Thursday, September 11, 2008

What I'm Workng On

I'm back. . .kinda. I still have some loose ends to resolve and at the same time I'm trying to get my trading goggles back in focus and my frame of mind back in the groove..
I've resumed work on the Kit of Parts (KOP) project by expanding the scope of the pivot study to include XLE and XLF. I've also added some metrics to the weekly pivot range delta, which will become data inputs in the final version of the code package. The plan is to upgrade the forward looking pivots following each Friday close and then review the resultant %range and %delta in conjunction with the slope and channel mean of the linear regression (30)study. The goal is the identification of high probability mean reversion candidates over a 3-5 week time frame, which is the reason the study uses weekly bars in lieu the typical of daily bars.
An integral goal of the KOP is the creation of an Excel-based toolbox that can used to objectively assess the relative probability of mean reversion targets.
Although a working theory of the project is that it will have fractal properties, that is, applicable to daily or 60 minute bars, I'm deferring any research in that area until the KOP is shown to be reliable on the weekly bars.
I'm using XLE and XLF in conjunction with the Qs and IWM as their options share common traits of high open interest, multi-exchange participation, good daily liquidity and .01-.02 bid/ask spreads on most of the strikes. Since the immediate focus of the KOP study is the use of butterfly positions to create a revenue stream, these traits are critical. Most brokers will put on 3 legged butterfly trades for one commission. My experience is that, when placed as limit orders in high liquidity option markets, market makers will typically work the orders to give you a fill within a penny or two of the order limit. A little oversight may be required as part of the order execution, but in many cases the orders will float through without adjusting the limit size. I'm using butterfly positions because the risk is fixed and the trades can be setup with a defined risk/reward ratio. . .with a target minimum of 1:3. Although it's possible to set up zero or near zero butterfly debits, these are typically not high probability situations. The KOP goal is to identify the higher probability scenarios.
The ETFs I'm using are for demonstration purposes only based on the traits I've mentioned above. As we move forward with development of the KOP, I suspect that a few of you will have suggestions for screening criteria that may enhance performance even further.
Speaking of enhancing performance, Dr. Brett has started an ambitious series in which he will explain all about systems trading, culminating with his presentation of a real trading system, all of which will be captured in a free ebook format. Since the Doc is a self-confessed discretionary trader, this is something of a swing in his approach and I look forward to following the series. His system will trade a basket of ETFs, no doubt as a means to dilute risk. My only concern with this approach (NOT A CRITRICSM!) is that it will require a substantal capital outlay in order to mimimize the effect of multiple commissions. As Cucca says . . . we shall see.
Tip of the hat to the Doc for mentioning my Grand Slam system.

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