As I mentioned in my previous post, the Collaboration-is-Good trade signalled a Buy on S&P Futures on Tuesday at the close. This is a fade trade -- others might call it a mean-reverting trade, but it isn't really, since there is no "mean" we're reverting to. By fade trade, I mean that it buys on strong dips of otherwise up-trending markets, and sells on strong rallies of otherwise down-trending markets. So when S&P Futures shed 28 points on Tuesday after trending up quietly and strongly for months, CiG jumped on it.
I bought S&P futures in my fake-money account at the close on Tuesday for 1314.50. Wednesday close was 1305.25 (down another 9.50) and Thursday was 1302.25 (down another 3). If I had simply held that position throughout that time, by Friday morning it would have been down $612.50 per contract, or about 11%. But I didn't.
Wednesday morning before the stock market opened, I saw the hard sell-off at 2am from the mess in Libya, and I decided that although futures had come mostly back that night, I should move my stop up to 1312. Sure enough right after the open, the S&P sold off and hit my stop. I got a little lucky on the execution, and sold it for 1312.25, saving $12.50/contract in losses.
By the close on Wednesday, the trade was still signalled, so I rebought at 1306, starting at -$112.50/contract. Thursday was quieter, moving mostly sideways and a little down, and my trailing stop-loss of 10 points ($500/contract) was never hit. It was still a down day, however, so the trade stayed signalled.
Friday morning, my tour de force of trading skill failed me. I saw that the rally had finally started, and I wanted to set a closer stop before heading off to work. Somehow I mis-entered the price, and instead of putting in a stop order to get me out on another big sell-off, I accidentally sold at the market, then 1311, for a reversal in fortune to +$137.50/contract. Nice to have a profit, for sure, but I didn't want out at that point.
After arriving at the office, I kept an eye on the market and managed to buy back in at 1310 about an hour before the markets opened. I then set a 5-point trailing stop, which is generally way too little room for this trade, but I was pretty skittish of the stock market by this time; and got to work on my day job. Somewhere around 11am, after rallying all morning, there was a little market dip that closed me out at 1313, for another $150/contract. I saw no reason to press my luck further, and closed the trade.
Total profit: $287.50/contract, or about 5% on margin capital. If I had not been so skittish with my stop order on Friday, the close signal would have come in the afternoon at around 1318.75, profiting $575/contract, or about 10%. On the other hand, my discretionary trading had a positive impact: if I had just bought on Wednesday afternoon and held on, the trade-prescribed 100-tick stop-loss would have just barely not kicked in at the low on Thursday, so my open-to-close profit would have been $225/contract. So to recap, my discretionary trading was good, but I got a little more nervous on Friday than I should have.
Making the decision to violate the rules of a mechanical trade in real-time is always a tough judgement call. Mechanical trades are useful for finding entry and exit points when an emotional human might not be able to pull the trigger on his own. But blindly following them is not a long-term profitable decision -- despite my active trading behaviors, I believe in an efficient market most of the time. In this context, that means that if there were a profitable mechanical trade out there, someone has already done it so much that it has been used up.
By carefully considering whether now is the time to stray off the path laid out by the mechanical trade plan, and using the plan to question his decisions and lend some objectivity to their logic, an experienced trader can enhance his returns. I'm not experienced enough to do that reliably, but in this case I had the help of NeighborTrader to reason out the pluses and minuses of each individual trading decision, and it worked out very well.
Collaboration, it seems, is indeed good.
Showing posts with label mechanical. Show all posts
Showing posts with label mechanical. Show all posts
26 February 2011
22 February 2011
Some Trades Are More Frightening Than Others
Not Frightening
Over the weekend, the Collar trade was assigned on its QQQQ calls, meaning that my QQQQ position was closed out at 58. After the events over the weekend, and the markets today, that ended up being a great trade all by itself (QQQQ closed today at 57.03, down 1.70 on the day).
The QQQQ Collar trade has been one of the few that I have been running with real money, and it has been going for about 18 months now. Over the last 18 months we have had, overall, a pretty significant up-trend to the market; and a limited-profit trade like a collar is going to underperform during strong up-trend periods. Sure enough, I've made some pretty good money in the collar trade: just under 16% in 18 months. But if I had just bought QQQQ and held it, I would have had a much better return: close to 39% over the same period. Despite this drastic underperformance, the trade is a success - it is a super-long-term trade, and in losing years, its losses are much more limited than a simple buy-and-hold. If it had not underperformed, that would be a signal that something wasn't being hedged correctly.
