Documente Academic
Documente Profesional
Documente Cultură
P. 22
BEAR NECESSITIES: Understanding stock behavior in down markets p. 14 ZONING IN ON IPO opportunities p. 58 VOLATILITY and swap spreads p. 42 SCALPING: Trading the tape, not the chart p. 28 SYSTEM LAB: Testing the double repo p. 46
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CONTENTS
January 2009 VOLUME 10, NO. 1 TRADING STRATEGIES FOR THE FINANCIAL MARKETS
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19
24
In every issue
57 Global Marketplace
International market performance.
59 ETF Snapshot
Volume, volatility, and momentum statistics for exchange-traded funds.
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Inside the Market Stagnant IPO, ETF listings reflect battered market
A lack of new companies going public speaks volumes about the current market condition, but a new study shows IPOs that survive a bad environment may be stronger in the long run. By Chris Peters
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Other stories: Carbon trading surge Golds perplexing performance Hedge-fund industry woes Central banks slash rates Global numbers
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Trade Diary
72 73
Taking a gamble on a banking stock. Taking quick profits and maintaining tight stops.
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Editors NOTE
in less than a decade. This wasnt supposed to happen; 2000-2002 was supposed to be the big flush-out. The speed and severity of this drop makes the previous bear market look like an orderly correction. Which is perhaps why we shouldnt
As people lose their capacity to be shocked and return their attention to the mundane tasks of everyday life, the day draws nearer when we will be able to say a bottom is in.
hope for a quick, massive rebound (right now that certainly doesnt seem to be an issue). It would simply be a sign the market hasnt exorcised its demons. Thats what you call a catch-22, because if its unhealthy for the market to rally robustly right now, that means the preferable alternative is for it to hang around the October lows or even move lower and continue to erode stomach linings and inflame blood vessels in the process. And with hedge-fund liquidations still underway and a likely spike in unemployment in our future, theres plenty of room for another downdraft.
But our cultures famously short attention span could come in quite handy in the months to come. People are already showing signs of becoming numb to the onslaught of negative news. The media will eventually tire of the story, and could be helped in this regard by the distraction of a new president. As people lose their capacity to be shocked, reconcile themselves to their trimmed-down balance statements, and return their attention to the mundane tasks of everyday life, the day draws nearer when in retrospect, of course we will be able to say with some confidence that a bottom is in. (The other thing that might help is publicly beheading the financial masters of the universe who helped get us where we are, and the government that decided we should foot the bill for them, but lets not hold our breath.) One day, things will be different. Just dont ask me or anyone else when, exactly. In Ken Grant on risk (p. 42) the long-time risk-management expert notes, One of the things that separates the real pros from the wannabes is the pros know bad markets and good markets, for that matter dont last forever, and they plan accordingly. I will make a bold forecast: 15 years from now, the S&P 500 index will be higher than it is today (Nov. 12, 2008). Now I feel terrible, though, because any time I make this kind of prediction, Im almost always wrong. But then, I have plenty of company.
Howard Simons is president of Rosewood Trading Inc. and a strategist for Bianco Research. He writes and speaks frequently on a wide range of economic and financial market issues.
Editor-in-chief: Mark Etzkorn metzkorn@activetradermag.com Managing editor: Molly Goad mgoad@activetradermag.com Senior editor: David Bukey dbukey@activetradermag.com Associate editor: Chris Peters cpeters@activetradermag.com Contributing writers: Thom Hartle, Howard L. Simons, Marc Chandler, Keith Schap, Robert A. Green Editorial assistant and Webmaster: Kesha Green Art director: Laura Coyle lcoyle@activetradermag.com President: Phil Dorman pdorman@activetradermag.com Publisher, Ad sales East Coast and Midwest: Bob Dorman bdorman@activetradermag.com Ad sales West Coast and Southwest only: Allison Chee achee@activetradermag.com Classified ad sales: Mark Seger seger@activetradermag.com
Keith Schap is a freelance writer specializing in risk management and trading strategies. He is the author of numerous articles and several books on these subjects, including The Complete Guide to Spread Trading (McGraw-Hill, 2005). He was a senior editor at Futures magazine and senior technical marketing writer at the CBOT.
Camillo Lento is a lecturer in the accounting department at Lakehead University in Thunder Bay, Ontario, Canada. Before joining the faculty of business administration, Lento obtained his Chartered Accountant (Ontario) Designation, while in senior positions in accounting, auditing, and business valuations. He holds a masters degree in management and an honors bachelors of commerce degree (majors in accounting and finance) from Lakehead University, and has marked non-comprehensive simulations at the ICAOs School of Accountancy. Lento has various publications in journals such as the Journal of Applied Business Research and Applied Economics Letters, and has presented original research at many international conferences.
John Grady first learned the art of scalping while trading futures for a proprietary trading firm in Chicago. It was there he discovered the importance of reading the order book and realized technical analysis is typically more of a hindrance than a help in day trading. He is the author of No B.S. Day Trading and currently trades from his home in southern Florida. For more scalping strategies and information on how to read the order book, visit www.NoBSDayTrading.com.
for more than 20 years. His diverse background encompasses positions such as German National Hockey team player, coach of the Malaysian National Hockey team, and president of VTAD (the German branch of the International Federation of Technical Analysts). In 2001 he became a partner in Wealth-Lab Inc. (www.wealth-lab.com), which he still runs.
OPENING Trades
Index S&P 500 (SPX) Nasdaq 100 (NDX) Russell 2000 (RUT)
Oct. Nov. Nov. 24-28 4 10 low high close 845.27 1,007.51 919.21 1,251 493.27
The Nasdaq 100 and Russell 200 indices actually made lower lows in late October, while the S&P 500 and the Dow made slightly higher lows. All the indices rallied briskly through Nov. 4 before putting in a huge post-election day loss. Nonetheless, as of Nov. 10, the S&P was around 9 percent above its Oct. 10 low.
ETF iShares S&P California Muni Bond WisdomTree Earnings Top 100 Fd. Vanguard Intermediate-Term Bond Vanguard Short-Term Bond ETF Europe 2001 HOLDRS Biotech HOLDRS iShares DJ US Oil & Gas Market Vectors-Gaming ETF SPDR Lehman Intl Treasury Bond
Sym CMF EEZ BIV BSV EKH BBH IEO BJK BWX
20-day 11/10 return on close 11/10 102.99 12.07% 28.11 71.99 76.34 95.91 47.14 42.29 16.70 49.20 7.62% 5.60% 5.20% 5.06% 3.83% 3.42% 3.09% 3.04%
60-day avg. daily volume 6,088 10,654 59,328 138,097 688,141 1,078 199,549 1,030,815 2,559 138,722
173.11 3.66%
Source: eSignal
Source: eSignal
Source: eSignal
MARKET Pulse
ith nearly all stock markets mired in official bear territory, many traders are trying to make money by selling short. This seemed incredibly compelling when the Dow Jones Industrial Average plunged 27.35 percent in the first eight days in October alone. But the immediate 20-percent rebound within three days likely scarred many short sellers who entered toward the end of the Dows initial drop. Trading stocks from the short side is virtually always more
difficult than trading from the long side. Statistics show market volatility spikes when prices drop, making it a more challenging environment in which to earn profits. The first step in developing an approach tailored for a down market is to measure the markets typical price behavior during bearish conditions. Bull vs. Bear: The details matter (Active Trader, November 2002) compared the S&P 500 tracking stocks (SPY) daily price characteristics in bull and bear markets: 1998 to 2000 vs. 2000 to 2002, respectively. Here, we take a look at SPYs short-term behavior during more recent bullish and bearish periods, focusing on differences in its daily ranges, close-to-close moves, and price runs of different lengths and sizes.
KC
The S&P 500 tracking stock (SPY) fell 38.7 percent from March 1, 2000 to Feb. 28, 2003 a very volatile period that resembles price action in 2008.
Source: eSignal
For more information about the following concepts, go to Key concepts on p. 63.
SPY rallied 34.8 percent from March 3, 2003 to Feb. 28, 2006, although it traded sideways in much of 2004.
Source: eSignal
and bear markets. The first three columns list SPYs close-toclose move, its largest up move (LUM, close to next days high),
continued on p. 1 0
0.59% 0.49%
-0.52% -0.40%
0.53% 0.43%
-0.53% -0.41%
1.16 1.08
1.06% 0.95%
The markets intraday moves were roughly twice as volatile during the last bear market (2000-2003) than during the subsequent bull market (2003-2006).
Opening gaps up were more likely to be filled in bull markets than bear markets. But opening gaps down were filled 68 percent of the time, regardless of market conditions.
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and its largest down move (LDM, close to next days low). The middle columns show SPYs overnight and intraday moves open to high, open to low, and open to close. The last two columns list SPYs daily (high-low) range and its daily range as a percentage of each days midpoint. Finally, the percentage of gains (Pct. > 0) is shown for several periods. From a directional standpoint, there are no dramatic differences between the bull and bear markets. Obviously, the market was skewed toward losses during the bear market and tended to post small gains in the bull market. But Table 1s
SPY was much more volatile in the bear market, with a typical daily range between $1.00 to $3.00. The largest number of high-low moves fell in the $1.51 to $2.00 range.
SPY was much less volatile in the bull market; the majority of its moves ranged between $0.50 to $1.50, well below the typical bear market daily range.
SPY reached fewer higher highs, higher lows, and higher closes during the bear market of 2000 to 2003 than during the subsequent bull market of 2003 to 2006.
climbed back to its opening price 68 percent of the time, regardless of market conditions.
The majority of SPYs close-to-close moves ranged from $0.01 to $1.50 in the bear period, while less than 25 percent of its moves exceeded $1.00 in the bull period (Figure 6).
The market tended to drop sharply after hitting new five-day highs in bear markets, but the counter-rallies can be surprisingly strong.
for the subsequent bull market. The differences are striking. The majority of bear-market daily ranges are between $1.01 and $3, peaking from $1.51 to $2. By contrast, most bull-market daily ranges are between $0.51 and $1.50, culminating from $0.51 to $1. The average bear-market range was $2.24 vs. just $1.16 in the bull period. Figures 5 and 6 show the same type of distributions of close-to-close differences in the bear and bull markets, respectively. In the bear market, roughly 75 percent of all close-to-close differences were $0.51 or larger. In the bull market, however, only about half of them fell into that category.
continued on p. 1 2
More than half of SPYs close-to-close moves were less than $0.51 in the bull period.
SPY formed lower highs, lower lows, and lower closes more often during the bear market than during the bull period.
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One way to define an uptrend is to look for a string of consecutive higher highs, higher lows, and higher closes. Downtrends would contain strings of Consecutive HHs+HCs back-to-back lower lows, lower highs, and lower 2 3 4 5 6 closes. # of times: 98 37 12 2 1 In theory, the market would seem more likely to % of times: 13.03% 4.92% 1.60% 0.27% 0.13% form a series of consecutive highs in bull markets Average move: 2.73% 4.09% 5.94% 3.46% 3.98% and a string of consecutive lows in bear markets. Median move: 2.34% 3.45% 5.69% 3.46% 3.98% Nonetheless, Figures 1 and 2 show that SPYs longer-term trends were broken up by frequent sellConsecutive HHs+HLs+HCs offs and counter-rallies. 2 3 4 Table 3 (p. 10) compares the number of times # of times: 75 23 5 SPY formed consecutive higher highs, higher lows, % of times: 9.97% 3.06% 0.66% and higher closes in bull and bear markets. The Average move: 2.75% 4.39% 7.20% Median move: 2.35% 3.83% 7.13% table also shows the number of combinations of higher highs and higher closes (HH+HC) and highThe market closed higher up to seven days in a row in the bear er highs, higher lows, and higher closes market of 2000 to 2003. However, strings of higher highs and higher (HH+HL+HC) in each period. closes formed less often and were shorter in length. The market clearly reached more highs during the bull market than the bear market, which is TABLE 6: BULL MARKET CONSECUTIVE HIGHS no surprise. SPY climbed to highConsecutive HCs er highs, higher lows, or higher 2 3 4 5 6 7 8 9 closes at least 54 percent of the # of times: 227 130 71 37 18 9 4 1 time in the bull period, and it % of times: 30.07% 17.22% 9.40% 4.90% 2.38% 1.19% 0.53% 0.13% Average move: 1.14% 1.69% 2.44% 3.26% 4.04% 5.18% 6.24% 5.31% reached either of these milestones Median move: 1.07% 1.53% 2.14% 2.87% 3.31% 3.86% 4.98% 5.31% less than half the time in the bear period. Consecutive HHs+HCs Also, combinations of highs 2 3 4 5 6 7 8 HH+HC and HH+HL+HC # of times: 143 71 34 14 5 3 1 formed more often in the bull % of times: 18.94% 9.40% 4.50% 1.85% 0.66% 0.40% 0.13% period. For example, HH+HC patAverage move: 1.26% 1.87% 2.53% 3.69% 5.33% 6.37% 5.22% terns occurred 44 percent of the Median move: 1.18% 1.57% 2.21% 3.25% 3.86% 4.65% 5.22% time in the bull market vs. just 33 percent of the time in the bear Consecutive HHs+HLs+HCs market. And there is a similar, but 2 3 4 5 6 7 8 smaller, difference between # of times: 103 40 17 7 3 2 1 % of times: 13.64% 5.30% 2.25% 0.93% 0.40% 0.26% 0.13% HH+HL+HC patterns in those Average move: 1.29% 1.81% 2.25% 3.04% 3.65% 4.25% 5.22% periods. Median move: 1.26% 1.58% 2.04% 3.24% 3.82% 4.25% 5.22% Table 4 (p. 11) resembles Table 3, but lists the number of times The market closed higher up to nine consecutive days in the bull market of 2003 to SPY formed lower highs, lower 2006. Although there were longer strings of higher closes in the bull market, the marlows, and lower closes. As you ket tended to gain more ground during consecutive highs in the bear market (Table 5), might expect, consecutive lows another sign of increased volatility. were more common in the bear
12 www.activetradermag.com January 2009 ACTIVE TRADER
period. SPY hit lower highs, lower lows, or lower closes at least 51 percent of the time in the bear market, while it formed those patterns much less often in the bull market. The same dynamic applies to combinations of lows LL+LC and LH+LL+LC patterns, which were more common in the bear market. By contrast, LH+LL+LC patterns occurred only 25 percent of the time in the bull market, the least frequent pattern in Tables 3 and 4.
# of times:
Table 5 lists runs of consecutive daily SPY highs % of times: during the bear market from March 2000 to March Average move: 2003. The first section shows the number and perMedian move: centage of times the market made consecutive As expected, there were more consecutive lows in the bear market higher closes from two to seven days in a row. For than consecutive highs. example, SPY formed back-to-back higher closes 170 times (22.61 percent), and it made seven conclimbed just half as far when it formed the same patterns in the secutive higher closes only twice. To find the exact number of runs of a specific length, subtract the number of the next longest run from the length you are tryTABLE 8: BULL MARKET CONSECUTIVE LOWS ing to determine. For example, there were 31 cases of four conConsecutive LCs secutive higher closes, but those runs are already included in the 2 3 4 5 72 runs of three consecutive HCs. As a result, there were 41 # of times: 131 49 14 2 instances (72-31) of three consecutive HCs only. % of times: 17.35% 6.49% 1.85% 0.26% Table 5s lower two sections show HH+HC and HH+HL+HC Average move: -1.20% -1.84% -2.18% -2.15% patterns of various lengths. For example, SPY formed up to six Median move: -1.03% -1.66% -1.95% -2.15% consecutive days of HHs and HCs, while it posted up to four days of back-to-back HHs, HLs, and HCs. The final two rows of Consecutive LLs+LCs each section show SPYs average and median close-to-close 2 3 4 5 moves during each run. For example, the market jumped an # of times: 85 30 8 1 average 7.2 percent during its series of four consecutive % of times: 11.26% 3.97% 1.06% 0.13% Average move: -1.34% -1.91% -2.15% -1.53% HH+HL+HC days in the bear market. Median move: -1.24% -1.98% -1.64% -1.53% Table 6 is similar to Table 5, but it lists runs of consecutive daily SPY highs during the bull market. If you compare Tables 5 Consecutive LHs+LLs+LCs and 6, you will notice several key differences between bearish 2 3 4 and bullish environments. First, SPY formed longer strings of # of times: 62 21 5 consecutive highs during the bull market up to nine days of % of times: 8.21% 2.78% 0.66% consecutive HCs and eight days of HH+HC and HH+HL+HC Average move: -1.43% -1.98% -2.36% patterns. And those bullish patterns were more common in the Median move: -1.37% -1.76% -1.82% bull market. In the bear market, however, SPY rose further during consecSPY rarely formed consecutive lows in the bull market, and these down moves were roughly half as large as their utive highs. For example, SPY jumped an average 2.33 percent bear market counterparts (Table 7). during two back-to-back HC days in the bear market, but it
continued on p. 14
Consecutive LHs+LLs+LCs 2 3 4 5 91 33 8 3 12.10% 4.39% 1.06% 0.40% -2.77% -4.20% -6.46% -6.50% -2.51% -3.54% -5.32% -6.28%
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bull market. In short, bear-market uptrends were less common and shorter in length than their bull-market counterparts, but they were stronger, supporting the conclusion that SPY is more volatile during bear markets. Tables 7 (p. 13) and 8 list the number of consecutive daily SPY lows in bear and bull markets, respectively. SPY made longer strings of consecutive lows in the bear market up to seven consecutive days of LCs vs. a maximum of five in the bull market. Also, patterns of consecutive lows were more common in the bear market, which is no surprise. Finally, SPY fell twice as far during bear-market patterns, compared to their bull-market equivalents.
