Business Handbook - Tortoise Capital



Appendix I: System 1 Details

System Name: RLCO/SQC/New HOD-LOD.

System Objectives: SQN of at least 4; average R multiples of 2R/day, 5R/week, and 20R/month; generates 4-10 trades per day with holding periods of 10-60 minutes; functions in all longer-term market types, but may not perform as well in quiet sideways markets.

Position Sizing Objectives: Make at least 100% per year with a 5% chance of having a maximum 25% peak to trough drawdown during one month. What is important to me is attaining a balance between ensuring that I don’t have my worst-case loss at the end of the year and maximizing the chances of meeting my goal.

System Description: RLCO/SQC/New HOD-LOD actually consists of three different systems (SQC, RLCO 10/30, and New HOD/LOD), which are described under one general “category” of day trading systems that use Dr. Ken Long’s Regression Line Crossover (RLCO) “lens” to view the market and frame trades. They consist of four different entry types, but the exits are all the same and the “RLCO lens” applies to them all. The objective is to be positioned to take advantage of a price signal in my favor if I can frame the trade with a favorable reward:risk (R:R) ratio. In terms of trading rules, I like to describe them as a series of systems that are in the same family (i.e. discretionary day-trading systems) that I plan to use interchangeably throughout the day using the same trading account, which is why they appear in the same system description appendix. However, for the purposes of determining system quality, I will test and evaluate the three different entries as three separate systems.

SQN: I have not calculated SQNs for these three systems in production yet. However, I have calculated a combined SQN (including all three systems) on 285 trades of the symbol TNA using a simulator. In that simulation, I obtained an SQN (normalized to 100 trades) of 6.7. See the attached Excel spreadsheet for a list of the R-multiples, system expectancy, R standard deviation, win rate, SQN, and an R-multiple histogram.

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System Type: Rules-based discretionary day trading systems consisting of a combination of band trading, short-term trend following, and chart pattern trading systems.

Market Types: These systems should work in all market types, but will probably not perform as well in quiet, flat markets. For these market conditions, I would need to maintain very tight stops.

System Edges: Frequent trading opportunities, low risk ideas, ability to cut losses short (sometimes less than 1R), a greater ability to trade in flow with the markets than a pure mechanical system because I am looking at price actions in several different periods on one chart, very low correlation to my other systems. These systems also favor a direction-neutral frame of mind, which removes the pressure to be right about price direction.

Key Beliefs:

• Regression lines and Bollinger Bands combine the insights of moving averages, the discipline of descriptive statistics, and a framework to pinpoint important critical states in different timeframes.

• Critical states are moments when the market is under tension and ready to make a larger than normal move in either direction.

• A change of trend may be imminent when the 30-period regression line crosses over (or under) the 10-period regression line outside of what Ken calls “the river” (i.e., the +/- 1 Standard Deviation of the 30-period Bollinger Band). This is the key belief behind the RLCO 10/30 system.

• A price breakout of a sideways quiet channel (SQC) can be a signal of price momentum in either direction. This is the key belief behind the SQC system.

• A new High of Day (HOD) or new Low of Day (LOD) can be a signal of price momentum and institutions expressing buying/selling interest. This is the key belief behind the new HOD/LOD system.

• These are not mechanical systems. I must be able to stalk, trade, monitor, and take profits (or abort trades) for one or more stocks/ETFs during the day session (9:30 AM to 4:00 PM ET). While it is possible to have a successful setup, entry, and exit occur in an hour or less, I should be prepared to spend several hours in front of the screen each day that I choose to execute these systems.

• These systems will likely provide several trading opportunities per day.

• Trading experience and market intuition are key factors in the successful execution of these strategies. In other words “Trader Quality Number (TQN)” (as compared to the System Quality Number or SQN) is extremely important to the success of these systems.

• I must always remember that exits matter much more to the overall profitability of these systems than entries.

• I want to see price moving in my direction before I commit, so I look for evidence that a turning point is in place. Evidence of price moving in my direction is a key belief for these systems. Without that evidence, I am just guessing that my entry is the turning point I am looking for. Like the first mouse that tries to eat the cheese in a mousetrap, I risk being caught if price continues in the same direction. I prefer to be like the second mouse and wait for evidence of price moving in my direction. The second mouse that attempts to eat the cheese often walks away with it (i.e., profits), when the trap has been sprung by the first mouse.

• I want the best return in the shortest time period and hope for a 2:1 reward to risk ratio in less than 60 minutes. Ken has often exited with a profit in less than 30 minutes.

