What's wrong with Russell trading systems?
October 24, 2005
The Russell was supposed to be the savior of day trading systems. With approximately the same daily ranges, but twice the point value, the Russell market has about twice the "effective range" of S&P futures. That means twice the possible profits or losses.
With volatility so low in stock index futures markets and some famous S&P day trading systems such as Compass having down years in 2004, twice the profits or losses sounded great. But one slight problem has popped up in 2005 - the profits for many Russell systems haven't been there, while investors have found "twice the LOSSES" can pack quite a wallop.
What is going on with the Russell systems? Why have several e-mini Russell systems like Clipper eRL and R-Mesa eRL hit new maximum drawdowns and seen much higher volatility than they did in 2004 and in the backtesting prior to that.
The answer to that question may lie in the continued great performance of the Russell 2000 index. While many of the major US stock indices remain well below their all time highs hit in early 2000 (the Nasdaq is -67% and Dow Jones -12% below their all time highs), the small cap Russell 2000 index hit new all time highs of 688.36 this year on August 3rd. Obviously nobody told the Russell that the bubble burst or that there was a bear market.
While new all time highs are certainly a good thing for those holding Russell 2000 component stocks or an ETF tracking the Russell, to judge by the performance of systems like Clipper and R-Mesa eRL — it has not been a good thing for Russell trading systems.
But why is the high price of the Russell a bad thing for trading systems? Shouldn't higher prices mean larger daily trading ranges and therefore more opportunity for profit? That's exactly what higher index values mean - higher point value ranges. Instead of a 1% move in the Russell equaling 3 or 4 points, it now means 6 or 7 points. But these larger point value moves also mean the possibility of larger losses in dollar terms. A 1% loss is still mathematically 1%, but the dollar based loss a 1% move represents has increased in the past few years as the index has hit new all time highs.
But hold on, you say, isn't there also the larger possible dollar gains? It seems logical that the two should offset each other, but the missing ingredient here is that systems operating on the Russell are quoted in fixed units (single contracts) and have fixed minimum starting balances (many as low as $10,000).
As an example, if an e-mini Russell system takes a "normal" losing trade which equals 1% of the index in point terms (currently 630*.01 = 6.30 pts), that loss has become larger recently (6 points versus 4 points). That translates into a larger dollar based loss ($600 versus $400), and because this larger dollar based loss is still based off a FIXED amount of capital - the $10,000 recommended minimum balance - the percentage loss for the system jumps form 4% to 6% on basically the same "normal" losing trade.
The higher daily average price of the Russell as it has hit new all time highs in each of the last two years shows in the data. The average daily price of the Russell this year has been about 634, which is about 10% higher than the average daily price in 2004 (580) and about 40% higher than the average price between 1996 and 2003 (432) - which is the time period most Russell systems were tested on.
Drawdown as a percentage of index value:
One way to see whether the current drawdowns are due to the system's "breaking" or due to the increased risk that higher underlying prices in the index bring is to look at the current and past drawdowns in terms of the value of the underlying index.
Taking the Clipper system as an example, the recent $8,340 drawdown represents a whopping 83.40% drawdown on the developer's recommended initial capital of $10,000; and was 112% more than the prerelease drawdown of $3,940. Those are surely sobering numbers and led Attain to recommend investors stop trading the system as it had breached our statistical "line in the sand".
But when looking at the current and past drawdowns as a percentage of the value of the Russell 200 index, we saw some interesting numbers. The current drawdown (in points) equals 13.15% of the index value, while the prerelease max drawdown equaled a very similar 9.14% of the index. The current drawdown is just 44% higher than the prerelease drawdown in these terms, which is still high but no where near the increase in drawdown seen on the dollar based numbers.
.The moral of the story is that index value should not be ignored when predicting future drawdowns. Systems trading the Russell market, in particular, which is very close to all time highs, may have seen their risk parameters shift higher. As the old saying goes: "Systems don't break - they just get more risky"
- Jeff Eizenberg
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.
Feature | Week In Review | Chart of the Week |
Feature | Week In Review | Chart of the Week |
A near 30 point range in the S&Ps? It felt like the good old high volatility days in 2000 last week as S&P futures rallied 28 points off it lows Wednesday, then fell nearly the same amount on Thursday. The end result for buy and hold investors was a nonevent, but several systems used the brief spike in volatility to add significant profits.
With a new Fed chairman on the way, another Hurricane in Florida, and continued higher than average energy prices, one would expect volatility to remain high for some time — and indeed after months of languishing near historic lows, the CBOE's Volatility Index (VIX) is up 35% in October.
Elsewhere, foreign stocks had a tougher week than their US counterparts. The Nikkei 225 (Japan) led the way falling -9.05%, although one has to think most of this sell off was caused by profit taking, after watching the Nikkei rally since May. In Europe the Eurostoxx 50 fell -1.88%, while the FTSE 100 fell -2.84%.
Crude oil prices below $60 per barrel? Don’t look now but it appears that the market is headed that way. Crude Oil prices were down another -2.19% closing at $60.63 per barrel, the closest the sub $60 prices that the market has been since mid-August. The other energy markets were down as well with Unleaded Gas futures finishing -4.93% lower, Natural Gas futures were down -4.58%, and Heating Oil futures were down -4.56%.
In currency trading the US Dollar had another strong week with the US Dollar Index gaining +1.12%. Most of the foreign markets finished lower with the benchmark Eurocurrency dropping -1.25%, the Swiss Franc fell -0.08%, and the Japanese Yen lost -1.02%. The Canadian Dollar finished the week unchanged.
