StockIndexFuturesTradingCollection-M[1]

STOCK INDEX FUTURES TRADING COLLECTION “Using the TICK to identify the intraday trend” by David Bean (Active Trader, May 2006).

“Counterpunch stock index futures system"

by Active Trader Staff (Active Trader, Nov. 2002) “Extreme open-close days”

by Xavier Maria Raj (Active Trader, April 2005). “The Fibonacci Swing Filter”

by Gomu Vetrivel (Active Trader, Feb. 2005). “Trading the opening gap”

by John Carter (Active Trader, Dec. 2004). “Hitting the street: The S&P 500 futures' intraday reactions to economic reports” by David Bukey (Active Trader, May 2005).

“Sector vs. index: The single stock futures-Dow spread” by Keith Schap (Active Trader, Nov. 2005).

“Trading the basis: How stock index arbitrage impacts the market” by David Lerman (Active Trader, March 2003). “Stock index spreads: S&P vs. Naz”

by Keith Schap (Active Trader, May 2006). “The multibar range breakout system”

by Dennis Meyers, PH.D. (Active Trader, Jan. 2004). “Following through in the S&Ps”

by Thom Hartle (Active Trader, Dec. 2003). “Getting in on follow-through days”

by Thom Hartle (Active Trader, Jan. 2004). “Follow-through in the E-Mini Nasdaq 100” by Thom Hartle (Active Trader, Aug. 2004).

“Up-down volume and next-day follow-through” by Thom Hartle (Active Trader, Dec. 2004).

“E-Mini morning reversal and afternoon breakout patterns” by Gomu Vetrivel (Active Trader, Jan. 2006). “The telltale spread”

by Thom Hartle (Active Trader, Nov. 2003).

2 7 9

13 17 21 27 31 35 39 44 49 54 60 66 70

TRADING Strategies

Using the TICK

TO IDENTIFY THE INTRADAY TREND Analyzing TICK readings over the past five years provides the foundation for an intraday trend strategy. BY DAVID BEAN

T

he TICK indicator measures intraday momentum in New York Stock Exchange (NYSE) stocks by tracking the difference between upticking stocks (last price higher than previous price) and downticking stocks (last price lower

than previous price). The TICK subtracts the number of downticking stocks from the number of upticking ones to generate a momentum snapshot of the market at any given time. For example, if at 10 a.m. 2,000 stocks were trading higher than their previous

FIGURE 1 FIVE-YEAR AVERAGE NYSE VOLUME (15-MINUTE INTERVALS) The second-largest NYSE volume occurred in the first 15 minutes of trading, which is a good time to determine the daily trend because price moves are more meaningful when backed by large volume.

prices while 1,500 stocks were trading lower than their previous prices, the TICK value would be +500 (2,000-1,500). Traders typically use the TICK indicator to gauge the level of buying or selling pressure throughout the day. If the TICK reading is high, the market is showing “internal” strength, which is different from the “outward” price movement. According to popular interpretation, TICK levels that correspond with price action help confirm the market’s direction, but TICK values that diverge from price can warn of possible reversals. For example, a typical bullish signal occurs when the S&P 500 is climbing when the TICK is positive (or trending higher). However, if the S&P 500 is rising but the TICK turns negative (or trends lower), the rally could be nearing its end. (For more information on the TICK, see “TICK basics.”)

From analysis to trading

This kind of analysis depends on logically defining “high” or “low” TICK readings. The following study analyzed intraday TICK behavior in the past five years to find potentially bullish and bearish TICK levels. However, the resulting trade strategy also relied on NYSE volume analysis and price action to confirm the intraday trend and gener2

www.activetradermag.com • May 2006 • ACTIVE TRADER

TABLE 1 FIVE-YEAR TICK STATS

ate trade signals. The focus was on the first 15 minutes of the daily trade session because over the past five years the NYSE’s secondlargest volume has occurred during this period. Above-average TICK readings generate buy signals at 9:45 a.m. ET. By contrast, sell signals require below-average TICK readings along with downward price moves (gaps or weakness) within the first 15 minutes. The logic of this approach is that highvolume periods combined with price moves and TICK readings in the same direction help determine the trend for the rest of the day.

Trend clues at market’s open

Figure 1 shows the NYSE’s average volume of more than 3,700 stocks in 15minute intervals from 9:30 a.m. to 4 p.m. ET over the past five years. While volume is highest in the last 15 minutes of trading, the second-highest volume occurred in the first 15 minutes of the regular session — from 9:30 a.m. to 9:45 a.m. The day’s open and close stand out because institutional traders must execute large amounts of market-on-open and market-on-close orders; the price moves that occur during these periods can leave clues about the market’s likely direction. Although you can trade stocks and stock-index futures in the afterhours electronic market, those markets offer very little volume to offset positions against overnight breaking news while the U.S. stock market is closed for 17.5 hours.

Defining TICK thresholds

Table 1 shows statistics behind the TICK indicator’s historical behavior over the past five years. Overall, the TICK had a bullish bias. The average daily TICK high was nearly twice as large as the daily low (+1,007 vs. -673). Also, the TICK’s average close after 15 minutes was not only above zero (+201) but exceeded +300 almost six times as often as it fell below -300. Buy and sell signals

must take this upside bias into account. The strategy’s bullish and bearish thresholds are based on the TICK’s average close of +201 after 15 minutes. There are thresholds for both high and low readings as well as for where the TICK closes. The high and low thresholds are +750 and -350, which are approximately +/-550 from the average close of +201; the closing TICK thresholds are +500 and -100, which are approximately +/- 300 from the average close of +201. This means the TICK is bullish if it either reaches +750 within the first 15 minutes of trading or closes above +500 at 9:45 a.m. Similarly, the TICK is bearish if it drops below -350 within the first 15