• I assume that institutional money will come into the trade at perceived points of value (support) during the day, and I should not be surprised to see that my stock/ETF does not hesitate at the first logical tactical resistance level, but continues to forge right ahead past a previous intraday “swing” high.

• These systems can go either long or short. Although my belief is that stocks and the market have a bias to the long side in the long term, since these are short term systems, that bias will have little to no effect. After all, the market must breathe in, then out, then in…

• I believe I can improve my edge by being able to recognize a few chart patterns that recur regularly throughout the day in many stocks and ETFs.

• These are intraday strategies. I expect to be in a position measured in terms of minutes from entry to exit. Trades that last 30 to 60 minutes are common. I want to move my stops to “no lose” (or breakeven) within the first 20 to 30 minutes, if possible. Otherwise, my belief is that the turning point and rally (or breakdown) I was anticipating is not going to happen, and I am better off preserving my capital for another opportunity.

• If the trade is not going to work, it’s not unusual for my initial stop to be hit within 5 to 10 minutes, thus taking me out of the trade and giving me a -1R loss (or a fractional R loss). If the trade doesn’t move up to at least +1R or hit my initial stop in the first 60 minutes, then I should (probably) exit the trade, depending on what SPY/the market is doing. By cutting my losses short (and not waiting for them to hit my initial stops to ensure full -1R losses), I can improve my results as measured by my R-multiple distribution, expectancy, and TQN.

• Context is important. The action in SPY and the recent trend in the stock or ETF (daily and hourly) are useful in identifying which stocks/ETFs to trade and what I can reasonably expect in terms of price action. For example, if SPY is in a bull market and a stock breaks to a new high, it may find little resistance to continuing the rally to higher highs on an intraday basis. With a strong trending stock in a bull market, Ken has found that +5R to +10R returns are possible intraday. On the other hand, if I am trading a stock/ETF that has been in a multiday tight trading range, I should be prepared to enter at support levels and proactively exit at resistance levels. With a stock in a tight trading range, Ken has found that +1R or +2R returns are as much as one can expect to walk away with in these market conditions.

System logic, concepts, and definitions:

• “The market” is SPY, which is the ETF representing the S&P500 index. It is highly correlated to my target trading population, and I believe that my target stocks/ETFs often move in the same direction.

• “Short term” means intraday moves that are typically less than 60 minutes and often less than 30 minutes. I generally use a 3-minute (3”) intraday chart with candlesticks showing the price action. Other time frames (e.g., 1, 5, or 15 minutes) can be used as well, but I like the 3-minute charts for equities and 15-minute charts for forex.

• Entry – see below for when and how to enter trades.

• Initial Stop (istop) is the initial amount I put at risk and is the price between my entry price and my initial stop or exit price. Typically, it is $0.10 – $0.20 below (or above) my entry price or $0.01 below a recent low (or high) on the 3 minute chart.

• Reward:Risk Ratio is calculated as:

(Target Price – Entry Price) / (Entry Price – Initial Stop Price)

• Profit Targets:

o The first profit target is the 30 period Bollinger Band mean.

o The second profit target is the +/- 1 Standard Deviation of the 30 period Bollinger Band.

o The recent highs (or recent lows) on a 3 minute chart or other logical points of resistance or support (e.g., resistance level from 60 minute or daily chart).

o The VWAP (Volume Weighted Average Price).

• I want the best return in the shortest time period and would love to see a 2 to 1 return in 30 minutes or less. I will respect the power of whatever caused such a price change though, and remember that the aftershocks may not yet be over.

Trading population:

• Large cap U.S. stocks (minimum 1M shares per day): Dow 30 Industrials, S&P100, Nasdaq100, S&P500, S&P400 (midcaps). However, in recent testing that I performed, I have reason to believe that SQC may work in the forex markets (see attached spreadsheet for details on SQN, expectancy, and R-multiple distribution, as well as an R-multiple distribution histogram).

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• Large liquid ETFs (minimum 100K shares per day).

• I prefer stocks and ETFs with prices in the range of $10 to $50 per share, although prices up to $75 per share are acceptable.