US Treasuries finished higher as well with 30 year bonds gaining +1.00%, while the US 10 year note gained +0.50%.
Finally, grains had another down week with Soybeans falling -2.91%, Wheat dropped -2.65%, Corn fell -1.00%, and Sugar futures lost -1.20%.
*Day Trading**
Last week’s increased volatility gave the majority of the short term models their chance to shine. We are starting to see both volume and trading ranges significantly higher over the past few weeks at the CME, and hopefully this pace can be sustained moving forward.
Several systems welcomed the inflated trading ranges with open arms. AG Xtreme SP took top honors last week profiting +$6,150 on two trades Tuesday and Wednesday. Ironically, the system is not being actively promoted by the developer but those customers who have stuck with the program saw gains of over 20% (based on recommended +30K initial capital) last week alone. Compass SP made new equity highs gain last week after profiting +$4,528.75 on four trades. R-Mesa SP bounced back last week with profits of +$4,274.40 on three trades - incredible considering two of three were losing trades for the system.
The Electric Daybreaker II system had a breakout week after the developer made some updates to the code from the system previously traded at Attain. It was a photo finish between the Electric Daybreaker eRL and NQ, which made +$730 and +$710 respectively. The ES tacked on an additional +$357.50 per contract.
Elsewhere,Impetus eRL made +$420 per contract on three trades last week, with the most profitable trade taking place on Wednesday's big move and Nautilus ES traded three times for profits of +$535, while Bounce eRL and Bounce eMD made +$530 when traded together, with the eRL making +630 and the eMD losing -$100. The system also has versions that can hold positions overnight (listed as swing trading - see the next session).
Unfortunately, futures trading is a zero sum game and not all systems handled the volatility as well as those previously mentioned. Daybreaker SP traded just twice and lost -$425 after being stopped out by a hair on a long trade Wednesday just before the huge rally. Helix ES got knocked around as well and its reversal logic put it in the red by -$537.50 on ten trades. RC Success ES traded every day last week for a setback of -$687.50.
Moving on, R-Mesa eRL took just a single trade on Wednesday, losing -$850 per contract due mainly to the reversal trade; while Clipper eRL struggled again last week and lost -$1,358.30 on seven trades. See the topic of the week below on what may be ailing the Russell systems.
**Swing Trading**
Swing trading systems remained relatively quiet last week despite several blockbuster days for index day trading systems.
This week’s swing trade of the week was not in the overly covered index markets, but rather in the Crude Oil market. Axiom CL 90, traded exclusively at Attain, entered short on Monday in attempt to capitalize on the week’s $4.50 point range in the Crude. The system earned +$1,430 in open and closed trade profits by the end of the week. Axiom is a channel breakout system and as was evident last week the short term breakout trend in the CL is down. We also trade Axiom CL 135 which was earning +$240 heading into the weekend on a short trade from 10/14.
Results were mixed in the index markets, with the Axiom Index systems, again, leading the way. Axiom Index NQ locked in gains of +$550, Axiom Index ES earning +$427.50, and Axiom Index eMD earning +$130.40. Also posting solid gains was Bounce Swing eRL which earned +$620; however Bounce Swing eMD did lose -$100. While Bounce typically trades on similar days in both markets, last week was a classic example of how diversifying into both markets can help overall profitability.
After several impressive trades which started to bring Tzar back from its drawdown, the system was unfortunately caught on the short side of the recent market rally. For the week, Tzar ES lost -$155 in open and closed trade losses, while Tzar eMD, eRL , and NQ held short and are currently posting open trade losses of -$170, -$540, and -$630 respectively. Athena eRL and Eclipse eRL also struggled last week, losing -$960 and -$1,735.60 respectively.
Finally, after posting solid profits in its first weeks of trading, Delphi eRL and Delphi eMD each gave back some profits last week. Delphi eMD lost -$1,142.49 while Delphi eRL lost -$1,696 in open and closed trade losses. The system is long from last week and is now looking good after today’s big up-move.
In the bonds Jaws Narrowneck gave back -$675 on one trade. Mesa Bonds and Notes earned back some open trade profits of +$1,093.75 and +$640.625 as of Friday.
**Long Term**
Last week was a slow week for commodity traders as there were few new trades entered or open trades exited. However, the systems were affected by the general market moves.
The meats markets were on the move as rumors persisted that some of the volatility there was due to Refco exiting some large positions. Live Cattle, Feeder Cattle, and Lean Hogs all moved lower last week. Those that are holding long include Aberration Plus, which is holding long in the live cattle for a loss of -$240.00 per contract, and SEMA4 Symmetry, which is making +$750.00 per contract also in the live cattle. Finally, Axiom LT is also holding long in the live cattle for gains of +$750.00 per contract.
Grains also moved lower, but systems are holding both long and short positions so performance was mixed. Systems with long positions include SEMA4 Symmetry which is making +$612.50 in KC Wheat, but is also losing -$850.00 per contract in Minneapolis Wheat. Axiom LT is also long in Minneapolis Wheat for a small gain of +$25.00 per contract. Meanwhile, Brix is long in KC Wheat for profits of +$450.00 per contract, while Andromeda is also long in KC Wheat for profits of +$250.00 per contract.
Short positions are more abundant and more profitable. Andromeda is short in corn for profits of +$1062.50 per contract, and in Soybeans for profits of +$600.00 per contract. Aberration is short in corn for profits of +$312.50 per contract, SEMA4 Symmetry is short in corn for profits of +$687.50 per contract, while Axiom LT is the biggest winner in corn with gains of +$1425.00 per contract on a short trade.
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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.