Lincoln Fiske on the poor S&P trading environment.
August 22, 2005
With several day and swing trading systems struggling recently (namely R-Mesa, Axiom ES, Eclipse), everyone is asking - what is the problem? Well, if you're Trading Visions Systems, Inc. developer - you tackle the statistics to see exactly what the problem is. You look at volatility and trading ranges across time, and see what markets look OK and which ones aren't looking so hot.
Mr. Fiske sent a letter to his clients recently detailing the record low volatility and possible affects on his systems: Axiom, Spectrum, and Impetus; and we asked him to elaborate in this week's newsletter. The following are his thoughts on the current poor trading environment for S&P day and swing trading systems.
By Lincoln Fiske:
As a developer, I'd like to blame the markets when a system isn't performing. This can certainly be a cop-out, but to an important degree, a system can only do so much with what the market is offering. The recent S&P action-or lack of action-is a good example.
This very important change in volatility can be seen by looking at the chart of the daily S&P cash.
(Click Image to Enlarge)
First, average true range has been declining relentlessly since late 2002. Consider the indicator in subgraph one, the yellow line showing the average daily true range (as a percentage of the index) over that last year, and the red line showing it over the last month. The current levels are the lowest they've been since 1997. This daily level of volatility most affects day trading systems, since they must have enough daily range from which to carve a successful trade, and the ineffectiveness of many such systems recently can largely be explained by this phenomenon.
Secondly-as would be expected--swing ranges (ranges over days and weeks) have also declined radically. This can be seen in the bottom subgraph, where the cyan line represents the high-low range for the whole prior year (expressed as a % of the index), and the white line represents the same over the prior month. The current levels have not been seen since 1995. In fact, the last month reached a meager level seen only 3 times since 1985! It's notable that the 2.2% range of the last month is about what the range was running on a daily basis for the last half of 2002 (more than 100 days in 2002 had a range of over 2%)! This change is swing ranges can also be seen in the price chart where two congestion periods have been marked. The first lasted from December of 2003 to November of 2004, and the second from November of 2004 to July of this year, two very long range-bound periods. Sea changes like this have a big impact upon swing system performance, since there just aren't the swings to provide sizable profits, or worse, the swings are just large enough to trigger whipsaw trades.
For a long-range look at volatility, the chart below shows the same indicators, but adjusted to fit monthly data. As you can see, we are at the lower end of volatility cycles over the years.
(Click Image to Enlarge)
When or why volatility will pick up in the future is impossible to say, though the one certainty in markets is that there will always be change. Seeing as how change from extremely low volatility will mean higher volatility, it does look from the chart that it may happen sooner (in 1-2 years) rather than later. When it does, be ready for the possibility of some increased profits!
Most systems will find increased profits in moderate to high-volatility environments, but fortunately, not all systems will do poorly at the same time. Some are not as sensitive to volatility, and some will operate well through different phases of volatility.
So what does one do in a less-than-optimum trading environment? The temptation is to drop the system and/or the market, but because it's so hard to predict changes in markets(or volatility), this risks putting us on the sidelines right when volatility returns. And just because a system isn't performing presently on a market, doesn't mean the system is broken or even that the market should be dropped. A better alternative may be to consider diversifying.
Diversification is essential in any investment arena, and especially in futures, precisely because the investor is then less subject to the whims of one highly leveraged market or system. The change in the S&P has been a healthy one that has caused many of us to broaden our perspectives to look at other indices. The two that I've found especially worthwhile are the emini Russell 2000 (eRL) and Midcap (eMD). Although all the indices have to some degree experienced reductions in volatility, both of these markets provide more volatility than the S&P, and even more importantly, they have dollar values per point twice that of the mini S&P ($100 vs. $50). Volatility*point value=opportunity, and eRL/eMD have 2-3 times the opportunity of ES. Trades that are unsuccessful on an ES swing can succeed on eRL/eMD because there's enough dollar-valued movement to get in and out of the trade at a gain or breakeven.
Will we return to the heyday of the S&P? I think it's possible, but I don't know when. In the meantime, there are excellent alternatives in other markets. The Axiom Index eMD, for example, which operates in the e-mini Mid Cap market, hit new equity highs recently as volatility in the Mid Cap index has held up despite the falling volatility in the S&P index. And several of the TradingVisions Vista Portfolios, which combine a number of systems and markets, have also hit new equity highs recently - again showing the power of diversification.
There are also opportunities outside of the index markets which we're just starting to explore. The one in the news nearly every day is Crude Oil. With electronic mini-Crude contracts now trading, and much increased volume and liquidity in the pit traded contract, Crude is looking more and more like an excellent market for swing trading - and possibly even day trading - so I have begun research on swing trading that market profitably....stay tuned !
- Lincoln Fiske
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 |
Last week saw a rarirty as Crude oil prices actually moved lower, falling -2.34% for the week, but consumers probably won’t notice the difference at the pump anytime soon. Stocks also ignored the crude sell off remaining virtually unchanged for the week. SP futures finished slightly lower down -0.05%, as did NASDAQ futures which were down -0.08%, Russell 2000 futures which were down -0.06%, and Midcap 400 futures which were down -0.09%.
Foreign currencies picked up some of the trading slack left behind by the stock indices. The US Dollar Index rebounded with gains of +1.91% due to strong economic data. The dollar’s competition got hit hard with Eurocurrency losing -2.20%, the Swiss Franc lost -2.14%, the Japanese Yen was down -1.00%, the Aussie Dollar fell -2.79%, and finally the Canadian Dollar dropped -1.42%.