• A key consideration in the selection of which stocks/ETFs to stalk is the intraday volatility and the instrument’s signal to noise ratio consistency, which Ken calls the Frog Quality Number (FQN). A high FQN means the instrument has demonstrated consistent and high average range within the last 30 days. I want sufficient volatility for there to be one or more opportunities for successful trades with a 2:1 reward to risk ratio. At the same time, I want to keep my initial stops to $0.10 if possible, although $0.20 or $0.30 is reasonable for higher priced stocks with higher FQNs. I will choose my initial stop based on the instrument’s Frog Standard Deviation (SD), which, according to Ken Long, is a good measurement of the instrument’s “noise”. Ken Long publishes the calculations of FQNs and Frog SDs in his chat room on a daily basis.

• Examples of ETFs and stocks that fit this profile include KO, AA, GE, CAT, MRK, JNJ, HD, PG, INTC, IWM, UWM, QLD, VXX, UVXY, TNA, etc. Some of the best targets are the slow moving “cows” that have huge liquidity and intraday volatility large enough to provide one or more moves of $0.20 to $1.00 from intraday low to intraday high. They tend to cycle between oversold and overbought along with the market (SPY). They also tend to move in an orderly way and have tight bid/ask spreads, which makes market orders (vs. limit orders) acceptable for entry and exit.

Finding targets:

The following lists some examples of how to find targets:

• Find broad sectors or instruments that are the most oversold on a 10-day basis. They have the potential to turnaround.

• Any instrument that shows up on Ken Long’s daily report as a swing trade set-up is a good candidate for these systems.

• Any instrument that has a high FQN (3.0 or above) and high volatility that appears on Ken Long’s daily report.

Setup rules:

For the setups, I want to see SPY (the market) supporting my entry with price action that is moving in my direction on the theory that most of my trades will be highly correlated with the market. I also want to generally only take trades that are in the direction of the slope of the Bollinger Bands. The only exception to this rule is after a strong move, which usually entails three “legs” of movement between which price consolidates or a mild retracement occurs. After a strong three leg move, there is a higher possibility of a trend reversal.

• RLCO (Regression Line Crossover) 10/30: The following must occur for this set-up to be valid:

o The 10 period regression line crosses the 30 period regression line outside of the +/-1SD 30-period Bollinger Band and is moving towards or into the “river”.

o The 30 period regression line is starting to curl up (when going long), or roll over (when going short).

• SQC (Sideways Quiet Channel): The following must occur for this set-up to be valid:

o Price has moved sideways for several minutes, the 30-period Bollinger Bands have become very narrow, the slope of the 30-period Bollinger Band equals 0, and the price and RL 10 and RL30 are all inside the “river”.

• New HOD/LOD (high of day/low of day): The following must occur for this set-up to be valid:

o After 10:30 AM Eastern, the stock or ETF is either making a new HOD or LOD with very strong momentum – usually in the same direction as SPY is pointing, but not always. Going opposite to SPY is OK when the following conditions are met: the symbol is making a new LOD/HOW, is very weak/strong compared to SPY, and is a member of a very weak/strong sector.

• Determine if the trade meets the 2:1 Reward to Risk ratio. Use the Initial Stop, Entry, and Profit Target to calculate the Reward:Risk ratio. If it provides a minimum of 2:1, then I can frame the trade.

• Using GYR (green-yellow-red) color concept (for chaotic markets) to assess opportunities:

o I use yellow to highlight the range between yesterday’s high and low in SPY (the market). If today’s price action is in the yellow range, then today’s market is uncertain. Green represents price action above yesterday’s high and red highlights price action below yesterday’s low.

o If the market opens in the yellow range, my strategy is to look for trades where I can get a 2:1 R:R with smaller position sizes. As it heads towards green or red, I want to add to my position as it breaks out above yesterday’s high or below yesterday’s low. If yesterday’s high/low acts as resistance/support, then I expect a reversal, and when I see evidence of failure I will exit the trade for something close to the minimum 2:1 return objective.

o When price moves into the green range, I want to be in trades that have the potential to outperform SPY. When price goes into the red range, I want to look for opportunities to go short or go long with inverse ETFs (e.g., TZA).

Entry rules:

If the setup is valid and Reward:Risk is greater than or equal to 2:1, then enter when:

• For RLCO 10/30: several entries are possible as follows:

o Enter immediately after the crossover and the 30-period regression line either curls up (for going long) or rolls over (for going short). When using this entry, the price target is only the Bollinger Band mean because this is generally a countertrend trade at this point in the trade lifecycle. In other words, the slope of the Bollinger Bands is probably not in alignment with the direction of the trade. Or

o Wait until price first enters the 1 SD Bollinger band (the river). When using this entry, the price target is only the Bollinger Band mean because this is generally a countertrend trade at this point in the trade lifecycle. Or

o For more confirmation of trending, wait until the price crosses the center of the Bollinger Band, or

o For even more confirmation of trending behavior, wait until the price crosses the other side of the 1 SD Bollinger band.

o The lazy W entry: In choppy markets and for re-entries, consider entering after price finds support at any of the following places:

o Edge of the south (bottom) side of the river (when going long; do opposite when going short), or

o Bollinger Band mean, or

o Edge of the north (top) side of the river (when going long; do opposite when going short).

