Dollar / NYAD mean reversion

Here's a trade setup I'm exploring that looks similar to the GE/NYAD setup but, in this case we're looking at the dollar as reflected by the UUP, the Proshares double dollar bullish ETF. The big difference between GE and UUP is, of course, that the dollar typically trends opposite the major market indices, so a chart of the UUP looks a lot more like the VIX than it does the SPY.
In the above chart, the UUP is shown (colored candles) with the NYAD in the shadow candles.
The trading box in orange describes the divergence and reversion setup.
The lower chart annex is the true NYAD overlaid with the 8/16 MAs and a 5,20,3 MACD signal line and a classic 12,26,9 MACD histogram in the lower study panel.
Notice how the zero line crosses on the MACD histogram have provided solid confirmation of either the 8/16 MA crosses or the parabolic SAR signals.
The technique of using the MACD signal line in conjunction with the MACD histogram is something I've been fiddling with lately and in the process developed this pairing which produces fairly consistent results when used in conjunction with the NYAD. Whether this pairing can deliver similar results with other indicators and/or equities will be a subject for future post explorations.
As with the GE/NYAD trades, the UUP/NYAD trades involve a lot of waiting around. On trending days no trades typically develop, while on volatile range days, 2-4 setup opportunities may present. This type of trade can test the resolve of the more hyper traders, but, as usual you have to let the trades come to you and avoid the perils of seeing a setup (and trading) when no setup and no trading edge exists.

XLE closeup

This is a closer look at the XLE Spyder energy sector ETF, one of my 4 ETF basket that I regularly trade. The interesting thing about the chart configuration of the XLE is the flat profile of the LR75 channel(blue), with the mean yielding a clear reversion target of 47.
In December we put on the Jan 47 butterfly with great results, and we are currently in the Feb 47 butterfly, having entered on Jan 21st as the XLE touched 47. The great things about the XLE (depending on your viewpoint) are the highly liquid options and the penny spreads, although the spreads open up a bit as the strikes move away from the ATMs.For those who prefer to just trade the ETF and not play the premium decay game, the XLE triple, ERX, generates more bang for the buck (assuming you're right), as evidenced by this little backtest of the past 500 bars using a simple long/short RSI system on the ERX and XLE on 5, 10, 60 minute and daily bars (ERX has only been up since 11/6/08, so there's not really 500 days of data). Options on the ERX are thin and the spreads are humongous, so don't even think about it.

Finally, an impressive piece of work from Market Rewind providing a neat little snapshot of ETF performance metrics for a variety of time periods. Thanks Jeff.

Weekly Update - new template

First of all, here's a new thumbnail look at my little 4 ETF basket using line charts of the ETFs and the VIX and overlaid with the new Telechart moving linear regression (7) study (described below). This is a little visual lesson in mean regression theory and is designed to help forecast when the ETF/VIX divergence is about to mean revert.

For this week's secondary study (below) I've returned to the VIX daily and weekly bars and the T2100 advance/decline line daily and weekly bars.
While Don Worden's comment at Friday's close was in support of an oversold environment, the technical studies presented in these 3 charts suggest a grimmer prognosis as all technicals are essentially downtrend at the zero line.

The big change this week is a reconfiguration of the 3LRs study (3 linear regressions) to a new 4LRs study. Previously, I was using periods of 30,11 and 3 to define the LR channels. I've now revised the LR periods to 75,30,11. I've added the LR75 to help better detect potential butterfly candidates, a strategy which has worked out well so far. Telechart has also added a moving average linear regression (MLR) study to their inventory of indicators and after playing with various settings, I've settled on a MLR7 to replace the LR3, which was the least useful LR of the study (IMHO) in forecasting momentum and direction. Note how the MALR7 mirrors the cycle of the RSI2 and stochastics 10,2,2 in the middle technical pane of the charts. I've also reconfigured the MACD 5,20,3 indicator to display as a histogram for a somewhat clearer view of momentum and zero line reversals.

Finally, here's an interesting site using a sophisticated algorithm to time the markets. They provide a free weekly forecast of the SPY low. . .you've got to spend some money if you want the rest of the stats. They've been pretty right on for the past month, although this week's forecast was not a rousing success (HEY!, everybody misses a few). Good for confirmations of market turn ups, put sales and potential short term longs.

