Trading: Choppiest environment in 50 years !

Very interesting:

How To Trade The Choppiest Environment In 50 Years
If you trade trend or breakout strategies and have found the market difficult in the last year or so, I’m about to show a prime reason for that diffuclty. Below is a strategy that buys the S&P 500 on the close of any up day. The position is closed at the close of a down day. Essentially your looking to buy strength and sit out weakness.



This strategy worked well in the 90’s, but since the market topped in 2000, it has performed poorly. Since the Spring of 2007 it has really accelerated lower. What this means is that performance following up days has been especially bad. It suggests the environenment has been especially choppy. Whereas strength begat strength in the 90’s, it has led to immediate weakness since.

Now let’s take a look at downside follow through. In this case the strategy is to sell short on any down day and then cover on an up day.



This was a break-even strategy through July of 2002. Since then it has done terrible. Interestingly, it’s done especially bad over the last year plus. Even though the market has fallen precipitously, the manner in which it has occurred has made it difficult to profit if you’re trying to short breakdowns. Down days have been followed by up days.

What about a combination strategy? Buy strength and short weakness in anticipation of further follow through. Below is a chart with the combo strategy:



Again, since March 2007 this strategy would have experienced an incredible freefall.

Perhaps it would be best to take a step back, though. In the next chart I show back to 1960 instead of 1993 in an effort to find other periods where choppiness has been so prevalent.



As you can see, buying after strong days and selling after weak ones worked well for 40 years. In 2000 that changed, and the last year and a half is the worst it has ever been with regards to follow through. This would suggest that strategies that may have worked well for forty years or more could be suffering greatly now. Traders should consider the current choppy market behavior when designing strategies. Buying weakness and selling strength is working better than buying strength and selling weakness. They could also monitor charts like these to see if tendencies begin to revert back to pre-2000. If tendencies do revert, adjustments may be needed.

LINK:
Quantifiable Edges: How To Trade The Choppiest Environment In 50 Years

Continued:

Part II: Trend Vs. Chop for Intraday Traders

Hi mate, do you mean this, just googled for that ?

Macro Man

Think I haven't stumbled on him yet, will have a look, this looks pretty interesting:

"One of the things that Macro Man does in his real job is to run indicators that attempt to determine which fundamental themes are driving currencies at any point in time (don't ask, he's not going to be more specific than that.) And what's interesting about the recent dollar move is that none of the fundamental themes that traditionally drive exchange rates has been in play during this dollar move.

This morning he quantified this into a combined "thematic strength" indicator, wherein a high reading indicates that currency markets are trading very thematically, and a low reading suggests that so-called fundamentals are not driving FX.



And what we can observe is that this is the least thematic market since the summer of 2003. It appears to have been micro (idiosyncratic decisions and/or momentum), rather than macro, that has driven the recent dollar rally. So if you've struggled to understand why the buck is up, don't worry; it's taken a lot of people by surprise."

OK, I think I found it:

"Well, what can you say? Yesterday was a "sell everything" day.....at least until that list included oil....after which it became a "buy everything" day. That is, until there were 45 minutes left in yesterday's US equity session, at which point it became a "sell everything" day again. Fun for the whole family!

As observed a few times over the last week or so, Macro Mas has found trading conditions evolve from pretty relaxing to downright terrifying at times. He's found it pretty easy to second guess every trading decision he makes, often after only a few minutes. That's an urge that he is trying to fight; in all conditions, but particularly when it gets a touch difficult, it's important to look forward rather than back.

In any event, it doesn't take much digging to confirm that conditions have been tricky, and that Macro Man hasn't dropped 50 points of trading IQ since the 4th of July. Consider that over the past 10 trading days, a period in which the SPX has dropped 5.1%, no less than seven of those days have witnessed an intraday rally of at least 1.5%. Unless one is a brilliant intraday trader- and Macro Man is not- this sort of market naturally lends itself to trades that have a, ahem, "suboptimal P/L impact."