The TICK has had a bullish bias over the past five years. Its average daily high is nearly double its daily low, its average close every 15 minutes was +201, and it exceeded +300 nearly six times as often as it dropped below -300 (based on 15-minute intervals). TICK value

Five-year high:

+1,541

Avg. daily high:

+1,007

Five-year low:

Avg. daily low:

Avg. closing value after 15 minutes:

No. of 15-minute closes above +300: No. of 15-minute closes below -300:

-1,495 -673

+201 12,855 2,262

T

TICK basics he TICK is a very short-term (intraday) indicator that measures the bullish (upticking) or bearish (downticking) activity in NYSE stocks throughout the day. TIKI is the symbol for the same indicator calculated on Dow Jones Industrial Average stocks; some data services also supply the TICK calculated on Nasdaq stocks. The TICK is a breadth indicator that gives traders an intraday look at the “internal” strength or weakness of the market — that is, the strength or weakness beyond whether the overall market is up on a point or percentage basis. By comparing the number of stocks advancing to stocks declining, the indicator reflects the market’s up or down momentum at a given moment. For example, if the S&P 500 index is up marginally but downticking stocks are consistently outnumbering upticking stocks (and the number of downticking stocks is increasing, reflected by a downtrending TICK indicator), it is likely that only a relative handful of strong stocks are propping up the overall market. When buying completes in these stocks, a down move may result. Two contrarian uses of the TICK indicator are to look for divergence between price and the indicator, and to use high or low TICK readings to identify momentum extremes (similar to how many traders use oscillators like the relative strength index or stochastics to locate overbought and oversold points). A divergence occurs when price makes a new high (or low) but the TICK makes a lower high (or higher low), failing to confirm the price move and warning of a slackening of momentum and potential stall or reversal. A similar phenomenon would be a steady trend in the TICK that runs counter to the trend of the market. Extreme high or low TICK readings sometimes accompany market climaxes. Because the TICK is a snapshot of the market at a given moment (and is thus very volatile), it can be deceptive. Because of this, the TICK is commonly smoothed with a 10-period moving average to remove some of the “noise” and better reveal the indicator’s direction and patterns.

ACTIVE TRADER • May 2006 • www.activetradermag.com

3

Strategy code

Tradestation EasyLanguage Code {Data1 is @ES.D or any of the following: @ER2.D, @YM.D, @NQ.D, @EMD.D Data2 is $TICK. Both Data1 and Data2 are 15 minute charts – a custom session should be built for @YM.D to trade between 8:30 am CST and 3:15 pm CST instead of starting at 7:20 am CST. *there are 27, 15 minute bars in the trading day} Inputs: R(5), L1(27); If Time=945 and H of data2 > 750 and L of data2 > -350 Then Buy Next Bar at market; If Time=945 and C of data2 > 500 and L of data2 > -350 Then Buy Next Bar at market; If Time=945 and Open > LowD(1) - 2*Average(Range,27) and L of data2 < -350 and H of data2 < 750 Then Sell Short Next Bar at OpenD(0) Limit; If Time=945 and Open > LowD(1) - 2*Average(Range,27) and C of data2 < -100 and H of data2 < 750 Then Sell Short Next Bar at OpenD(0) Limit; If Time=945 and C > C[1] and L of data2 < -350 and H of data2 < 750 Then Sell Short Next Bar at CloseD(1) Stop; If Time=945 and C > C[1] and C of data2 < -100 and H of data2 < 750 Then Sell Short Next Bar at CloseD(1) Stop; If Time=945 and C>(O + Average(Range,27)) and L of data2 > -350 Then Buy Next Bar at market; If Time=945 and C -350, buy at the market.

There are three long-entry and five short-entry rules. Although each rule is independent, meaning it could be tested individually, all eight rules are combined to make a single system designed to trade the S&P 500 E-Mini futures (ES). The rules were also tested on the Russell 2000 E-Mini (ER2), Midcap 400 E-Mini (EMD), Mini Dow (YM), and Nasdaq 100 E-Mini (NQ).

3. If the close of the first 15-minute bar > the open + the average range (high - low) of all 27 of yesterday’s 15-minute bars, and the TICK’s low > -350, buy at the market.

Trade rules

Long entries (at 9:45 a.m. ET): 1. If the TICK’s high > +750 and the TICK’s low > -350, buy at the market. 2. If the TICK’s close > +500 and the 4

Short entries (at 9:45 a.m. ET): 1. If today’s open > yesterday’s low (2 * the average range of all 27 of yesterday’s 15-minute bars), the TICK’s low < -350, and the TICK’s high < +750, sell short for the next 15 minutes (until 10 a.m.) at today’s open (limit). 2. If today’s open > yesterday’s low (2 * the average range of all 27 of

yesterday’s 15-minute bars), the TICK’s close < -100, and TICK’s high < +750, sell short for the next 15 minutes (until 10 a.m.) at today’s open (limit). 3. If the close of the first 15-minute bar > the previous day’s close, the TICK’s low < -350, and the TICK’s high < +750, sell short for the next 15 minutes (until 10 a.m.) at yesterday’s close (stop). 4. If the close of the first 15-minute bar > the previous day’s close, the TICK’s close < -100, and the TICK’s high < +750, sell short the next 15 minutes (until 10 a.m.) at yesterday’s close (stop). 5. If the close of the first 15-minute bar < the open - the average range of all 27 of yesterday’s 15-minute bars and the TICK’s high < 750, then sell short at the market. Exit: 1. Stop-loss = R * contract’s point value * average range of all 27 previous 15-minute bars since the same time yesterday. (R = multiplier that can be optimized for each market or risk preference; default = 5.) 2. Exit on close if still in market.

