Case Study: How to Significantly Cut Drawdowns Using Market Internals

In 2014, I spent about 6 months in a row with this unique traders tool called Market Internals, exploring its possibilities every single day, searching for new and creative implementation ideas for my own automated trading systems (ATSs). With a real obsession with this concept, I finally found almost 40 new ideas (mostly my own proprietary ideas) on how to squeeze the most out of this great tool, and slowly started implementing many of them into my own trading – with great success.

I truly believe that Market Internals can give a trader a small, unfair advantage – if thoroughly thought out and implemented well, especially in new, creative ways. Therefore, in this article, I would like to give you a very brief introduction into the Market Internals world, together with an example of one of my private Market Internals filters – to show you, how dramatic the impact of Market Internals deployment can be – in a favorable way.

Introduction: What are Market Internals (MI)

We all know how hard it is to find a new, viable trading edge. We are also aware that the scope of our possibilities is quite narrow: It doesn’t really matter what trading indicators or other tools of technical analysis we use – most of the time they all use the same source of data anyway. This data consists of Open, High, Low and Close values of the bars in our trading chart, and whatever trading indicator we use, we basically use only a slightly different interpretation of the same O-H-L-C values.

So, if we really want to go a step further and implement a broader view for our trading decisions (trading entry/exit conditions), we have to start investigating outside of the O-H-L-C values. We can, for example, implement information like Volume or Open Interest to our trading entry/exit conditions, which is not a bad idea at all, and many of my ATSs use O-H-L-C values together with Volume effectively.

However, we can still go a step further.

We can do something that many traders have no idea they can even do: We can start making our trading (entry/exit) decisions based not only on the data coming from the underlying market but also on taking into consideration the market (its overall direction, quality, strength and overall “mood”) as a whole!

Just imagine:

Wouldn’t it be fantastic to know where the stock market as a whole is heading, before we enter a position in our emini S&P strategy?

And that is exactly what Market Internals are about: The ability to read the market as a whole and effectively incorporate this much broader view into our trading decisions.

Market Internals: A quick introduction

So what exactly are Market Internals? Where do they come from?

It’s very simple: Market Internals are information about the overall stock market, provided by the stock exchanges (NYSE, AMEX), usually in the form of a standalone data feed.

And this data feed instantly provides us with real-time information about the overall stock market situation.

Using Market Internals we can immediately, in real-time, start receiving information like, for example:

  • How many stocks from the Dow Jones Index have just moved up and how many down?
  • Is the volume of all rising stocks from the Dow Jones index higher or lower than the volume of all falling ones?

Or even:

  • How do ALL stocks move in the entire NYSE? Are most of them rising or falling?
  • How many stocks have a price that hasn’t changed?
  • What is the direction of the majority of the volume? Up or down?
  • Do the 30 stocks in the Dow Jones index correspond with the rest of the market, or does the Dow Jones index now live its own life?

As you can see, there is plenty of information that can be obtained through this standalone data feed about the stock market as a whole (and later on, to be used in our strategies).

All this information can be split into several different categories, and every category has its own meaning and preferred method of implementation. However, because the space for this article is very limited, and the subject of Market Internals could give more than a dozen articles like this, I am going to focus only on one Market Internals category, one of my most favorite, the MI pair UVOL-DVOL.

Market Internals: UVOL-DVOL

This category of MI simply consists of two separate data feeds provided from the exchange:

$UVOL monitors the total volume of all rising stocks on the exchange.

$DVOL monitors the total volume of all falling stocks on the exchange.

By using these data feeds (often called MI indicators), we can monitor the volume on one side or the other, so we can get a better idea where the volume is moving to, i.e. which side is stronger. This is, of course, a very powerful view on the market that can provide us lots of important information (if we know how to use it).

From a practical means, we usually add two different data symbols into our chart (data2 and data3) to start using UVOL-DVOL pair for our trading.

Then we can start using these MI indicators as additional, or even leading filters (or as I usually call them – “Super Filters”) for our existing systems – with the goal to improve them significantly.

Let’s have a look at such a condition in practice. I am going to reveal one of my proprietary UVOL-DVOL MI conditions, which I use as a filter for many of my breakout index or stock strategies (MI can only be implemented on indexes or stocks of futures indexes).

UVOL-DVOL as a filter for significant improvement

To demonstrate the effect that Market Internals can have, I have decided to use the most simple condition that I could think of – a primitive breakout condition high=highest(h,N1). I haven’t done any optimization of the N1 parameter, nor have slippage and commission been included in the results shown below – the purpose of this article is not to present a functional breakout trading system but to demonstrate that Market Internals can be applied to even the most basic systems and get immediate, and very often dramatic, improvements. For the N1 parameter, I have used the first number that came to my mind, number 20.

