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Bulkowski on The Kacher-Morales Setup

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Written by and copyright © 2005-2019 by Thomas N. Bulkowski. All rights reserved. Disclaimer: You alone are responsible for your investment decisions. See Privacy/Disclaimer for more information. Some pattern names are the registered trademarks of their respective owners.

Kacher-Morales Setup Summary

I don't recommend this setup, but test it for yourself and make up your own mind.

Kacher-Morales Setup Backstory

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The December 2010 issue of Active Trader magazine had an article by Kacher and Morales titled, "Trading gaps with the most potential," that discussed a trading setup to take advantage of gaps on the price chart.

Every time I test an idea from a magazine, I hope that it will prove to be an exciting setup, one that works often and has a high probability of winning, making lots of money. I haven't found one that meets those criteria or even comes that close.

Kacher-Morales Setup Results Overview

This is one such setup. Here are the results.

Average gain ranges between 1.2% and 3.1%
Win/loss ratio ranges between 28% and 32%
Average drawdown: 5.5% to 8.9%
Hold time: 29 to 43 days

I ran 16 different tests and that's what I found. In other words, I was disappointed. I don't like that you're losing two out of every three trades and the 3.1% gain includes stocks priced below $5. That's not a range that most would call "quality," but after a stock splits, the historical price can be that low.

Insteel Industries in that test made $78,000, boosting the performance of the group when it climbed from 73 cents to $6.45 in 2004. Removing that stock and the average gain drops from 3.1% to 2.6%, and that test setup includes 1,504 trades. In other words, that one stock was a huge contributor to performance.

Kacher-Morales Setup Trading Rules

Here are my interpretations of their trading rules:

  1. Find up gaps in stocks that are at least 75% of the 40-day average true range (ATR)
  2. Volume on the day price gaps higher must be at least 1.5 times the 50-day average.
  3. The stock must be trending upward, or breaking out of a consolidation area several days or weeks long.
  4. "The up gap should occur in a constructive, fundamentally sound, leading stock."
  5. Sell if price closes below the low posted on the day price gaps up.
  6. Violates (used below) is defined as price closing below the simple moving average (SMA) and the coming day(s) sees price make a lower low than that posted when price closed below the SMA. This rule applies to both the 10-day and 50-day SMA.
  7. Sell if price violates a 10-day SMA providing the trade has lasted at least 7 weeks. If less than 7 weeks, look for a violation of the 50-day SMA.
  8. Exceptions to the prior selling rule are: The stock is in the semiconductor, retail, or commodities (like oil, precious metals) industries or it has a market cap greater than $5 billion.
  9. If those exceptions apply, use a violation of the 50-day SMA to sell.

I did not test the breakout from consolidation areas as outlined in step 3. I used linear regression of the price trend leading to the gap as a trend determiner, from 5 days to 40.

I have no idea how you'd test step 4 unless you're William O'Neil and have the resources of his newspaper. I didn't bother with the step.

For step 8, I excluded 13 industries along the lines suggested, such as integrated petroleum, aluminum, natural gas distributors, and so on. By "excluded," I mean they use the 50-day SMA instead of the 10-day. I also didn't "exclude" large cap stocks.

Since the authors didn't provide test results, I had nothing to compare against. I could have coded the setup wrong, and as described above, my test did not replicate theirs anyway.

Having said all that, I used 557 stocks in the test with daily price data from March 12, 2001 to October 1, 2010. Those two end points leave the S&P 500 index near the same price.

I didn't change their parameters. Rather, I deleted their rules to see what effect they would have. Having volume or not didn't change the results much. The rule to wait for price to make a lower low after a violation of the moving average sounded like a good idea but it made results worse. Go figure. That's step 6. I tested just selling the day after price closed below the moving average. I found that when price trended downward leading to the start of the gap, it produced better results. After playing with the obvious rule deletions, and seeing that performance didn't change much, I decided to get back to writing my book. That's another two days of my life I can't get back...

-- Thomas Bulkowski


See Also

Written by and copyright © 2005-2019 by Thomas N. Bulkowski. All rights reserved. Disclaimer: You alone are responsible for your investment decisions. See Privacy/Disclaimer for more information. Some pattern names are the registered trademarks of their respective owners. Cannibal: A guy who goes into a restaurant and orders the waiter.