Trade logic

All eight signals are based on TICK behavior and price direction within the first 15 minutes of trading. Two of the three long rules focus solely on exceeding TICK’s bullish thresholds and staying above its bearish ones. Also, four of the five short rules require TICK to penetrate the bearish levels as it stays below the bullish ones. The other two rules don’t wait for either TICK threshold to be met. To trigger a buy signal, price must climb further than the average range of all of yesterday’s 15-minute bars (long rule 3), or price must drop the same distance before selling short (short rule 5).

www.activetradermag.com • May 2006 • ACTIVE TRADER

below yesterday’s close, the strategy sells short with a limit order at today’s open in the second 15 minutes. That gap, however, must be smaller than twice the average range of yesterday’s 15-minute bars. The stop-loss depends on the average range of FIGURE 2 TRADE EXAMPLE yesterday’s 15-minute bars, the contract’s point value, The S&P 500 E-Mini fell slightly on Feb. 2, and the TICK low (-383) was bearish by 9:45 and a multiplier (R) to a.m. because it dropped below the lower threshold (-350). The system sold short at adjust the stop size. If that 1,284, and the S&P E-Mini sold off throughout the day — a gain of 12.75 points. stop-loss isn’t hit, the system holds the trade until the end of the day to let profits run.

However, these rules still require the TICK to remain above its average low (-350) or below its average high (+750), respectively. The first four short rules must be executed using stop or limit orders. For

example, if price climbs above yesterday’s close by 9:45 a.m., it must drop back to that point before the system sells short with a stop order in the second 15 minutes of the trading session (until 10 a.m.). Also, if the opening price gaps

Trade example

Figure 2 shows a 15-minute chart of the March 2006 S&P 500 E-Mini futures (ESH06) on Feb. 2. The market dropped slightly at the open, and the TICK readings at 9:45 a.m. were low (-383), high (+125), and close (+99). The S&P 500 had a short bias because the TICK’s low was below the bearish threshold of -350 and its high was below the bullish level of +750. The system placed a limit order at 9:45 a.m. at the E-Mini’s opening price (1,284.00), and the S&P 500

Source: Tradestation 8.1

TABLE 2 OVERALL TEST RESULTS

The strategy was profitable across the major indices in different time periods. All markets had a favorable percentage of gains, and all but one had average profits per trade of at least $54.72. However, the Nasdaq 100 didn’t perform as well. Start date E-Mini S&P 500

9/11/97

E-Mini Russell 2000 11/7/01 E-Mini Midcap 400 1/28/02 E-Mini Nasdaq 100

Mini Dow

5

7/1/99

7/28/02

No. of trades

Profit

1,128 $67,237.50 726 709

$42,990.00 $38,800.00

1,006 $14,160.00 579

$37,910.00

Drawdown Percentage Avg. profitable profit per trade

$10,637.50

53.90%

$59.61

$4,760.00

52.47%

$54.72

$6,280.00

$23,760.00 $3,520.00

52.75%

51.29%

56.82%

$59.21

$14.08

$65.47

Profit Avg. factor winning trade 1.33

-$393.90

1.31

-$400.74

$401.53

-$338.13

$454.73

1.05

$529.22

1.60

Ratio avg. win/ avg. loss

$444.10

1.33 1.35

Avg. losing trade

$307.39

-$549.72

-$259.10

1.11

1.19

0.96

1.19

www.activetradermag.com • May 2006 • ACTIVE TRADER

TABLE 3 TEST RESULTS: JAN. 1, 2003 TO FEB. 1, 2006

Performance suffered slightly in this second test because the markets’ daily ranges narrowed in the past three years. However, most markets remained profitable even if you consider slippage and commission costs (not included). Profit

No. of trades

Drawdown

E-Mini S&P 500

$20,112.50

477

$3,012.50

E-Mini Midcap 400

$23,360.00

553

$4,760.00

E-Mini Russell 2000 E-Mini Nasdaq 100 Mini Dow

$28,690.00 $7,670.00

$19,815.00

534

$6,280.00

511

$3,530.00

498

hit this price between 9:45 a.m. and 10 a.m., going short 0.25 points from the day’s high. The market sold off throughout the day, and the system exited at the close (1,271.25) for a 12.75-point gain. The Russell 2000 E-Mini, Midcap 400 E-Mini, and mini Dow all took similar trades as each of these markets climbed back to the open and then dropped. No trade was triggered in the Nasdaq 100 EMini because this market didn’t trade back to the open.

$3,520.00

Percentage Avg. profitable profit per trade 53.67%

$42.16

1.35

52.80%

$42.24

1.28

52.81% 51.86%

55.22%

$53.73 $15.01

$39.79

Test results

The TICK strategy was tested on historical intraday price data going back at least three years in the S&P 500 E-Mini futures, Russell 2000 E-Mini, Midcap 400 E-Mini, Mini Dow, and Nasdaq 100 EMini. Table 2 (p. 5) shows results for each index in different time periods from Sept. 11, 1997 to Feb. 1, 2006. For comparison purposes, each index was also tested over the same time period — Jan. 1, 2003 to Feb. 1, 2006 (Table

Related reading “The Crown pattern” Active Trader, January 2004. Here’s a way to use some specific calculations to improve the odds of trading a variation of a classic chart pattern — on an intraday basis. “Intraday trading with the TICK” Active Trader, April 2002. Find out how the TICK indicator can complement other trading tools in identify low-risk trades. Here’s how one trader combines the TICK with support and resistance analysis and retracement levels. “Indicator insight: TICK/TIKI” Active Trader, March 2001. How to calculate and interpret the TICK, a popular short-term indicator that measures intraday buying and selling pressure. You can purchase and download past articles at www.activetradermag.com/purchase_articles.htm.