Elsewhere, yesterday's post was a perfect example of the market Heisenberg Uncertainty Principle in action. In observing the strange lack of volatility in GBP/JPY, Macro Man evidently changed the dynamic, as the cross finally broke away from the 211 tractor beam to close New York at 210. At the time of writing, it's now in the mid 208's.

The ability of the yen crosses to withstand equity market volatility has certainly been puzzling, but it's not completely without precedent. After all, it was last June and July that the collapse of the Bear Stearns (remember them?) hedge funds sent the initial shockwaves of the current crisis through financial markets. For most of those months, FX carry was unperturbed: NZD/JPY rallied 8.8% from the end of May to July 23!"

LINK:
Macro Man: Buy...I mean sell...I mean buy....I mean sell

"suboptimal p/l impact" under these chop/chop conditions eh ;-)

Nice way of putting that.

The question really is what's changed in the last few years, computers were around before that, and the market participants haven't changed all that much either.

Hmm.

Hi Markus - Your post on choppy markets prompted me to back-test a simple system for a year on the FTSE100, to see if some profit can be made from volatility during these choppy times.
Buy at close if price is below previous close but above 14MA. Exit at next close.
Sell at close if price is above previous close but below 14MA. Exit at next close.
I know this is too simplistic to work but its OK for a quick test.

Test generated 90 trades in 12 months, of which 61% profitable (no allowances made for slippage). Gain 3679pts, loss 2010pts, net gain 1669pts.

I also tested with 10MA, giving 82 trades, 60% profitable, for net gain 1331pts.

I think that a simple stop-loss rule is also required, say 1% away from entry point, so as to cap larger losses. A simple rule could be added to allow winners to run, say close 2/3 position at next close and allow remaining 1/3 to run an extra day if in profit.

Simple stuff but could be fun.

Markus,

You've tested it on what to me is the most mean reverting (or just read mean) market out there. What happens if instead you tested it on -
Aussie SPI, HSI, N225, or Dax

Certainly the markets I trade in Asia are much better trenders than the SPI although they do tend to get flipped end on end by current US market reversals.

I don't really find this a problem with day trading US stocks. There used to be large moves of a dollar or two or three and although they are still there - just look at FRE and FNM recently - they are fewer and less long lasting. I've adapted to this by taking larger position sizes on smaller moves; sometimes this has involved scaling out more often and earlier when a move has paused, but the end of day results have remained very consistent.
We've got to adapt to changing conditions, just like every living organism. Or die.
Richard

tomorton said:

Hi Markus - Your post on choppy markets prompted me to back-test a simple system for a year on the FTSE100, to see if some profit can be made from volatility during these choppy times.
Buy at close if price is below previous close but above 14MA. Exit at next close.
Sell at close if price is above previous close but below 14MA. Exit at next close.
I know this is too simplistic to work but its OK for a quick test.

Test generated 90 trades in 12 months, of which 61% profitable (no allowances made for slippage). Gain 3679pts, loss 2010pts, net gain 1669pts.

Simple stuff but could be fun.

Click to expand...

Yup, sounds good, basically buying pullbacks in the direction of the underlying trend, ie you're going along with the normal ebb and flow of markets. Good test there.

GammaJammer said:

Well here are a few things I think have changed;

1) Interdependedness
2) Volatility of volatility
3) Volatility of liquidity
4) Information power dynamics
5) Sophistication
6) FX as asset class, not simply by-product
7) Short term-ism
8) Geopolitics and it's role in the markets (kind of a combination of 1 and 4 I guess.

I'm sure there are loads more - can splice it and dice it however you want. But how about those for starters?

GJ

Click to expand...

That certainly makes a lot of sense GJ, although I wouldn't be too surprised if this phenomenon might not cancel itself out at some point, ie too many people chasing the same strategies with the same tools etc can't really keep working indefinitely, whereas the more trending environment of the previous 50 years is a bit more of a perpetuum mobile.

But thats just me peering into a pretty opaque crystal ball ball, chop might very well be the future too I guess.

