The NASDAQ Composite sold off on Monday and spent the rest of the week struggling to regain the lost ground. Positive job creation numbers on Friday allowed the index to close the week with an accumulation day, although volume was still below average. The index closed the week with a small loss while the larger cap indexes made modest gains and new highs. Lower fuel costs and rising employment, and for the first time, improving middle class wages should continue to lift the markets while inflation remains low and the Fed maintains effectively negative interest rates.

No new features this week.
 

Risk Adjusted Return - Excellent Profits at Lower Risk

Our  cup and handle backtest tool allows you to research the parameters for buying cup and handle stocks that give the best returns as market conditions change. I periodically run many simulations of the tool testing many different scenarios and the last time I did that was in May, 2014 (see Important Strategy Revisions).

I did so again this week and found the maximum return since the start of the year would have been obtained with the settings shown in figure 1 below (click image to expand). The important parameters are highlighted in yellow. The key results are highlighted in red. Note that the overall return was 77.3% but that the drawdown was $3,403.7 (32.8%). (Drawdown is the maximum loss sustained in the portfolio). It would be the bold investor indeed that would tolerate a 33% loss before abandoning the strategy.

In the same figure, look at the "Risk Adjusted Return" which rates as 2.3. This is the total profit divided by the maximum drawdown. It is how much capital was put at risk to obtain the overall profit.

Suppose that instead of looking for maximum possible profit we looked for maximum risk adjusted return. This would give us Figure 2. Our drawdown has been reduced to 11.2% of our initial capital and our profit is 37.7%. This is still an excellent return when a passive investment in the S&P 500 returned only 13.3%.





Conclusion

For the optimal return (best profit at least risk) I now recommend the following trading strategy for cup with handle stocks:

• Each day, create a personal watchlist of stocks that satisfy
• RS Rank must be at least 90
• Industry Rank must be in the top 20 percentile (i.e. have a rank less than 43 in our industry ranking scheme
• Average daily volume >= 100,000.
• Buy on alert
• Sell at next open if volume at end of breakout day is less than 1.75 times average 50 day volume
• Sell if stock drops 6% or more from the breakout price.
• After purchase set a 4% trailing stop by monitoring daily high's and setting a stop loss at 4% of the maximum high after breakout. Adjust daily if necessary.
• Sell if trailing stop met intraday.