STP Algo Trader - The Method

Welcome to the latest issue of STP Algo Trader "The Method"!

Every Saturday, we will break down each of the inputs that go into our proprietary algorithmic trading system - Signal Trader Pro.

Not only do we want to share the inner workings of our system, but we want to educate you on how to become a better investor. Remember, our ultimate goal is to help you MAKE MONEY!

Over the last few months, we have conducted a thorough review of the various metrics that drive our algorithmic trading system, Signal Trader Pro.

We described the universe of stocks that we analyze and – most recently – the different metrics that make up our "15" point-scoring system.

We generate a BULLSEYE BUY signal in these stocks when a highly rated stock ("14" or "15" score) trades below an RSI of 30 and then back above it.

Once we generate that BUY signal, though, the system will also share with our subscribers when to sell the stock.

The first type of SELL is signal is a profit-taking SELL signal.

The way the system is set up, most of the time, it is looking to sell the stock when the stock rallies enough to equal two-thirds of the previous high in the stock over the last 90 days.

Our system only generates BUY signals in stocks that are in strong uptrends, so most often, the 90-day high is also near the high over the previous year.

Many of our BUY signal-rated stocks return to their previous highs. We do not wait that long, however, and look to take profits once we have seen the stock return most of the way there.

Over time, we have found that this was the optimal strategy in terms of maximizing return, as measured by net present value, across a short time frame.

Remember that Signal Trader Pro is a trading system designed to generate decent returns (mid- to high-single digits) over a relatively short period (average less than 60 days). We achieve this with an exceptional success rate (70%+) and an annualized return that exceeds +30%.

Even though many of our "winner" stocks will continue to win and go higher, we are looking to take advantage of the particular dislocation in the stock indicated by the RSI-driven BUY signal.

At some later point, we may consider using our scoring system also to identify long-term stocks to buy, but for now, we are focused on the great returns the system produces.

One subtlety to consider here is that we dynamically adjust the 90-day high over time. This helps eliminate positions that would remain in the system for too long.

Why do we do this?

The idea of the BUY signal is based on taking advantage of that price dislocation. If we get too far away from that dislocation, then the reason for being in the trade is no longer there.

The 90-day high moving through times means that if a stock has not rallied (and we sold using our normal profit-taking signal), then we sell it at a lower gain. This approach has been backtested using our data and has been shown to materially improve returns.

The second type of SELL signal is our “stop loss” discipline.

This is when we sell a stock after it has lost a certain amount from our entry price.

Most successful trading systems utilize some form of “stop loss” discipline.

Most often, these are based on a certain amount of loss (selling if it is down -10%) or by some relationship to a technical indicator (for instance, if it breaks the 50-day moving average.)

Our "stop loss" methodology is based on the movement in the stock price relative to the stock market. This means that we are not just looking at the movement in the stock price but also how much it has moved in relation to the market.

An example would be a stock that is down -5%, with a stock market that is flat. Then the total "alpha-based" loss would be -5%.

If that same stock were down -5%, though, with the stock market down -15%, then there is no "alpha" loss.

(Technically, the stock is producing positive "alpha," which is great, but our system is focused on actually making you money!)

For our system, we are looking for an “alpha” loss of -10%.

This could mean that the stock is down -10%, with the stock market flat. It could also mean that the stock market is down -15% to -5%.

The caveat is that we are always looking for an absolute loss of at least -10%. We do not close out positions for simply underperforming the stock market.

The benefit of an "alpha" based stop loss discipline is that it prevents you from getting "shaken out" of quality positions in a stock market sell-off.

We instituted this methodology several years ago, based on backtesting it across multiple market environments. We saw that it was clearly the most optimal return for our readers.

Our co-founder, Mark Intrieri, does a great job showing how these SELL disciplines work in a recent review of our recommendation in Broadcom Inc. (AVGO).

You can read that here.

What’s your stop-loss strategy? Drop a comment or let us know in the STP WhatsApp group chat!