• For SQC: Enter when the body of a candle (not the wick) breakouts of the +/- 1SD Bollinger Bands.

• For New HOD/LOD: enter ASAP (generally in the direction of SPY, but not always), as long as the instrument is moving with some momentum (several green candles in a row when going long or several red candles in a row when going short). Only use this system when the instrument is either in the green or red zones – not in the yellow zone. Also, only enter if RL10 has not “stretched” too far away from the RL30. RL30 must be relatively steep (generally above 60 degrees when entering long; opposite for short) to provide confirmation of momentum.

Exit rules:

• Market stops you out:

o Initial Stop is hit

o Trailing Stop is hit

o If price leaves the +/1 SD Bollinger Band and then starts to re-enter the “river”, as Ken calls it (i.e., the +/-1 SD Bollinger Band), I should (probably) exit the trade unless price finds support at the Bollinger Band mean and my initial stop has not been triggered. This exit would most likely lead to a fractional 1R loss as opposed to a full 1R loss.

o If price fails at the Bollinger Band Mean (either short or long), I should (probably) exit the trade, as this is what Ken calls “failure to follow through”. This exit would most likely lead to a fractional 1R gain as opposed to a full 1R gain after an entry outside of the river.

• Trailing Stops:

o Move the stop to “no lose” once I have +0.5R in hand. Now, I can monitor/manage the trade knowing I have nothing to lose.

o Move the stop up in 0.5R increments.

o Or, I can let it run with a looser stop, such as +1R, if trends are strong and intraday volatility is relatively high. Then I monitor/manage the trade carefully to preemptively harvest profits (see below).

o Or, I can use a trailing stop of the low of the last two candles. This seems to work best when a rapid move upward is beginning to level off. Do the inverse when going short.

• Hesitation or end of move:

o At points where price action is hesitating, I need to decide whether it’s near the end of the current move or whether I believe the move will continue after pausing. Assuming I conclude from the overall context that the current move is near it’s end (usually after three legs up/down), then these are logical places to exit:

▪ If the RL 10 crosses the RL 30, I should be closely stalking an exit. If the RL 30 starts to roll over (when long) or curl up (when short) and if I see two adverse candles in a row, each with a close lower/higher than the previous candle, then it is reasonable to think the move is over and I should exit the trade at the close of the 2nd adverse candle or sooner if price is moving rapidly.

▪ If the RL 10 crosses the RL 30, and price re-enters the river, I should exit the trade and look for support at either the BB mean or south side of the river (when going long) to re-enter.

▪ If the RL 10 crosses the RL 30 and if the price is at or near resistance, and I get a doji or multiple dojis or a doji and then an adverse candle, then I should exit the trade.

▪ If the RL 10 crosses the RL 30 and if price had been moving rapidly, as evidenced by several relatively large candles, and then the candles become smaller in size and begin to flatten out, then I should exit the trade.

▪ If I see two “dragon horns” (i.e., topping/bottoming tails on two candles), then I should exit the trade, particularly after a strong move.

• Preemptive harvesting / profit-preservation exits:

o When I have a 3R winner, and it is starting to stall at an expected hesitation point, I am never wrong to cash it.

o If I have a position that has not hit a stop, and the market (SPY) is dropping (when long) or rising (when short), then I can conclude my position is working better (or worse) than the market. I than make a decision:

▪ Exit the position favorably.

OR

▪ Tighten my stop.

• Time stops:

o If price does not move at least 1R multiple within 60 minutes, I will consider exiting the trade – but only if I see a better opportunity in another symbol.

Optional decision rules:

• For reduced intraday volatility, use large caps or large ETFs. For more volatility, use individual stocks or volatility ETFs (VXX, UVXY) with daily volume greater than 1M shares.

• For more aggressive trades, I can use leveraged ETFs (TNA, UVXY) to get more volatility out of each trade than the primary unleveraged index signals.