Related reading
Bull vs. Bear: The details matter Active Trader, November 2002. This comparison of bull- and bear-market characteristics provides concrete statistics upon which to base upside and downside trading strategies. Short-term stock market runs Active Trader, July 2008. A detailed look at how markets have tended to move following price runs of different lengths and sizes. Analyzing the bear Active Trader, June 2008. Measuring how the S&P 500 has responded to 20-percent drops in the past offers clues about what could be in store for the market. Losing your shorts Active Trader, September 2002. Short strategies are influenced by bear-market volatility and the short squeeze. Familiarity breeds profitability Active Trader, September 2002. This study analyzes price patterns to determine the odds that different kinds of price moves will occur. Know thy market Active Trader, October 2001. Regardless of what kind of trader you are or what approach you use, knowing the typical price behavior for the markets you trade is essential. Heres how to do it.
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TRADING Strategies
BY CAMILLO LENTO
any traders argue that you shouldnt rely on a single rule to make trading
market when a buy consensus emerges among different trade signals, and you sell the market when a sell consensus appears. Combining multiple signals reduces the risk of selecting and relying on a single rule at any given time. For example, you can use five trading rules e.g., two MA crossovers, a percentage filter rule, moving average convergence divergence (MACD), and Bollinger Bands to develop a combined signal that triggers a long signal when three of the five rules are bullish. Or you can also use a stricter version that requires four of the five signals to agree on a position. A combined approach offers an opportunity to earn profits even when individual trading signals are unprofitable. The CSA strategys appeal lies in synthesizing individual rules into a more powerful whole. It is likely a combined signal performs better because information related to future price moves is dispersed among
decisions. However, multiple trading rules can provide conflicting signals a significant, but common issue. For example, on any given day, a 2-percent filter rule may signal a buying opportunity, while a 10/20-day moving average (MA) crossover rule may suggest the opposite. One solution is to combine individual trading signals to form a consensus in one direction. The following summary is based on a recent academic study that describes a Combined Signal Approach (CSA) to technical analysis. The CSA strategy weighs two or more trading rules and calculates a combined signal that is designed to be more effective than the sum of its parts.
Strength in numbers
With a combined approach you buy the
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MA crossover rule
Parameters Annual returns (%) Dow Jones Trading rules Buy & hold Profit No transaction costs NASDAQ Trading rules Buy & hold Profit No transaction costs 1/50 1/200 5/150 2.3 10.8 -8.5 0.5 8.6 -8.2 2.6 10 -7.4
Filter rule
Parameters 2% 0.5 11.7 -11 5% 0.3 11.7 -11
2.7 6.1
-3.4 1.5
13.9 4.9 9
-8.2 6 -14.2
6 8.3 -2.2
15 6.4 8.7
18 4.1 14
* returns that are significant at the 5% level of significance The combined signal approach was superior to trading all 12 rules individually, especially on the Nasdaq Composite, which gained from 8.9 percent to 13.3 percent annually.
es were smaller than the individual trading rules (-3.4 percent vs. -8.5 percent).
nine trading rules all of the first tests rules except those based on Bollinger Bands. The test spanned 50 years of daily S&P 500 price data from Jan. 1, 1950 to March 19, 2008. The approach was tested with different numbers of consensus
votes triggering a trade signal: two of nine, three of nine, etc., up to six of nine rules. Testing a range of values provides evidence for both a strict (6/9) and a loose (2/9) system. (There are not enough consensus signals to provide a robust test
MA crossover rule
Parameters Annual returns (%) No transaction costs Trading rules Buy & hold Profit Transaction costs Trading rules Buy & hold Profit 1/50 1/200 5/150 11 9.7 1.3* 7.7 9.7 -2 11.3 9.5 1.9* 10 9.5 0.5* 10.8 9.7 1.1* 10 9.7 0.3* 1% 15 9.8 5.2* 7.1 9.8 -2.6
Filter rule
Parameters 2% 7.3 9.8 -2.4 0.9 9.8 -8.8 5% 7.9 9.8 -1.8 7.5 9.8 -2.2
Avg. of 12 rules
(2/9) (3/9) (4/9) (5/9) (6/9) 9.9 9.7 0.2 7.5 9.7 -2.1
3.2*
1.8* 1.9*
1.8*
0.0*
1.6*
0.0* 0.1*
-0.2
-2.6
* returns that are significant at the 5% level of significance The combined strategy generated profits on the S&P 500, while the average trading rule lost 2.1 percent annually after trading costs.
17 www.activetradermag.com January 2009 ACTIVE TRADER
KC
For more information about the following concepts, go to Key concepts on p. 63.
Related reading
The profitability of technical trading rules: A combined signal approach by Camillo Lento and Nikola Gradojevic. Journal of Applied Business Research 23(1): 1327. A combined signal approach to technical analysis on the S&P 500 by Camillo Lento. Journal of Business and Economics Research, forthcoming. Working paper available at http://ssrn.com/author=970955. Combined signal approach: further evidence from the Asian-Pacific equity markets by Camillo Lento. Applied Financial Economics Letters, forthcoming.
of a 7/9 system.) Table 2 is similar to Table 1 and compares the annual performance of each rule to different versions of the combined approach. Again, the individual rules led to consistent losses in the S&P 500 as they did in the Dow. The average trading rule lost 2.1 percent annually after trading costs. However, the combined strategy generated profits. Before transaction costs, all versions of the CSA approach beat the market, and four of the five versions outperformed the individual rules 0.2-percent average gain. The results are similar after adjusting for transaction costs, although a significant portion of the profits are eliminated. The 5/9 and 6/9 combined techniques were the only systems that lost money. This could be because its parameters are too strict, resulting in too few positions. Both tests show a combined approach significantly improves upon the individual trade rules performance; it also removes problems associated with multiple conflicting signals. Further analysis of Asian-Pacific stock market indices showed the CSA strategy was profitable in
22 of 24 tests with annualized profits as high as 28.3 percent on the Jakarta Composite index. The results are robust given that the combined approach was profitable in three different markets with various parameters.
tested in this study use daily prices, you can always apply a combined framework to rules that work with shorter or longer data frequencies (tick, intraday, or weekly). The idea is simple add multiple rules together so each one gets a directional vote, which avoids problems caused by conflicting signals. Additionally, a combined signal appears to be more powerful than individual rules alone. This framework likely reduces the noise or imperfections of individual trading rules and synthesizes dispersed information into a more potent signal. The concept is supported by statistically significant profits in the Dow, Nasdaq Composite, and S&P 500 in different time periods going back 50 years. By contrast, most trade rules, taken individually, were unprofitable during this period.
For information on the author see p. 4.
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TRADING Strategies
BY JOHN GRADY
f youre a day trader who has always approached the market from a technical analysis perspective, you might want to contemplate spending a little less time looking at the charts and a little more time learning how to read the order book. Major players tend to look at charts very infrequently. Theyre aware of major support and resistance, but once theyve made a mental note of where these levels are, they stop looking at charts and start watching the bids and offers. Contrary to popular belief, scalpers generally are not looking to capture the bid-ask spread. Although scalpers might take one tick if thats all they think they can get, they are typically shooting for anywhere from three to seven ticks, depending on current volatility. If the market is roaring in one direction, they will certainly take 15 or 20 ticks, rather than simply getting out just to take a profit. However, such moves are few and far between. In general, scalpers are looking to exit as soon as they feel the momentum has died.
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The scalper does not use a trailing stop. If he is fairly certain a move is over and hes sitting in a six-tick winning trade, he sees no reason to risk three ticks to capture another unlikely three ticks. He will take his six-tick profit, move to the sidelines, and watch. If the move continues, he can always buy again. If it doesnt, he covered at the right price.
The following scalp strategy is based on the concept of leaning on bids and offers. Its a setup scalpers look for every day a setup that can lead to the infamous false breakout. One important aspect of this type of trading is that you must have access to a market-depth trading platform that is, one that shows multiple levels of bids and offers to execute any scalping
Strategy snapshot
Strategy: Leaning on the bid/offer. Strategy type: Intraday/scalping. Logic: If traders keep selling into a bid just below a major resistance
level (based on the order book, not just a chart) and the price refuses to go offer, its usually a good indication of strength a sign someone is going to try to run that level. The opposite would be true for an offer that refuses to go bid just above a major support level.
strategy. If youre using an execution platform that only shows the inside bid and offer, you are operating at a huge disadvantage and you will probably never make money as a day trader.
The longs tipped their hand before the break. No matter how many times sellers hit the 26.5 bid, the price wouldnt go offer.
For example, on the morning of Monday, Aug. 25, 2008, the U.S. 10-year T-note futures (TYU08) made a large spike up after the release of economic data (Figure 1). The market stopped at 116-27.5 (a clear resistance level on any chart) and quickly sold off to 116-24. After a few minutes, price started to grind back up again. When the market reached
116-26.5 bid, 116-27 ask, it stopped and traded at those two prices for a while. There were 1,700 contracts offered at 116-27.5 and it was obvious traders would be leaning on that price which represented resistance not because it was a line on a chart but because of the large offer. In other words, shorts were hoping the offer at 27.5 would keep the market
down and were using it as resistance. In this situation, scalpers short at 26 or 27 are trying to limit their risk to two or three ticks. If it looks like 27.5 is going to go bid (i.e., become the current bid price), they will try to cover there. Scalpers who are looking to get long will also try to buy at 27.5 because they know
continued on p. 21
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the shorts are leaning on that offer. This is an ideal situation because it represents a spot where new money is buying and scared money is exiting. That combination is what causes sharp price moves in one direction. In contrast, the average trader might
be looking to make a trade once there is a breakout through 27.5. A scalper is not looking to buy or sell the breakout. Hes looking to buy or sell before the breakout or catch the breakout itself. In this situation, the longs tipped their hand before the break. No matter how
many contracts were sold into 26.5, the price wouldnt go offer: sell 500, stays 26.5 bid; sell 500 more, stays 26.5 bid; sell 300, stays 26.5 bid. If traders keep selling into a bid and they keep buying and bidding that price, its usually an indication of
continued on p. 22
Order depth
The accompanying charts show snapshots of the 10-year T-note order book from Friday, Sept. 12, a day on which the markets momentum was to the downside. The middle columns show price levels (116030 represents 116-3/32, and so on). The blue columns to the left show bids; the red columns to the right show offers. The market sold off sharply 213 contracts traded at 116-01 and then heavy buying took place at 11601.5 (6,828 traded). This buying stopped the sell-off and the market retraced back to 03. However, the retracement was short-lived and the market couldnt stay bid at 02.5 (notice the 10,381 contracts traded at this price); no matter how many bids hit into 02.5, the market would not go up. Finally, the longs lost the battle. The 1,336 at 01.5 traded and the market went 01.5 offer (Figure B). Anyone leaning on that price was up the creek. The 01s got slammed and the market went straight to 115-31.
Source: X Trader
21
serious strength. When this type of action takes place just below a major resistance level, its probably a sign someone is going to try to run that level. In this case, you want to buy at 26.5 or 27 or catch the break at 27.5 or 28 (maybe 28.5, tops). You dont want to buy at 29, 30, or 31 because this is where big money will exit. If someone was long 3,000 contracts going into that break, he is not looking for 10 ticks he will try to cover on the immediate move up and will work offers between 29 and 31. Otherwise, if the market suddenly stops and he tries to dump 3,000 contracts, he could end up pushing the market against himself. Even if his selling doesnt stop the market, you dont want to buy when someone is dumping 3,000 contracts. You want to buy when everyone is buying at 27.5. The notion Dont follow the herd is nonsense. The saying should be Follow the herd and make a sharp right just before you reach the edge of the cliff. Following the herd is a great way to make money. The herd often includes major players who have access to millions of dollars and who buy and sell thousands of contracts or shares traders who can actually move the market. You have to anticipate what the herd is going to do and then do it with them. Of course, you dont want to follow the herd if it means youll be the one holding the bag. This is why you shouldnt buy at 30 or 31. But you certainly dont want to be standing in front of a stampede; you dont want to sell at 27.5 or 28 in this situation. If you know traders are leaning on a price, dont join the offer in an
22
attempt to keep the market down. You will lose that battle.
Flipping
This scenario also offers an opportunity for really big traders to hammer the shorts. Its quite possible the offer at 27.5 is not real someone might be showing size with no intention of actually selling.
should be Follow
the herd and make a sharp right just before you reach the edge of the cliff.
The trader who is long 3,000 contracts at 26 might be the 1,700 offer at 27.5. When the market gets heavily bid at 27, he will pull his 1,700 offer and bid 2,000 at 27.5. This is called flipping. In one instant, the player has transformed the immediate market from a bearish to a bullish condition. Traders who are unaware of such tactics will be in for a rude awakening. However, no flipping has to take place for the shorts to get hammered. What
often happens is someone with a lot of money buys everything in sight, which was what happened on Aug. 25. There were 1,700 contracts offered at 27.5 and 2,000 offered at 28 and they were all taken out at once. A huge trader just plowed through the market bought 3,700 contracts and bid for 2,000 more at 28. No one even had a shot at 27.5 or 28. Shorts scrambled for the door and the market was instantly 29.5 bid, 30 offer. How will you know if an offer is real or not? You wont. How will you know if someone is going to buy everything in sight? You wont. All you can do is look for the kind of action described at 26.5 (no matter how many contracts were sold into that bid, the market just wouldnt go down) and go long somewhere between 26.5 and 28.
No chasing
Although this was not one of those times, there are plenty of times you can catch the breakout as its happening. If you miss the break and the market is suddenly trading 29.5 bid by 30 offer as it did this day, dont go long. If you miss it, you miss it. You can be sure the guy who bought 3,700 contracts at 27.5 and 28 already had offers at 29, 29.5, and 30 before he bought. His whole intention was to cause a sharp upward spike and cover as people panicked. Other longs who were waiting for that rally were also covering at those prices. This is why you see many false breakouts (as if there is such a thing), and why technical analysis kills many day traders. On this day, the market touched
Related reading
If traders are leaning on a price, dont join the offer in an attempt to keep the market down. Youll lose that battle.
116-31 and then dropped all the way back to 116-25. If youre long in a scenario like this, you want to cover when the big money is covering. If youre long at 27 and the market spikes up, under no circumstance should you let it come all the way back to you. You might not want to have an offer working at 29 as the market is pushing up, but if you see it touch 31 and sell off back to 29.5, then you want to get out at 29. The technical trader who likes to buy support and sell resistance will short at 27.5, and if his risk-control rules call for a five-tick stop-loss and a 10-tick profit target, hell exit the trade at 30 for a fivetick loss and curse profusely while watching the market fall right back to 25. The technical trader who likes to play breakouts will buy at 30 with the idea that resistance should become support, so when the market falls back to 27 (below the initial resistance of 27.5) he will exit for a six- or seven-tick loss. Hes cursing twice as much as the short trader because he doesnt understand why the breakout didnt work and he has to watch as the market touches 25 and then trades
Harris Brumfield: Pit trader gets wired Active Trader, December 2003. Harris Brumfield, a pit trader turned screen trader turned technology entrepreneur, talks about pushing the volume envelope and the future of electronic trading. Mark Oryhon: DAX scalper Active Trader, December 2005. This active trader has developed the specialized skills necessary for integrating fast-moving market data on the fly. Momentum scalper Active Trader, August 2006. A one-page Face of Trading profile of Richard Lopez, a 30-year-old trader who uses a scalping technique. Of molecules and markets Active Trader, June 2003. A one-page Face of Trading profile of Andrew Ackerman, a 34-year-old trader and former molecular biology research associate who uses a scalping technique.
all the way back up through 30. Neither of these traders know what happened because they dont understand the mindset of scalpers.
are, but because he knows how to read the volume in the order book, he also has a good feel for whether the level will hold or if a breakout will occur. Quite often, he is the volume. The average trader can only buy or sell maybe five or 10 futures contracts or a few hundred shares of stock. He cannot move markets. If you want to make money day trading, you have to think like the traders who buy and sell thousands of contracts and shares. And if you want to know what they are thinking, you have to watch the bids and offers, not the charts.