This trade is not without its problems, however. First, there is a great deal of subjectivity about what strikes to use for the covered calls and the protective put - I tried to solve this problem by setting some range parameters. Next, I have been running this trade in an online broker that is geared more toward stock traders than option traders. As a result, its commissions for options are terrible: $10.75 for a one-way one-lot option trade, vs the $1.50 I negotiated with thinkorswim. When I'm doing 14 option trades a year, plus the fairly frequent assignment fee of $25 followed immediately by the need to repurchase the QQQQ outright for $7 flat, it gets expensive fast. Finally, I have noticed that the time value on the about-to-be-front-month options drains significantly over expiry weekend. But since my online broker is very touchy about naked short options, I have to choose between an expensive fee-to-price ratio rolling trade, or letting the premium disappear over the weekend.
Since the collar essentially closed itself out over the weekend, I decided now would be a good time to transfer its required capital to thinkorswim and run it there. I may retain the stock/call/put configuration, or I may run an equivalent position of a simple bullish vertical option spread. If I do that, I lose the calendar component of the 6-month put vs the 6 1-month calls, but I'm not convinced that component is valuable anyway. In any case, I have some research to do before the money transfer settles.
Frightening
Back to fake money, the CiG trade lit up like a Christmas tree today, thanks to those crazy Libyans. S&P futures sold off 28 points or about 2%, which signalled a Buy at the close. I have been bearish S&P for about 6 months (it has gained 300 points during that time) but this is a mechanical trade -- my viewpoint doesn't figure into it. Have you ever tried to make yourself buy something when you don't believe in it and it has just sold off by 2%? It isn't easy.
The gold futures trade last month wasn't easy, either, but it turned out fine; by the law of single-datapoint-patterns, that means this one should be just fine too. Nevertheless, NeighborTrader and I did have some vertiginous fun imagining that we were each managing million-dollar accounts and thus had to buy 100 futures knowing that each point would make or lose $5000. That would make today a $140,000 losing day for that account, had it been long that amount. I think I'm happier in fake money for now.
I also had a preliminary Sell signal setting up in Ten Year Note futures... we'll see what tomorrow brings on that one.
Somewhere in Between
Rounding out the flurry of activity today, the sudden market downturn made the volatility indexes pop about 4 points. Everyone has heard of the VIX, which measures implied volatility in options on the S&P 500. Since my iron condor trade is on Russell (RUT), I use the VIX's cousin: RVX. Anyway, the 4 point pop in the RVX was just what I needed to get a better price on opening an iron condor position, since it is a negative-vega trade. I put on the 760/770/900/910 April Iron Condor, for a credit of $3.25/share. Pretty respectable, considering the low-IV environment we've had the last few weeks. If the RVX is predictive, however, I'll be in for a roller coaster ride this month.
Over the weekend, the Collar trade was assigned on its QQQQ calls, meaning that my QQQQ position was closed out at 58. After the events over the weekend, and the markets today, that ended up being a great trade all by itself (QQQQ closed today at 57.03, down 1.70 on the day).
The QQQQ Collar trade has been one of the few that I have been running with real money, and it has been going for about 18 months now. Over the last 18 months we have had, overall, a pretty significant up-trend to the market; and a limited-profit trade like a collar is going to underperform during strong up-trend periods. Sure enough, I've made some pretty good money in the collar trade: just under 16% in 18 months. But if I had just bought QQQQ and held it, I would have had a much better return: close to 39% over the same period. Despite this drastic underperformance, the trade is a success - it is a super-long-term trade, and in losing years, its losses are much more limited than a simple buy-and-hold. If it had not underperformed, that would be a signal that something wasn't being hedged correctly.
This trade is not without its problems, however. First, there is a great deal of subjectivity about what strikes to use for the covered calls and the protective put - I tried to solve this problem by setting some range parameters. Next, I have been running this trade in an online broker that is geared more toward stock traders than option traders. As a result, its commissions for options are terrible: $10.75 for a one-way one-lot option trade, vs the $1.50 I negotiated with thinkorswim. When I'm doing 14 option trades a year, plus the fairly frequent assignment fee of $25 followed immediately by the need to repurchase the QQQQ outright for $7 flat, it gets expensive fast. Finally, I have noticed that the time value on the about-to-be-front-month options drains significantly over expiry weekend. But since my online broker is very touchy about naked short options, I have to choose between an expensive fee-to-price ratio rolling trade, or letting the premium disappear over the weekend.