Position sizing rules:

• Example for a $0.1 stop: $250 at risk, $0.10 from entry to stop

o $250 / ($0.10/share) = 2,500 shares

• When I first start trading this system in production (i.e., with real money), I will start off with no more than 0.25% of my total account equity at risk. After 100 trades and a good R-multiple distribution, I will move my risk level per position to 0.5%. I will continue to move up my risk level in increments of 0.25% after each series of 100 trades with decent R-multiples, until I reach a maximum risk level of 1% of my total account equity per position.

• I need to consider total position size relative to margin requirements. For example, 2,500 shares of a $50 stock will be a total position of $125,000 and may require an account size of at least $62,500 intraday (depending on broker, etc.).

Scaling-in rules:

• I will scale-in, or add to my original position size, if the following conditions are met:

o Price has moved in my favor.

o I have moved my initial stop and am at “no lose” or higher; more often, I will be at +2R or higher.

o The trend for the stock/ETF appears strong.

o SPY/the market is also moving in a strong trend in my favor.

o The reward:risk at the current price is at least 2:1.

• At the first opportunity to scale-in, I will add a second “bullet” as Ken refers to his position sizes, which means one unit of risk. Each bullet is an equal unit of risk.

• At the second opportunity to scale-in, I will add a third bullet. I must have at least 4R in hand before adding a third bullet.

• At the third (and final) opportunity to scale-in, I will add a fourth bullet. I must have at least 6R in hand before adding a fourth bullet.

Trade management:

• It is quite likely that I will have several trade opportunities each day. Ken has found that three to five trades of +1R to +3R, or one or two high R-multiple trades, are quite common, even in the “cows” of the DJ30. It’s not unreasonable to look forward to as many as 40 or more trade opportunities in a week. Given that, I should not worry about a well-executed trade where I followed the rules and took a -1R loss – another trade opportunity is right around the corner. The losses are just the cost of doing business.

• When I am in the trade, experience and intuition will go a long way to improving my profits through trade “efficiency”, or getting the most out of a move in my direction, while cutting losses short.

• A key belief is that my setup indicates a likely change in direction and a rapid move to previous (intraday) swing highs (or lows) or prior points of resistance (or support). Therefore, I will not wait very long for the trade to move in my direction. If after entering and price doesn’t move in the intended direction within 60 minutes, then I will probably exit the trade and wait (patiently) for another opportunity. After all, I can always re-enter.

• When my trade moves close to my profit target, I am never wrong to use a “Zeno Stop.” With a Zeno stop, I evaluate the reward to risk ratio by looking at my profit target relative to the current price of my position, instead of relative to my current stop. For example, if price has moved in my favor, and I am currently looking at a 2R gain with a target that is 0.1R away from the current price, why risk 1R (from current price to my current stop) to get the remaining 0.1R out of a trade from that point forward? The reward:risk is not worth it, so I can close the trade and take the profit. The Zeno Stop is named after Zeno's (arrow) Paradox ().

• If, for example, SPY has been declining through the morning and my target is showing relative strength (e.g., buying pressure, sell off, buying pressure, sell off to higher low), then I can expect my target to take off when SPY begins to show strength.

• I like to trade instruments that have recently improved their performance more than other instruments in relation to SPY. This shows price momentum.

• I will generally avoid opening a new position during lunchtime in NYC, generally from 11:30am or 12:00 pm ET to 1:00pm or 1:30pm ET. If a position is open going into lunchtime, I will tighten stops to protect profits and monitor it carefully, or cash it and enjoy lunch. However, I like to be prepared to enter a breakout of SQC at any time, including lunch hour.

Preferred brokers:

Low cost transaction per share, low slippage, and high speed of execution are the most important criteria for these systems. Large deep discount brokers should satisfy these requirements.

How I plan to start the system from all cash:

I will paper trade the system for three months (or at least 100 trades) until I am comfortable with the number and types of signals I receive, and that I can respond to the signals and set the buy/sell orders and trailing stops. Then, I will trade at reduced position size with real money at a deep discount broker in order to build confidence and professionalism with real money before increasing the position size incrementally and gradually.

Additional beliefs supporting this strategy:

• Markets trend and tradable trends exist on intraday charts.

• Large caps and broad ETFs have sufficient volatility during the day to enable me to day-trade them profitably.

• It is possible to have a profitable system trading large caps (“cows”) and broad ETFs that have relatively low volatility.

• The RLCO lens works on multiple time frames, e.g., from 1 minute to daily charts.

• Prior points of support and resistance are useful signposts for identifying when price may turn around and go higher (at support) or stall (at resistance).