For information on the author see p. 4.
23
TRADING Strategies
We hope to challenge
rading strategies are typically offered up in books and magazines as sets of crisp rules or programming code neatly packaged, off-the-shelf commodities ready for consumption by the trading public. However, little light is shed on the process that went into arriving at those trade rules even if the results of historical testing are discussed at length. The next 11 issues of Active Trader will attempt to remedy this situation in a series of articles outlining our staffs development and implementation of a mechanical trading system. The goal of the series is to fully illustrate the process of designing and trading a systematic strategy and, more importantly, show the realities of putting that strategy to work in the markets by risking money on it. We will embark on this journey with as few preconceived notions as possible and we will fully disclose all the steps we take and the mistakes we make. We will develop the trading idea from scratch. And although we will make every effort to develop a profitable strategy that will perform well in the future and we have more than a casual interest in this goal, since we will be risking our own money on it we have no guarantee of success. (Also, we will be constrained by certain realities, including the fact that as full-time journalists we can trade only part-time, and that we have only a small amount of capital to risk.) We will present the articles to our readers so they can walk through the process with us and learn from our missteps and hopefully, our successes. The following topics will be covered in the article series, but they do not represent everything it will touch upon. We dont know what direction our research
24
notions regarding the ease and simplicity of systematic trading, and how different trading is from both historical testing and paper trading.
will take us and we will report on the process as it develops; there are many other avenues this project might travel. 1. What market(s) well trade, and why. 2. The type of approach well use, and the practicalities that will define it (amount of time available to execute trades, etc.). 3. Defining the initial trade setup and determining its performance characteristics. 4. Developing a testing regimen. 5. Initial testing. 6. Fleshing out the system: exit rules, money management, and risk control. 7. Retesting. 8. Interpreting the test results. 9. Preparing to trade. 10. Trading the system. 11. Comparison to historical performance and to simultaneous paper trading. In chronicling the good and the bad, we hope the series will shed some light
on the difficulties of system design and systematic trading. More specifically, we hope to challenge popular notions regarding the ease and simplicity of trading in general and systematic trading, specifically and how different trading is from both historical testing and paper trading. As we have noted many times in Active Trader, the gap between analysis and actual trading is a wide chasm indeed. As we start, it is apparent there are many basic questions that appear easy to answer but are quite complicated and which will have important repercussions for the project as a whole. For example, to begin research and testing, we have to decide which instrument or instruments we want to trade. That decision will reflect certain assumptions and biases on our part, and will shape the subsequent research and trading. If we trade stocks, which stocks, and why? Why futures, or why forex? By opening one door we automatically close others. We have to make choices. This might not be the case if we had a large capital base to access, but we like many individual traders do not. Portfolio diversification is not a tool that will be at our disposal. Nor are we convinced a system must or should be traded on a portfolio basis (one of the more interesting concepts we will eventually address). Finally, we hope to solicit feedback from our readers about the experiment as it unfolds, and will launch a blog on our Web site (www.activetradermag.com) for that purpose. Next month: Market selection and the general trading approach or type of strategy we want to trade.
TRADING Strategies
Maybe not
Outright option positions shouldnt be thought of as casual substitutes for stock or futures positions. They have advantages, but only in specific conditions. BY KEITH SCHAP
ou may have heard people talk about options as an alternative way to own a stock, gold, a Treasury note, or corn. The idea, these people say, is that where an ounce of December gold might cost $780 per troy ounce ($78,000 for one 100-troy-ounce contract), and require $5,500 initial margin, a December 800 call option might cost only $31 per troy ounce, or $3,100 for one contract. Buying a call option, then, seems to be an inexpensive way to own whatever it is you want to buy. Table 1 displays a sample of futures
prices, a stock price, the cash-equivalent value of one contract or round lot, the initial margin requirement, a relevant option strike price, the option quoted price, and the dollar price for one options contract. In every case, the call price is well less than the margin requirement, to say nothing of the cash-equivalent value. However, this is short sighted because it fails to take into account the true character of options and how they differ from futures or stocks. For one thing, when you buy a stock, gold, corn, or a Treasury note, you can hold your asset for a relatively long time
in anticipation of a price increase. This is not the case when you buy a call option. Time is the enemy of options buyers.
KC
For more information about the following subjects, go to Key concepts on p. 63.
Option greeks (delta, gamma, theta, and vega) Implied volatility Out of the money At the money
The option prices may be less than the margin requirements, but this is only part of the picture when comparing options to their underlying instruments.
25
Repricing a 112 call option at 10-day intervals, assuming no futures price, IV, or interest rate changes, isolates the time factor.
Further, the interaction of time decay, implied volatility (IV) change, and underlying futures or stock price change affects options prices in ways futures or stock traders simply do not have to contend with.
The rate of decay accelerates, especially during the last three repricing periods.
Two things are obvious. The 112 call loses most of its initial value; the ending value is roughly 28 percent of the initial value. Also, the loss accelerates throughout the entire period and especially during the last three repricing periods. The table includes the greeks at 90, 60, and 30 days. For now, consider only the theta column. Theta values represent the options sensitivity to time; the larger the
theta value, the greater the effect of time decay. These numbers are negative to show the passage of time erodes option value. Notice the 60-day theta is roughly 0.14 greater than the 90-day theta. The 30-day theta is 0.315 greater than the 60-day theta. This squares with the observation of an accelerating loss of option value.
continued on p. 27
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The futures price changes required to offset time decay are nearly the same, averaging 7/32.
The IV at 10 days must be almost three times greater than the IV at 90 days to hold the 112 call price at 1-38.
Now lets look at how much the futures price must rise at each 10-day interval to neutralize the effect of time decay and hold the 112 call price at 1-38. This experiment assumes no change in IV or the interest rate. Table 3 shows the results. The futures price changes are all nearly the same, averaging 7/32. Figure 2 graphs this information and again shows the futures price changes to be essentially linear. A third experiment considers how much the IV must increase at each 10day interval to neutralize the effect of time decay and hold the 112 call price at the initial 1-38 level. This experiment assumes a constant 111-24 futures price and no change in the interest rate. Table 4 and Figure 3 show the results of these repricings. Notice the IV at 10 days must be almost three times greater than the IV at 90 days to hold the 112 call price at 138. As the passage of time becomes increasingly erosive, it takes greater IV increases to achieve this balance. The vega column in Table 2 sheds light on this. Vega indicates how much a
27
change in IV will change the option price. Notice the vega values decrease in contrast to the increasing theta values. Clearly, an option with a 14 vega is more sensitive to IV change than an option with an 8 vega. As a result, it will take a greater IV change to have the same effect on the option price, as apparent in Table 4 and Figure 3.
FIGURE 3: THE INTERACTION OF TIME AND IMPLIED VOLATILITY CHANGE (IN TERMS OF PERCENT CHANGE)
shaping options prices. Two versions of another experiment illustrate this interaction. Assume similar initial market conditions as before, the one exception being 7.5 percent IV instead of 7.8 percent. Also, now assume the 10-year T-note futures price trends higher in regular 8/32 increments at each 10-day repricing moment. In the first version of the experiment, IV increases in quarter-percent (0.25 percent) increments; in the second version, it increases in half-percent (0.50 percent) increments. Table 5 displays the results of these
As time passes, it takes increasingly larger IVs to maintain the call price.
continued on p. 29
With 10 days to option expiration the call price has decreased enough to result in a net loss.
ACTIVE TRADER January 2009 www.activetradermag.com 28
TABLE 7: BIG FUTURES PRICE AND IV CHANGES DURING A SHORT TIME MAKE FOR BIG OPTION RESULTS
Initial values 10-year T-note futures Days to option expiration Implied volatility Interest rate 10-year T-note 112 call Delta Gamma Theta Vega 10-year T-note 115 call Delta Gamma Theta Vega 111-24 90 7.5% 1.5% 1-34 0.4820 0.2985 -0.5863 14.1108 0-34 0.2255 0.2252 -0.4432 10.6552 531.25 1-16 1,250.00 718.75 135.29% 1,531.25 $ value Ending values 113-24 80 8.5% 1.5% 2-51 2,796.875 1,265.625 82.65% $ value $ result ROI
A shorter time frame minimizes the effect of time decay and maximizes the impact of futures price and IV increases.
two experiments. In both tables, the 112 call price increases, but the rate of the call price increase slows, and in the case of the larger IV increases, reverses direction. Notice the paltry returns resulting from these call price changes. In the case of the smaller IV increases, the gain is only 24/64 ($375). The case of the larger IV increases generates better results, but not by much. The move from the 1-34 initial call price to the 2-00 final call price results in a 30/64 gain ($468.75). The move from 1-34 to the 2-04 peak call price amounts to a 34/64 gain, or
$531.25. These gains pale in the face of the 2-00 ($2,000) futures price gain. Option trading specialists frequently recommend using out-of-the-money (OTM) options rather than at-the-money options such as the 112 call. Table 6 (p. 28) repeats the experiment of Table 5, substituting the 115 call for the 112 call. In both cases, the call price increases slightly and then decreases enough to result in a net loss at the repricing 10 days to option expiration. Clearly, this is not a trade any rational trader would want to make.
When the trades are set up to have roughly matching exposures, in terms of position deltas, the options improve considerably on the futures result.
29
112 or the 115 call option given the initial market conditions from Table 5. Now suppose the futures price rose two points to 113-24 and IV rose to 8.5 percent with 80 days to option expiration. Table 7 displays the details of these two trades. The shorter lifespan of these trades minimizes the effect of time decay, and the futures price and IV increases result in larger gains. The net result of the 112 call trade is $1,265.625, which amounts to an 82.65 percent return on investment (ROI, which is derived by dividing the dollar result by the initial dollar value: 1,265.625 / 1,531.25 = 0.8265). The net result of the 115 call trade is $718.75, which amounts to a 135.29 percent ROI. Still, these dollar results fall significantly short of the $2,000 futures gain. But look at the deltas of these two calls. The 0.4820 delta of the 112 call indicates this option has slightly less than half the upside exposure of a futures contract (by definition, the delta of a futures contract is one). The 0.2255 delta of the 115 call indicates this option has roughly 22.5 percent as much upside exposure as a futures contract. This means it requires a position long 21 of the 112 calls to have roughly the same upside exposure as a position long 10 T-note futures, given these market conditions (10 / 0.4820 = 20.75). Further, it requires a position long 44 of the 115 calls to have roughly the same upside exposure as 10 futures contracts. Table 8 shows the initial futures margin and option prices for one contract, the delta, the position cost (although margin isnt really a cost), the position delta, and the net gain for positions long 10 T-note futures, 21 of the 112 calls, and 44 of the 115 calls.
Related reading
Optionality: Why options are better than insurance Active Trader, November 2007. Getting the most out of an options trade requires looking beyond the clichs and understanding how these tools really work. Trading a trend: Adding options to futures Active Trader, March 2007. Options can make it easier to take advantage of a longer-term trend, but you have to get the details right. Keith Schap: Options Strategy Collection, Vol. 1 This collection contains articles from 2005 and 2006 written by Active Trader and Futures & Options Trader contributor Keith Schap, author of The Complete Guide to Spread Trading (McGraw-Hill, 2006). In these articles, he explores different options spreading techniques, seasonal trading strategies, and ways all types of traders can use volatility to their advantage. Keith Schap: Futures Strategy Collection, Vol. 1 This collection contains articles from 2005 and 2006 written by Active Trader and Futures & Options Trader contributor Keith Schap, author of The Complete Guide to Spread Trading (McGraw-Hill, 2006). These articles discuss a variety of futures (including single stock futures) spreading techniques, seasonal trading strategies, and using implied volatility in futures trading.
Once the trades are set up to have roughly matching exposures in terms of position deltas, the options improve considerably on the futures result. Notice also the lower cost of the 115 call; its even lower than the futures margin.
simple substitution. Instead, outright call or put options should be the market tool of choice when traders anticipate very particular underlying price and IV developments within relatively short time horizons. This use of options allows you to capitalize on the inherent optionality, especially of an OTM call. Taking advantage of the way an OTM call value accelerates under these circumstances is the primary reason for trading options in the first place.
For information on the author see p. 4.
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ADVANCED STRATEGIES
or those of you who wish to become masters of counterintelligence, here is a surefire method of interrogation to separate financial professionals from pretenders: Start talking about swap spreads, the shape of the yield curve, and the term structure of fixed-income volatility. The pros will remain interested while the
poseurs will run out of the room screaming for mercy. This is a shame, for the intersection of the market indicators provides valuable insights into the direction of corporate bonds and, by extension, stocks. A swap spread is nothing more than the difference between the Treasury rate and the fixed-leg of a swap, which is the present
value of the yield curve. Here is a chain of causation commonly seen in the many financial crises of the past fifteen years: 1.To the extent increased credit stress induces a monetary response from the Federal Reserve, a flight-to-quality leading to both a steeper yield curve and to higher short-term interest rate volatility will ensue. 2.Higher short-term volatility expands swap spreads (the difference between Treasuries and LIBOR-based interest rate swaps). 3. As money flees to the safety of the short-end of the yield curve, swap spreads expand faster there than at the long-end of the yield curve, thus leading to an inversion of swap spreads, which lead in turn to wider credit spreads for corporate bonds and their underperformance relative to Treasuries; and finally pressure on stocks. As they say at quitting time, thats enough damage for one day. As these relationships go a long way toward narrating the demolition derby that was financial markets between January and September 2008, lets take a look
Bond traders get nervous when yields plunge to what they think are unsustainably low levels. A steeper yield curve produced by Federal Reserve stimulus is viewed as a temporary situation; bond traders start to buy insurance against its unwinding, pushing volatility higher.
31
During the 2000-2002 and 2007-2008 steepenings of the yield curve, the oneand especially the two-year notes implied volatility shot higher, and by September they reached levels seen for Third World countries during currency crises.
Swap spreads tend to rise in times of financial stress as investors move from the counterparty credit risk of the LIBOR world to the perceived safety of Treasuries. This relationship is likely to be distorted in the future as the bond market grapples with the astounding levels of federal debt created during the various bailouts of 2008.
32
The more stressed the markets become, the more inverted the term of swap spreads. The shorter-dated swap spreads moved to levels well over their longer-dated counterparties a trend that exploded higher during the September 2008 financial crisis. (Each color band = 5 basis points.)
Rising swap spreads reflect increased stress in the financial system, which should be reflected in credit spreads rising after swap spreads.
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34
Double-repo systems
Double repenetration of a simple moving average sets up both long and short positions. BY VOLKER KNAPP
Market: Futures. System concept: In his book Trading with DiNapoli Levels, Joe DiNapoli describes the double repo indicator, which represents the double repenetration of a specialized short-term moving average. The system was initially designed to trade from the short side. Here we will test both shortIn this ideal scenario, corn peaks in summer 2008, quickly creates a triple top, and side and long-side versions of the then turns south. system, the former on futures and Source: Wealth-Lab Developer 5.1 the latter on stocks. The trade setup begins when a price thrust occurs. The definition of thrust is flexible; DiNapoli 1. Setup: does not provide a systematic definition in his book. In these a) Detect thrusting market action when todays high tests, it is defined as a move that exceeds the high 10 days ago is more than four times the 10-day ATR above the by a multiple of the average true range (ATR). This makes the high 10 days ago. parameter responsive to market volatility. In a proscribed amount of time of the up thrust, price must b) Within 10 days of this thrust, identify when price close below a displaced simple moving average (SMA), which is closes below a three-day displaced SMA. a moving average shifted forward a certain number of bars; close back above the displaced SMA; then close a second time (the c) Wait for the closing price to cross back above the double repo) below the displaced SMA. DiNapoli uses a threethree-day displaced SMA. day simple moving average (SMA) displaced by three days; other moving average lengths could be tested. 2. Entry (futures): When price closes below the The technique as DiNapoli originally described it also includthree-period displaced SMA a second time, enter short ed Fibonacci levels, profit objectives, and specific displaced tomorrow on a stop at todays low. moving averages. The version tested here is a limited, objective representation of the pattern. Note: The entire setup and trade signal must occur within a 10-day span. Strategy rules: The setup rules are identical for the short (futures) and long 3. Exit: Cover short at the market tomorrow when (stock) versions of the systems. The entry and exit rules differ the 13-day SMA crosses above the 26-day SMA. for each market.