Here is the basic code that I will use to demonstrate the impact of the Market Internals “Super Filter”. The test will be completed on the EMD.D market, 15 minute timeframe, from 3/22/2006 – 3/21/2016:

If high = highest(h,20) then buy this bar at close;

setstoploss(600);

setexitonclose;

Here are the results:

Net Profit: $79,440

Profit factor: 1.17

Avg. Trade: $36.52

Max Drawdown (close to close): $12,650

Net Profit / Max DD: 6.28

Number of trades: 2175

Now let’s move to the implementation of a very simple Market Internals condition that is based on the following rules:

  • Calculate the difference between UVOL and DVOL,
  • Calculate a 30 bar simple moving average of this difference,
  • If the UVOL-DVOL difference is above the moving average of the UVOL-DVOL difference AND high = highest(h,20), a Long position is opened,
  • The position is closed by the end of the day or when the 600 USD stop-loss is hit.

In a moment, I will show you the outcome of the application of this code to the original system. But first, I need to mention that I have used several small add-ons, like for example, taking into consideration the zero line of the UVOL-DVOL difference to cancel the “Super Filter” in certain situations – all of this is included in the code and the workspace that you can download at the end of this article. Yet the basic idea is exactly as I have described it – to work with the UVOL-DVOL difference and with the moving average of this difference.

Let’s take a look at the results after application of the Market Internals “Super filter”. First, the performance report:

Net Profit: $76,000

Profit factor: 1.38

Avg. Trade: $63.81

Max Drawdown (close to close): $7,790

Net Profit / Max DD: 9.76

Number of trades: 1191

And finally, the comparison table showing the results before and after the application of the Market Internals based “Super Filter”.

Metric / Before MI / After MI / Improvement

Net Profit / 79,440 / 76,000 / -4.3%

Profit Factor / 1.17 / 1.38 / +17.9%

Avg. Trade / 36.52 / 63.81 / +74.7%

Max DD (C-to-C) / 12,650 / 7,790 / -36.8%

Net Profit Max DD / 6.28 / 9.76 / +55.4%

Trades / 2175 / 1191 / -45.2%

I believe that the numbers speak for themselves – maximum drawdown has improved by almost 40% (36.8%), Average trade by +74.8%, and the Net Profit to Maximum DD ratio by +55.4%. All really great improvements, and I see similar improvements of Market Internals very often.

Conclusion

I have been using Market Internals for my own trading since 2014.

Here is what I have generally achieved by implementing them into my own trading strategies:

  • Reduce max. Drawdown
  • Improve Avg. Trade
  • Improve Net Profit / Max DD ratio
  • Smoother equity curve
  • Overall improvement of portfolio performance
  • Getting additional psychological confidence by knowing that I only trade in highly favorable market conditions.

I was really surprised that Market Internals are used by so few traders, yet, when I present them the Market Internals possibilities, they usually get quite excited and implement it to their own trading systems with instant positive impact.

This is exactly the reason why I like them and encourage all traders to investigate them further.

Supernatural Marketing

“Make the HEART of this people fat, and make their EARS heavy, and shut their eyes; lest they see with their EYES, and hear with their ears, and understand with their heart, and convert, and be healed” Isa 6:10

“For this people’s HEART is waxed gross, and their EARS are dull of hearing, and their eyes they have closed; lest at any time they should see with their eyes, and hear with their ears, and should understand with their heart, and should be converted, and I should heal them” Mat 13:15

There are three dimensions of marketing: FrontDoor Marketing, BackDoor Marketing, and Supernatural Marketing. Much of what is known and practiced in the marketplace is FrontDoor Marketing! Very little is known of BackDoor Marketing and much less is known of Supernatural Marketing! In marketing generally, the “Eyes,” “Ears,” and “Heart,” of potential customers are the major targets of all marketing efforts!

These three targets hold the key to prosperity and lack for businesses and their products and/or services in the marketplace! If these three important targets of your potential customers are closed against your products and/or services, you and your business will suffer neglect, lack, insignificance, and poverty in the marketplace! Conversely, if these three targets are opened in favour of your products and/or services, you and your business will enjoy unprecedented patronage, abundance, significance, and prosperity!

Satan has a mandate to close the “Eyes,” “Ears,” and “Heart,” of potential customers/clients in the marketplace against your business, products and/or services because you are a Christian doing business in the marketplace! This explains why many Christians struggle with business in the marketplace! Supernatural Marketing seeks to help Christians doing business in the marketplace to overcome this siege of the devil.

Why The Ears, Eyes & Heart Of Your Potential Customer Is So Important!

There are six fundamental reasons why the Ears, Eyes & Heart Of Your Potential Customer Is So Important!