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Profit factor 1.30 1.14

1.38

Avg. winning trade

Avg. losing trade

Ratio avg. win/ avg. loss

-$392.36

1.13

$304.35

-$270.09

$363.97

-$325.18

$444.01 $231.25

$262.56

-$228.13

-$241.43

1.13 1.12

1.01

1.09

3). Comparing Tables 2 and 3 shows that although the average profit per trade dropped in recent years, the average trade is still large enough (at least $39.79) to make money after slippage and commission costs. (The Nasdaq 100 E-Mini’s average profit of $15.21 was the exception to this rule.) Average profits fell because the markets’ daily ranges have decreased in recent years. The system trades often — roughly three times a week in each market over the past three years, or 500 trades in 750 trading days. Overall, the system caught roughly 10 percent of the S&P 500’s 50-day average daily trend. For example, if the S&P E-Mini has a 10-point daily range, and the system captures 10 percent of it, then its average profit is one point ($50). This roughly matches the system’s average profit in the S&P 500 in both time periods. (As of Feb. 1, the S&P E-Mini’s 50-day average range was 9.84 points.)

Further research

One idea that deserves additional attention is to sell rallies short when the TICK signals a downtrend, or buy dips after it signals an uptrend at 9:45 a.m. Instead of trading just one contract after any of the eight rules signal a trade, you could trade multiple contracts (e.g., one for each signal). However, you’d have to limit short positions to three to balance the size of long and short trades in the market.Ý

www.activetradermag.com • May 2006 • ACTIVE TRADER

&

FUTURES

Trading System Lab

OPTIONS

Markets: Stock index futures.

EQUITY CURVE 3,000,000 2,500,000

Account balance ($)

Counterpunch stock index futures system

2,000,000

System logic: This is basically the same countertrend 1,500,000 system tested on the Dow Jones stocks in the equity Trading System Lab. The only difference is the system 1,000,000 trades the futures markets in this test a little more aggressively: There are only three markets (the S&P 500, 500,000 Nasdaq and Dow futures), and the lower margin requirements of futures mean less money is tied up in 0 each position. 1/1/93 1/1/94 1/1/95 1/1/96 1/1/97 1/1/98 1/1/99 1/1/00 1/1/01 1/1/02 As a result, when a trade reaches an initial exit level (see Rules, below) the system will exit only one-third of the posi- determined by the following formula: tion; the remaining two-thirds will be exited upon reaching the second exit level. (By comparison, the stock system exited trades in CT = AC * PR / 4TR two equal portions.) However, the actual rules for where and when where AC = Available capital to enter and exit are the same. Two-thirds of the position is left open because the trailing stop PR = Percent risked generates profits that are a tad better and more reliable than the 4TR = Four times the true range for the day preceding the entry simple stop-loss exit. Had the stop-loss exit turned out to be the more reliable of the two, the relationships would have been Test period: January 1993 to July 2002. reversed. This is simply a way to make the most of the statistical traits of the system while limiting losses and locking in profits. Test data: Daily prices for the S&P 500, Nasdaq 100 and Dow (This approach was not used for the stock system because the same Jones Industrial Average futures contracts. $25 deducted for sliprelationship wasn’t as clear. Also, the original position is smaller for page and commission per contract traded. stocks, which makes trading in smaller and uneven-sized increStarting equity: $1 million (nominal). ments, i.e., thirds or quarters, etc., less feasible.) Test results: The system did not fare as well on futures as it did Rules: 1. Go long tomorrow on the open if a) today’s close is below both on individual stocks. However, there are a few reasons for this yesterday’s close and the close of the previous week, b) yesterday’s that, when examined, make the results more understandable. (For close is below the previous day’s close and c) the close of the previous SAMPLE TRADES week is below the close of the week 10,400.00 Dow Jones Industrial (DJ), daily before that. L-trail L-trail 2. Exit one-third of the position with 10,200.00 L-trail a loss if the trade goes against you by L-trail L-trail 10,000.00 1 percent. Go long 3. Exit one-third of the position with 9,800.00 Go long L-trail a profit if the trade goes your way by 9,600.00 Go long Go long 4 percent. Go long 9,400.00 4. Exit two-thirds of the position L-trail with a profit or loss if the trade Go long 9,200.00 moves 1.6 percent away from your Go short Go short 9,000.00 Go long maximum open profit (i.e., use a trailing stop 1.6 percent away from the 8,800.00 high of the trade). L-trail 8,600.00 5. Exit two-thirds of the position S-trail with a profit if the trade goes your 8,400.00 way by 4.5 percent. L-trail S-target 8,200.00 6. Exit the entire position after eight days in the trade. 8,000.00 Reverse the rules for short trades. Money management: Risk 6 percent of available equity per market. The number of contracts to trade (CT) is 7

Go long 20 27 June Source: Omega Research ProSuite

10

17

24

July

8

15

22

7,800.00 Go long 29

August

7,600.00

www.activetradermag.com • November 2002 • ACTIVE TRADER

DRAWDOWN CURVE 1/1/93 0%

1/1/94

1/1/95

1/1/96

1/1/97

1/1/98

1/1/99

1/1/00

1/1/01

-5% -10% -15% -20% -25% -30% -35%

one thing, the amazing results from the stock test make comparisons a little unfair.) The equity chart reveals the results for the futures markets really didn’t start to take off until late 1997 — almost halfway through the testing period. The big reason for this is that up until late 1996, the S&P 500 was the only tradable market. Trading in the other two contracts didn’t begin until late 1996 (Dow) and late 1997 (Nasdaq). If you look at only the second half of the test period, the estimated average annual return would probably be almost twice the 7.87 percent the complete system produced. Adding other (foreign) stock indices to the mix probably would have enhanced results even more by adding a bit of diversification, which would have kept the drawdowns lower. Trading more markets would also have allowed us to trade each market a little less

STRATEGY SUMMARY

Profitability End. equity ($): 2,067,431 Total return (%): 107 Avg. annual ret. (%): 7.87 Profit factor: 1.17 Avg. tied cap (%): 3 Win. months (%): 48 Drawdown Max. DD (%): Longest flat (m):