35 www.activetradermag.com January 2009 ACTIVE TRADER
For more information about the following concept, go to Key concepts on p. 63. Average true range Fibonacci levels Simple moving average
KC
The sample trade in Figure 1 illustrates a model case where the moving average crossovers happen relatively quickly. Money management: Allocate 3 percent of account equity per position. Starting equity: $1,000,000. Deduct $2.5 commission and one tick of slippage per trade. Test data: The system was tested on the Futures & Options Trader Standard Futures Portfolio, which contains the following 20 contracts: British pound (BP), soybean oil (BO), corn (C), crude oil (CL), cotton 2 (CT), E-Mini Nasdaq 100 (ND), E-Mini S&P 500 (ES), 10year T-Notes (TY), Euro currency (EC), gold (GC), Japanese yen (JY), coffee (KC), wheat (W), live cattle (LC), lean hogs (LH), natural gas (NG), sugar (SB), silver (SI), Swiss franc (SF), and T-Bonds (US). Test period: October 1998 to September 2008. Test results: The results were not very encouraging the system generated a profit of just less than 52 percent over the course of a decade. It signaled only 121 trades and had a winning percentage of just 45 percent. However, the low market exposure (around 7 percent) suggests risking a bit more than we did (3 percent equity
continued on p. 37
36
The equity curve can be divided into three periods: two quick profit-earning periods separated by a long drawdown from 2001 to 2007.
Source: Wealth-Lab Developer 5.1
An extended drawdown and low activity were big challenges for this system.
Source: Wealth-Lab Developer 5.1
Profitability
Net profit: Net profit: Profit factor: Payoff ratio: Recovery factor: Exposure: Commission paid: Drawdown Max DD: Longest flat period: -17.52% 1742 bars $591,842 51.98% 1.62 1.76 2.27 6.96% $598
per position) could have brought in more profit. On the bright side, the average profit per trade was a solid 0.76 percent, or about $4,300 enough to not have to worry about trading costs. The equity curve (Figure 2) can be divided into three periods. The first one lasted until 2001 and was marked by increasing equity. In these three years, the system was able to earn nearly 30 percent. The next phase was an extremely prolonged drawdown (seven years), which bottomed out in March 2004 and finished near the end of 2007. The profits were essentially flat these years, moving back and forth. Finally, 2008 began another major profitable period similar to the first in amplitude,
but much more volatile. On the whole, the system appeared to profit cyclically, gaining in short bursts after excruciating waits. Although Figure 3 shows the actual loss was never greater than 17.5 percent, its hardly possible to use a trading system that generates no signs of life for so long. The worst time for trading, emphasized in Figure 4, was 2001 to 2003 as commodities bottomed out before beginning a multiyear rise. However, the system did virtually nothing in 2005 and 2006. Figure 5 reveals out-of-balance net profit with lean hogs (LH) and corn (C) contributing the vast majority of profits.
PERIODIC RETURNS
Avg. return % Monthly Quarterly Annually 0.39 1.20 4.22 Sharpe ratio 0.03 0.02 0.09 Best return % 13.18 20.55 21.20 Worst return % -7.57 -5.00 -4.52 % profitable periods 44.17 47.50 54.55 Max consec. profitable 5 5 2 Max consec. unprofitable 9 4 3
LEGEND Net profit Profit at end of test period, less commission. Profit factor Gross profit divided by gross loss. Payoff ratio Average profit of winning trades divided by average loss of losing trades. Recovery factor Net profit divided by maximum drawdown. Exposure The area of the equity curve exposed to long or short positions, as opposed to cash. Max. DD Largest percentage decline in equity. Longest flat period Longest period, in days, the system is between two equity highs. No. trades Number of trades generated by the system. Win/loss The percentage of trades that were profitable. Avg. profit The average profit for all trades. Avg. hold time The average holding period for all trades. Avg. win The average profit for win-
ning trades. Avg. hold time (winners) The average holding time for winning trades. Avg. loss The average loss for losing trades. Avg. hold time (losers) The average holding time for losing trades. Max consec. win/loss The maximum number of consecutive winning and losing trades. Avg. return The average percentage for the period. Sharpe ratio Average return divided by standard deviation of returns (annualized). Best return Best return for the period. Worst return Worst return for the period. Percentage profitable periods The percentage of periods that were profitable. Max consec. profitable The largest number of consecutive profitable periods. Max consec. unprofitable The largest number of consecutive unprofitable periods.
37
The system suffered three consecutive losing years as the commodities markets bottomed out.
Source: Wealth-Lab Developer 5.1
Lean hogs and corn were responsible for the majority of profits.
Source: Wealth-Lab Developer 5.1
Bottom line: This system was not optimized. We tested the double-repo signal across a wide range of exit and parameter combinations mixing channel breakouts, profit-taking stops, and time-based exits and found some profitable results.
Nonetheless, trading this pattern from the short side, as taught by the author, although profitable, lacked consistency as well as an attractive rate of return.
Test 2: Stocks
In tests of the regular double repo pattern on various stock portfolios (not shown), the short-side system was always a loser no wonder, given the multi-year stock market uptrend that lasted until late 2007. As a result, the following stock test reverses the signals i.e., the setup remains the same, but the system now goes long instead of short. 1. Setup: FIGURE 6: SAMPLE TRADE-TEST 2 a) Detect thrusting market action when todays high is more than four times the 10-day ATR above the high 10 days ago. b) Within 10 days of this thrust, identify when price closes below a three-day displaced SMA. c) Wait for the closing price to cross back above the three-day displaced SMA. 2. Entry (stocks): When price closes above the threeperiod displaced SMA a second time, enter long tomorrow on a stop at todays high. Note: The entire setup and trade signal must occur within a 10-day span. 3. Long exit: Sell at the market tomorrow when the
continued on p. 39
This example of a failed double-repo pattern occurred during a prolonged uptrend and resulted in a nearly 100-percent profit.
Source: Wealth-Lab Developer 5.1
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The system produced a consistent equity curve throughout most of the test period.
Source: Wealth-Lab Developer 5.1
PERIODIC RETURNS
Avg. return % Monthly Quarterly Annually 1.10 3.33 12.73 Sharpe ratio 0.60 0.62 0.52 Best return % 23.05 26.78 47.26 Worst return % -6.00 -5.84 -5.21 % profitable periods 57.50 60.00 81.82 Max consec. profitable 6 5 5 Max consec. unprofitable 6 3 1
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Bottom line: The double repo, essentially a countertrend pattern that resembles a double top following an upward thrust, seems best traded from the long side in the stock market. Although it barely outperformed buy-and-hold, its risk was much lower. Coupled with a trend-following exit, it creates a strategy with a moderate risk level. However, the results are
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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 systems behavior in realtime trading.
Trading setup
Hardware: PC: Intel Quad core 2.4 GHz with 3 GB RAM, two 19-inch flat panel monitors.
Laptop: Pentium 1.7 GHz with 1.23 GB RAM. Software: TradeStation, Interactive Brokers, Button Trader. Internet connection type: Redundant DSL and cable for back-up. Brokerage type: Interactive Brokers.
olan Marchand first gained exposure to trading through a summer job during college as a runner on the options floor at the Pacific Stock Exchange in San Francisco. This was back when it was still an open outcry auction, he says. It was very exciting, even though I didnt know the first thing about options. The firm I worked for traded their own account and didnt share many details about their methodology. The only thing I really learned was that if there is a flu bug going around on the trading floor, everybody gets it. His next exposure came after college while working in Italy for two years as Europe switched over to its new common currency, the Euro. Marchand, a highschool math teacher at an American School in Rome, was paid in lira. Interested in how the changeover would impact his savings, he held some money in Euros and watched exchange rates and the fluctuations in his account. From there, he started reading books on trading, the markets, and technical analysis. However, Marchands career took several twists and turns. He returned to the U.S. and taught high-school math a few more years. Then he ventured into the mortgage brokerage business for four years, and he also rehabbed real estate in New Orleans. Marchand was living in New Orleans when Hurricane Katrina hit and devastated an old rooming house he had restored
and had been running as a youth hostel. He left New Orleans and resettled in Portland, Ore., where he began dabbling in currency trading. However, he mostly just bought and held the Euro, riding the major uptrend that occurred in recent years. After deciding to relocate to a better climate in California in early 2008, Marchand took the leap to full-time trading, with very little experience under his belt. Marchand had set aside enough money to pay his living expenses for a year, so he didnt have to support himself through trading. He was attracted to the flexibility a trading lifestyle could offer. Initially, Marchand admits his trading was schizophrenic as he attempted to chase individual stocks based on chat room tips. However, through attending trading seminars and meeting a mentor, he has developed the very specific trading style he now implements. Trading Methodology: Marchand is a purely technical trader, scalping in EMini stock index futures. He puts on roughly three to five trades per day, which last approximately one to five minutes. He monitors 1-, 2-, 5-, 15- and 60minute and daily charts as he seeks to trade with the trend, entering on pullbacks. He trades both the long and short side. I buy the first pullback from a base breakout, making sure there is support below and [no resistance above], he says. I hold my first contract for 10 ticks and my second contract gets trailed barby-bar on the one-minute chart. It may sound boring, but it works over and over again. I may only get three setups in a day. I may get 10. I may not get any. But
Ive learned through expensive trial and error that if I deviate from my plan and start taking more aggressive trades, I lose money. Marchand has also learned the importance of stepping away from trading intraday. If I put on a trade and [it becomes] a losing trade, I set my kitchen timer and I dont make another trade for 15 minutes, he says. Thats how Ive gotten through my revenge-trade mentality. Marchand has a set dollar amount for a daily goal. If he hits his goal and keeps on trading, but then gives back a third of profits, hell stop trading for the day. Or, if he is down $400 for the day, hell stop trading. Became profitable when: He developed a rule-based trading plan, wrote it down, and taped it to his monitor. In between trades, I force myself to re-read these rules. Most important lesson learned: Dont look for excitement. I look for boring, predictable patterns. Best thing about trading: If I hit my daily goal and its an hour into the morning, I can do other things. Best trading books: Pristine course textbooks, Trading in the Zone by Mark Douglas. When not trading: Marchand gardens, spends time with his girlfriend, cooks, and swims in the ocean. He takes care of his health through yoga, meditation, and vitamins.
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Q& A
en Grant, founder of New York-based riskmanagement firm Risk Resources, concluded his Oct. 23 newsletter with an observation and a request: The next several weeks are likely to resemble the last several weeks, which is to say that they will be murder to endure. I think that low or no risk is the way to go, but I guess you probably have surmised that already. But this time is different; this time Im not asking, Im begging you to be careful. Volume dropped sharply after the 1987 market crash, and it took Although this might sound like shutting the corral door years for trading activity to return to earlier levels. long after the bull has made its exit, Grant had begun sounding warnings about the high level of risk in the marFIGURE 2: CONTRACTING VOLUME kets 15 months earlier in 2007 long before what many thought would be a market correction turned out to be a full-blown collapse. Grant is not just another talking head warning of the perils of the current market. Risk Resources, the 12employee firm he launched three years ago, specializes in hedge-fund risk management, and also consults for institutions, including the Chicago Mercantile Exchange, on risk matters. We create and manage hedge funds reporting platforms, he says. I think were the only firm around thats doing bona fide outsourcing of risk management. Grant started the firm after a career in the risk-management trenches that included stops at the Merc and French Volume has already dropped in the stock market in the aftermath bank Sociti Gnrale, capped by several years with Steve of the September-October flush-out. Cohens SAC Capital and Paul Tudor Jones Tudor Investments firms at which he was in charge of designalready been pulled out of the market (see Hedge-fund industry ing and maintaining the risk infrastructure that dictated how shrinks by $210 billion in Q3, p. 53), Grant pointed out there much traders could risk, the firms exposure, and how to maxiwas much more liquidation on the horizon and the markets mize trader profitability. (See Ken Grant: Confessions of a risk high volatility and contracting volume promised to make the manager, Active Trader, December 2004.) remaining redemptions more, not less, problematic than those Grant was in no small part responsible for breaking the story of that had already occurred. (However, he believes the situation is the hedge-fund redemption situation as the market sell-off manageable.) reached a crescendo. Although billions of hedge-fund dollars had
42 www.activetradermag.com January 2009 ACTIVE TRADER
Q&A continued
long side. Thats what I believed then; thats what I believe now. The things that have been most disastrous to hedge funds have been the government interventions. The really bad months earlier this year were March, when the market was tanking and the Bear Stearns [bailout] caused everyone to feel a bit better; and July, when crude was going up toward $150 barrel and banks were tanking. Then the government announced the groundwork for the Fannie-Freddie [takeover] and energy started to reverse. If you look at charts of most of the major risk factors, you see a major inflection point around July 15 in equities, energy benchmarks, and credit benchmarks. It was an absolute turn-on-a-dime on the charts, which is not good for hedge-fund investments. (The July low is marked with an arrow in Figure 3.) I dont know whats going to happen right now, but I sure dont think the upside justifies the downside, no matter what you do.
smart people tried to pick the bottom, and theyve been burned and lied to. And we have to shake that out. The big examples are the financings that have occurred over the past six to nine months in the financial services sector where, say, an investment fund comes in and lays money into a Merrill or a Lehman. The Mitsubishi UFJ episode was just a joke: They negotiated a 20-percent purchase [of Morgan Stanley] at $25 and a week and a half later the stock was at $7. And that weekend [Morgan Stanley CEO] John Mack was still saying the deal is going to go through under its normal terms.
The market should recover, but its going to take several quarters.
AT: What do you say to the argument that whenever things seem to be at their worst, thats when theres the greatest opportunity? KG: I agree, but there are a couple of reasons it doesnt dilute my current opinion in any way. First, the market is exceedingly treacherous long and short. Do I think the market is cheap here? Yes. And I think a lot of the problems right now are driven by a combination of technicals and panic. But the point is this: It is still a market in deep disrepair. In terms of investment, its my very strong belief the market should recover, but its going to do so over several quarters. Theres a great deal to be said for waiting until the volatility comes out of the market. If youre Warren Buffet, this is a good time to buy. If I had an unlimited amount of capital, sure, Id buy a bunch of companies and Id probably buy a few condos in Florida, too. But since most people are trying to manage their returns, I think the [opportunities] will be no worse when the markets are functioning more normally and theres more clarity. If you want to make some money as an investor in this market, [thats going to happen] over a period of years. By contrast, I think its going to be very easy to get completely rolled over while the market is still broken, no matter what you do. One of the reasons were in this mess is because some very
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AT: Do you interpret a day like yesterday (Oct. 28, when the S&P 500 tested the Oct. 10 low but rallied to close up more than 10 percent on the day) as a good thing or evidence the market is still broken? KG: One of my strongest opinions is the path toward a healthy capital market will not take the form of a v-bottom in the equity market. I was probably as happy as most people that the market rallied like it did, because at least it put some space between where I think the lows are and current levels. It could continue to go up although I would guess its going to close down hard today because no matter what the Fed does [regarding interest rates], its going to be a sale for equities: If they dont cut rates, the market will probably crash; if they cut 25 basis points, it will drop very deeply; if they cut 50 points, the market will want to signal to the Fed they want even cheaper money; and if they cut 75, everyone will say, Look, theyre in full panic mode. (Note: The Fed cut rates 50 basis points and the S&P after trading higher much of the day closed down 1.9 percent.) My primary scenario is there may be at least one more 10- to 20-percent down move before we can see where things are, and it would be driven by a combination of [rising] unemployment and a deeper consumer recession thats not priced into the market. But until that happens, people will be sniffing around down near the October lows. If the S&P can rally 90 points yesterday, the next wave of selling isnt going to crash through where I think the support is. I dont root for the market to go up in an aggressive way right now because I dont think theres a framework for a sustained rally. Whenever I feel compelled to make a prognostication, its based on fund flows not on a lot of fundamental analysis or financial analysis. When you look at approximately 400 portfolios every day, you start to get an idea of peoples decision factors. And in my opinion, everyone is waiting for a group consensus that, say, corporate earnings in the U.S. can start to build from a worstcase scenario and that its a good time to funnel capital into [equiwww.activetradermag.com January 2009 ACTIVE TRADER
ties]. I certainly dont see that right now. I dont want to be a buzz-kill guy Im probably a little less pessimistic than most people I talk to. I think we can get out of this thing. The equity markets ought to be the first to recover, and they can recover quickly over the next year. But theyre not going to recover just because everyone is in desperation sell mode and then one day decides theyve had enough. I just dont think thats plausible.
hedge fund space; their involvement, compared to previous crises, was entirely tangential. Although theyve been buffeted very badly, two things have kept hedge funds out of the spotlight. One, they report their numbers only monthly and, two, they tend to have at most
The path toward a healthy capital market will not take the form of a v-bottom in the equity market.
quarterly liquidity (i.e., investors can withdraw funds only on a quarterly basis). Risk reduction in the hedge-fund arena is just catching up. Lets assume the whole world is trying to deleverage by 30 to 50 percent. Because of their lockups (the minimum period investors must agree to leave their capital in a fund), hedge funds didnt liquidate when, say, Lehman went bankrupt. My best guess is that around 25 to 30 percent of hedge-fund assets under management (AUM) several hundred billion dollars will go out the door by year end.
