STP Algo Trader - Market Insights

Our approach to making money in the stock market is to analyze every potential outcome in terms of probability.

We often use the example of the game of Blackjack as an analogy.

Blackjack is interesting because once you know what cards you have and what card the dealer is showing, then the probabilities of the outcome are known.

This doesn’t mean that you will automatically win (or lose) your bet, but it does mean you can identify when the odds are for or against you.

The stock market and individual stocks are the same.

Our algorithmic trading system, Signal Trader Pro, goes through a universe of 1400 stocks to identify high-probability "win" situations.

Think of it as a system that can tell you which table to walk up to and start playing before you even place your bet.

One critical difference between the stock market and a casino, though, is that the overall market environment plays a role in your chance of success.

Imagine a casino where the odds are on weekdays and worse on weekends.

It doesn’t mean you couldn’t win a blackjack on a Saturday, but it does mean you might want to place your bets differently.

We designed our system to address this aspect of the stock market.

The majority of the time, the stock market operates in a steady upward trend with relatively low volatility. This is roughly 70% of the time. We call this the BULL position in the stock market.

In this environment, the returns of an individual stock position are driven by the stock.

The other 30% of the time, though, the stock market enters into what we call a NON-BULL position. This occurs when the uptrend breaks and volatility increases significantly.

It does NOT mean we are in a BEAR market (a sustained downtrend), but it does mean more caution is warranted. We know that casino tables don't pay out as well, and there is a risk that you could lose everything quickly.

The primary way we determine the type of environment in which the current stock market exists is by examining market volatility. The best measure of this is the CBOE Volatility Index, commonly referred to as the "VIX."

This is an index created by the Chicago Board Options Exchange that shows the market’s expectations for volatility over the next 30 days.

We won't get into the calculation of the index here, but it is an excellent measure of both fear and risk.

Here is a chart of the VIX going back to 2000…

What is important about this chart in terms of our system is that every time the stock market has entered into a prolonged downturn, the VIX has seen a material short-term rally.

We quantify this by looking for the trailing 10-day average of the VIX exceeding the previous 10 days by at least 100%.

This means that this spike in the VIX presages every terrible time in the stock market.

Note that this does not mean that every spike in the VIX means a terrible stock market is forthcoming. It just means the risk has increased.

The potential for a downtrend in the stock market (one where the casino payouts deteriorate) is what led us to execute our BULL SWITCH in our system.

This is when we raise (lower) the bar in terms of what we are looking for in an oversold stock. The bar is moved down from a “30” RSI to a “25” RSI. We want positions to be even MORE oversold.

We also begin to focus on only the highest-quality positions. Those that score a "14" or "15" in our system.

We engaged this BULL SWITCH back in mid-April.

Our view is that if the market were to recover quickly, we might leave some money on the table. If it didn’t, however, we would avoid catastrophic losses.

We also would still benefit from the rally in our high-quality positions.

This is exactly what DID happen.

We saw one of the steepest and most powerful stock market rallies in decades.

More importantly, we saw one of the steepest drops in the VIX ever.

Here is a chart showing the VIX over the last year…

Here is a table from the awesome Charlie Bilello that puts this drop in the VIX in perspective…

Going back over thirty years, this has been the steepest 6-week drop in the VIX that we have ever seen.

Take a look at the data, and you see across the next 20 steepest declines; there was only ONE time the S&P 500 was lower six months later. It was never lower a year later.

This is just one of a host of technical indicators we have seen in recent weeks that indicate that the market has moved back into a BULL position.

As a result, we think the casino odds have moved back in our favor!

This means we are hitting the BULL SWITCH again and moving back to our normal position.

We believe the stock market is returning to being a market of stocks rather than a market focused solely on trading with the overall market.

This is a welcome return, and we believe it will lead to significant profits for our subscribers in the future.

Game on!

Do you think we’re back in a bull market? Is it ok to take risk again? Let us know your thoughts in the comments section online or at [email protected]