30.4 44.6

Trade statistics No. trades: 1,258 Avg. trade ($): 849 Avg. DIT: 3.4 Avg. win/loss ($): 15,166 (7,894) Lrg. win/loss ($): 105,730 (57,373) Win. trades (%): 36.3 TIM (%): Tr./Mark./Year: Tr./Month:

70

28.1 21.9 10.9

LEGEND: End. equity ($) — equity at the end of test period • Total return (%) — total percentage return over test period • Avg. annual ret. (%) — average continuously compounded annual return • Profit factor — gross profit/gross loss • Avg. tied cap (%) — average percent of total available capital tied up in open positions • Win. months (%) — percentage profitable months over test period • Max. DD (%) — maximum drop in equity • Longest flat — longest period, in months, spent between two equity highs • No. trades — number of trades • Avg. trade ($) — amount won or lost by the average trade • Avg. DIT— average days in trade • Avg. win/loss ($) — average winning and losing trade, respectively • Lrg. win/loss ($) — largest winning and losing trade, respectively • Win. trades (%) — percent winning trades • TIM (%) — amount of time there is at least one open position for entire portfolio, and each market, respectively • Tr./Mark./Year — trades per market per year • Tr./Month — trades per month for all markets

1/1/02

aggressively, which also would have created smoother equity growth. Speaking of drawdown, note that both the maximum drawdown and flat time for the test period are not related to the current bear market. Instead, they are both a function of the limited trading opportunities in the first part of the test period. Currently, the system is in a 20-percent drawdown, and although that is significant, and much more than most traders can tolerate, it is a far cry from the 80-plus percent decline in equity for a buy-and-hold strategy in the Nasdaq 100 index. Another way to improve the results could be to trade it on other futures markets as well, such as the currencies, energies and interest rates. Because of the system’s short-term nature, it is not suitable for agricultural commodities, which usually need longer trends to produce profits large enough to justify trading (for non-professional traders).Ý

ROLLING TIME WINDOW RETURN ANALYSIS Cumulative

12 months

24 months

36 months

48 months

60 months

36 48 months months

60 months

Most recent: Average: Best: Worst: St. dev.:

-8.30% 9.10% 52.95% -15.56% 15.03%

20.77% 26.18% 75.15% 89.69% 19.44% 31.22% 43.14% 55.41% 86.74% 101.76% 135.61% 147.21% -22.47% -25.96% -17.60% -6.38% 26.07% 37.05% 44.71% 46.18%

Annualized

12 months

24 months

Most recent: Average: Best: Worst: St. dev:

-8.30% 9.10% 52.95% -15.56% 15.03%

9.90% 9.29% 36.36% -11.95% 12.28%

8.06% 9.48% 26.36% -9.53% 11.08%

15.04% 9.38% 23.89% -4.72% 9.68%

13.66% 9.22% 19.84% -1.31% 7.89%

LEGEND: Cumulative returns — Most recent: most recent return from start to end of the respective periods • Average: the average of all cumulative returns from start to end of the respective periods • Best: the best of all cumulative returns from start to end of the respective periods • Worst: the worst of all cumulative returns from start to end of the respective periods • St. dev: the standard deviation of all cumulative returns from start to end of the respective periods Annualized returns — The ending equity as a result of the cumulative returns, raised by 1/n, where n is the respective period in number of years

Send Active Trader your systems

If you have a trading system or idea you’d like tested, send it to us at the Trading System Lab. We’ll test it on a portfolio of stocks or futures (for now, maximum 60 markets, using the last 2,500 trading days), using true portfolio analysis/optimization. Most system-testing software only allows you to test one market at a time. Our system-testing technique lets all markets share the same account and is based on the interaction within the portfolio as a whole. Start by e-mailing system logic (in TradeStation’s EasyLanguage or in an Excel spreadsheet) and a short description to [email protected], and we’ll get back to you. Note: Each system must have a clearly defined stop-loss level and a suggested optimal amount to risk per trade.

Disclaimer: The Trading System Lab is intended for educational purposes only to provide a perspective on different market concepts. It is not meant to recommend or promote any trading system or approach. Traders are advised to do their own research and testing to determine the validity of a trading idea. Past performance does not guarantee future results; historical testing may not reflect a system’s behavior in real-time trading.

ACTIVE TRADER • November 2002 • www.activetradermag.com

8

TRADING Strategies

Extreme OPEN-CLOSE days Bars that close near their highs or lows can sometimes trick traders into thinking follow-through price action is likely.

The following analysis incorporates the opening price and a few simple risk-control and exit rules to capture follow-through moves when they are most likely.

T

BY XAVIER MARIA RAJ

raders are always looking for clues regarding when a price move is likely to follow through vs. stop in its tracks. Short-term traders especially watch price behavior during a given trading system to determine whether to hold existing positions overnight or get out before the close. The relationships FIGURE 1 EXTREME BANDS between open and close prices is often The upper band is the top 10 percent used to gauge the of the bar and the lower band is the momentum during a bottom 10 percent of the bar. An given trading periopen or close that occurs in either of od. For example, a these bands can be considered to be bar that opens and in an extreme of the bar’s range. closes at roughly the same price in the middle of a trading Upper band — top 10% of bar bar reflects balanced trading during that period. A bar that follows several bars with higher highs and lows and opens at a low price, trades much higher, and then closes back near Lower band — bottom 10% of bar the open, might imply the upside momentum has evaporated and a downturn could be imminent. The patterns we will analyze here occur when price Source: TradeStation opens near one end 9

of the day’s trading range (the high or low) and closes near the other extreme of the day’s range. We’ll refer to these as strongclosing and weak-closing bars. We’ll test these patterns to see what kind of price action typically follows them, and if they FIGURE 2 STRONG CLOSE DAYS A strong-close day (SCD) opens in the lower band (the bottom 10 percent of a price bar) and closes in the upper band (the top 10 percent of the bar). Russell 2000 index (RUT.X), daily

550.00 545.00 540.00 535.00

Strong close days

530.00 525.00 520.00

16

Source: TradeStation

23

www.activetradermag.com • April 2005 • ACTIVE TRADER

Strategy code can be used as the basis for a trading strategy.

