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In search of Volatility, Volume, & Tradable Markets

April 16, 2007

 

How many of you out there are trading the Schatz, Bobl or Bund markets?

I'm guessing there are many more of you who have heard of Lumber and Pork Bellies then Bobls and Schatzs, and the number of long term trend following portfolios we see still containing Lumber and/or Pork Bellies fuels that argument.

Would it surprise you to learn, then, that the two funny sounding markets have over 25,000% more total volume and open interest. That's right. At total volume plus open interest of over 1.6 million contracts a day, the Schatz has approximately two hundred and fifty times the volume and open interest than in the Lumber market, which has a paltry 6,500 contracts a day in volume + open interest.

For those who don't know, the Schatz is the German equivalent of the US Two Year Note, and the Bobl is the German equivalent of the US Five Year Note, and the Bund the 10 yr equivalent. All three are traded on the all-electronic Eurex exchange based in Europe. What systems trade these markets? Well, besides the normal trend following systems like Checkmate or Aberration - there are swing trading systems such as Signum EBL which has been amongst our top 5 in several of the past few week's newsletters: Click here to see the performance: http://www.attainaccess.com/display_results.php?id=885

Check Your Portfolio:

Part of being successful in not just trading system and CTA investments, but commodity investing in general, is knowing which markets to consider for your portfolio. Many trading system investors utilizing long term, trend following system are unfortunately at the mercy of the system developer - who generally puts his or her portfolio together with an eye towards performance, not volume, volatility, or their by product liquidity.

Liquidity is of the utmost importance, however, as it directly influences performance. Poor liquidity will result in poor fills - and poor fills, as we all know, will result in poor performance. The goal in commodities investing is therefore to get the best fills, and one huge way to achieve that is to insure you're trading in those markets with the best liquidity.

Liquidity is greatest in those markets where there is good volume and reasonable levels of volatility, and poorest in those markets with low volume and relatively high amounts of volatility.

It's no coincidence then, that the best fills come in those markets at the top of the green table below ranking markets by average daily front month volume + open interest, and that the worst fills come in those markets at the top of the yellow table below ranking markets by their year over year change in volatility.

Many of the markets at the top of the yellow table have adequate volume to support trading, but the markets move so quickly and violently that hitting exact price points becomes anything but an exact science. Natural Gas, for instance, averaged over 900,000 total contracts in volume and open interest, but slippage there can be upwards of 100 times the tick value. Compare that to Euro Dollar slippage of just 1 times the tick value and S&P slippage of at worst, 10 times the tick value.

The 7 markets at the bottom of the green volume + open interest table below (highlighted in orange) are markets Attain recommends staying away from altogether. We classify those markets as "barely tradable", as each has total volume + open interest of no more than 7,500 contracts per day on average.

If you have trouble seeing how small a volume number like 7,000 is, imagine an order in Pork Bellies in a typical trend following system like Aberration. If there are 200 people around the world who trade Aberration (I would guess that number is more like 2,000 when considering knock offs and similar strategies), and each did 2 Pork Belly contracts on the Aberration signal. That would be 400 contracts, or 10% of the average daily volume, all doing the same thing at the same time, and that is not where you want to be.

It is interesting to note that for the third straight year, more markets saw a decrease in their average volatility than an increase. This is no doubt why trend following systems and those CTAs who implement some sort of trend following approach have continued to under-perform. Trend following is a long volatility strategy, and the decrease in "global volatility" has hurt returns. On the flip side, the decrease has been good for CTAs like FCI who implements a short volatility strategy.

The tide seemed to be turning last year, when 32 out of 73 markets (43%) saw an increase in volatility versus just 9 out of 69 markets (13%) in 2005. But Apr. 06- Apr 07 saw a decrease again, to only 19 out of 68 markets we tracked (28%) seeing volatility increases.

So before diving headlong into a portfolio of markets you assume are tradable, do a little research and see how tradable your portfolio of markets really is. If you're looking at markets that trade less than 7,500 contracts a day, you should look again. Additionally, if you think you can day trade Natural Gas or Palladium — be prepared for slippage numbers 50 to 100 times the tick value. If your system can handle that big of a handicap, then you might just have something.

- John Cummings

IMPORTANT RISK DISCLOSURE


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Feature | Week In Review: US stocks continue slow crawl higher.... | Chart of the Week

***Overview***

The US Stock market has started to look a lot like the fictitious 'little engine that could'. It keeps chugging along, despite a big shift down a month ago when it seemed like momentum would turn the other way, garnering up more strength to continue pushing higher. Despite the threat of higher interest rates, a weak housing market, and more expensive gasoline - the US economy continues to grow, and with it the stock market has grown as well. The gains last week aren’t overly impressive but heading into today SP futures were sitting on the cusp of 6 year highs. In light post holiday trading SP futures climbed +0.59%, Dow Jones futures were up +0.40%, and NASDAQ futures were up just a few points. In smallcap trading Russell 2000 futures gained +0.94% and Midcap 400 futures gained +0.84%.