AT: What do you see going on in terms of hedge-fund redemptions? Have you seen more straightforward investor pullouts, or are funds getting crushed in their trading, too? KG: Its a combination of the two. Theres been some alarmingly poor performance. But this was the first time in a long time a disaster wasnt really [centered around] a hedge-fund trade. As this crisis has deepened there was virtually radio silence out of the
ACTIVE TRADER January 2009 www.activetradermag.com
AT: And you claim, all things considered, the hedge-fund redemption process is relatively stable? KG: Im tracking this very carefully and it doesnt appear the redemption process is any worse than I initially feared. [The money is] coming out in a relatively orderly fashion because, for instance, no counterparty risk has manifested itself. The fact that the hedge-fund industry has been reasonably proactive in recognizing the problems over the past year and a half and has reduced its risk has actually made things worse for people who are trying to reduce risk now. Non-invested hedge funds arent making markets, and theyre not the only ones. The sell side isnt making markets, either; volumes have dropped. The [market] is not particularly well equipped to accommodate the late liquidators. I just dont see how it will end until into the first quarter, when everyone should know what their redemptions are and the dust should start to settle. Also, theres a lot of uncertainty in the redemption process. One of the perennial problems in the hedge-fund space is that they raise capital very inefficiently through fund of funds, capitalintro organizations, and similar channels. Id estimate the average
continued on p. 46
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Q&A continued
dollar is intermediated at least a half-dozen times. Thats how the industry got to $2 trillion under management, but when the arrows are pointing the other way, there are a half-dozen points of redemption risk. Its been a very uncertain process. The other big problem is many fund of funds have mismatched their funding. Some of them trotted across Europe and raised a lot of money. The Europeans wanted quarterly liquidity, so the fund of funds gave it to them. But on the other side, the fund-of-funds managers invested in hedge funds with two- or three-year lockups; they were giving quarterly liquidity when they didnt have the same liquidity on the other side. I know several fund of funds that have put in full redemptions to every one of their managers because they had to. Theyre hoping that when they find out what their redemptions are, theyre going to be able to cancel those redemptions or at least reduce them in size. My message to my hedge-fund and fund-of-funds clients is that fourth-quarter performance is not anywhere near as important as franchise risk. Im begging them to figure out what their Jan. 2 AUM is and to make sure they can adjust to the point where on Jan. 2, their portfolio reflects that AUM.
There are thousands of hedge funds that are down maybe 10 percent right now, but Id say anyone down 10 percent is having one of the best alpha years theyll ever have. But thats not the message investors are taking right now.
AT: If they dont, theyll be massively over-leveraged, right? KG: Yes, but theres a worse outcome than that, which is that they may find themselves unable to meet even their year-end redemptions without causing enormous further damage to their returns. The late liquidators could lose significant amounts of money just raising cash to meet Dec. 31 redemption flows, and if this happens, its likely their remaining investors will cry uncle themselves. This is why its so important to get in front of the liquidity management process. I think I can summarize by saying that hedge funds are seeing the same deleveraging by investors that every other pool has had, but its been orderly much more orderly than, say, the liquidation of Lehman Brothers or the deleveraging of Citigroup. I find some irony in that since Ive been listening for a decade to lectures from the [banks] about what we didnt know about risk management. But its a painful process. Its biggest impacts are causing some very, very deep disruptions in the pricing patterns of the markets, but I think the industry can easily accommodate $500 to $600 billion of redemptions and rebuild from there. My last point is that when people do want to start taking risk again when capital pools are seeking risk a lot of money is going to come back to the hedge funds.
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AT: Is sentiment worse or better than the beginning of the month? KG: Theres a justifiable sense here in New York that something is gone for good. I think theyre probably overreacting, but youre looking at the hedge-fund industry alone losing tens of thousands of jobs, and the financial services industry is going to lose many more. Its peoples livelihoods and their investments. To use a very tired clich, its very much a gut-check time. As I said, Im probably a little more upbeat than most people, partly because its not the worst time to be selling risk-management services to multiple risk takers. But I believe one of the things that separates the real pros from the wannabes is the pros know bad markets and good markets, for that matter dont last forever, and they plan accordingly. And the people who survive this are in a position to make a fortune. Right now people are very emotional; theyre not making particularly good decisions. And thats what makes this the game it is: Sometimes it will break your heart. Also, somewhere down the road were going to have to pay the piper if [the bailout plan] works. Because everyone knows, at least from a karma perspective, that its not good when the governments of this world have to throw trillions of dollars at a problem. That cant be costless. We cant use TARP (the Troubled Asset Relief Plan) and make a profit on it and have the Chinese continue to fund our debt its just not likely. AT: How might paying the piper manifest itself, other than paying taxes through the nose? KG: Myriad ways: slow growth for years to come, less innovation, etc. All of this could make America a less lively and interesting place in which to live for a while. On the whole, though, Im optimistic we will climb out of this mess, slowly, doggedly, but surely. The U.S. still has the best mechanism for monetizing innovation than any country in the history of the world. It has great people and vast natural resources. This year has been a real blow to us, but I think eventually, it will bring out the best in this country. Lets just hope the Chinese dont decide to dump our debt during the recovery process; thats something I dont even want to contemplate.
www.activetradermag.com January 2009 ACTIVE TRADER
In this section
Carbon trading on the rise Gold update Hedge funds take hit Central banks slash rates Managed money Global numbers 51 51 53 54 55 56
BY CHRIS PETERS
n the biggest drought since mid2003, initial public offerings (IPOs) in the U.S. market have ground to a halt over the past few months. October and September were devoid of IPO activity the latest signs of the stagnant market. But its not a U.S.-only phenomenon. A PricewaterhouseCoopers survey showed a 62-percent decrease in IPOs offered on European exchanges in the third quarter
of 2008 compared to the same period in 2007. Meanwhile, the Toronto Stock Exchange had no new IPOs in Q3 and only 10 from January through September, compared to 17 during the same period last year. Table 1 shows the number of IPOs in the U.S. market for each month back to 1998. Notice the sudden increase in total IPOs between 1998 and 1999 as the tech bubble inflated and the sudden drop-off
that extended through 2003. Following through on the momentum of 2004-2007, 2008 started out strong with 13 IPOs priced in January. But as the year progressed and the economic crisis began to accelerate, each new month returned a bleaker picture for companies thinking of going public.
Total 247 486 406 83 70 69 217 The recent lack of IPO activity is reminiscent of the period following the dotcom crash.
Source: Renaissance Capitals IPOhome.com
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nies filing IPOs with the Securities and Exchange Commission (SEC) in the past 24 months with the number of filed companies that are either postponing or withdrawing their IPOs. The former has declined significantly over the past year as the latter hit a recent high in October. Through October, 84 IPOs had been withdrawn or postponed, compared to only 17 during the same period last year. The IPO retreat is no surprise considering the market conditions of late. IPOs thrive in expanding markets and tend to pop up in the fastest-moving sectors. There were 573 technology IPOs in 1999 and 2000, more than the total number of IPOs from 2006 through October 2008 combined. Table 2 shows IPOs separated by industry. Even after the dotcom bubble burst, the tech industry remained one of the strongest in the field, producing a solid percentage of IPOs each year. Other resilient industries were the health care, energy, and (until 2008) financial industries. Overall, year to date through Nov. 4,
The number of IPO filings decreased over the past year and cancellations rose to a recent high in October.
Source: Renaissance Capitals IPOhome.com
new IPO pricings are down 80.1 percent compared to last year, while filings with the SEC have declined 53.7 percent. Although also down in number, nonU.S. IPOs have gained prominence, comprising 28 percent of all IPO proceeds in 2008. Last year non-U.S. IPOs comprised 19 percent of the total, a significant increase from 2002 and 2003 when they comprised only 6 percent.
Total 483 401 83 69 69 217 214 223 Technology IPOs in the dotcom bubble era dwarfed the number of total IPOs launched since 2006.
Source: Renaissance Capital's IPOhome.com
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The extended performance of IPOs released during the economys current downturn remains to be seen.
released at a discount sometimes up to 15 or 20 percent of what prices would normally be. The extended performance of IPOs released during the economys current downturn remains to be seen. The Renaissance IPO Index is a float-adjusted market capitalization-weighted index representing all IPOs capitalized with at least $50 million. They are added to the index at the close of their first day of trading and removed on the second anniversary of their listing. Figure 3 compares the indexs cumulative monthly moves to those of the S&P 500 from January 2003 through October 2008. The figure highlights the correlation between IPOs and the broader market. The IPO index took off relative to the S&P 500 in 2004 and from July 2004 until October 2007, when both indices peaked, the IPO index outperformed the S&P 70 percent of the time on a monthly basis. From the end of October 2007 through October 2008, however, the IPO index has lost 49 percent while the S&P 500 has dropped 37.5 percent.
IPOs released during market downturns have tended to perform better in the long run because of the sound fundamentals required to make it through a turbulent market and the discounts at which the stocks are frequently offered.
Source: Renaissance Capital and Jay Ritter, University of Florida
The cumulative monthly performance of the Renaissance IPO index compared to the S&P 500 shows the IPO index outperformed the S&P for the past three years.
Source: Renaissance Capital's IPOhome.com and eSignal
these periods tended to fare better in the intermediate term than those released in other years. According to a Renaissance spokesperson, this is because investors tend to be more discriminating during these times and the IPOs are often
Through the third quarter, 173 new exchange-traded funds (ETFs) entered the U.S. market. And although Q3 had the lowest quarterly increase in two-and-ahalf years, 106 ETFs launched in Q2, helping to bring the year-to-date total just
The rate at which ETFs have entered the market has increased dramatically over the last few years.
Source: Yahoo Finance
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Counting carbs
CFI prices spiked dramatically earlier this year, and the number of contracts traded has increased substantially from last year.
As interest in the carbon trading market has increased, so has the price activity. As Figure 1 shows, CCXs 2009 vintage CFI contracts price action was fairly tame heading into 2008. However, from the beginning of the year to June 2008 CFI contract prices increased 289.5 percent, before falling over the next five months to
a new contract low. The exchanges monthly report for October highlighted a 244-percent yearto-date increase in CFI contract volume over 2007. Combined with the CFI futures and options, 2008 has seen over 100 million metric tons of CO2 traded on the exchange.
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008 was a historic year for the gold market, which hit an alltime high in March as frontmonth futures topped $1,030/ounce and the soon-to-expire December 2008 futures (GCZ08) charged to $1,048 (Figure 1). But despite market chatter that $1,500 or even $2,000 gold would be next, the market abruptly reversed as the commod-
ity bubble burst and a dollar rally emerged as the stock market began to crumble in earnest. As a result, instead of pushing gold to the stratosphere, the October Massacre in stocks was accompanied by the yellow metal falling as low as $681 late in the month.
Dollar action
Because gold is denominated in U.S. dol-
lars, the bear market in the greenback since 2002 was actually a bullish factor for the yellow metal. Figure 2 shows a monthly chart of continuous gold futures from January 2001 to November 2008. After nearly a decade of trading sideways from $275 to $400, gold bulls awoke in late 2002. The subsequent bull market pushed gold from $276 at the beginning of 2002 to $1,014
in March 2008. Meanwhile, crude oil rallied to an all-time high of $147/ barrel in July 2008, helping drive inflation concerns a fundamental underpinning to the gold rally in recent years. This fall, crude oil fell sharply, removing inflation concerns, which took away some impetus to buy gold. Also, it was no coincidence that the U.S. dollar index plunged from 125.50 in January 2002 to 70.69 in March 2008. The bucks recent upturn has acted as a major catalyst for some deflation in gold, crude oil, and other commodity markets this year.
Gold topped out in March, and some of its sharpest losses since then occurred in October as the stock market collapsed.
Source: TradeStation
Gold climbed from $276 at the beginning of 2002 to $1,014 in March 2008. However, it has fallen sharply in the past six months.
Source: eSignal
doing well, which eroded demand for all commodities including gold. During September and October, hedge funds were forced to close out many posi-
tions because of customer withdrawals (redemptions), position squaring, and overall risk aversion.
continued on p. 5 3
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he hedge-fund industry is poised to post its worst year ever according to Chicagobased Hedge Fund Researchs (HFR) third-quarter report. The hedge fund industrys total capital shrank 11 percent from $1.93 trillion at the end of Q2 2008 to $1.72 trillion in Q3. The capital outflow of $210 billion in Q3 exceeded 2007s entire capital inflow of $194 billion. I think its a capitulation issue, says Ken Heinz, President of HFR. People indiscriminately want to be in cash at all costs and they dont really care whether a funds doing well or doing poorly. More than $31 billion of the loss was due to investor withdrawals, the single largest net capital withdrawal in the history of the industry. As of Nov. 7, indices
tracking hedge-fund performance for the year were down by double digits. The Barclay Hedge Fund index was down 18.8 percent year-to-date through October, while HFRs Fund Weighted Composite Index showed a 10.5-percent loss. If the trend continues through the end of the year, this could be the hedge fund industrys first negative yearly performance since 2002, when the average hedge fund declined by 1.45 percent. In September this year, hedge funds lost nearly 5.5 percent on average the industrys second-worst month. In August
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George Gero, vice president at RBC Capital Markets Global Futures, says gold futures open interest fell from 415,000 positions on Aug. 15 to 303,000 on Nov. 4. That tells me there has been a major liquidation, he says. Hedge funds had to liquidate to meet margin calls in stocks. Nobody cared about inflation or deflation; they were being forced [to liquidate] by [their] prime brokers. Cash was needed by hedge funds, but a lot of gold traders, including Bear Stearns, Lehman Brothers, and AIG, are gone. In the short-term, you have lost a big part of the speculative audience.
cal gold brokers saw the demand for gold coins and bars increase. In October, weve seen a tremendous off-take in physical gold, says Andrew Montano, director of precious metals at Scotia Mocatta in Toronto, a gold dealer. Weve had real big demand in that area. Montano found increased retail interest in owning physical gold during the equity meltdown in October. It was a run away from feared currencies, he says. Gold is no governments IOU. Gold is the ultimate reserve or store of wealth.
Monetary injections
Some say inflation will ultimately reappear in the wake of the billions of dollars that have been injected into the global
banking system to relieve the credit bottleneck and the hefty cuts in official monetary policy rates by central banks around in the world. After all, an increase in money supply is generally thought to be inflationary. Next year it may be a totally different picture because all this bailout money all over the world will inflate the currencies, Gero says. Inflation will rear its head and people will get back to looking at gold for fundamental reasons, not trading reasons. However, gold bulls may need to bide their time. Before we have inflation, we have to have a serious round of deflation, Montano says. Housing prices and commodity prices are still collapsing.