The way I am coping with this environment is by going extremely short term, ie looking at one minute charts on volatile two or three instruments that move well like the EUR/USD, oil and an index like DAX or Dow.

Classic charting 101 still works like a charm down here, whereas the 1 hr charts I used to use for entries and exits previously are just being chopped to bits at the moment.

The way I see it it's either micro time frames like tick or one minute chartst, or go all the way up on the time frame, are the two workable strategies I see at the moment.

nine said:

Markus,

You've tested it on what to me is the most mean reverting (or just read mean) market out there. What happens if instead you tested it on -
Aussie SPI, HSI, N225, or Dax

Certainly the markets I trade in Asia are much better trenders than the SPI although they do tend to get flipped end on end by current US market reversals.

Click to expand...

Nine, I didn't actually backtest that myself, just found his study on the web.

Actually what you say poses a very interesting question though, how would his trendy system backtest on other markets.

Another thing that quite amazed me was that the market he tested EVER had the trendiness for almost 50 years that his study suggests, I'd previously thought index futures in general and his in particular are just like you say, very mean reverting.

Yup, I've certainly never made any money trying to trade mean reversion, the only thing that works for me is letting the market confirm for me that it's going up or down before entering.

;-)

Certainly choppy at the moment. Nothing seems to move much, just lurches through the low and back up or through the high and back down.

True.

Brett Steenbarger had a good piece on the current chopchop too:

"Short-Term Reversal Patterns Among Global Equity Indexes

A number of traders have commented to me on how choppy the market conditions have become. A strong movement seems under way, and then it just as strongly reverses.

As a way of looking simply at recent trading conditions, I went back to the start of 2007 and investigated three-day returns as a function of the prior three-day returns. Specifically, I looked at what happens when the market is up jointly on a one- and three-day basis (uptrending) and when it is down jointly on a one- and three-day basis (downtrending).

When the S&P 500 Index (SPY) has been up for the past one and three days, the next three days average a loss of -.30% (80 occasions up, 83 down). When SPY has been down for the past one and three days, the next three days average a gain of .22% (82 up, 51 down). If traders wait several days for a trend to assert itself and then jump on board, they are likely to start in the hole.

When we look internationally at the Europe, Australasia, and Far East (EAFE) stocks (EFA), when those are up on a one- and three-day basis, the next three days average a loss of -.27% (76 occasions up, 80 down). When EFA has been down over the last one and three days, the next three days have averaged a gain of .09% (74 up, 65 down).

Finally, when we examine emerging market stocks (EEM), we find that when they are up on a one- and three-day basis, the next three sessions average a loss of -.31% (86 up, 81 down). When EEM has been down over the last one and three days, the next three days have averaged a gain of .69% (79 up, 45 down).

Across the globe, short-term trend following has been hazardous for traders' wealth. Even longer-term traders need to take these reversal patterns into account, if only to size positions and set stops for expected heat."


LINK:
TraderFeed: Short-Term Reversal Patterns Among Global Equity Indexes

And from a commenter on Steenbargers page from my last post:

"Anyone Feel Like They Are Flipping A Coin, When Trading This Market?

by Woodshedder on August 25th, 2008 at 1:00 am

I want to introduce to all of you a statistical measure which has come to have a significant influence on the trading systems I am developing. Ralph Vince describes the measure very well in his book Portfolio Management Formulas. This measure is called the Z-Score, or the Runs Test.

I want to skip most of the statistical jargon and get right to the meat of the issue, but I will be happy to answer specifics in the comment section.

To understand why the Z Score or Runs Test is important, we need to digest Rob Hanna’s statement from his recent post How to Trade the Choppiest Environment in 50 Years. Rob writes, “As you can see, buying after strong days and selling after weak ones worked well for 40 years. In 2000 that changed, and the last year and a half is the worst it has ever been with regards to follow through. This would suggest that strategies that may have worked well for forty years or more could be suffering greatly now.”

Also, it is important to read Dr. Brett Steenbarger’s recent post Short-Term Reversal Patterns Among Global Equity Indexes.