Let’s check them out!

1. VISIBILITY

The first purpose of marketing is “Visibility.” Marketing makes your product or service perceptible or noticeable to the eyes, ears, and mind of your targeted client or customer, depending on the medium you employ. The eyes and ears are gates to the “Mind” of man. The more people see or hear about your product or service, the more it is ingrained into their mind until it is deep-rooted. Because your product or service is a seed at this initial stage of marketing, it soon begins to germinate when your marketing efforts is sustained.

If an organization sustains its marketing effort, before long, it would bear fruit. Take note, human response rate differ according to their personality. The reserved (introverts) ones are laggards, they are naturally inclined to foot-dragging. In contrast, the outgoing ones (extroverts) are naturally inclined to respond first to your marketing effort.

The above reasoning presupposes that if you do not embark on a sustained, focused, and targeted marketing, the public will be oblivious of your product and services and that could translates into eventual stagnation or collapse of your business.

2. AWARENESS

Visibility of your product or service in the mind of your targeted customer over time creates a consciousness or awareness in the “Heart” of your targeted customers when sustained and spirited marketing is the watchword. Remember, conviction takes place in the heart. Until the customer is convinced in his or her heart to accept your product and service, there will not be patronage and repeated buying, which is the goal of every entrepreneur.

When you emphasis the unique value proposition or unique selling point of your product or service long enough through sustained marketing, your target group will understand its usefulness and this is how a market buzz and frenzy is created.

When the public are persuaded in their heart that your product or service is the first and best choice, they’ll respond voluntarily and positively to your organization’s offerings and that is what eventually attract your clients to you, when he or she have “Genuine” need of your product or service.

3. CONVICTION

When your product or service is projected strong enough in the minds of your target customers through sustained marketing; it gets ingrained in their minds! After sometime, because the product or service remains constantly in focus, he begins to believe the benefits of the product or service is real. It won’t take long before he receives a suggestion from his mind to give the product or service a try.

Unconsciously, the customer has accepted the product or service because of the conviction in his mind that the product or service is worth giving it a try. Now, at this point, if the product or service is worth its salt, when the customer gives a try, he is convinced that the product or service is worth it. When the customer makes another effort to patronize the product or service again, he will be hooked because in the mouth of two or three witness, every product is established in the heart of the customer!

4. ACCEPTANCE

The resultant effect of visibility, awareness, and conviction of your product or service by your targeted customers is a positive “Mental attitude” – created by the Holy Spirit – that your product or service is believable, credible, and trustworthy and therefore, the customers accepts it as true and eventually prefers it above other products and services.

The question you want to ask yourself is, when people generally think of using the kind of product or service you are offering on a scale of 1 to 3, where does your offering stand. Instructively, the product or service that occupies the first two rungs of the scale will be more favoured in the order of their standing. It is your responsibility to get your product or service to this position!

Assuming the product you’re offering in the marketplace is a detergent and we have 50 potential customers in your “Coverage area” – and that varies in scope – that wants to buy one each. When they think in their mind of the best and preferred detergent to buy, where does your company’s brand stand in their mind? Where your brand stands in their minds, will be determined by three factors: the quality of your marketing, the quality of your product, and your customer service.

5. BRANDING

Sustained marketing gives your product or service a positive flight that galvanize it above others in your industry. Persistent marketing ingrain your brand permanently in the heart of your target customers. When the image or brand identification is ingrained in the hearts of your targeted customers; after they’ve used your product or service and found it satisfactory, they’d over time become habituated to it, which makes it a first choice in their decision making process.

6. SPREAD

When steps, 1-5 assumes a rhythmic flow in your business efficiency and effectiveness, your products and services will begin to find its way to more home, hands, and families. Over time, your product or service distribution begins to expand and extend over a wide sphere due to visibility, awareness, conviction, acceptance, and branding.

Your customers will begin to do word of mouth publicity of your products and services to friends, neighbours, and family. This is because they are satisfied with your product or service, because they believe that your organization have delivered on its promises!

Why Inexperience Will Cause Newbie Internet Marketers to Fail

Failure. The one thing all Internet marketers never want to hear. And that is understandable Nobody wants to fail, right?

I have researched some of the reasons why most newbie internet marketers fail. In this article, you may identify yourself – or others you know. This article is not meant to be one of condemnation. It is being delivered so you can identify what areas you can improve and avoid the dreaded “F” word!

First, let me state up front that I mean nothing derogatory with the term “newbie.” Everyone was a newbie at some point in time. It is kind of like being a called a “rookie” in major league sports. Once you have that first year under your belt, you are no longer a rookie. The same for internet marketing. However, a “newbie” could mean a 5 year marketer if that person continues to make “rookie mistakes.” I am using the term “newbie” simply because most new comers to internet marketing are looking for the “quick buck” and most tend to make the same mistakes – “rookie mistakes.”

