which is to let your profits run and cut your losses short. Profits increased by 2.1 times the original strategy and drawdown decreased almost threefold. It did hit one period of eight consecutive losses, and you really have to ask yourself if you could follow a strategy where you lose this many times in a row. But multiple small losses have to be accepted as a part of trading, especially when such a tight stop loss is utilized.

The one outlier trade was responsible for only 1,000 Nasdaq points, and clearly had less of an impact on the results. This can be seen in the strategy equity curve below, which is nicely up-sloping.

Click here for larger image.

Source: The TechnicalTake.com