1998 hedge funds lost 8.7 percent, largely precipitated by the liquidation of the Long-Term Capital Management fund. Performance turned around that year, however, and funds overall still managed to end the year with a 2.6-percent gain. Although 1998 produced the worstperforming month, the actual drawdown lasted only about four months, whereas the current drawdown has already been much longer, stretching back nearly 11 months. Also, the circumstances are much different from a decade ago. One interesting contrast is in 1998 the liquidation of a [single] fund precipitated poor performance and volatility at banks and financial institutions, Heinz says. [This time], the liquidation of banks and brokerage firms created a volatile, negative environment for hedgefund performance. Table 1 shows the year-to-date performance for each of Barclay Hedges hedge-fund sub-indices. According to this data, mirrored in HFRs performance indices, short-biased hedge funds have returned the best performance this year, returning profits in a sea of red, despite certain Securities and Exchange Commission (SEC) injunctions restricting some short sales. Funds focused on emerging markets appear to be hit the worst. As of Nov. 7, the Barclay Hedge Emerging Markets Index was down 37.76 percent year-todate through October. HFRs emerging markets indices, which split the data into specific regions, show the worst performing to be those focused in Asia (except for Japan) and Russia/Eastern Europe. As the year heads toward becoming the worst in history for the hedge fund industry, the outlook for the first few quarters of 2009 is none too bright as investors continue to jump ship. The consolidation, which is ongoing, will continue into 2009, Heinz says. For more information on implications of the hedge-fund contractions, see Kent Grant on risk on p. 42.
Central banks slash rates to prime markets FIGURE 1: U.S. DOLLAR INDEX
As the world financial system sputters, finance ministers across the globe attempt to grease the wheels with lower interest rates.
n early October, the U.S. Federal Reserve, the European Central Bank (ECB), the Bank of England (BOE), and the Swiss, Canadian, and Swedish central banks jointly announced emergency 0.5-percent rate cuts. The Bank of Japan (BOJ) joined in support of the statement, but at the time did not participate in the coordinated rate cut. As the month wore on, the U.S. dollar, which had already begun to climb off the generational low it hit in March, accelerated to the upside (Figure 1). The U.S. dollar index (DXY) made some uncertain moves after hitting its all-time low in March, but by Oct. 28 had reached a nearly two-and-a-half-year high. On that day the U.S. Fed announced another 0.5percent rate cut, dropping the fed funds rate to 1 percent.
The U.S. dollar surged from August through October after a two-and-a-half-year slide.
Source for all bar charts: eSignal
A worrisome yen
It was the strength of another currency, however, that had some people worried. Oct. 24 capped a surge in the Japanese yen (JPY) to a 13-year high against the dollar. This move prompted the Group of Seven (G7) finance ministers to release a statement saying We are concerned about the recent excessive volatility in the exchange rate of the yen and its possible adverse implications for economic and financial stability. Figure 2 shows the erratic behavior in the USD/JPY in October as well as the dollars drop to its lowest point vs. the yen since July 1995. Despite its already
Octobers yen volatility prompted the G7 nations to release a statement of concern.
low rates, the BOJ decided to decrease its overnight lending rate from 0.5 to 0.3 percent on Oct. 31. On Nov. 6, the ECB decided to cut rates by another 0.5 percent, dropping its rate to 3.25 percent. The Bank of England also cut rates, as did the Swiss National Bank and the Danish central bank. Figure 3 displays the monthly average
continued on p. 5 5
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Top 10 traders ranked by September 2008 return managing less than $10 million as of Sept. 30. 1. 2. 3. 4. 5. 6. 7. 8. 9. Capital Alt. Invest. Mgmt District Capital Mgmt. (Divers.) Ashley Capital Mgmt. Attain Portfolio Advisors (Modified) Beechdale (Negative Gamma) T4T S.r.l. (System) Somers Brothers Capital (Divers) Parizek Capital (Futures) MarketEthos (ME Plus 3X) 44.85% 28.95% 24.50% 23.71% 21.38% 16.50% 15.01% 14.68% 14.48% 13.78% 123.99% 4.24% 8.76% 41.37% 30.08% 87.76% 52.69% 45.72% 24.49% -4.90% 9.3 3.4 2.2 6.1 7.0 1.4 3.6 1.1 6.7 2.0 Australian officials announced an aggressive plan to buy back the Australian dollar following a steep four-month slide.
Based on estimates of the composite of all accounts or the fully funded subset method. Does not reflect the performance of any single account. PAST RESULTS ARE NOT NECESSARILY INDICATIVE OF FUTURE PERFORMANCE. Source: Barclay Hedge (www.barclayhedge.com)
55
Gross Domestic Product* Release Period date Change AMERICAS Argentina Brazil Canada EUROPE France Germany UK Q2 Q2 Q2 Q2 Q2 Q2 9/17 9/10 8/29 8/14 8/14 9/30 20.0% 7.7% 2.5% 0.1% -0.1% 0.4% 1-year change 24.2% 12.9% 5.2% 3.5% 4.4% 4.4% Next release 12/18 12/9 12/1 11/14 11/13 12/23 AFRICA S. Africa Period Q2 Release date Change 8/19 5.0% 1-year Next change release 16.2% 11/25
ASIA AND SOUTH PACIFIC Australia Q2 9/3 Hong Kong Q2 8/15 India Q2 8/29 Japan Q2 8/13 Singapore Q2 8/11
2.7% 12/3 4.2% 11/14 16.3% 11/28 -0.6% NLT 11/19 2.1% NLT 11/21
Unemployment Release Period date AMERICAS Argentina Q2 9/22 Brazil Sept. 10/23 Canada Oct. 11/7 EUROPE France Q2 9/4 Germany Sept. 10/30 UK June-Aug. 10/15 Rate 8.0% 7.6% 6.2% 7.6% 7.1% 5.7% 1-year Next Change change release -0.4% 0.0% 0.1% 0.0% -0.1% 0.5% -0.5% -1.4% 0.4% -0.8% -1.1% 0.4% 12/22 11/19 12/5 12/4 11/27 11/12 Period Release date Rate 1-year Next Change change release
ASIA AND SOUTH PACIFIC Australia Sept. 10/9 Hong Kong July-Sept. 10/20 Japan Sept. 10/31 Singapore Q3 10/31
Release Period date Change AMERICAS Argentina Brazil Canada EUROPE France Germany UK Sept. Oct. Sept. Sept. Sept. Sept. 10/10 11/7 10/24 10/14 10/15 10/14 0.5% 0.5% 0.1% -0.1% -0.1% 0.5%
Consumer Price Index (CPI) 1-year Next Release change release Period date Change AFRICA 8.7% 11/11 S. Africa Sept. 10/29 0.2% 6.4% 12/5 3.4% 11/21 ASIA AND SOUTH PACIFIC Australia Q3 10/22 1.2% 3.0% 11/13 Hong Kong Sept. 10/23 3.0% 2.9% 11/14 India Sept. 10/31 0.7% 5.2% 11/18 Japan Sept. 10/31 0.0% Singapore Sept. 10/23 0.0% Producer Price Index (PPI) 1-year Next Release change release Period date Change AFRICA 11.6% 11/11 S. Africa Sept. 10/30 -3.5% 14.7% 12/8 8.0% 11/28 ASIA AND SOUTH PACIFIC Australia Q3 10/20 2.0% 6.1% 11/28 Hong Kong Q2 9/12 1.7% 8.3% 11/20 India Oct. 11/7 -0.9% 8.5% 11/10 Japan Sept. 10/14 -0.4% Singapore Sept. 10/30 -4.2%
Release Period date Change AMERICAS Argentina Brazil Canada EUROPE France Germany UK Sept. Oct. Sept. Sept. Sept. Sept. 10/10 11/6 10/30 10/30 10/20 10/13 0.7% 1.4% -1.2% -0.4% 0.3% -0.3%
All data as of Nov. 7 LEGEND Change: Change from previous report release NLT: No later than Rate: Unemployment rate
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Global MARKETPLACE
FOREX (VS. U.S. DOLLAR)
Current price vs. U.S. dollar
0.01007 0.14683 0.12903 0.02105 0.67779 0.03049 0.02887 0.03726 0.85814 0.4731 1.29369 0.8652 0.12979 0.60431 1.59487 0.69334 0.10332
Rank* Country
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17
Currency
Japanese yen Chinese yuan Hong Kong dollar Indian rupee Singapore dollar Taiwanese dollar Thai baht Russian ruble Swiss franc Brazilian real Euro Canadian dollar Swedish krona New Zealand dollar British pound Australian dollar South African rand
1-month gain/loss
5.98% 0.36% 0.24% -1.36% -1.72% -1.96% -2.07% -2.99% -3.10% -4.34% -6.06% -6.37% -8.51% -8.73% -9.98% -10.46% -12.84%
3-month gain/loss
8.85% 0.51% 0.69% -11.11% -6.72% -6.44% -3.70% -12.29% -9.76% -25.66% -16.62% -9.98% -20.69% -16.76% -18.53% -24.78% -24.47%
6-month gain/loss
5.94% 2.46% 0.57% -14.57% -7.77% -7.10% -9.19% -11.50% -9.55% -21.89% -16.36% -12.01% -21.60% -22.86% -19.15% -26.29% -21.83%
52-week high
0.011 0.14683 0.12903 0.03842 0.7434 0.03335 0.03396 0.04334 1.0375 0.6414 1.6038 1.1038 0.1718 0.8214 2.1161 0.9849 0.1555
52-week low
0.0087 0.1339 0.1279 0.01843 0.6594 0.02974 0.02775 0.03652 0.8471 0.394 1.2329 0.768 0.1235 0.5349 1.5276 0.6005 0.0841
Previous rank
1 4 3 13 7 6 2 10 8 17 12 9 14 11 5 16 15
ACCOUNT BALANCE
Rank Country
1 2 3 4 5 6 7 8 9 10 11 12 Singapore Switzerland Hong Kong China Taiwan Sweden Germany Netherlands Russia Japan Canada Brazil
2007
39.157 70.797 28.038 371.833 32.979 38.797 252.501 52.522 76.163 210.967 12.726 1.712
Ratio*
24.269 16.577 13.534 11.336 8.603 8.53 7.603 6.758 5.906 4.815 0.886 0.13
2006
29.765 57.192 22.936 249.866 26.3 33.297 177.664 55.874 94.34 170.437 17.838 13.621
2008+
37.099 45.731 26.191 399.325 33.09 33.041 279.017 51.107 115.286 194.269 14.803 -29.215
Rank Country
13 14 15 16 17 18 19 20 Mexico France India UK U.S. Australia South Africa Spain
2007
-5.813 -30.588 -15.494 -105.224 -731.214 -56.342 -20.557 -145.141
Ratio*
-0.568 -1.179 -1.408 -3.752 -5.296 -6.198 -7.262 -10.079
2006
-2.231 -15.439 -9.8 -82.975 -788.115 -40.362 -16.602 -110.14
+ 2008
-15.882 -83.488 -34.58 -101.454 -664.125 -52.555 -23.908 -169.209
Totals in billions of U.S. dollars *Account balance in percent of GDP +Estimate Source: International Monetary Fund, World Economic Outlook Database, October 2008
57
Nov. 6
0.53824 0.68278 0.29677 1.86711 0.54274 0.99239 0.66342 0.54711 0.36575 0.66889 0.43493 1.23315 0.80181 0.53633 0.80818 85.21795 46.97731 85.91263 158.388 68.83476
1-month gain/loss
7.63% 6.76% 6.25% 4.87% 4.00% 3.45% 3.13% 2.13% 1.78% -0.38% -0.54% -4.21% -4.40% -4.67% -7.65% -8.65% -9.83% -11.74% -15.10% -15.59%
3-month gain/loss
10.79% -1.13% -8.72% 10.90% 10.54% 0.27% 8.24% -17.40% -10.84% 7.97% -7.64% -2.28% -16.42% -9.73% -16.64% -17.11% -31.73% -17.32% -25.17% -30.93%
6-month gain/loss
11.90% 6.00% -3.36% 13.50% 8.85% 2.81% 8.16% -11.21% -6.61% 5.19% -8.81% -3.33% -16.22% -11.83% -18.52% -14.64% -26.30% -16.98% -23.70% -30.45%
52-week high
0.5677 0.7391 0.339 169.958 0.5427 1.1152 0.6992 0.6719 0.4197 0.7476 0.4895 1.4418 0.9833 0.6411 1.0629 105.071 69.3981 124.527 239.811 107.167
1 Franc / Pound 2 Real / Aussie $ 3 Real / Pound 4 Euro / Yen 5 Canada $ / Pound 6 Franc / Canada $ 7 Franc / Euro 8 Real / Canada $ 9 Real / Euro 10 Canada $ / Euro 11 Aussie $ / Pound 12 Pound / Euro 13 Aussie $ / Canada $ 14 Aussie $ / Euro 15 Aussie $ / Franc 16 Franc / Yen 17 Real / Yen 18 Canada $ / Yen 19 Pound / Yen 20 Aussie $ / Yen
Country
Index
Nov. 6
20,125.27 9,555.41 4,272.40 16,715.00 5,924.90 3,387.25 4,106.50 19,650.86 4,813.57 36,362.00 904.88 8,899.14 1,819.20 9,734.22 13,790.04
1-month gain/loss
-4.27% -6.60% -6.90% -7.01% -8.26% -8.75% -9.64% -9.65% -10.64% -13.63% -14.38% -15.03% -16.10% -17.52% -17.93%
3-month gain/loss
-25.31% -28.97% -22.12% -24.60% -17.82% -23.85% -18.17% -28.13% -26.64% -36.81% -29.81% -32.86% -36.98% -35.42% -37.61%
6-month gain/loss
-36.97% -33.71% -31.26% -35.85% -21.46% -32.80% -28.93% -37.06% -31.40% -48.20% -36.20% -36.90% -44.00% -43.97% -47.49%
52-week high
33,232.89 15,154.80 6,610.90 30,403.00 8,918.80 5,795.22 6,741.40 32,292.90 8,117.79 73,920.00 1,523.57 16,107.70 3,632.76 21,206.80 29,962.90
52-week low
18,363.69 8,537.34 3,665.20 14,521.00 5,265.90 2,959.29 3,693.90 16,480.00 4,014.60 29,435.00 839.80 6,994.90 1,473.77 7,697.39 10,676.30
Previous
6 15 5 7 2 3 1 11 4 12 13 10 9 14 8
South Africa FTSE/JSE All Share Canada S&P/TSX composite UK FTSE 100 Italy MIBTel Switzerland Swiss Market France CAC 40 Australia All ordinaries Mexico IPC Germany Xetra Dax Brazil Bovespa U.S. S&P 500 Japan Nikkei 225 Singapore Straits Times India BSE 30 Hong Kong Hang Seng
Interest rate
Fed funds rate Overnight call rate Refi rate Repo rate Overnight funding rate 3-month Swiss Libor Cash rate Cash rate Selic rate Overnight call rate Discount rate Repo rate Repurchase rate
Rate
1 0.3 3.25 3 2.25 2 5.25 6.5 13.75 4 3 7.5 12
Last change
0.5 (Oct. 08) 0.2 (Oct. 08) 0.5 (Nov. 08) 1.5 (Nov. 08) 0.25 (Oct. 08) 0.5 (Nov. 08) 0.75 (Nov. 08) 0.5 (Oct. 08) 0.75 (Sept. 08) 0.25 (Nov. 08) 0.5 (Oct. 08) 0.5 (Nov. 08) 0.5 (June 08)
May 08
2 0.5 4 5 3 2.75 7.25 8.25 11.75 5 3.5 7.75 11.5
November 07
4.5 0.5 4 5.75 4.5 2.75 6.75 8.25 11.25 5 3.25 7.75 10.5
Nov. 6
96.325 117.52 94.85 137.84 115.43
1-month
1.86% 0.30% -0.03% -0.76% -2.15%
3-month
2.26% 4.14% 0.92% 0.43% 0.83%
6-month
1.71% 2.89% 1.30% 1.06% 0.51%
High
96.41 118.5 95.18 141.90 120.03
Low
93.60 109.65 93.18 132.09 110.83
Previous
5 1 4 3 2
58
ETF Snapshot
Date: Nov. 6
The following table summarizes the trading activity in the most actively traded exchange-traded funds. The information does NOT constitute trade signals. It is intended only to provide a brief synopsis of each markets liquidity, direction, and levels of momentum and volatility. See the legend for explanations of the different fields.