• The system can be profitable if I can frame the risk:reward as 2:1 or better.

• The S&P500, represented by the ETF SPY, is a proxy for the overall market. Most of the time, the large caps and broad ETFs are highly correlated with SPY. Intraday uptrends in SPY will usually signal an uptrend in the large caps and broad ETFs.

• I take on substantially more risk if I hold positions overnight, so I exit positions before the end of the day session.

• I can gain an edge by trading “old reliables”, those stocks/ETFs that I get to know in-depth and understand how they behave.

How Will I know the Systems are Broken? If the SQNs fall below 2, the systems may be broken.

What Could Go Wrong with these Systems?

• These systems are highly dependent on my skills as a trader as well as my psychology, so if I’m not operating at near 100% efficiency when trading these systems, they may not work.

• These systems will likely underperform in quiet sideways markets.

Chart examples (provided by Dr. Ken Long):

RLCO 10/30 chart example #1 (orange line is price):

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RLCO chart example #2 (depicts the lifecycle of an RLCO trade and the various points of interest/action):

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SQC chart example:

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New HOD chart example:

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Appendix II: System 2 Details

System Name: Andersson Regression Line Stretch (ARLS).

System Objectives: SQN of at least 4; average R multiples of 1R/day, 3R/week, and 12R/month; generates 3-4 trades per day with holding periods of 10-30 minutes; functions in all longer-term market types.

Position Sizing Objectives: Make at least 100% per year with a 5% chance of having a maximum 25% peak to trough drawdown during one month. What is important to me is attaining a balance between ensuring that I don’t have my worst-case loss at the end of the year and maximizing the chances of meeting my goal.

System Description: ARLS is a discretionary, rules-based, day trading system that uses Dr. Ken Long’s Regression Line Crossover (RLCO) “lens” to view the market and frame trades. The objective is to be positioned to take advantage of an extreme price level that generally goes against the overall trend to then revert back to the higher level trend (the 30 period regression line).

SQN: I have not calculated an SQN for this system in production yet. However, I have calculated an SQN on 314 trades of the symbol TNA using a simulator. In that simulation, I obtained an SQN (normalized to 100 trades) of 7.59. I have also calculated an SQN on 235 forex trades using the AUD/USD currency pair. In that simulation, I obtained an SQN (normalized to 100 trades) of 4.42. See the attached Excel spreadsheet for a list of the R-multiples, system expectancies, R standard deviations, win rates, SQNs, and R-multiple histograms for both tests.

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System Type: Rules-based discretionary day trading system using the concept of reversion to mean after a strong price move.

Market Types: This system should work in all market types, but will probably not perform as well in quiet, flat markets. In quiet markets there are not many set-ups.

System Edges: Relatively frequent trading opportunities, low risk idea, high win rate, high SQN, ability to cut losses short (sometimes less than 1R), a greater ability to trade in flow with the markets than a pure mechanical system because I am looking at price actions in several different periods on one chart, very low correlation to my other systems.

Key Beliefs:

• Regression lines combine the insights of moving averages, the discipline of descriptive statistics, and provide a framework to pinpoint important critical states in different timeframes.

• An “RL-stretch” occurs when the 10 period regression line and/or price have moved a substantial distance away from the 30 period regression line. This causes traders to either want to jump on the bandwagon to continue to move the price to further extremes, or more often, take a trade in the opposite direction of the short-term move (i.e., buy on dip, sell on blip) so that price reverts back to the higher level trend.

• This is a not mechanical system. I must be able to stalk, trade, monitor, and take profits (or abort trades) for one or more stocks/ETFs during the day session (9:30 AM to 4:00 PM ET). While it is possible to have a successful setup, entry, and exit occur in an hour or less, I should be prepared to spend several hours in front of the screen each day that I choose to execute these systems.

• This system will likely provide several trading opportunities per day, but usually only one or two opportunities/day/symbol.

• Trading experience and market intuition are key factors in the successful execution of this strategy. In other words “Trader Quality Number (TQN)” (as compared to the System Quality Number or SQN) is extremely important to the success of this system.

• I must always remember that exits matter much more to the overall profitability of this system than entries.

• I want to see price moving in my direction before I commit, so I look for evidence that a turning point is in place. Evidence of price moving in my direction is a key belief for this system. Without this evidence, I am just guessing that my entry is the turning point I am looking for. Like the first mouse that tries to eat the cheese in a mousetrap, I risk being caught if price continues in the same direction. I prefer to be like the second mouse and wait for evidence of price moving in my direction. The second mouse that attempts to eat the cheese often walks away with it (i.e., profits), when the trap has been sprung by the first mouse.