Defining strong and weak bars

The first step is to define what constitutes strong- and weak-closing bars. To do this, we’ll use “bands” that capture the top and bottom 10 percent of a price bar. The upper band is the top 10 percent of the bar and the lower band is the bottom 10 percent of the bar (see Figure 1). An open or close that occurs in either of these bands can be considered to be in an extreme of the bar’s range. A strong-close day (SCD) opens in the lower band and closes in the upper band (Figure 2). Similarly, a weak-close day (WCD) opens in the upper band and closes in the lower band (Figure 3). These days can be defined as follows: Strong-close day (SCD) = Open < (Low + Range/10) and Close > (High Range/10) FIGURE 3 WEAK-CLOSE DAYS A weak-close day (WCD) opens in the upper band and closes in the lower band. Russell 2000 index (RUT.X), daily

The following EasyLanguage code can be downloaded from the Active Trader Strategy Code page at www.activetradermag.com/code.htm. Code for other software platforms is also available. Initial system test: VAR:X(0),Y(0),R(0); R=RANGE; IF C>H-((R/10)) AND OH-((R/10)) AND O (High - Range/10) and simple, easy-to-execute strategy — especially considering that Close < (Low + Range/10) the parameters were unoptimized. Now let’s see if this basic Strong-close days suggest demand was high from the begin- performance can be enhanced with additional risk-control and ning of the trading session and continued to be robust until the profit-taking rules. closing bell; weak-close days indicate selling pressure was Augmenting the approach dominant from the start of the day until the close. Let’s hypothesize that because demand or supply was solid We conducted a second test using simple stop-loss and price through the end of the day, there will be some follow-through target rules. The stop-loss will be the midpoint of the SCD or WCD, and the profit target will be 10 index points above the movement the day after an SCD or WCD. 11

Gross loss

($234,100.00)

www.activetradermag.com • April 2005 • ACTIVE TRADER

high of an SCD or below the low of a WCD: Stop-loss for long trade = Midpoint minus one tick Stop-loss for short trade = Midpoint plus one tick Long target = High plus 10 points Short target = Low minus 10 points As was the case with the basic trading rules, these values are representative and have not been optimized. The definitions and logic for the complete strategy are: D1 = Current day (the SCD or WCD) D2 = Next day H1 = High of current day L1 = Low of current day M1 = Midpoint, or median price, of current day 1. Long Entry: On an SCD (D1) place a buy-stop order for the next day (D2) at the high (H1) plus one tick. 2. Short Entry: On a WCD (D1) place a sell-stop order for the next day (D2) at the low (L1) minus one tick. 3. Long Exit: Place a stop-loss order at the median price (M1) minus one tick. 4. Short Exit: Place a stop-loss order at the median price (M1) plus one tick. 5. Long Target: Place a limit sell order at the high (H1) plus 10 points. 6. Short Target: Place a limit buy order at the low (L1) minus 10 points. The performance for the two indices after incorporating these stop-loss and target rules are shown in Tables 3 and 4. Notice that although the winning percentages for each index declined (but both remained about 60 percent), their respective profit factors increased to 3.08 and 2.21, indicating the strategy became more efficient. Also notice the maximum drawdowns decreased in both cases. The number of trades remained the same.

Simplicity and room for experimentation

As is often the case, a simple trading idea produced some favorable results. 12

This trading approach could be applied without any help from a computer, and it lends itself to further modification and experimentation. Testing across a wide range of markets and experimenting with different upper and lower bands, stop-loss levels and profit targets are excellent departure points.Ý

TABLE 3 ENHANCED SYSTEM TEST: RUSSELL 2000 The winning percentage declined for the Russell 2000 (as it did for the S&P 400), but the profit factor increased. Performance summary: All trades Total net profit Gross profit

Total # of trades Number winning trades

Largest winning trade Average winning trade Ratio avg. win/avg. loss Max. consec. winners Avg. # bars in winners

$446,884.48 $662,127.50

637 436

$4,975.50 $1,518.64 1.42

13 0

Max. intraday drawdown ($14,725.52) Profit factor 3.08 Account size required $14,725.52

($215,243.02)

Gross loss

Percent profitable Number losing trades

68.45 201

($5,587.50) Largest losing trade Average losing trade ($1,070.86) Avg. trade (win & loss) $701.55 Max. consec. losers Avg. # bars in losers

5 0

Max. # contracts held Return on account (%)

500 3,034.76

Source: TradeStation

TABLE 4 ENHANCED SYSTEM TEST: S&P 400 Despite the lower winning percentage for both indices, the strategy was more efficient: It produced more profit with lower drawdown. Performance summary: All trades Total net profit Gross profit

Total # of trades Number winning trades

Largest winning trade Average winning trade Ratio avg. win/avg. loss Max. consec. winners Avg. # bars in winners

$245,312.50 $448,075.00

482 298

$4,975.00 $1,503.61 1.36

11 0

Max. intraday drawdown ($13,725.00) Profit factor 2.21 Account size required $13,725.00

Gross loss

Percent profitable Number losing trades

($202,762.50)

61.83 184

($8,875.00) Largest losing trade Average losing trade ($1,101.97) Avg. trade (win & loss) $508.95 Max. consec. losers Avg. # bars in losers

Max. # contracts held Return on account (%)

5 0

1 1,787.34

Source: TradeStation

www.activetradermag.com • April 2005 • ACTIVE TRADER

The Fibonacci SWING FILTER TRADING Strategies

One way to filter market noise and focus on tradable price moves is to gauge price swings in terms of retracement

P

percentages. This approach creates an adaptive trading system that adjusts to the market’s behavior.