Symbol
QID SDS TWM DXD SKF SRS DUG
Sector
Leveraged inverse index Leveraged inverse index Leveraged inverse index Leveraged inverse index Leveraged inverse index Leveraged inverse index Leveraged inverse index
Volume
50.74 M 58.46 M 10.03 M 13.28 M 24.87 M 6.06 M 20.32 M
1-year return
89.27% 68.72% 54.56% 51.21% 46.26% 36.46% 0.24%
10-day move/rank
-6.28% / 44% -5.96% / 33% -10.13% / 86% -7.23% / 33% -5.21% / 29% -9.38% / 25% -13.00% / 25%
20-day move/rank
-11.24% / 67% -14.00% / 93% -15.04% / 86% -14.90% / 94% -20.47% / 88% 2.50% / 13% -35.86% / 93%
60-day move/rank
84.05% / 98% 44.71% / 93% 67.89% / 94% 29.23% / 88% 14.08% / 35% 64.84% / 92% 15.76% / 19%
Volatility ratio/rank
.66 / 60% .84 / 80% .88 / 75% 1.04 / 83% .89 / 80% 1.18 / 82% .78 / 70%
-60.39% / 96% -63.48% / 89% -63.05% / 100% -54.32% / 98% -47.11% / 96% -47.14% / 97% -49.28% / 84% -44.05% / 92% -38.21% / 94% -32.13% / 95% -41.80% / 98% -50.92% / 87% -30.38% / 94% -34.77% / 95% -41.17% / 98% -40.95% / 100% -16.05% / 43% -31.71% / 98% -38.33% / 95% -34.36% / 100% -33.21% / 97% -32.25% / 95% -35.93% / 99% -35.55% / 97% -29.56% / 98% -29.33% / 97% -35.24% / 86% -33.27% / 97% -24.45% / 88% -29.31% / 87% -33.06% / 71% -25.04% / 84% -24.50% / 95% -46.51% / 97% -25.45% / 23% -24.25% / 100% -11.45% / 71%
.20 / 28% .14 / 8% .17 / 10% .22 / 30% .29 / 13% .29 / 60% .22 / 28% .32 / 38% .26 / 30% .37 / 53% .30 / 67% .17 / 7% .37 / 52% .30 / 62% .30 / 18% .27 / 33% .55 / 75% .38 / 47% .27 / 33% .29 / 38% .31 / 47% .30 / 3% .26 / 17% .31 / 30% .33 / 45% .34 / 42% .27 / 27% .36 / 5% .37 / 82% .32 / 28% .14 / 10% .23 / 25% .45 / 78% .11 / 3% .12 / 47% .43 / 47% .18 / 0%
hundred-twenty 60-day moves. A reading of 100 percent means the current reading is larger than all the past readings, while a reading of 0 percent means the current reading is smaller than all previous readings. These figures provide perspective for determining how relatively large or small the most recent price move is compared to past price moves. Volatility ratio/rank: The ratio is the shortterm volatility (10-day standard deviation of prices) divided by the long-term volatility (100day standard deviation of prices). The rank is the percentile rank of the volatility ratio over the past 60 days.
59
Note: Average volume and open-interest data includes both pit and side-by-side electronic contracts (where applicable). Price activity for CME futures is based on pit-traded contracts, while price activity for CBOT futures is based on the highest-volume contract (pit or electronic).
Stock snapshot as of Nov. 6
Symbol
MS MER RIO C RIMM BAC PBR GE EMC INTC TWX CHK CSCO AAPL MSFT T PFE XOM ORCL JPM WFC
Volume
61.48 M 40.89 M 61.50 M 149.13 M 37.45 M 116.44 M 37.43 M 142.72 M 38.55 M 96.34 M 38.76 M 43.26 M 84.40 M 61.71 M 123.32 M 44.32 M 73.94 M 56.50 M 55.20 M 69.50 M 66.37 M
1-year return
-71.61% -69.53% -66.44% -65.20% -57.64% -54.25% -53.90% -52.21% -47.41% -44.85% -44.61% -43.98% -40.73% -40.07% -38.10% -33.70% -28.30% -19.45% -12.96% -9.57% -9.13%
10-day move/rank
-14.88% / 44% -7.31% / 29% 4.63% / 0% -12.13% / 39% 3.81% / 33% -12.52% / 36% 3.11% / 25% -2.45% / 18% 11.26% / 43% -4.41% / 25% 0.63% / 0% 5.03% / 14% -1.74% / 19% 0.89% / 15% -6.45% / 31% 2.89% / 10% -4.27% / 27% -0.61% / 0% -0.59% / 10% 1.08% / 29% -8.17% / 55%
20-day move/rank
23.61% / 100% 21.85% / 100% -1.72% / 2% -10.90% / 42% -18.75% / 18% 2.50% / 16% -9.97% / 24% -3.52% / 16% 0.29% / 0% -11.09% / 13% -5.35% / 5% 27.22% / 100% -1.45% / 0% 11.67% / 85% -6.37% / 44% 13.00% / 93% 4.47% / 59% 2.88% / 85% 3.95% / 24% 4.31% / 24% 5.58% / 31%
60-day move/rank
-61.67% / 94% -36.60% / 62% -53.76% / 86% -35.32% / 97% -62.21% / 97% -30.28% / 76% -51.85% / 88% -37.43% / 100% -30.15% / 94% -42.50% / 100% -38.47% / 100% -52.18% / 74% -30.32% / 100% -44.73% / 95% -25.19% / 100% -16.96% / 60% -16.65% / 93% -10.50% / 48% -26.77% / 100% 3.66% / 17% -1.78% / 2%
Volatility ratio/rank
.16 / 0% .25 / 53% .18 / 33% .39 / 43% .12 / 12% .30 / 43% .22 / 20% .24 / 43% .34 / 62% .28 / 23% .25 / 2% .13 / 10% .29 / 27% .19 / 18% .41 / 27% .48 / 88% .68 / 82% .58 / 68% .48 / 47% .75 / 68% .49 / 52%
Market
E-Mini S&P 500 10-yr. T-note E-Mini Nasdaq 100 5-yr. T-note Mini Dow Crude oil 30-yr. T-bond 2-yr. T-note E-Mini Russell 2000 Eurocurrency Corn Gold 100 oz. Soybeans Natural gas Wheat E-Mini S&P MidCap 400
Symbol
ES TY NQ FV YM CL US TU TF EC C GC S NG W ME
Exchange
CME CME CME CME CME NYMEX CME CME ICE CME CME NYMEX CME NYMEX CME CME
Volume
3.42 M 654.5 498.3 450.5 294.5 258.5 239.1 229.3 204.3 199.8 128.0 105.9 84.9 61.9 36.0 35.4
OI
2.83 M 1.39 M 364.9 1.38 M 99.4 243.6 758.5 729.9 488.5 154.5 460.7 174.5 110.4 88.9 154.0 106.9
10-day move/rank
-1.17% / 0% -0.10% / 0% -1.04% / 0% 1.05% / 54% -0.84% / 0% -10.42% / 25% -0.90% / 27% 0.80% / 75% 1.99% / 33% -0.91% / 0% -3.13% / 19% 2.45% / 100% 1.70% / 17% 8.72% / 100% -0.11% / 0% 2.45% / 25%
20-day move/rank
-0.88% / 10% 1.75% / 61% -2.48% / 4% 2.71% / 100% 1.19% / 33% -29.82% / 85% 0.08% / 0% 0.97% / 92% 1.78% / 22% -7.11% / 81% -13.74% / 57% -17.41% / 93% -8.22% / 33% 2.26% / 43% -13.60% / 40% -2.04% / 12%
60-day move/rank
-29.58% / 98% 0.02% / 4% -36.11% / 99% 3.59% / 89% -24.49% / 95% -47.61% / 96% 0.20% / 11% 1.91% / 94% -33.53% / 96% -14.70% / 86% -29.87% / 75% -11.53% / 69% -29.59% / 71% -17.47% / 16% -38.56% / 99% -35.28% / 97%
Volatility ratio/rank
.35 / 42% .53 / 48% .28 / 15% .61 / 70% .45 / 78% .11 / 3% .65 / 55% .32 / 48% .38 / 8% .16 / 3% .14 / 10% .16 / 0% .11 / 7% .18 / 85% .16 / 3% .32 / 32%
*Average volume and open interest based on highest-volume contract (March 2008).
This information is for educational purposes only. Active Trader provides this data in good faith, but it cannot guarantee its accuracy or timeliness. Active Trader assumes no responsibility for the use of this information. Active Trader does not recommend buying or selling any market, nor does it solicit orders to buy or sell any market. There is a high level of risk in trading, especially for traders who use leverage. The reader assumes all responsibility for his or her actions in the market.
60
THE Economy
FIGURE 1: QUARTERLY GDP PERFORMANCE
Date and time: Oct. 29 at 2:15 p.m. Summary: The Fed cut its target fed funds
interest rate 0.5 percent to 1 percent, its lowest level in four-and-a-half years. The deepening economic slowdown was attributed mainly to a drop in consumer spending, while the continued weakening of foreign economic activity has hurt exports. The FOMC continues to expect inflation will moderate over the next few quarters as energy and commodity prices stabilize. The following tables compare the S&P 500s daily and weekly reactions to economic releases as well as historic behavior since 1997 (or earlier).
ECONOMY CONTRACTS IN Q3
Report: Gross domestic product for Q3 2007
(adv.)
Seasonally adjusted
Date and time: Oct. 30 at 8:30 a.m. Actual: -0.3 percent Previous: 2.8 percent Consensus: -0.5 percent S&P 500 reaction
2.58% 2.44%
CPI and PPI year-over-year growth fell in August and September, largely because of dropping energy costs.
Source: Bureau of Labor Statistics Not seasonally adjusted
Report: Producer Price Index (PPI) Date and time: Oct. 15 at 8:30 a.m. Actual: -0.4 percent (core 0.4 percent) Previous: -0.9 percent (core 0.2 percent) Consensus: -0.4 percent (core 0.2 percent) S&P 500 reaction
-9.03% -4.30%
62
Key CONCEPTS
At the money (ATM): An option whose strike price is identical (or very close) to the current underlying stock (or futures) price. Average and median: The mean (or average) of a set of values is the sum of the values divided by the number of values in the set. If a set consists of 10 numbers, add them and divide by 10 to get the mean. A statistical weakness of the mean is that it can be distorted by exceptionally large or small values. For example, the mean of 1, 2, 3, 4, 5, 6, 7, and 200 is 28.5 (228/8). Take away 200, and the mean of the remaining seven numbers is 4, which is much more representative of the numbers in this set than 28.5. The median can help gauge how representative a mean really is. The median of a data set is its middle value (when the set has an odd number of elements) or the mean of the middle two elements (when the set has an even number of elements). The median is less susceptible than the mean to distortion from extreme, non-representative values. The median of 1, 2, 3, 4, 5, 6, 7, and 200 is 4.5 ((4+5)/2), which is much more in line with the majority of numbers in the set. Bollinger Bands: Bollinger Bands are a type of trading envelope consisting of lines plotted above and below a moving average, which are designed to capture a markets typical price fluctuations. The indicator is similar in concept to the moving average envelope, with an important difference: While moving average envelopes plot lines a fixed percentage above and below the average (typically three percent above and below a 21-day simple moving average), Bollinger Bands use standard deviation to determine how far above and below the moving average the lines are placed. As a result, while the upper and lower lines of a moving average envelope move in tandem, Bollinger Bands expand during periods of rising market volatility and contract during periods of decreasing market volatility. Bollinger Bands were created by John Bollinger, CFA, CMT, the president and founder of Bollinger Capital Management (see Active Trader, April 2003, p. 60). By default, the upper and lower Bollinger Bands are placed two standard deviations above and below a 20-period simple moving average. Upper band = 20-period simple moving average + 2 standard deviations Middle line = 20-period simple moving average of closing prices Lower band = 20-period simple moving average - 2 standard deviations Bollinger Bands highlight when price has become high or low on a relative basis, which is signaled through the touch (or
63
minor penetration) of the upper or lower line. However, Bollinger stresses that price touching the lower or upper band does not constitute an automatic buy or sell signal. For example, a close (or multiple closes) above the upper band or below the lower band reflects stronger upside or downside momentum that is more likely to be a breakout (or trend) signal, rather than a reversal signal. Accordingly, Bollinger suggests using the bands in conjunction with other trading tools that can supply context and signal confirmation. Bootstrapping: A method for estimating results from a data set by creating multiple series of random samples and comparing them to the original set. This approach is used to confirm the statistical significance of back-tested performance. Moving average convergence-divergence (MACD): Although it is often grouped with oscillators, the MACD is more of an intermediateterm trend indicator (although it can reflect overbought and oversold conditions). The default MACD line (which can also be plotted as a histogram) is created by subtracting a 26-period exponential moving average (EMA) of closing prices from a 12-period EMA of closing prices; a nine-period EMA is then applied to the MACD line to create a signal line.
www.activetradermag.com January 2009 ACTIVE TRADER
True range is the greatest (absolute) distance of the following: MACD = EMA(C,12)-EMA(C,26) Signal line = EMA(MACD,9) Out of the money (OTM): A call option with a strike price above the price of the underlying instrument, or a put option with a strike price below the underlying instruments price. True range (TR): A measure of price movement that accounts for the gaps that occur between price bars. This calculation provides a more accurate reflection of the size of a price move over a given period than the standard range calculation, which is simply the high of a price bar minus the low of a price bar. The true range calculation was developed by Welles Wilder and discussed in his book New Concepts in Technical Trading Systems (Trend Research, 1978). True range can be calculated on any time frame or price bar five-minute, hourly, daily, weekly, etc. The following discussion uses daily price bars for simplicity. 1. Todays high and todays low. 2. Todays high and yesterdays close. 3. Todays low and yesterdays close. Average true range (ATR) is simply a moving average of the true range over a certain time period. For example, the five-day ATR would be the average of the true range calculations over the last five days. Volatility: The level of price movement in a market. Historical (statistical) volatility measures the price fluctuations (usually calculated as the standard deviation of closing prices) over a certain time period e.g., the past 20 days. Implied volatility is the current market estimate of future volatility as reflected in the level of option premiums. The higher the implied volatility, the higher the option premium.
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TRADING Resources
BarclayHedge and Global Fund Technologies, LLC announced the launch of MyFundFinder.com, a capital introduction platform designed to match hedge fund managers with institutional and high net worth investors. MyFundFinder.com is a web-based platform designed to provide hedge-fund managers with a capital-raising tool and to provide investors free access to search online through more than 1,900 hedge funds, funds of funds, and managed futures funds (CTAs) to discover, match, and connect with those that meet their investment needs. Additional platform features include industry discussion forums, geographical mapping, and new fund launches, all centered on a community-driven site. HedgeCo Networks, LLC has launched its online analytical and
reporting tool, the Hedge Fund Calculator. Available as a monthly or annual subscription service, the Hedge Fund Calculator was designed for hedge funds and funds of hedge funds, and facilitates the computation of quantitative statistics, net performance numbers, and the creation of branded marketing materials. Key features of the Hedge Fund Calculator include: online access, branded and customized tearsheets, a contact manager, and benchmark analysis. To view a demo or sign up for a free Webinar, visit HedgeFundCalculator.com.
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BOOKSHELF
Stock Traders Almanac 2009
By Jeffrey A. Hirsch and Yale Hirsch Wiley, 2009 Hardcover, 193 pages $39.95 This annual almanac, first published in 1967, is composed of years of market history arranged on a calendar. It analyzes cycles and patterns in the stock market and examines seasonal tendencies. This trove of yearly, monthly, weekly, daily, and intraday data stretches back for decades, highlighting a wide range of best and worst performances. It offers event-specific studies such as post-election and end-of-quarter data, and analyzes many market maxims such as the January barometer and the Santa Claus rally.
The Art of the Trade: What I Learned (and Lost) Trading the Chicago Futures Markets
By Jason Alan Jankovsky Wiley, 2008 Hardcover, 183 pages $29.95 This book is a reworking of Jankovkys first book Dancing With Lions published under the pseudonym Trader X. Drawing upon more than 20 years in the futures and options business, Jankovsky recounts his journey to success, clawing his way through the Chicago financial ecosystem. Through his account, Jankovsky exposes the seedy underbelly of an industry where drug use, financial irresponsibility, and personal vendettas are commonplace.
The Stock Market Philosopher: Insights of a Soviet-Born New York-Bred Hedge Fund Trader
By Gennady Favel W&A Publishing, 2008 Hardcover, 142 pages $19.95 This book provides a look at one mans path from young immigrant to hedgefund trader. Favel writes about the markets from his own perspective, drawing on his experiences growing up in the Soviet Union trading Bazooka Joe gum wrappers, his young-adulthood trading comic books and gambling, and on through college and his professional career. He discusses how his experiences have shaped his view of the markets and offers insights into how they work.