In commodity trading the metals markets remained on a tear as emerging economies like China continue to gobble up these precious goods. Palladium led the way gaining +6.92%, Copper rallied +4.71%, Silver was up +2.55%, and Gold moved +1.55% higher. Elsewhere energies were also on the move with Crude Oil losing -1.40%, RBOB Gas lost -2.39%, Heating Oil moved +1.93% higher, and Natural Gas futures gained +2.62%. Grains and Tropical’s also were very active especially wheat futures which rallied +6.87% on fears that a drought in China will sap world wheat supplies. Corn was up +2.13% and Soybeans lost -2.96%. In the tropical markets Cotton lost -3.18% and Coffee rallied +0.79% higher.

Finally trading in the world currency markets is picking up steam as Eurocurrency futures neared all time highs just in time for the summer travel season. For the week - Euro futures climbed +1.22% while Dollar Index futures fell -1.01%. Swiss Franc futures were up +0.60% and Japanese Yen futures remained unchanged for the week.

***Commodity Trading Advisors (CTAs)***

At this point in the month a majority of CTA’s have reported their final April / 1st Quarter numbers. Topping April’s list and YTD performance is our own Phoenix Energy program. Phoenix earned +3.8% in March and is now up +4.6% YTD. The strategy actively scans and trades the 4 highest volume energy markets (Crude Oil, Natural Gas, Heating Oil, and RBOB/Unleaded Gas) on a short term swing basis. The basics of the program are to identify short term trends and then to capitalize quickly by locking in gains via trailing stops and or profit targets. Despite Phoenix’s difficult stretch last Fall during the collapse of Amaranth the strategy has been very consistent and adds an element of diversification that most investors portfolios lack.

Elsewhere, Zenith Resources Index Options strategy had a noteworthy month of trading with gains of +3.4% taking the strategy on to new equity highs. Many had criticized Zenith for his reduced returns in 2006; however in knowing his strategy of selling deep out of the money options with a focus on risk management – his critics were silenced as the strategy successfully navigated the 2/27 – 3/5 market crash (largest drop since 9/11).

Beyond Zenith, several other option sellers also began the road to recovery – Zephyr Aggressive added +1.9% and +1.2% in the Moderate, Diamond Capital earned +1.2%, and Cervino Capital added +0.9%. Many of the other option sellers who incurred losses during March did so as a result of a defensive measure brought on by the market sell off – such advisors included Zenith Diversified -0.6% and Ace Investment Strategists -10.4%. Argus Capital, World Capital, and Crescent Bay also suffered losses in March; however have not yet reported.

Finally, in the commodity markets, Dighton USA topped the quarterly commodity returns with a gain of +2.5% on the quarter despite a loss of -2.6% in March and FCI gained +1.5% in q1 and is off to a positive start here in April. Several other long term trend followers suffered losses in q1; including Clarke Capital, Attain Portfolio Advisors, Potential Unlimited, Nu Wave Combined Futures, and Meyer Capital.

You can find a full recap on our website http://www.attainaccess.com/cta.

***Day & Swing Trading***

It was a slow trading week for day and swing trading system - with stock markets around the globe slowly making their way higher. While the upside is generally favorable for the average investor, it usually makes for stagnant trading conditions for futures traders as volatility usually decreases in bull markets as we’ve seen following the initial panic from the meltdown at the end of February in global equities.

While conditions were slow, swing systems that are holding long positions tacked on some open trade equity to their current positions. Tzar ES had been holding short for most of the year and finally reversed long after a short-lived down move on Wednesday. For the week, the program made +$1,070 in open and closed trade equity and is the only Tzar market of the ES, eRL and NQ that is currently in a position. SeasonalST eRL/ ES continues to rebound from long trades that initially went against the system and the current trade is no different. Last week the program made +$640 and +$220 in open trade profits after taking some heat earlier in the week before stocks rebounded on Thursday and Friday. Adaptive Euro Index had a tougher time with last week’s conditions and lost -$2,150.83 for the week after entering long on several gap up situations.

Top performer across the day trading systems was Omega3 v1 Dax with profits of +$215.50. Compass SP was next in line with profits of +$100 after a losing trade on Wed followed by a winning trade on Friday to close the week on a positive note. On the losing side, Impetus eRL had one losing trade on Wednesday for a loss of -$204. BetaCon 4/1 ESX struggled last week and ended the week -$372.26 on a trio of trades. Phi Plus Dax had similar problems in the German futures and lost -$1,011.86.