Qs Inside Days

Here's another addition to the new KOP Qs using the inside day system I profiled earlier this month. Not a lot of trades, about 1 every 3 weeks, but the results are pretty impressive, with marginal drawdown. Refer to the original inside day post for system concept details and open code posted as Comment #1. Keep in mind our test period is only 9/07 to present.

TS2000i code is below:

Qs 7&7 system

This is part of my continuing upgrading to the BZB Dirty Dozen systems that I mentioned earlier in the week. I've decided for now to focus on improving the Qs' systems, as the IWM based systems are chugging along just fine with their original default settings. The Qs, of course, are a bit more problematic that the IWM, due to volatility, only 100 stocks in lieu of the IWM's 2000 and a number of other issues. After years of trading both these ETFs, the IWM is the much easier road to hoe for systems traders, but HEY!, I'm a glutton for punishment, so like Curious George, I'm digging in.

This particular study was inspired by a simple system developed by Larry Connors known as the Double 7s. Rules are to buy the SPY if the close is a 7 day low, and then exit the position when SPY gets to a 7 day high. Needless to say the results of this system with the Qs are pretty awful. That's because the Qs have a totally different support/resistance cycle and reflect different trader biases.
So, I've tweaked the original concept a bit and used fixed bar exits to help define the Qs cycle.
these adjustments yield a fairly reliable trading model.
The system only trades 71 times, about once a week, with an equal number of long and short trades. Drawdown is kept fairly well in check (no stops). The only thing I don't like is the max consecutive losers on the short side. 4 is pushing my comfort level, as I prefer to see a number of 2 or less.
Nevertheless, keep in mind the intent of these single system studies is to build a more robust Kit of Parts of non-correlated systems that will yield high probability EOD (at close) signals

Now I need to back up a bit and mention that for the new KOP Qs (Son of KOP Qs) I'm only going to use the backtest period of 9/14/08 to the present. That's because there's obviously been a shift in market momentum during that period and I want the systems in this version of the KOP Qs to fully reflect that. While the market dump didn't really begin until 11/08, going back to 9/14 let's me use a 50 day MA lookback without cutting into my target 11/1 start date.
TS2000i code shown below:

Inputs: Len1(9), Len2(3), Len3(5), Len4(10);
If Close = LowestFC(Close, Len1)
Then BUY This Bar at Close;
If BarsSinceEntry= Len3
Then ExitLong This Bar at Close;
If Close = HighestFC(Close, Len2)
Then SELL This Bar at Close;
If BarsSinceEntry= Len4
Then ExitShort This Bar at Close;

Risk Map

Here's a free risk map of the NAZ100 via NASDAQ. I find this little tool useful for setting up leaders and laggers for my 3 finger lead and 3 finger reverse systems. Also helpful in creating correlated pair trades, using either one leg or both.

NYAD and the TICK

One of my readers asked about the relationship of the NYAD, TICK and TRIN per a post back in July 07. This post addresses one way I use the TICK as a confirmation for the NYAD. . .which, of course, is one of my prime directives for both trending and trading range market triggers and the primary component of the GE/NYAD divergence trades.
As with last week's post, these charts reflect 10 minute bars over 8 days. The first thing you notice here is that I'm much more concerned with the action of the TICK indicators (MA 12 & 24) than I am with the actual TICK chart. I've found that although the NYAD produced the best trigger signals using an 8 & 16 MA, the TICK is a bit more votatile and has a greater ATR, so I have to slow down the MAs a bit . . . yielding the 12 & 24 MAs as a better choice for viewing reversals, although the MAs still reflect a shaky character in contrast to the NYAD.
Note that the TICK generates a few false signals, both up and down, while the NYAD produces a clearer picture of what's about to come down the pipe. . . which is why if I were to prioritize these two, the NYAD would always come out on top.
For me, the TICK's primary function is as a confirmation of the NYAD trigger signals.
For another viewpoint: Dr. Brett uses a volatility and volume weighted TICK to drive many of his trades. Pop over to his site and type in TICK in the "Blog -Search" bar and delve in to see how he does it. Although his algorithm is proprietary and is used in correlation with the fee based Market Delta program, it's worth a close look.