Since the collar essentially closed itself out over the weekend, I decided now would be a good time to transfer its required capital to thinkorswim and run it there. I may retain the stock/call/put configuration, or I may run an equivalent position of a simple bullish vertical option spread. If I do that, I lose the calendar component of the 6-month put vs the 6 1-month calls, but I'm not convinced that component is valuable anyway. In any case, I have some research to do before the money transfer settles.
Frightening
Back to fake money, the CiG trade lit up like a Christmas tree today, thanks to those crazy Libyans. S&P futures sold off 28 points or about 2%, which signalled a Buy at the close. I have been bearish S&P for about 6 months (it has gained 300 points during that time) but this is a mechanical trade -- my viewpoint doesn't figure into it. Have you ever tried to make yourself buy something when you don't believe in it and it has just sold off by 2%? It isn't easy.
The gold futures trade last month wasn't easy, either, but it turned out fine; by the law of single-datapoint-patterns, that means this one should be just fine too. Nevertheless, NeighborTrader and I did have some vertiginous fun imagining that we were each managing million-dollar accounts and thus had to buy 100 futures knowing that each point would make or lose $5000. That would make today a $140,000 losing day for that account, had it been long that amount. I think I'm happier in fake money for now.
I also had a preliminary Sell signal setting up in Ten Year Note futures... we'll see what tomorrow brings on that one.
Somewhere in Between
Rounding out the flurry of activity today, the sudden market downturn made the volatility indexes pop about 4 points. Everyone has heard of the VIX, which measures implied volatility in options on the S&P 500. Since my iron condor trade is on Russell (RUT), I use the VIX's cousin: RVX. Anyway, the 4 point pop in the RVX was just what I needed to get a better price on opening an iron condor position, since it is a negative-vega trade. I put on the 760/770/900/910 April Iron Condor, for a credit of $3.25/share. Pretty respectable, considering the low-IV environment we've had the last few weeks. If the RVX is predictive, however, I'll be in for a roller coaster ride this month.
05 October 2010
I Spy a Crossover
I'm running a mechanical trade in paperMoney on SPY that is based on Simple-Moving-Average Crossovers. I just started running this trade, but I did a little back-of-the-envelope backtesting before I started and I really liked the way it performed over the last couple of years. Since the 25-day SMA crossed the 200-day SMA to the upside today, it bears mentioning.
There are two competing indicators in this trade: moving average crossovers (MACO) and individual investment sentiment, which I use as a contrary indicator (CS).
Moving Average Crossovers
MACO is bullish when the SPY daily closing price is higher than the SPY 25-day SMA, which in turn is higher than the SPY 200-day SMA. MACO is bearish in the opposite situation: when SPY closes below the 25-day SMA, which in turn is below the 200-day SMA. In any other closing price configuration, MACO is neutral/flat.
If this was where it ended, this would be a classic long-term trend-following trade. It would have killed in 2009, and been killed in 2010.
Contrary Sentiment
The American Association of Individual Investors publishes a set of weekly indicators based on surveys of their members. They give the percentage of their responding members that are bullish, bearish, and neutral. I have arbitrarily chosen the bullish indicator, and I use the prior calendar year's average value as a midpoint - this year, that midpoint is 36.8%. I then set the entry lines 10% above and below that value. I get a new value from AAII every Wednesday, when they publish the survey.
CS is bullish when the surveyed value is below (yes, below) the low entry line, bearish when the surveyed value is above (yes, above) the high entry line, and signals "exit" when the surveyed value crosses the midpoint. I basically use it to fade individual investor sentiment, because I think most people are morons - especially those who spend money on a membership to a website so they can donate their time filling out surveys.
So when that bullish indicator is above 46.8%, CS will initiate a "short" signal, remaining in "short" state until the indicator drops below 36.8%. When the bullish indicator is below 26.8%, CS will initiate a "long" signal, remaining in "long" state until the indicator rises above 36.8%. I'm trying to only place bets against other investors when it is more or less universally agreed upon how great/shitty the world is.
As a momentum-fading indicator, CS kills in sideways markets like most of 2010 has been. It gets killed in trending markets like 2009, where everyone got really excited and stayed really excited while the stock market rallied a gazillion points for no reason.
Putting it all together
Now I aggregate the signals thus:
The combination I describe above didn't consistently beat the "buy and forget" strategy, but: (a) it was a lot more fun; (b) buy-and-forget is what we all already do in our 401(k)s anyway - this whole trade is a diversification, in my opinion. And, honestly, it has beat the snot out of "buy and forget" so far this year.