***Long Term***

Rate futures spent last week in a sideways to lower trade sparked by economic reports that suggested inflation pressures could hold the Fed steady for the time being. Early week activity was firm ahead of the Producer Price Index release, but the market softened as the report did show a ber reading versus the average analyst estimates. Releases this week are bit heartier with more inflation sensitive readings which could spark a breakout of the recent sideways trend if they back up the results of last weeks economic reports. The recent volatility and lack of trend has sent the long term systems to the sidelines for the time being searching for a breakout of a new trend.

Currency activity last week was choppy as ideas that economic growth in Europe is outpacing other world sectors continued. Speculation of interest rate movement from the major international players kept the Japanese currency and the U.S. dollar in a sideways to lower trade. The Europeans continued to find a bit of a bid on ideas of higher interest rate moves for both the Euro countries and the U.K. The reports scheduled for the coming week are inflation sensitive which could spark changes for rate policy in Europe and could spark some ber trending action. The recent volatile swings have kept long term trend followers on the sidelines, although Aberration did go short the DX this past Friday.

Most Grains and Oilseeds experienced more volatile sideways action last week as the sector continued to digest the recent USDA releases along with current weather developments. The market seems to be focusing on ideas of corn planting problems in the Midwest, although recent weather forecasts do call for a warmer drier period. The live cattle market posted sharp declines on lower cash and product trade during the week. Aberration currently is long BO making +$714.00 (open trade), Short CTN making +$155.00. Long LC was stopped out for a loss of -$380.00 (open trade).

Please Login to: http://www.attainaccess.com for the latest updated statistics.

IMPORTANT RISK DISCLOSURE
Futures based investments are often complex and can carry the risk of substantial losses. They are intended for sophisticated investors and are not suitable for everyone. The ability to withstand losses and to adhere to a particular trading program in spite of trading losses are material points which can adversely affect investor returns.

Past performance is not necessarily indicative of future results. The performance data for the various Commodity Trading Advisor ("CTA") and Managed Forex programs listed above are compiled from various sources, including Barclay Hedge, Attain Capital Management, LLC's ("Attain") own estimates of performance based on account managed by advisors on its books, and reports directly from the advisors. These performance figures should not be relied on independent of the individual advisor's disclosure document, which has important information regarding the method of calculation used, whether or not the performance includes proprietary results, and other important footnotes on the advisor's track record.

The dollar based performance data for the various trading systems listed above represent the actual profits and losses achieved on a single contract basis in client accounts, and are inclusive of a $50 per round turn commission ($30 per e-mini contracts). Except where noted, the gains/losses are for closed out trades. The actual percentage gains/losses experienced by investors will vary depending on many factors, including, but not limited to: starting account balances, market behavior, the duration and extent of investor's participation (whether or not all signals are taken) in the specified system and money management techniques. Because of this, actual percentage gains/losses experienced by investors may be materially different than the percentage gains/losses as presented on this website.

Please read carefully the CFTC required disclaimer regarding hypothetical results below.

HYPOTHETICAL PERFORMANCE RESULTS HAVE MANY INHERENT LIMITATIONS, SOME OF WHICH ARE DESCRIBED BELOW. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE SHOWN; IN FACT, THERE ARE FREQUENTLY SHARP DIFFERENCES BETWEEN HYPOTHETICAL PERFORMANCE RESULTS AND THE ACTUAL RESULTS SUBSEQUENTLY ACHIEVED BY ANY PARTICULAR TRADING PROGRAM. ONE OF THE LIMITATIONS OF HYPOTHETICAL PERFORMANCE RESULTS IS THAT THEY ARE GENERALLY PREPARED WITH THE BENEFIT OF HINDSIGHT. IN ADDITION, HYPOTHETICAL TRADING DOES NOT INVOLVE FINANCIAL RISK, AND NO HYPOTHETICAL TRADING RECORD CAN COMPLETELY ACCOUNT FOR THE IMPACT OF FINANCIAL RISK OF ACTUAL TRADING. FOR EXAMPLE, THE ABILITY TO WITHSTAND LOSSES OR TO ADHERE TO A PARTICULAR TRADING PROGRAM IN SPITE OF TRADING LOSSES ARE MATERIAL POINTS WHICH CAN ALSO ADVERSELY AFFECT ACTUAL TRADING RESULTS. THERE ARE NUMEROUS OTHER FACTORS RELATED TO THE MARKETS IN GENERAL OR TO THE IMPLEMENTATION OF ANY SPECIFIC TRADING PROGRAM WHICH CANNOT BE FULLY ACCOUNTED FOR IN THE PREPARATION OF HYPOTHETICAL PERFORMANCE RESULTS AND ALL WHICH CAN ADVERSELY AFFECT TRADING RESULTS.