ACTIVE TRADER January 2009 www.activetradermag.com
Keynes and the Market: How the Worlds Greatest Economist Overturned Conventional Wisdom and Made a Fortune on the Stock Market
By Justyn Walsh Wiley, 2008 Hardcover, 209 pages $27.95 Walshs book looks at the life and theories of famed economist and profitable stock trader John Maynard Keynes. The author looks at Keynes methods to see why he was so successful, how investors like Warren Buffet have adapted his principles, and how average traders can benefit from his methods in todays markets.
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ICAP has launched its Global Currency Data Feed, a proprietary feed of real time streaming prices from a selection of sources, including ICAPs electronic spot FX broking platform EBS and ICAPs internal pricing systems. The feed comprises prices for more than 155 currency pairs and cross currency pairs from more than 180 countries. Market participants can obtain the data feed via direct connection or selected vendor partners. ICAP Market Information and Commentary offerings include real-time, end-of-day, and historical market data, as well as research and commentary from economists and analysts. Wave59 Technologies released Wave59 RT 3.0, an update of its real-time technical market analysis program. Version 3.0 includes the ability to design, backtest, optimize, and automate custom trading systems using Wave59s QScript language. Wave59 RT is a charting and analysis program designed around versions of classical technical tools, as well as a suite of proprietary algorithms. For additional information on Wave59 RT 3.0, contact Jonn Millarkie at (866) 494-7613 or visit www.wave59.com to download a 30-day free trial. CME Group and BM&FBOVESPA announced the order routing of BM&F derivatives products on CME Globex. The order routing linkage enables customers using the CME Globex electronic trading platform to trade BM&FBOVESPA products directly, including futures and options on one-day Inter-Bank Deposits, the Bovespa Stock Index (pending regulatory approval), and commodities such as Arabica coffee, live cattle, and corn. BM&FBOVESPA customers will have the ability to trade CME Group products directly through their BM&FBOVESPA connections, including CME Group futures and options on interest rates, equity indices, foreign exchange, commodities, and energy and metals products. More information on the agreement can be found at www.cmegroup-bmfbovespa.com. CME Group also has launched the latest version of CME E-quotes, a real-time streaming market data application offering quotes, charting, advanced analytics, and news on CME Group-traded products, including interest rates, equity indices, foreign currencies, commodities, energy, metals, and alternative investments. It also offers access to prices for products listed on the Minneapolis Grain Exchange and the Kansas Board of Trade, which are available for electronic trading on CME Globex. For more information and a free twoweek trial, visit www.cmegroup.com/e-quotes. Invesco PowerShares Capital Management LLC has listed an
emerging markets infrastructure portfolio on NYSE Arca. The PowerShares Emerging Markets Infrastructure Portfolio (PXR) is an exchange-traded fund (ETF) based on the S-Network Emerging Infrastructure Builders IndexSM. The index is designed to measure the overall performance of securities of companies involved in infrastructure construction and development in emerging market countries. Industries include construc67
tion and engineering, construction machinery, construction materials, diversified metals and mining, heavy electrical equipment, industrial machinery, and steel.
CQG, Inc., the charting, analytics, and trade-routing platform for global electronically traded futures markets, has added SEB Futures to its list of Futures Commission Merchant (FCM) partners. CQG has teamed with SEB to connect traders to Euronext, Globex, ICE, and Eurex. Traders clearing through SEB have access to CQGs market analysis tools and advanced order execution software.
optionMONSTER introduced trade MONSTER, an online brokerage designed by professional traders for self-directed investors. Cofounded by Jon DRJ Najarian and Pete Najarian, the optionMONSTER group of companies provides tools and education for individual investors in options and stock markets. trade MONSTER allows you to customize how trade, position, and market information is displayed. trade MONSTERs educational content is embedded throughout the site and ranges from basic glossaries to detailed discussions of sophisticated option strategies. In addition, trade MONSTER offers webinars from the Najarians and invited guests. FX Solutions, LLC (www.fxsolutions.com) announced its merger with IFX Markets Inc. Both companies are wholly owned subsidiaries of City Index Group. IFX Markets customer accounts will transfer to FX Solutions, which provides foreign exchange trading capabilities to retail customers, introducing brokers and white label partners in more than 50 countries worldwide. IFX Markets customers who trade on the GTS platform will find features such as fixed spreads, streaming interbank market prices, automatic execution, multiple order types, and integrated risk management allowing up to five stops and limits per order, including trailing stops.
John Bollingers BBForex.com, which provides Bollinger Band analytics for the forex community, has a new feature merging technical analysis with forex news from various news publishers. Users can monitor forex charts and the latest news relating to specific symbol pairs as it occurs. To assist new forex traders, a basics section has also been added. It provides general forex information, currency pricing factors, forex trading instruments, investment common sense, and a forex glossary. The Web site is free.
Trading Resources is a forum for industry businesses to announce new products and upgrades. Listings are adapted from company press releases and are not endorsements or recommendations from the Active Trader Magazine Group. E-mail press releases to editorial@activetradermag.com. Publication is not guaranteed.
Web WATCH
ollective2.com tracks the performance of thousands of trading systems. System developers publish their systems on the site, which enables people to subscribe to
systems on a case-by-case basis. Developers can provide as little or as much information as they like about their trade rules, but for subscribers the systems are essentially black boxes opaque instructions telling them when to trade. The site provides equity curves and performance statistics calculated using live quotes. Along with statistics such as average trade length, profitability over time, and win percentage, Collective2 also calculates each systems realism factor, which it says indicates how likely hypothetical results are to be repeated in real-world trading. This includes factors such as slippage, trade size, and liquidity. Collective2 tracks stock, futures, options (but not options on futures), and currency systems. After someone subscribes to a system, the vendor sends trade signals to the site for subscribers to act upon. They can also send alerts to subscribers regarding market conditions or advising them to be prepared for upcoming trades. Figure 1 shows Collective2s order entry window, which handles stop and limit orders and more advanced order types. System designers can use the order entry screen to post signals or, alternately, send signals directly to subscribers from platforms such as TradeStation, TradeBullet, Interactive Brokers, MetaTrader, and NinjaTrader. In addition, more advanced programmers can trade signals directly to the site using Collective2s signal entry application programming interface (API). Subscription fees are determined by the designers; some offer free trial periods. Subscribers pay in one of three ways: a recurring charge, a charge on profitable periods, or a charge on individual profitable trades. Collective2 takes 30 percent of all subscription fees. Also, system designers pay the site $98 every six months to publish an initial system, with a reduced fee for additional systems. But designers can post a system and enter up to five trade signals for free. After a system is registered, designers can see who has paid, when they paid, and when the next payment is due. Almost every section of the site includes detailed, step-bystep instructions, and some sections also include instructional videos. Many pages are accompanied by a small window offering advice or helpful links.
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The order entry window resembles an online brokers entry window and sends trade signals directly to subscribers.
Source: Collective2.com
TRADING Calendar
LEGEND
CPI: Consumer price index ECI: Employment cost index FDD (first delivery day): The first day on which delivery of a commodity in fulfillment of a futures contract can take place. FND (first notice day): Also known as first intent day, this is the first day on which a clearinghouse can give notice to a buyer of a futures contract that it intends to deliver a commodity in fulfillment of a futures contract. The clearinghouse also informs the seller. FOMC: Federal Open Market Committee GDP: Gross domestic product ISM: Institute for Supply Management LTD (last trading day): The final day trading can take place in a futures or options contract. PMI: Purchasing managers index PPI: Producer price index Quadruple witching Friday: A day where equity options, equity futures, index options, and index futures all expire.
January 2009
1 2 3 4 5
December employment report November construction spending December ISM non-manufacturing report FND: January heating oil and RBOB gasoline futures (CME) November factory orders FDD: January crude oil, natural gas futures (CME) December ISM manufacturing report FDD: January gold, silver, and copper futures (CME)
6 7 8 9 10 11 12 13
November wholesale inventories FDD: January heating oil and RBOB gasoline futures (CME) LTD: January currency options
November trade balance November business inventories December retail sales LTD: February crude oil options (CME) December PPI December CPI December production and capacity utilization January U of M consumer sentiment (prelim.) LTD: January equity and index options; January single stock futures (OCX)
14 15 16
S
28 4 11 18 25
M
29 5 12 19 26
T
1 8 15 22 29
F
2 9 16 23 30
S
3 10 17 24 31
30 31 6 13 20 27 7 14 21 28
17 18 19 20
LTD: February crude oil futures (CME)
www.activetradermag.com January 2009 ACTIVE TRADER
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Report times
21 22 23 24 25 26 27 28 29 30
December existing home sales LTD: February natural gas, heating oil, gold, silver, and copper options (CME) LTD: January gold, silver, and copper futures (CME); February natural gas futures (CME) December durable goods December new home sales FND: February natural gas futures (CME) Q4 GDP (adv.) Q4 employment cost index January U of M consumer sentiment (final) January Chicago PMI FND: February gold, silver, and copper futures (CME) LTD: February heating oil and RBOB gasoline futures (CME) December housing starts FND: February crude oil futures (CME) LTD: February treasury options (CME)
Economic release
GDP CPI ECI PPI Productivity and costs Employment Personal income Business inventories Durable goods Retail sales Trade balance Housing starts Chicago Fed national activity index Production & capacity utilization Leading indicators Consumer confidence Univ. of Michigan consumer sentiment
8:30 a.m.
31 February 1 2 3 4 5 6
FDD: February crude oil, natural gas futures (CME) January ISM manufacturing report December personal income FDD: February gold, silver, and copper futures (CME) FND: February heating oil and RBOB gasoline futures (CME) January ISM non-manufacturing report Q4 productivity and costs (prelim.) January employment report
Wholesale inventories Philadelphia Fed survey Existing home sales Construction spending Chicago PMI report ISM report on business ISM non-manufacturing report on business New home sales Factory orders Federal budget Consumer credit
The information on this page is subject to change. Active Trader is not responsible for the accuracy of calendar dates beyond press time.
ACTIVE TRADER January 2009 www.activetradermag.com 70
UPCOMING Events
Event: The Options Intensive Two-day Seminar Date: Dec. 4 Location: CBOE Options Institute, Chicago For more information: www.cboe.com Event: Dynamic Hedging of Long Volatility Strategies Date: Dec. 4-5 Location: Sheraton Suites on the Hudson, New York For more information: www.marcusevans.com
ADVERTISING Index
Advertiser Ablesys www.ablesys.com Active Trader Bookstore www.invest-store.com/activetradermag CME Group www.cmegroup.com/tradeforex Deutsche Bank
Event: The World Money Show Date: Feb. 4-7 Location: Orlando Date: March 17-19 Location: Hong Kong Date: May 11-14 Location: Las Vegas For more information: Go to www.moneyshow.com and click on Events Event: International Traders Expo Date: Feb. 21-24 Location: New York, New York For more information: www.tradersexpo.com
Event: 25th Annual Risk Management Conference Date: March 8-10 Location: The Ritz-Carlton, Laguna Niguel, Dana Point, Calif. For more information: www.cboermc.com Event: Live Trading Software and Trading Expos Date: April 5-7 Location: Miami Date: June 7-9 Location: Houston For more information: http://livetradingexpo.com Event: The 15th Forbes Cruise for Investors Date: June 2-14 Location: Lisbon to Venice For more information: Go to www.moneyshow.com and click on Events Event: International Traders Expo Date: June 3-6 Location: Los Angeles For more information: www.tradersexpo.com
Interactive Brokers www.tradersexpo.com MB Trading www.mbtrading.com PFG Best www.pfgbest.com/webseminar TD AMERITRADE www.tdameritrade.com Track N Trade www.trackntrade.com TradeStation www.tradestation.com Trade The News www.tradethenews.com Wealth Lab www.wealth-lab.com
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TRADE Diary
TRADE
Date: Oct. 6-10. Entry: Long Citicorp (C) at an average price
of 14.68.
Source: TradeStation
RESULT
Exit: Position still open. Profit/loss: -3.16 (21.5 percent). Trade executed according to plan? Yes. Outcome: Down approximately 9 percent on Oct. 28, this position has actually fared better than any of the other
stocks weve picked up recently at bargain prices. Such moves have to be put into perspective given the historic nature of the current market, though at one point the position was up 17 percent. The last few bars of the weekly chart inset hint at the extreme volatility that preceded and followed this trade. Buying a banking stock is indeed a gamble the discount at which we purchased C testifies to the extent the market fears them but C (along with JPMorgan Chase and Bank of America) survived the October massacre, and we put on a relatively small position to hold as an investment. In the short-term, the position is a disaster. On a decade or longer time frame, the statistics indicate the purchase price will be quite favorable. That, anyway, is the rationale.
Note: Initial targets for trades are typically based on things such as the historical performance of a price pattern or trading system signal. However, individual trades are a function of immediate market behavior; initial price targets are flexible and are most often used as points at which a portion of the trade is liquidated to reduce the positions open risk. As a result, the initial (pre-trade) reward-risk ratios are conjectural by nature.
Trade Summary
Date 10/6/08 10/7/08 10/10/08 Stock C Entry 16.34 15.50 13.45 Initial stop N/A Initial target N/A IRR N/A MTM 11.52 Date 11/6/08 P/L -3.16 (21.5%) LOP 2.57 LOL -2.68 Length 8 days
Legend IRR: initial reward/risk ratio (initial target amount/initial stop amount). LOP: largest open profit (maximum available profit during lifetime of trade). LOL: largest open loss (maximum potential loss during life of trade). MTM: Marked to market (trades open profit or loss at a given time). 72
TRADE Diary
Volatile conditions call for cautious trading. TRADE
Date: Monday, Oct. 20. Entry: Long the S&P 500 tracking stock (SPY) between 94.90 and 95.80. Reason(s) for trade/setup: With the market having bounced (on Oct. 16) after making a semichallenge to the Oct. 10 low, SPY is poised to follow through on Fridays stealth up day higher low, higher high, and slightly lower close. The goal is to play the day from the long side, taking small profits in stages, raising stops quickly to remove risk, and re-entering on additional pullbacks as appropriate. We initially bought at three prices 95.80, 95.20, and 94.90 as price was moving down after a strong open.
Source: TradeStation
Initial stop: 93.04, 1.31 below the mornings swing low. Initial target: 96.46. Second target: 96.80.
RESULT
Exit: Multiple exits see summary table. Profit/loss: +5.27. Trade executed according to plan? Yes. Outcome: Not executed perfectly, to be sure, but one of the
more satisfying days recently. After taking partial profits at 96.46, we raised the stop to above breakeven (at 95.73) for the entire three-part initial position. The stop was hit, but when the market failed to follow through, we re-entered at 95.65.
We caught a good point after the smallest of dips below the entry price the market turned up, making only one notable pullback for the remainder of the session. We took off part of the new trade at the secondary target (96.80), raised the stop to 95.88, and put in an order to sell another portion at 97.75 a level we thought had only a small chance of getting hit. The market ultimately blew through that level, and we held the remainder of the position overnight. Instead of following through the next day, though, the market turned back down, stopping out the remainder of the trade. Looking at the chart may leave the impression we could have saved ourselves a lot of trouble by not raising stops and holding the initial position longer, but this is only obvious in hindsight. Anyone who has been in the market lately knows this kind of day has been the exception to the rule sharp intraday retracements are de rigueur on most up days, and down days have been more prevalent in general.
Note: Initial targets for trades are typically based on things such as the historical performance of a price pattern or trading system signal. However, individual trades are a function of immediate market behavior; initial price targets are flexible and are most often used as points at which a portion of the trade is liquidated to reduce the positions open risk. As a result, the initial (pre-trade) reward-risk ratios are conjectural by nature.
Trade Summary
Date Stock 10/20/08 SPY Entry 95.80 95.20 94.90 95.65 Initial stop 93.04 Initial target 96.46 IRR 0.24 0.58 0.84 Exit 96.46 95.73 95.73 96.80 97.75 Date 10/20/08 P/L +0.66 (0.69%) +0.53 (0.56%) +0.83 (0.87%) +1.15 (1.2%) +2.10 (2.2%) LOP 3.31 LOL Length -0.55 4-5 hours
96.80
10/21/08
3.46
-0.11
1 days
Legend IRR: initial reward/risk ratio (initial target amount/initial stop amount). LOP: largest open profit (maximum available profit during lifetime of trade). LOL: largest open loss (maximum potential loss during life of trade). 73 www.activetradermag.com January 2009 ACTIVE TRADER