It is my intention to provide you with the information I have discovered and identified my own shortcoming with as well. I may not have made all of the mistakes I will get into, but I have made more than one of them (I can attest to that)! But I am including a few of the others I have not made (phew!) because I have found there are many people who have made them.

The Number 1 Reason Why Newbie Internet Marketers Fail:

They Do Not Have the Experience

That is pretty clear, right?

Most newbies lack the experience of marketing a product in which they never have a face to face interaction with their clients. Most people understand about face-to-face marketing and the art of “smiling, agreeing with the statements made by the customer, etc.” Internet marketing is a completely different environment.

Experience in this area is the only way to gain the skill set necessary to be successful. Does that mean the newbie marketer is already destined to fail? No. It means the newbie marketer must make the extra effort to ensure success.

By learning the methods needed to capture the attention of the buyer; learning what the potential preferences are of the buyer; learning the reasons why the buyer desires their product; learning how to communicate the advantages of their product to satisfy the buyer’s needs – all without any verbal interaction. Only using the written word (and in audio or video marketing as well – but the newbie will never “see” the client).

This means the new internet marketer must make a concentrated effort to study the market; study the products; study the tactics used by the experts. This takes time and dedication. It means admitting you do not know everything. It means admitting you cannot do it on your own (as least not right away). It means accepting the fact that immediate riches will probably not be flooding into your back account right way.

Now, there are exceptions to every rule. But those exceptions are few and far between. But most newbie marketers (myself included when I first started out) think “they” will be the exception and will reach financial independence ahead of their peers. This mindset will almost always result in discouragement and failure.

What are the ways to overcome this “Inexperience Factor?”

Probably the best way to gain experience is by “doing.” That sounds simple enough, right? But let me explain…

The worst thing a newbie can do is to enter the highly competitive field of internet marketing and think he or she is going to become rich overnight while competing against some marketers who have been doing this for years. The best solution to this situation is to team up with an experienced marketer who can guide them through the first stages of internet marketing and help the newbie avoid some of the pitfalls that plague newbies and drive them from success straight into failure.

There are numerous places to gain that type of experience and information. It would take volumes to write about each one. My intent here is simply to make the newbie marketer aware that “you are not destined to failure.” As a matter of fact, failure in and of itself is also a learning tool. Thomas Edison was quoted as saying, when questioned by a reporter as to why he was not discouraged after failing 10,000 times in making the light bulb, his answer was, “Why should I be discouraged? I found 10,000 ways it would not work!”

So it is with gaining experience in internet marketing. You can go the way of 10,000 failures on your own, just so you know not to try it that way again, or you can read about the one or two ways a person who has had success did it and then follow the same path. I’m not talking about “copying” the person (though some advocate that). I’m talking about seeing what your comfort zone is; I’m talking about what “clicks” with your personality, experiences, desires and goals.

Not every method works for every person. If you examine successful marketers, almost all of them utilize the fundamentals but then they tend to specialize in certain areas. Take, for example, a football team. You see the players all decked out in their uniforms and you can rationally say about any one individual, “He is a football player.” And that statement would be true.

But if you look at the individual players and analyze their strengths and weaknesses, you soon realize that some of them weigh 300+ pounds. That person probably is not a wide receiver or a running back. Most likely, he is a lineman. Another is short and lanky and you see him out kicking field goals all practice long. You see a player throwing balls through tires hung at different levels and different yardages – he is probably a quarterback. Each person has a unique set of skills they bring to the “football team.”

So it is with internet marketing. You may not be cut out to be a marketer in the self-help niche. You may be more of a hands on type of person who enjoys working on cars or building houses, making you uniquely qualified to assist others in that niche. People looking for information on “How to fix their car” or “How to remodel their kitchen.” Others may be more uniquely qualified to give “relationship advice.” Others on “How to build a website.”

You see, there are 1,001 different ways (actually more than that) to make a living as an online marketer. YOU have a special skill set that somebody needs to know. And you have the opportunity to share the experience you already possess in that area – and be paid for it! You need to sit down and ask yourself (and give an honest answer), “What do I know that other people always ask me about?”

It could be anything from repairing a clogged drain to fixing a car engine; from hanging dry wall to installing landscaping. Whatever you enjoy doing; whatever you are always helping someone with; whatever people are always seeking your advice on – these are the areas you need to focus. This is probably going to be your niche market. This is the area you will probably be the most successful.

The successful marketers are able to identify what they did wrong and begin to take corrective action to put them on the path to success. Failure to identify weak areas will just mean the marketer is more likely to repeat the same mistakes over and over again.