Both authors conclude that short-term trend following is not working very well. We can test their conclusion by applying the Z-Score to the data from the indices. I should mention that both Bhh from IBDIndex and Damian from Skill Analytics have been instrumental in helping me flesh out the rest of the ideas presented below.

The Z-Score can determine whether wins or losses are dependent on previous wins or losses. Think of dependency in this way: Do wins begat more wins? Do losses begat losses? If so, this relationship would be described as a positive dependency. What if wins begat losers, and losers begat wins? This would be a negative dependency.

While Z-Score has traditionally been used to analyze the win and loss streaks of a trading systems, it seems that another application for the measure may be to analyze the win and loss streaks of the indices in order to determine whether there is any dependency. Are the sequences of wins and losses containing more or less streaks (of wins and losses) than would be expected in a truly random sequence? When digesting this, consider the fair coin, where one flip is equally as likely to be heads as it is tails. We want to determine if the indexes are trading as a fair coin, or one that is biased to heads or tails, or both.

Below are the Z-Scores for the S&P 500 (SPX), using all data available from yahoo, which goes back to 1950. In January of 1993, the S&P 500 SPDRs was introduced. I will quit using SPX data and use SPY data from 1993 forward.

All Data, 1950 to Present: Z-Score -9.359014

This negative Z-Score implies a positive dependency at a confidence level of much higher than 99.73%. In short, a positive close on the S&P 500 generally begat more positive closes, and losing days generally begat more losing days, over this broad time span.

1960 to Present: -7.196132

1970 to Present: -3.795268

Note that the positive dependency is decreasing, yet from 1970-Present, the confidence level is still above 99.73%.

1980 to Present: Z-Score .3465443

1990 to Present: Z-Score 1.692151

1993 to Present (With SPY Data): Z-Score 2.115444

Note that there has been a switch. The positive Z-Score implies a negative dependency, where buying begats selling, and selling begats buying. Be careful though with this data, as the score must be above 1.64 to have a confidence level of greater than 90%.

2000 to Present: Z-Score 1.3608623

2003 to Present: Z-Score 1.1696094

2006 to Present: Z-Score .4530397

2007 to Present: Z-Score 1.3030246

October 2007 to Present: Z-Score .3994188

Note that from 2000 on, the Z-Scores move lower. The highest score from this period, 1.303, gives a little better than an 80% confidence level. I interpret this data to mean that the S&P 500 is basically moving through a random walk, although the confidence level is not high enough to draw any firm conclusions.

January 2008 to Present: Z-Score -0.628093

February 2008 to Present: Z-Score -0.400456

March 2008 to Present: Z-Score -0.246511

April 2008 to Present: Z-Score -0.403907

May 2008 to Present: Z-Score -0.288564

June 2008 to Present: Z-Score 0.0022265

July 2008 to Present: Z-Score -0.09631

From January 2008 to the present, we begin to once again see negative Z-Scores. A negative score implies a positive dependency, where selling begats selling and buying begats buying. The scores are not significant enough to exhibit a high level of confidence.


Conclusions
The recent data show no definitive dependency, either positive or negative. This means that buying because the market has closed up or selling because it has gone down has not been working as well as in the past. Also, buying weakness or selling strength, in order to catch a reversal, has not been working as well either.


Right now, betting on the market, as represented through the SPY, is similar to betting on the flip of a fair coin. This data, while it may not prove the conclusion of Hanna and Steenbarger, certainly does not disprove it."

LINK:
Technical Analysis at iBankCoin.com

Sounds sensible and is definitely sthg that should work quite well, just afraid that I'd need to hire some quants to get that kind of stuff up and running.

;-)

But what also works is just going down to a lower time frame, eg EUR/USD has had some picture book perfect trends as per Technical Analysis 101 today on a 1 minute chart, first a classic shake-out promptly followed by a charming fake-out, but that initial twitchiness was then followed quite decently by a downtrend of lower lows / lower highs, again followed in the afternoon by the reverse at ca 14:00 CET, quite doable provided one doesn't get greedy or stubborn or fall in love with one direction and start wishing for things that aren't there.