BY G. VETRIVEL rices move every second of every day, which term price fluctuations are removed from the data; the shorter means many, if not most, market fluctuations rep- the lookback period (e.g., 10 bars), the shorter the trend the resent random “noise” rather than meaningful average reflects. price moves. No matter how short the time frame Similar logic applies to defining Fibonacci price swings. A a trader operates on, some price action is simply irrelevant. breakout above or below the range of a Fibonacci-defined price The challenge is finding a way to filter out noise and identi- swing — for example, a 38.2-percent retracement of a previous fy tradable price moves in your chosen time horizon. There are move — can be considered the end of an existing trend or the many ways to accomplish this. Some traders require an initial beginning of a new trend, the magnitude of that trend being trade setup to be validated by a secondary rule, or filter, before dependent on the size of the price swings. This logic allows us acting upon the signal. Other traders approach the problem at to objectively determine market tops and bottoms. the source and attempt to smooth price data itself, so they This technique does not attach any particular significance to apply trading approaches to data that has already had its a single Fibonacci ratio and it does not have a fixed lookback “noise” removed. period, as does a moving average. The ratios (which can change The method outlined here presents a way to smooth data for each bar) are determined by the current market conditions, using Fibonacci-based price moves. This process consists of which makes the Fibonacci-swing approach an adaptive defining a price-swing structure that filters out shorter-term smoothing technique. Also, this approach avoids the problem price fluctuations so you react only when a trend of significant of lag that affects all moving averages (the longer the average, magnitude changes direction. the longer it takes to respond to changes in price direction). This Fibonacci-swing technique will be illustrated using a simple stop-andFIGURE 1 DEFINING A TOP AND GOING SHORT reverse (SAR) strategy, which means when a long position is exited a new Bar 1 is the new high and a short trade is triggered when the current bar short position is simultaneously estab(Bar 0) falls below the 50-percent level of Bar 2. lished, and vice versa. The strategy will then be tested on eight years of daily Russell 2000 E-mini (ER), daily price data in four stock indices. 1 2 595 0

Defining price swings with Fibonacci ratios

The most common tool for smoothing price data is the moving average, which traders use to define trends and issue trade signals. For example, if price moves above a moving average, the trend is considered up, while the opposite is true when price falls below the moving average. The degree to which the data is smoothed and the length of the trend depends on how long the moving average is: The longer the lookback period (e.g., 100 bars), the longer the trend the average represents and the more short13

38.2%

590

50%

585 580 575

9

23

Source: TradeStation

Bottom

March

570 8

15

22

29

www.activetradermag.com • February 2005 • ACTIVE TRADER

FIGURE 2 DEFINING A BOTTOM AND GOING LONG Bar 1 is the new low and a long trade occurs when Bar 0 rises above the 38.2percent retracement level of Bar 2 (measured from the bottom of Bar 2).

Calculating Fibonacci price swings

A Top

Russell 2000 E-mini (ER), daily

520

The rules for calculating Fibonacci 515 swings for determining tops and bottoms use the following definitions: 510 • Current bar = Bar 0; previous bar = 505 Bar 1, etc. • Fibonacci ratios used: 23.6 percent, 500 38.2% 38.2 percent, 50 percent, 61.8 percent, 78.6 percent and 87.5 percent. 23.6% 495 • Pairs of consecutive retracement 2 percentages are always used to define 490 1 0 price swings — i.e., 23.6 percent and 38.2 Bottom percent, 38.2 percent and 50 percent, etc. 485 Pairing 23.6 percent and 50 percent would be incorrect, for example. 19 May 6 13 20 27 June 10 17 Defining a top/beginning of a down Source: TradeStation swing: If Bar 1 retraces between 38.2 and 50 percent of Bar 2’s range (measured TABLE 1 S&P 500 TEST RESULTS downward from Bar 2’s high), and the low of Bar 0 is below the 50-percent level The tests produced an average of nearly 700 trades per market over eight (the midpoint) of Bar 2’s range, then the years of daily data, which lends credibility to the results. highest high between the previous bottom and Bar 0 (including Bar 0) is a top. Performance summary: All trades Other retracement ratios are applied Total net profit $662,375 Open position P/L $775 in a similar fashion. For example, if Bar 1 Gross profit $1,668,640 Gross loss $1,006,265 retraces between 50 and 61.8 percent of Total number of trades 771 Percent profitable 44.36% Bar 2, and the low of Bar 0 is below the Number of winning trades 342 Number of losing trades 429 61.8-percent level of Bar 2’s range (meas$8,550.00 Largest winning trade $34,225 Largest losing trade ured downward from Bar 2’s high), then Average winning trade $4,879.06 Average losing trade $2,345.60 the highest high between the previous Ratio avg. win/avg. loss 2.08 Average trade (win and loss) $859.11 bottom and Bar 0 is a top. The same Max. consecutive winners 6 Max. consecutive losers 8 approach would be used for 23.6 percent Avg. number of bars in winners 4 Avg. number of bars in losers 1 and 38.2 percent, and so on. Figure 1 shows how a top is defined $39,665 Max intraday drawdown using this technique. The low of Bar 1 Profit factor 1.66 Max. number of contracts held 1 retraces between 38.2 and 50 percent of Account size required $39,665 Bar 2’s range, and Bar 0’s low is below Source: TradeStation the level of a 50-percent retracement of Bar 2. The top is the highest high between the previous bottom and Bar 0 (including Bar 0), Entry and exit rules which means Bar 1’s high is the top. The following rules are for the Fibonacci-swing trading system These rules are reversed to define lows. we will test on different stock indices: Defining a bottom/beginning of an up swing: If Bar 1 1. Enter long/exit short if Bar 0’s high is above the 38.2-perretraces between 38.2 and 50 percent of Bar 2’s range (meas- cent level but below the 50-percent level of Bar 1’s range. Place ured upward from Bar 2’s low), and the high of Bar 0 is above a buy-stop order to exit the existing short position and enter the 50-percent level of Bar 2’s range, then the lowest low long at the 50-percent level of Bar 1’s range. between the previous top and Bar 0 is a bottom. Repeat these calculations for the different percentage pairs Similarly, if Bar 1 retraces between 50 and 61.8 percent of Bar to determine the range that captures the current retracement. 2, and the high of Bar 0 is above the 61.8-percent level of Bar 2’s 2. Enter short/exit long if Bar 0’s low is below the 61.8-perrange (measured upward from Bar 2’s low), then the lowest cent level but above the 50-percent level of Bar 1’s range. Place low between the previous top and Bar 0 is a bottom. a sell-stop order to exit the existing long position and enter Figure 2 (p. 14) shows the identification of a bottom using short at the 50-percent level of Bar 1’s range. 23.6 and 38.2 Fibonacci percentages: The high of Bar 1 retraced Repeat these calculations for the different percentage pairs between 23.6 percent and 38.2 percent of Bar 2 and the high of to determine the range that captures the current retracement. Bar 0 retraced more than 38.2 percent of Bar 2. The bottom is 3. Special outside bar condition: If there is an outside bar (a the lowest low between the previous top (Bar A) and Bar 0. As bar with a high above the previous high and a low below the a result, the low of Bar 1 is the bottom. previous low) or a gap bar (a low above the previous high or a Note: There cannot be two consecutive bottoms or tops. high below the previous low), place the buy-stop order at the high or the sell-stop order at the low. ACTIVE TRADER • February 2005 • www.activetradermag.com