• I want the best return in the shortest time period and hope for a 2:1 reward to risk ratio in less than 60 minutes.

• This system can go either long or short. Although my belief is that stocks and the market have a bias to the long side in the long term, since this is a short term system, that bias will have little to no effect. After all, the market must breathe in, then out, then in…

• I believe I can improve my edge by being able to recognize one chart pattern that recurs regularly in the morning in many stocks and ETFs.

• This is an intraday strategy. I expect to be in a position measured in terms of minutes from entry to exit. Trades that last 30 to 60 minutes are common. I want to move my stops to “no lose” (or breakeven) within the first 20 to 30 minutes, if possible. Otherwise, my belief is that the turning point and rally (or breakdown) I was anticipating is not going to happen, and I am better off preserving my capital for another opportunity.

• If the trade is not going to work, it’s not unusual for my initial stop to be hit within 5 to 10 minutes, thus taking me out of the trade and giving me a -1R loss (or a fractional R loss). If the trade doesn’t move up to at least +1R or hit my initial stop in the first 30 minutes, then I should (probably) exit the trade, depending on what SPY/the market is doing. By cutting my losses short (and not waiting for them to hit my initial stops to ensure full -1R losses), I can improve my results as measured by my R-multiple distribution, expectancy, and TQN.

• Use tight stops, with the belief that if the rebound to the RL30 doesn't happen quickly, it won't happen at all.

• The profit targets are very tight, with the belief that it is only a slight correction to get back to the higher trend line.

• Price usually likes to stay relatively close to the RL30.

• This system involves small reversions to the mean that are often countertrend; therefore, I am happy to take a quick and dirty +1R and run. Because of the high win rate, harvesting many +1R wins, as opposed to waiting around for much larger R-multiples, is a reasonable strategy for this system.

System logic, concepts, and definitions:

• “Short term” means intraday moves that are typically less than 60 minutes and often less than 30 minutes. I use a 3-minute (3”) intraday chart with candlesticks showing the price action. Other time frames (e.g., 1, 5, or 15 minutes) can be used as well, but I like the 3-minute bars for equities and 15-minute bars for forex.

• Entry – see below for when and how to enter trades.

• Initial Stop (istop) is the initial amount I put at risk and is the price between my entry price and my initial stop or exit price. Typically, it is $0.10 – $0.20 below (or above) my entry price or $0.01 below a recent low (or high) on the 3” chart.

• Reward:Risk Ratio is calculated as:

(Target Price – Entry Price) / (Entry Price – Initial Stop Price)

• Profit Target: The only profit target is the 30 period Regression Line.

Trading population:

• Large cap U.S. stocks (minimum 1M shares per day): Dow 30 Industrials, S&P100, Nasdaq100, S&P500, S&P400 (midcaps). However, in recent testing that I performed, I have reason to believe that ARLS may work in the forex markets (see attached spreadsheet above for details on SQN, expectancy, and R-multiple distribution, as well as an R-multiple distribution histogram).

• Large liquid ETFs (minimum 100K shares per day).

• I prefer stocks and ETFs with prices in the range of $10 to $50 per share, although prices up to $75 per share are acceptable.

• I want to keep my initial stops to $0.10 - $0.20 if possible, although $0.30 or $0.40 is reasonable for higher priced stocks. I will choose my initial stop based on an observation of the 3-minute charts over a one-week period to determine how much the price usually “stretches” away from the RL-30 before rebounding to the RL-30. If it has a tendency to re-bound after a $0.60 stretch, then a $0.30 stop would be reasonable to provide a solid 2:1 R:R ratio.

Finding targets:

The following lists some examples of how to find targets:

• Any instrument that shows up on Ken Long’s daily report as a swing trade set-up is a good candidate for this system.

• Any instrument that has high volatility (UVXY) that appears on Ken Long’s daily report.

Setup rules:

For the setups, I want to see price and/or RL-10 stretching “far away” from RL-30. “Far away" is determined discretionarily; however, you should see at least a 2:1 reward:risk ratio (RR) to get back to the RL-30 for the set-up to be valid. Reward to risk ratios are highly dependent on what you believe is a manageable istop (I used $0.40 in the TNA test, which meant that I had to see a least an $0.80 stretch before considering an entry). I also want to see one candle closed in the direction of the gap (i.e., green for long, red for short).

