Monday's column I reviewed two concepts I thought were critically important. So, if you haven't, check out that column, as I think there's some useful stuff there.
Today, though, let me finish up with two more ideas that you ought to be thinking about.
No. 3: You Probably Forgot About Slippage
For many of you, this is such an esoteric topic, you probably haven't given it much thought. But, you probably should, particularly if: a) you do a lot of trading and, b) your approach is based on back-tested data.
First, what is slippage? My definition is any fill that differs from what end-of-day data off a chart would lead you to believe. As an example, if your methodology had you buying XYZ at the open, you might look at the chart, see 24 as the opening price, and use that for your calculations. However, you may very well have gotten 24 1/4 as your fill, since the 24 might have been an opening sale, with your 24 1/4 as the opening buy. And in this scenario, your slippage would be about 1%.
Similarly, you may have noted that you had a target on XYZ of 26, and it hit that the day after your purchase. You therefore note you would have made an 8% profit. In reality, though, XYZ may have only touched 26 briefly, trading only 100 shares at that price. Depending on your lot size, then, you might never have been filled, or at best, received only a partial fill at 26, with the rest at 25 7/8. But, to illustrate my point, then, let's assume a slippage on the sale of another 1%.
Now, let's go further and assume you are a very active trader, and make 500 trades per year, with a lot size of 1,000 shares each, and an average price for each of your trades of 25. Now, even if each trade has only .5% slippage total, your "slippage cost" for the year is still $62,500!
You see? Slippage seems innocuous at first, but in the end, can be extremely insidious. I've tested a wide variety of trading styles, some yielding over 100% per year compounded. The problem? Those results are all without slippage. Throw even a conservative number in, and my wonderful gains often turn into losses.
My advice, then? If you're an active trader, keep a key eye on how your fills compare with your back-tested methodology. The results may surprise you.
No. 4: You're Not Nearly as Good as You Think You Are
Oh boy, the hubris out there among so many people new to the market can be just stifling at times. People who spotted
at 1. Those folks who nailed biotech. The geniuses who shorted the
at the top.
Yeah, I hear from them all. In fact, there's quite a few who have offered to "teach me a thing or two about trading."
Well, Lord knows, I do have a lot to learn about trading. And, perhaps these very folks could teach me something.
However, I do know one thing above all else: Unless you've been trading since, let's say 1928, you can't possibly be as good as you think you are. The reason? You haven't lived through every single kind of market condition! Sure, it's easy to set the world on fire when the market's going straight up. Heck, just get in the way of a few stocks, and you have it knocked.
But, what about a market that drops 30% over five days (1929)? Or what about a market that doesn't make a new high for nearly seven years (early 1970s)?
Now, maybe you can handle those situations. In fact, maybe you'd be splendid in those situations. But, the fact is, you just don't know until you get there.
I've read a lot about other traders and if there is one overriding personality element behind those I consider great, it's this: They're humble to a fault. That doesn't mean they're not confident. No, it means they fully realize they're only as good as their last trade, and that the market can take it all away in an instant. Any time they spend thinking how darn great they are is time spent not being careful and wary. And it's these times, I guarantee you, that will cause you the most pain.
So, if you think you have it all figured out, I can guarantee you this: You don't.
OK, now for a different topic altogether, as I make good on my promise to revisit the gap arena. As a review, it was my contention the tiresome "all-gaps-are-filled" homily was nonsense. And, even if it were true, you most certainly could make tidy profits in a trade
that gap was filled. (See
the column a few weeks ago on my
trade as an example.)
That said, the Department of Economics at the very fine
weighed in with some excellent work by
, an associate professor of economics. Included below is Bruce's initial note to me, my rebuttal and his return correspondence. Enjoy.
Gary: I have back-tested (prior to your column of Feb. 9) the gap-filling conventional wisdom. I have some results you might be interested in. For the S&P 500 constituent stocks between June 2, 1997, and May 25, 1999, there were 2,670 gaps up (defined as an open 2% higher than the previous day's high). 74.23% of those gaps were filled (defined as a low with 1/4 point of the high of the day prior to the gap) within 10 days. The gaps were filled in an average of 2.22 days. Bruce Mizrach
Department of Economics
Very interesting, Bruce. Very interesting. Now, of the gaps that were filled, how many were filled where the gap was originally formed by a volume surge (say 150% of the 50-day moving average of volume)?
are the ones I'm betting are not filled that often.
Also, I'd say a gap is filled if there is a
, not just a low, in the gap opening. If you include the "tail" of the candle (the low) as you have done, I can agree with your results. Often, though, it's the close that's most important.
Gary, I have finally had a chance to back-test your conjecture. Using the close, 62.85% of the gaps are still filled (defined as a close with 1/4 point of the high of the day prior to the gap) within 10 days. The average number of days to fill the gap is 2.81. 47.9% of the gaps meet the volume criteria you specified (150% of the 50-day simple moving average). Of these, 53.83% have closes that fill the gaps (as previously defined) in an average of 3.16 days. Bruce
First, a big note of thanks to Bruce. It was kind of him to apply his resources to our little discussion.
Conclusions, though? Well, it's clear some gaps are filled in a timely manner ... and others aren't. In other words, we have data, but we really aren't that much closer to anything conclusive. Certainly nothing we could trade on.
What to do then? Always view gaps within context, and realize that trading solely on the basis of a gap -- or any chart pattern for that matter -- is silly. No, what differentiates profitable trading from unprofitable trading is how you manage the trade once you're in it. That's right: Gap or no gap, it's the dead horse of money management that I keep kicking, that will differentiate successful from unsuccessful trading.
Gary B. Smith is a freelance writer who trades for his own account from his Maryland home using technical analysis. At time of publication, he held no positions in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Smith writes five technical analysis columns for TheStreet.com each week, including Technician's Take, Charted Territory and TSC Technical Forum. While he cannot provide investment advice or recommendations, he welcomes your feedback at