Where are we now?
The last entry signal in CS was "short" on 16 September, when the survey came out 50.89% bullish. It has since drifted lower. The most recent survey on 30 September was 42.5%, which would not cause a new position, but it remains "short" because we haven't gone through 36.8% yet. We get a new survey tomorrow, and I'll go out on a limb and predict that it will remain above 36.8%. In fact, for double-or-nothing I'll predict an up-tick from last week.
MACO, on the other hand, has been flat/neutral since 2 September, when SPY closed at 109.47: above the 25-SMA of 109.09 but below the 200-SMA of 111.79. SPY has been trading above both of its moving averages since gapping higher over the weekend before 13 September, and today it finally dragged the 25-SMA higher than the 200-SMA at the close, generating a "long" signal:
There are two competing indicators in this trade: moving average crossovers (MACO) and individual investment sentiment, which I use as a contrary indicator (CS).
Moving Average Crossovers
MACO is bullish when the SPY daily closing price is higher than the SPY 25-day SMA, which in turn is higher than the SPY 200-day SMA. MACO is bearish in the opposite situation: when SPY closes below the 25-day SMA, which in turn is below the 200-day SMA. In any other closing price configuration, MACO is neutral/flat.
If this was where it ended, this would be a classic long-term trend-following trade. It would have killed in 2009, and been killed in 2010.
Contrary Sentiment
The American Association of Individual Investors publishes a set of weekly indicators based on surveys of their members. They give the percentage of their responding members that are bullish, bearish, and neutral. I have arbitrarily chosen the bullish indicator, and I use the prior calendar year's average value as a midpoint - this year, that midpoint is 36.8%. I then set the entry lines 10% above and below that value. I get a new value from AAII every Wednesday, when they publish the survey.
CS is bullish when the surveyed value is below (yes, below) the low entry line, bearish when the surveyed value is above (yes, above) the high entry line, and signals "exit" when the surveyed value crosses the midpoint. I basically use it to fade individual investor sentiment, because I think most people are morons - especially those who spend money on a membership to a website so they can donate their time filling out surveys.
So when that bullish indicator is above 46.8%, CS will initiate a "short" signal, remaining in "short" state until the indicator drops below 36.8%. When the bullish indicator is below 26.8%, CS will initiate a "long" signal, remaining in "long" state until the indicator rises above 36.8%. I'm trying to only place bets against other investors when it is more or less universally agreed upon how great/shitty the world is.
As a momentum-fading indicator, CS kills in sideways markets like most of 2010 has been. It gets killed in trending markets like 2009, where everyone got really excited and stayed really excited while the stock market rallied a gazillion points for no reason.
Putting it all together
Now I aggregate the signals thus:
- If both CS and MACO say "flat/neutral", my position is flat
- If CS and MACO disagree (long/short or short/long), my position is flat
- If CS and MACO agree on a position (rare), I take that position
- If one says "long" and the other "neutral", I'm long (but see below)
- If one says "short" and the other "neutral", I'm short (but see below)
- If there was a disagreement (long/short, short/long), and MACO goes to neutral/flat, I do not initiate a position until the next CS survey release is in the "initiate" zones. I do not "back into" positions.
- I only use closing prices for the MACO portion, and I trade the next day on the open. If SPY gaps back through into neutral territory before the open, I treat it as no signal. This basically just makes the backtesting easier.
The combination I describe above didn't consistently beat the "buy and forget" strategy, but: (a) it was a lot more fun; (b) buy-and-forget is what we all already do in our 401(k)s anyway - this whole trade is a diversification, in my opinion. And, honestly, it has beat the snot out of "buy and forget" so far this year.
Where are we now?
The last entry signal in CS was "short" on 16 September, when the survey came out 50.89% bullish. It has since drifted lower. The most recent survey on 30 September was 42.5%, which would not cause a new position, but it remains "short" because we haven't gone through 36.8% yet. We get a new survey tomorrow, and I'll go out on a limb and predict that it will remain above 36.8%. In fact, for double-or-nothing I'll predict an up-tick from last week.
MACO, on the other hand, has been flat/neutral since 2 September, when SPY closed at 109.47: above the 25-SMA of 109.09 but below the 200-SMA of 111.79. SPY has been trading above both of its moving averages since gapping higher over the weekend before 13 September, and today it finally dragged the 25-SMA higher than the 200-SMA at the close, generating a "long" signal:
- SPY Close: 116.04
- 25-day moving average: 112.46
- 200-day moving average: 112.05
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