In this market you know even less than usually whats going to happen next, but provided one doesn't mind being stopped out a bit and quite regularly at that, but manages to hang on to a trend when you do get one, is quite doable.

Thing I always have to remember is that doing this type of trading you're not looking to make money every day or even every week, but you still have to keep trading to catch those opportunities that do present themselves and that then more than make up for the losses.

But for anyone struggling, either do what GJ says which makes sense, or scroll all the way down to tick or 1 minute charts.

My opinion is that too many people trade and the law of large numbers applies very short-term. The random moves are due to long and shorts split equally in half. This will change when one side drops out broke and the other prevails. Then you get momentum that feeds itself.

Sorry to be so simplistic but I do not need backtests to figure out that 20 year old chaps with fast computers around the world try to become rich trading.

The answer is there are too many players using sophisticated tools. Just wait a few months. Smart money will come in after things calm down.

Ron

GJ, I suppose I'm just a big friend of KISS, of keeping it as simple as possible while still getting the desired results.

I think in a way that simple charting - or tape reading as say Livermore called it, only difference being ones depiction of price was numerical while mine is visual - has the advantage that it basically always has and always will work on a net profitable basis as long as there is sufficient movement in markets.

And, on top of that, it's an area where I think you don't have all that much competition, I'd presume that these days not all but definitely most hedge funds for example use some form of data mined correlations and computer driven models they base their trading on.

Another detriment down that road is that you'd be competing with them in an area where their success is already diminishing as too many of them are all doing the same thing largely, and at the same time, and in the same markets.

I think Renaissance Technologies, who definitely showed that mathematical computer driven models can be very successful, started a real catch-me-if-you-can race in the latest big thing, but as always too much competition offering the same gizmo is not good for business.

Finally, those people may exist, but on all these mechanical systems sites like wealthlab or tradestation etc etc, when I was starting out fishing for answers there, I have never seen or heard of a programmer who was able to get a programme to do the same very simple stuff I do visually on a chart...

It was always, well, patterns may look easy, but easy to programme they are not.

So using simple price patterns that worked a hundred years ago and still work today would seem to be an advantage I believe.

But then I must admit that it is years ago that I went looking for answers there.

Are you and your group mainly mining data for inter / intra market relationships etc and using mathematical models in your proprietary trading ?

Or do you also have people just doing basic charting ?

"Five Trading Behaviors I'm Seeing Among Traders Making Money Now

TraderFeed
FRIDAY, OCTOBER 24, 2008

As I'm writing this, the ES futures are lock limit down and my email count is off the charts. Lots of fear, not much greed: fear, not only for one's trading, but for retirement savings and the economy. Most of people's money is tied up in some combination of stocks, bonds, and residential real estate. That means that many, many people are worth 25+% less than they had been just a year or so ago.

It is difficult to insulate those fears and concerns from one's trading. And yet, I do hear from traders who are making money in these markets. There *is* volatility, and there can be opportunity. Here are ten factors that stand out among the traders I talk with who are making money in the current environment:

1) Patience - The ones who are afraid of missing moves, who chase moves as a result, are getting hurt. The ones who wait for clear signals and good reward-to-risk opportunities can take advantage of the volatility. The successful traders aren't afraid of missing a move; they know, in this volatile environment, other opportunities will arise.

2) Position Sizing - Trading smaller when markets are moving more means that one or two losing trades won't knock you out for the day or the week. The successful traders tell me they're making plenty of money with smaller size simply because we're moving triple digits in the Dow just about every day.

3) Resilience - When you're wrong in these markets, you can really be wrong. My first trade yesterday lost over 20 S&P points; I wound up the day solidly in the green. By managing risk, you also manage emotions and can stay in the game. The successful traders are in there, making trades. They get off the canvas when they're wrong and they play defense, even as they look for opportunity.

4) Minimizing Distractions - One thing I noticed is that the successful traders in this environment have taken active measures to protect their personal finances. The less successful ones have been distracted by losses they're incurring outside of trading. It is difficult to focus on trading if you're worried about unemployment or loss of savings; addressing personal security helps maximize focus during trading.