14

TABLE 2 RUSSELL 2000 TEST RESULTS If the stop-orders are not hit the next day, the appropriate percentage pairs are calculated on that day’s bar and new orders are placed accordingly. For each bar, the system checks to see which percentage pair applies to the current retracement. As a result, the percentages can change from bar to bar — e.g., 38.2and 50-percent one day, 50- and 61.8-percent the next and so on. When the price swing is moving up, ratios are calculated from the high to determine the long exits and short entries. Similarly, ratios are calculated from the low to determine the short exits and long entries.

Trade examples and test results

The Russell 2000 posted the highest profit factor and winning percentage of all the indices. Performance summary: All trades

Total net profit Gross profit

Total number of trades Number of winning trades

$2,664.37 $3,807.75 690 359

Open position P/L Gross loss

Percent profitable Number of losing trades

Largest winning trade Average winning trade Ratio avg. win/avg. loss

$84.44 $10.61 3.07

Largest losing trade Average losing trade Average trade (win and loss)

Max intraday drawdown Profit factor Account size required

$42.64 3.33 $42.64

Max. number of contracts held

Max. consecutive winners Avg. number of bars in winners

11 4

Max. consecutive losers Avg. number of bars in losers

$5.06 $1,143.38 52.03% 331

$16.53 $3.45 $3.8614 6 1

100

Source: TradeStation

Returning to Figure 1 (p. 13), because the low of Bar 1 retraced between 38.2 and 50 percent of Bar 2 (measured from the top of Bar 2 down), enter a sell-stop order at the 50-percent level of Bar 2. In Figure 2 (p. 14), because the high of Bar 1 retraced between 23.6 percent and 38.2 percent of Bar 2 (measured from the bottom of Bar 2 up), enter a buy-stop order at the 38.2-percent level of Bar 2. Because this is a stop-and-reverse strategy, the reverse orders act as trailing stops for the current positions. Tables 1, 2 , 3 and 4 show the results of tests conducted on the S&P 500 (SPX), Russell 2000 (RUTX), NIFTY (Indian NSE Index), and Dow Jones Industrial Average (INDU). The test

spanned eight years of daily price data –– from Jan. 1, 1997 to Oct. 25, 2004. The performance in these tables indicates the strategy is robust: It has a winning percentage rate of at least 40 percent, an average win/loss ratio of 2 and profit factor (gross profit/gross loss) of 1.55 in all indices, except the Russell 2000, which had exceptionally good performance and a profit factor of 3.33. Slippage and commission charges were not included. The strategy produced more than 700 trades on average in each index — more than 2,800 trades total. The high number of trades adds credibility to test results — confidence in future results is directly related to the number of samples in testing. By comparison, positive results for a long-term trend-following

System code

The following TradeStation EasyLanguage code for the Fibonacci stop-and-reverse system can be copied at www.activetradermag.com/code.htm. if l>=h[1] then Sell Short Next Bar at l-.05 stop; if if if if if if if if

l=h[1]-(h[1]-l[1])*.236 then Sell Short Next Bar at h[1]-(h[1]-l[1])*.236 -.05 stop; l=h[1]-(h[1]-l[1])*.382 then Sell Short Next Bar at h[1]-(h[1]-l[1])*.382-.05 stop; l=h[1]-(h[1]-l[1])*.5 then Sell Short Next Bar at h[1]-(h[1]-l[1])*.5-.05 stop; l=h[1]-(h[1]-l[1])*.618 then Sell Short Next Bar at h[1]-(h[1]-l[1])*.618-.05 stop; l=h[1]-(h[1]-l[1])*.786 then Sell Short Next Bar at h[1]-(h[1]-l[1])*.786-.05 stop; l=h[1]-(h[1]-l[1])*.875 then Sell Short Next Bar at h[1]-(h[1]-l[1])*.875-.05 stop; ll[1] then Sell Short Next Bar at l[1]-.05 stop; lhhv1 then hhv1=h[ii]; if l[ii]hhv2 then hhv2=h[ii]; if l[ii]