Market activity was mixed in the grains with soybeans (-6.25%) and corn (-3.68%) both moving lower, while wheat (+1.04%) prices moved higher.
Finally, the bond market also had a slow week with both 30 year bonds and 10 year notes remaining unchanged. Traders will be looking towards tomorrow’s existing home sales report and Wednesday’s new home sales report to provide more guidance on the bond markets direction.
*Day Trading**
The majority of the day-trading systems were able to regain some lost ground last week after struggling in the first half of the month. Nonetheless, the bulk of the short term models are still in the red for the month of August but will look to finish the month on a positive note.
BWT Zones SP dominated the day trading returns for the week up $3,500 per contract. The trade of the week came on Tuesday when the system went short and profited $2,800 per contract-effectively capturing nearly the whole day’s trading range. Compass had back to back winners on Monday and Tuesday amounting to a gain of $1,512.25. Impetus eRL is slowly but surely creeping out of its current drawdown and gained $314.90 per contract on two trades.
Several other systems were able to scrape together small profits as well. Clipper eRL traded three times for profits of $140 per contract. Day Breaker SP traded on Friday only, but was able to lock in $130 on the trade. R-Mesa eRL batted .500 last week, trading twice for a net gain of $80 per contract.
On losing side, Helix ES traded nearly twice a day for a small loss of -$32.50 per emini. Bounce eRL and eMD lost -$110 and -$280 on one and two trades respectively. RC Success traded three days last week for a loss of -$115 per contract. The Electric Day Breaker Portfolio lost -$285 across the four systems which include the ES, NQ, eRL and eMD. BWT Zones eRL traded nine times last week, which is active but fairly common for the system, losing -$318 per contract.
**Swing Trading**
The August swing trading doldrums continued on through last week… The hardest hit thus far has been Eclipse eRL and last week was no exception. The system closed out losses of -$2,622.50 on 3 trades per contract; however was short earning back +$320 in open trade equity coming into this week.
The Axiom portfolio has also had a very difficult stretch over the past few weeks. In closed trade results Axiom ES lost an additional -$715 on 3 trades, Axiom eRL lost -$711.20, Axiom eMD lost-$377.80, and Axiom NQ lost -$360. The NQ was short coming into the day making +$180 in open trade equity.
Out of the Axiom Index swing systems, Axiom ES has had the least productive year as it is currently down -$7,060 YTD. Despite the contract's recent lack luster performance, the ES has yet to eclipse its maximum historical drawdown by 1.5 times hypothetically tested levels - and when considering the four market portfolio (ES, eMD, NQ, and eRL) the Axiom system is well within all of its historical testing…for any contrarian investors out there looking to get into a good system on a dip - this could be good timing.
In other index trading Apollo ES was able to earn the week’s top honors earning +$245 per contract on one trade. Bounce eMD and eRL also traded last week; however unfortunately came up just short losing -$280 and -$110 respectively. Tzar eRL rounded out the week of swing trading losing -$2,100 on a long position it had held since July 14th. Tzar is currently holding long the eMD, ES, and NQ.
Finally, bond portfolios had a descent week. In open trade equity Mesa Notes earned +$406.25, Mesa Bonds earned +$281.25 and the Narrowneck Bond portfolio earned +$250. Mesa Bonds is holding long for gains of +$1,968.75 from August 10th and Mesa Notes is holding Long from April 11th for gains of +$1,347.53.
**Long Term**
We have mentioned this several times over the past month, and will do so again - short foreign currency and long Dollar Index positions have been good positions for trend following systems this summer. Axiom LT has been short for the entire summer in the Swiss Franc and Japanese Yen markets to go along with its long Dollar Index position. All three trades are profitable as the system is making +$2537.50 per contract (open trade) in the Swiss, +$4481.25 per contract (open trade) in the Yen, and +$1235.00 per contract (open trade) in the Dollar Index.
Andromeda and Aberration are also in a couple currency trades as well. Andromeda is making +$4488.25 in the Yen, while Aberration Plus is making +$1012.50 per contract in the Mexican Peso. Aberration Plus is also long in the Canadian Dollar for a loss of -$1050 per contract. Finally, SEMA4 Symmetry is long in the Dollar Index but it is a losing trade thus far as the system is down -$570.00 (open trade) per contract.
Elsewhere, the Japanese stock market is enjoying bull market conditions as the Nikkei 250 has risen approximately 12.75% since May. Trend following systems have taken notice with long positions as Aberration Plus +$525.00 per contract (open trade) and Andromeda +$2300.00 per contract (open trade), are enjoying the run up. Andromeda is also long in the e-mini Russell for gains of +$1590.00 per contract.
On the negative side, the recent brief run up in the bond markets has not been good for trend followers, as most were triggered short last month. Aberration Plus is losing -$862.50 per contract (open trades) in the 5 year notes and -$410.00 (open trade) per contract in the Eurodollars, while Andromeda is losing -$1596.80 (open trade) in the 10 year notes, however the system is making +$153.12 (open trade) in the two year notes. Axiom LT has also found success in the two year notes and is making +$512.50 per contract (open trade) but the system is losing -$425.00 per contract (open trade) in the 10 year notes, and -$2300.00 per contract (open trade) in the 30 year bonds.
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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.