Entry rules:

If the setup is valid, and Reward:Risk is greater than or equal to 2:1, then enter when:

• The 2nd green candle takes out the high of the first green candle (to go long); do opposite for short.

Exit rules:

• Exit when price reunites with the RL30, or

• When 2 candles in the opposite direction occur (if price has not yet rebounded to the RL-30), or

• When one candle in the opposite direction occurs after price has rebounded to the RL-30, or

• Preemptive harvesting / profit-preservation exits:

o When I have a 3R winner, and it is starting to stall at an expected hesitation point, I am never wrong to cash it.

• Time stops:

o If price does not move at least 1R multiple within 60 minutes, I will consider exiting the trade – but only if I see a better opportunity in another symbol.

Optional decision rules:

• Occasionally, the price rebound is so fierce after a big stretch that price overshoots the RL30 to the other side. Staying in the trades longer might occasionally result in bigger R-multiples. Therefore, if the price is moving in my direction with considerable momentum, I might consider staying in the trade, despite the fact that one candle in the opposition direction of the trade may have occurred.

Position sizing rules:

• Example for a $0.1 stop: $250 at risk, $0.10 from entry to stop

o $250 / ($0.10/share) = 2,500 shares

• When I first start trading this system in production (i.e., with real money), I will start off with no more than 0.25% of my total account equity at risk. After 100 trades and a good R-multiple distribution, I will move my risk level per position to 0.5%. I will continue to move up my risk level in increments of 0.25% after each series of 100 trades with decent R-multiples, until I reach a maximum risk level of 1% of my total account equity per position.

• I need to consider total position size relative to margin requirements. For example, 2,500 shares of a $50 stock will be a total position of $125,000 and may require an account size of at least $62,500 intraday (depending on broker, etc.).

Scaling-in rules:

• Since this is not a trend following system, I will never scale into positions.

Trade management:

• Sometimes after a large stretch away from the RL30, price simply drifts sideways to catch up with the RL30, resulting in a small loss or scratch.

• When I am in the trade, experience and intuition will go a long way to improving my profits through trade “efficiency”, or getting the most out of a move in my direction, while cutting losses short.

• This system could be used in conjunction with the RLCO systems described in Appendix I above to potentially improve entries and exits - particularly in volatile markets (i.e., front-run an RLCO or SQC).

• When my trade moves close to my profit target, I am never wrong to use a “Zeno Stop.” With a Zeno stop, I evaluate the reward to risk ratio by looking at my profit target relative to the current price of my position, instead of relative to my current stop. For example, if price has moved in my favor, and I am currently looking at a 2R gain with a target that is 0.1R away from the current price, why risk 1R (from current price to my current stop) to get the remaining 0.1R out of a trade from that point forward? The reward:risk is not worth it, so I can close the trade and take the profit. The Zeno Stop is named after Zeno's (arrow) Paradox ().

Preferred brokers:

Low cost transaction per share, slippage and speed of execution are the most important decision criteria for this system when choosing a broker. Large deep discount brokers should satisfy these requirements.

How I plan to start the system from all cash:

I will paper trade the system for three months (or at least 100 trades) until I am comfortable with the number and types of signals I receive, and that I can respond to the signals and set the buy/sell orders and trailing stops. Then, I will trade at reduced position size with real money at a deep discount broker in order to build confidence and professionalism with real money before increasing the position size incrementally and gradually up to 1% of total equity.

Additional beliefs supporting this strategy:

• Large caps and broad ETFs have sufficient volatility during the day to enable me to day-trade them profitably.

• The RLCO lens works on multiple time frames, e.g., from 1 minute to daily charts.

• The system can be profitable if I can frame the risk:reward as 2:1 or better.

• I take on substantially more risk if I hold positions overnight, so I exit positions before the end of the day session.

• I can gain an edge by trading “old reliables”, those stocks/ETFs that I get to know in-depth and understand how they behave.

• Many entries (43% according to my testing results) occurred in the first 30 minutes of equities market open, due to opening gaps.

• Most entries (78% according to my testing results) occurred before noon in the equities market.

How Will I know the Systems are Broken? If the SQN falls below 2, the system may be broken.

What Could Go Wrong with this System?

• This system is highly dependent on my skills as a trader as well as my psychology, so if I’m not operating at near 100% efficiency when trading this system, it may not work.

• This system will likely underperform in quiet sideways markets.

Chart examples:

See two chart examples in the excel spreadsheet above entitled “RL-Stretch TNA and AUDUSD 6_17_2013.xls”.

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