5) Self-Maintenance - It's easy to get run down following markets through the day, every day, and then tracking them overnight and overseas. One troubled trader told me he was living, eating, and breathing trading. That is a risk factor for burnout, lessened concentration, and bad decision making. The successful traders aren't afraid to step away from the screens; once again, they know opportunity is not going to go away.

I'm finding that execution is the better part of success in these times. If you have a good idea, but the timing of your entry is wrong or your position is too large, you're likely to get stopped out at the worst conceivable time. By waiting for markets to put in a seeming high or low, waiting for a bounce or pullback that can't make a new price extreme, and *then* getting into a position, you can minimize the heat you take on trades. That, I'm finding, is half the battle."

LINK:
TraderFeed: Five Trading Behaviors I'm Seeing Among Traders Making Money Now

"Rockier Than 1929

BARRON'S

By STEVEN M. SEARS

Market volatility has outpaced 1987's, and is set to surpass 1929's.

TODAY'S STOCK MARKET IS POISED to surpass 1929's as the most volatile ever.

Goldman Sachs derivatives strategists told clients on Friday that Standard & Poor's 500 three-month realized volatility is now 66%, surpassing levels of the 1987 crash and the economic malaise of the 1930s. Volatility now rests within striking distance of a moment in stock-market history that has defined financial crisis for almost 100 years.

"During 1929, realized volatility peaked at 68%. We will likely pass that number in short order. That will make the current market the highest sustained volatility environment in S&P 500 history," says Goldman's Krag "Buzz" Gregory, an options strategist.



Current options volatility exceeds the experience of everyone trading options. The average peak in volatility during the last nine bear markets since 1950 was 30%, with a high of 64% in 1987. The persistent increase in options volatility is causing havoc for traders taught to believe that options volatility behaves like a rubber band. When stretched to an extreme, volatility snaps back. In this market, the rubber band keeps stretching.

The options market's fear gauge, the Chicago Board Options Exchange's Market Volatility Index (VIX), which is calculated by measuring the implied volatility of certain Standard & Poor's 500 index options expiring in 30 days, set a new all-time closing high of 80.90 on Thursday. This spells trouble for stocks.

VIX at 80 implies a Standard & Poor's 500 average daily move of about 5%.

SOPHISTICATED INVESTORS CAN TRADE INDEX VOLATILITY, but most investors are better served by focusing on a single stock. Best Buy (ticker: BBY), a big electronics retailer, is likely to struggle as consumers curb their purchases of expensive flat-screen televisions, computers and video games.

With the stock at about $17, Best Buy's implied volatility is about 136%, compared with realized volatility of about 101%. Even at such high levels, volatility can still increase, particularly as sales data prompt investors to focus on consumer-discretionary spending, holiday sales and the state of the U.S. economy.

A Goldman Sachs study of 10 years of monthly realized volatility found that electronics retailers are some of the most volatile retail companies in November and December. Average retailers experience high volatility in August and September, a November ebb, and a modest increase for the holidays.

Best Buy recently lowered sales and financial guidance. Circuit City, another big electronic retailer, has sought bankruptcy protection.

Credit analysts are worried about Best Buy's balance sheet. Fitch Ratings revised Best Buy's outlook to negative. Standard & Poor's just lowered the electronic retailer's credit rating to BBB-minus, from BBB, one step above junk-bond status.

Best Buy's stock is down 67% this year, and it could go lower yet."

LINK:
Rockier Than 1929 - Barrons.com

luckyd1976 said:

Some very interesting reads.

Aside from the few good Daytraders, Anyone else winning??? And if so, what (basic overview)strategies are working IN THIS environment???

Click to expand...

My solution: short term scalping.

BSD said:

My solution: short term scalping.

Click to expand...

Sucks I know. I know. But Im reluctant to rework my DT strategy for this environment SO I shelved it for the time being. Switched back on my FX. Equities were crushing me recently.