RSI(2) SAR

I'm embarking on a streamlining and update of the BZB Dirty Dozen systems. In the process I intend to get back to the focus of my months long exploration (begun May 2008) of using a basket of non-correlated systems (KOP) with a small baskets of ETFs in order to generate a high probability, low exposure revenue stream.
Today's post is one step in that direction. In this case SAR stands for Support And Resistance, not stop and reverse. Basically, I'm looking for tells when the RSI2 is about to roll over to the upside or the downside. I've found that a 2 day lookback yields the most consistent results. . . further back than that cuts into the equity curve considerably.

Those first drawdowns, putting the equity curve in negative territory are essentially all short trades, which bears a closer look as I merge this code into the new KOP. The problem there is that the fixed exit is set at 10, which caused early 3-4 day short gains to become losses as the market rallied. Adding a trailing stop should help fix that problem and will, of course, be a component of the new Son of KOP.

What the fixed bar Exits does reveal is a fairly consistent timing cycle "fingerprint" of each ETF (when other ETFs are tested and optimized).

As with many of the other RSI2 systems I've tested over the past year, 20 and 80 continue to perform as consistent S & R levels for the IWM.

TS2000i code is below and open code is posted as comment #1.

Weekly Update

The 3 LRs study (linear regression channels,30,11,3) shows that this week's action was mostly a consolidation of momentum and volume. The XLFs continue to display weakness relative to the rest of my little basket. Down $.99 for the week and hitting an intraweek low of $ 8.07 on increasing volume, the XLF is currently showing bearish technicals on both daily and weekly bars.

Above is the update of the daily and weekly bars for the VIX and a peek at the daily T2108 (% of stocks > 40MA) on daily and weekly bars. As with last week, there is a distinct divergence of trend in both the daily and weekly bars of the VIX and T2108. The VIX continues to hover in the high 40s with forays into the 50s intraday. Earnings continue to drive market surges, with a net neutral outcome for the week on the major indices.

Prognosis? A solid break , but whether it will be to the upside or downside remains to be seen.

When Probability Becomes Uncertainty

One of the main dichotomies in Peter Bernstein's study of risk profiled on Monday is the difference between probability and uncertainty.
If I toss a coin in the air and let it land on the table, over a period of time (law of large numbers) I would expect a high probability of a 50/50 distribution of heads and tails (mean reversion). I can calculate these probabilities using a variety of algorithms because I'm "certain" that gravity will operate and the coin will actually land in one of 2 alignments.
What if I tossed the coin and it didn't come down, but instead continued out into the cosmos?That would be a huge surprise and mess up my probability calculations, and if I were a betting man, and had I placed a wager on the outcome of the coin toss, I'll be more than a bit befuddled. That was an outcome that was completely off the chart, unexpected and unprepared for. Or what if the coin simply landed on its edge 50 % of the tosses and stood erect? That would also be a big surprise, one that I really hadn't anticipated and would lead me to be very uncertain about future coin tosses.

Within the context of the financial markets there is a constant flux between trading markets and trending markets and between mean reversion and random walk patterns where volatility serves as one measure of implied risk. JP Morgan is frequently cited for his explanation of stock market prices: "It will fluctuate". Yes, we expect prices to go up and down, we do not expect them to go to zero, we do not expect $50B ponzi schemes to wipe out net worth of hundreds of individuals and companies , we do not expect a highly respected lawyer and investor to issue $100M in counterfeit promissory notes, we do not expect (previously) low beta banks like WAMU to literally implode and disappear from existence. We do not expect Lehman Brothers to become insolvent and be delisted. And, perhaps most frustrating, nothing happens to these guys. Nobody goes to jail. The execs just say "our risk management models failed . . . so sorry." And then Congress just doles out more dollars.
Along the path of carnage that has ensued for the past 14 months many probabilities that were previously quantified with risk management tools have become utter uncertainties, as reflected in the the current level of volatility in the VIX and other tells as well as the pervasive mood of despair and helplessness. The number of "zombie" companies, both overt and covert, has increased dramatically and this does not bode well for the markets. As traders (and investors) we would like to maximize the probability of profitable outcomes and reduce the level of uncertainty. Today's market climate makes these goals problematic and there are few indications that the worst is over.

A couple of years ago, when Nouriel Roubini predicted that U.S. financial-system losses would total $1 trillion, everyone thought he was insane. He has since revised his estimate. Now he's looking at an even grimmer forecast.

Bloomberg: U.S. financial losses from the credit crisis may reach $3.6 trillion, suggesting the banking system is “effectively insolvent,” said New York University Professor Nouriel Roubini, who predicted last year’s economic crisis.“I’ve found that credit losses could peak at a level of $3.6 trillion for U.S. institutions, half of them by banks and broker dealers,” Roubini said at a conference in Dubai today. “If that’s true, it means the U.S. banking system is effectively insolvent because it starts with a capital of $1.4 trillion. This is a systemic banking crisis.”.

Now, Roubini's just one guy, although I personally I like the way he thinks and suspect he may be on to something. My own feeling is that there an utter lack of oversight and accountability on the part of the Congress doling out taxpayer dollars to "troubled" financial institutions, car makers, home builders, etc, etc, etc. and the companies themselves, who somehow manage to continually reward upper management at the price of the guys who actually do the work. I didn't know whether to laugh or cry when I heard Barney Frank of the Senate Banking Committee say "Well, we expected them (the banks) to do the right thing" when asked why there were no controls on the money doled out and when the banks just sat on the money rather than loaning it out, as had been "intended".
Whether Obama will be able to have any positive and productive impact remains to be seen. I'm not sure HOPE is the right message as it seems pretty vague, has a built-in failure excuse and, well, is not really a plan. Having survived 8 years of the previous "faith-based" administration of robber barons, I'm more inclined to favor something like "let's clean house, create an empowered SEC and Justice department with some teeth that will actually do something, develop some performance metrics and get some accountability from those we choose to help survive". But that's just my naive' stance and unlikely to ever become a working policy.
In the meantime, gird your loins and bide your time. . .things could get nasty.

10 minute NYAD

Those of you who've followed me for a while know I rely heavily on the NYAD (NYSE advance/decline line) for trigger confirmation. In a dynamic arena of constant head fakes, maker maker games and iceberg orders, the NYAD is a fairly transparent peekhole into the pulse of the market. Like the TICK, which often requires a volume component to validate the signal, the relative strength of the NYAD signal (for lack of a better term) can be enhanced by observing a market volume component, a concept which I'll explore further later this week.
For today's study I've just posted 8 days of the NYAD on 10 minute bars, with an overlay of my usual 8 & 16 SMAs (white, yellow lines) and a 3,14,3 signal line (blue) (which is the MA. component of the MACD).
Green arrows reflect bullish 8/16 crosses, white arrows reflect bearish 8/16 crosses. Unfortunately, due to the scale of the chart and the fact that some days the NYAD has hovered all day in the teens or low teens (low ATR), the visibility of the crosses is a bit constrained, so you really need to blow up the chart to see the crosses clearly. Nevertheless, this very simple indicator provides solid results when used in conjunction with the major indices or a basket of ETFs, such as my Qs,IWM,XLE,XLB mini basket.
This is not necessarily recommended as a stand alone system, but I constantly use it to provide confirmation for my trigger signals using the parabolics and the 8/16 crosses in smaller time frames such as the 2 and 5 minute bars and perhaps more importantly . . . to help me avoid premature exits, sometimes called ED (exit dysfunction) which are otherwise a costly annoyance.

ETF and Pre-open Heatmaps

Yesterday's close of the top 100 ETFs. Green is up, red is down.

Here's a nifty little heatmap, compliments of NASDAQ. Updates every minute. 3 heatmaps are provided as defaults: ETF 100, Qs components pre-open and Qs components real-time. You can also create your own custom heatmap. If you've got multiple screens and daytrade the hot sectors, this is a quick visual tools that will show the real time change in RS as the cells realign themselves and change color reflecting market position. The default portfolio does not include the double/triple ETFs or their inverses, which is why the custom heatmaps are a nice feature.

Sell 2 Consecutive Higher Highs

Here's an update of the High Count Reverse system, a short side only system that sells 2 consecutive higher closes. I've used the same start date of the backtest for comparison purposes. The system continues to perform very well, no doubt reflecting the continued downward bias of the market.

Keep in mind that pyramiding is turned on, so the system generates multiple entries but exits on the ninth bar following the original entry. Drawdown remains impressively small.

The system is currently flat.
TS2000i code is included in the original post.

Finally, to celebrate today's festivities, you can add this to your playlist and, well, just do it.

http://www.youtube.com/watch?v=ZclddLcOYYA&feature=related

Risk Management 101

It's been said that among traders there are those who quietly know and there are those who desperately hope. The trick is to equip yourself with the tools and mindset to enable you to join the ranks of the first group rather than the second. To that end I'm just finishing up Peter Bernstein's history of risk. Now, before you roll your eyes in utter boredom, I've got to say that this book is just as exciting as any Agatha Christie mystery or Charles Dickens classic. The cast of characters is equal to none. Along the way you'll learn about the quirks and foibles of such colorful notables as Fibonacci, Cardano, Bernoulli, Gauss, Galton, von Neumann (father of game theory), Markowitz and many, many more who were responsible for developments in mathematics that led to probability theory, betting, uncertainty principles, game theory, the insurance industry and, of course, risk management. The book covers a lot a ground but if trading is your thing and you want to develop a methodology to limit your losses, this book will certainly give you a lot of ideas to spring off from. This is not a trading book . . . there are no systems described or TS code for you to cut and paste. but you'll get a good perspective on how some of the best mathematical minds in history solved complex problems (sometimes with great success, sometimes with resounding failure). I bought a used copy through Amazon for $7.50, although it appeared new to me. A bargain at 10x the price IMHO.
Just a few things to ponder in closing:
Half the people you know are below average.
The 50-50 rule: anytime you have a 50-50 chance of making money in the market. .there is a 50-50 probability you'll lose money.
The early bird may get the worm, but the second mouse always gets the cheese.
And as my friend Steve Forbes says: "It's better to be lucky than smart".
Frankly, I tend to believe that you make much of your own luck and as such I'd prefer to be lucky and smart.

Weekly Update

Last week's update pretty much abandoned my VIX60 hope and instead forecast a VIX50-55, which turned out to be eerily correct. Projections like that and the whole butterfly scenario (updated below) are greatly facilitated by using linear regression studies like the LR30 channel, and of the many TA studies available to traders, this one remains one of my real workhorses for longer time frames. For those who haven't checked him out yet, Richard Muelhberg, uses the 3 LRs for daytrading a wide range of ETFs and futures and has an excellent, and very modestly priced, trader training service. Best of class (LR30 channel behavior) is the XLE. With the dunce cap in the left corner is the XLF, which is just plain awful looking. (Will somebody please give Barney Frank and the Senate Banking Committee a good cattle prodding to get their act together?)

Distinct divergence between daily and weekly signals on the VIX and the T2100 (advance/decline line), so next week should be interesting.

With all 4 of the ETF basket coming off extremely oversold RSI2 bottoms or double bottoms, the odds favor a surge for at least a few days, although a couple good pops could easily swing things back into the overbought range. Most of the BZB Dirty Dozen support/resistance systems are on BUY signals, but based on current momentum many also look to be quickly approaching a neutral stance.

Butterfly Update:

The XLE Jan 47 butterfly played out perfectly and based on the current LR30 channel, I'm inclined to do it again. More than likely I'll wait till next Wednesday to see out the long weekend effects the markets before jumping in. With the plethora of bad news streaming out, the odds don't favor a trend change at this time (IMHO), but stranger things have happened and if the Gaza situation gets resolved (unlikely), or if some of the majors give guidance higher (unlikely), then I'll look to close some of my neutral positions such as the XLP butterfly which is still right on the money, as is the XLU butterfly.

RSI 2 Breakout system

With all the buzz about the RSI2 lately (too many links to post), I thought I'd explore the trading opportunities when the RSI2 breaks out of an oversold or overbought range, as defined by a moving average. One of the problems with the RSI2 is that oversold or overbought conditions, as measured by the RSI2 can continue for some time, thereby frustrating traders who jump the gun with their entries. In previously profiled systems like the Grand Slam series (see BZB Dirty Dozen systems on the right panel of the blog) we used the "cross above" and "cross below" signals to trigger the trades. . .with respectable results. This system is a bit different in that it uses a moving average of the RSI2 indicator as a baseline and then looks for crosses above and below that MA line to trigger the trades. While not wildly successful, the results are certainly encouraging of further work in this direction and when added to the larger Kit of Parts systems, including the KOP10 and KOP16, to provide a nice confirmation.

TS 2000i is shown below.

Blogger, of course, won't let me post the open code because of the symbols so, as usual, the open code is posted as a comment for those who wish to cut and paste into their own platform.

The Earnings Game

With earnings season ramping up I thought it would be timely to profile several free earnings reporting sites that might help scalpers shave off a few bucks.

First up. . . Zack's The site highlights earnings surprises, up and down, along with a full menu of earnings summaries and a reporting calendar. Big surprises in the direction of the open can produce some quick returns. They also have a service called Surprise Trader for swing traders with a money back guarantee that's worth a look.

Next is RTT News This site profiles positive and negative pre-announcements along with an earnings calendar and a full report of latest earnings. This is interesting opportunity to trade the rumor and those that bought HMSY and MDAS at yesterday's open and then closed the trades at the first 3 bar parabolics reversal put some quick change in their pockets. If scalping appeals to your trading mind and risk comfort level, this is a fertile site for some quick gains.

Finally, hands down, the best non-technical blog of all time (IMHO) Between the Hedges To even begin a half way fair analysis of this site would require more time than I have. Bottom line, just link over there and delve in. Live upgrades, downgrades, market snapshots, momo stocks, charts, news, performance stats, links to magazines and newspapers around the world (how about the Times of India or the Brazil Post?), video news and more, much more. If you started reading the new material in this blog at 6 in the morning, there's virtually no way you could finish it all by 6 at night, so you've got to be a bit selective about your focus here. A real treasure trove.

This is a late post addition, but deserves a close read. Bepsoke, a site I have mentioned many times before, produced a series earnings season posts on Jan 13th. Scroll down on the Besoke link to catch 'em all.

XLF A Year Later

Back on Feb27, 2008 I profiled the XLF financial sector Spyder. This was the makeup back then:

Below is the current makeup of the XLF. As you can see, there's been a bit of re-alignment in the portfolio with JPM and WFC carrying more of the load. This adjustment makes a lot of sense when you review a recent study by Bespoke which examined the 5-year CDS (credit default swap) prices of various financial companies. Wish I could just post the chart for comparison purposes, but that would be rude to Bespoke, a great site for enquiring market minds. The bottom line is that, based on Bespoke's study of US firms, MS, GS, AXP, UBS and C are at the highest risk of defaut and JPM, WFC and BAC are the lowest.

Now, if you watched Larry Williams' presentation on the I-Trade link I provided last week you know that Larry might consider this a marginal buy candidate based on the level of the open interest. This argument is supported somewhat by the recent short interest chart, although keep in mind the last date charted here is 12-15-2008, so we're a little behind the curve.

With the RSI2 clearly at oversold levels, selling the Feb 10 puts will put $.64 in your pocket, leaving you with the ETF at $9.36 if things get really nasty. Just something to consider. A buy/write on the Feb 11s will yield $.98.

More on the Put Write

Last week I mentioned the Put/Write strategy in lieu of a Buy/Write approach. While I can't claim that the post stimulated a lot of interest, several other bloggers have run with ball, including Bill Luby, who has some excellent links on the topic. One of Bill's commentators notes that there actually is a Put/Write ETF . . . ETJ, which suffered a major drawdown in October, but which now is solidly out performing much of the market.
I also noted with some amusement that the February issue of Active Trader Magazine (sorry, you've got to pay for this one) has a feature article by Steve Papale on the merits of selling puts/versus covered calls.

Weekly Update

Bob Dylan said "You don't need a weather man to tell which way the wind blows" and the 4 ETF basket study of the 3LRs suggests we've got more of the same to go. Although the RSI2 (the indicator Larry Connors calls the "holy grail") is fast approaching oversold levels, the MACD and the stochastics argue for a continued slide. So much for a "Kiss the channel goodbye", the Qs and IWM have retreated back to the LR30 mean and XLF, showing the greatest weakness of the 4, looks headed for the lower support channel band at 11.00.

The VIX rose almost 10% for the week to close at 42.82 and both the daily and weekly LR30 studies support a continued rise. Although my target of 60 looks a little unlikely, a 50-55 level certainly seems doable if things get agoing to the downside. Earnings season kicks off next week and, like a good game of liars poker, expect in inordinate amount of head fakes and countervailing trading, which should translate into a hike in the volatility.

T2100 (advance decline line) is following suit with the 4 ETF basket and adds credence to the argument for the downside.