THE MEAN TRADE

Of course, we would all like to be able to buy the low and sell the high of every move, but this is a reality that can only be realized when practiced in hindsight. In real-time there are very few traders that can pull this feat off with any kind of real consistency. To catch the beginning of a trend implies that we must either anticipate price exhaustion and the subsequent reversal of the previous trend, or anticipate and catch the breakout from a trading range. What makes this task so complicated and frustrating is that there are so many false reversals and false breakouts.

In practice then, catching the beginning of a trend may not really be the optimal entry. If you are going dance with the market, you want the market to lead. So it is often best to wait for buyers/sellers to make their move and show their hand before you enter the market. That doesn't mean you chase highs and lows; rather you buy/sell the first pullback from an initial push as your entry. Of course, you always buy weakness in a strong market, and sell strength in a weak market. If you're patient and wait for after the initial thrust that kicks off a trending move, you have a natural stop loss point: if market participants are truly rejecting price at the start of that move, you shouldn't see that price again.The key to making this execution approach work, is being patient enough when you're a buyer to let sellers "take their turn", and when you're a seller to have the patience to wait out the buyers' next bounce. You want to see those sellers and buyers get trapped on the next leg of the trend so their exits will help your position.

Unfortunately though, markets are in a trading range 80% of the time, which means that markets are trending only 20% of the time or approximately 4 days a month. Markets like the ES and ZB which are heavily arbed and dominated by HFTs and algorithmic trading, are often lacking volatility, and are choppy and directionless. This has proven to be a major challenge for short term traders, who often find themselves faked out on seeming moves that reverse. It would make sense then, that following a momentum based strategy as the mainstay of your methodology would not be optimal. It would seem that not only including, but concentrating on a strategy that offered you the opportunity to capitalize on current market conditions would be economically prudent.

The general idea is to find points in the market in which bulls or bears are trapped. They have committed to positions, but can no longer move the market their way, and the market has become over-extended. They then have to exit out of their positions and the market reverses which provides a trading opportunity. Because traders often presume that breakouts will continue in their direction without actively planning for the possibility of retracement, we should take advantage of this dynamic and actively build a scenario for a possible reversion trade.

As a rule traders are drawn to movement and momentum. They like to trade breakouts from ranges, and they like to see clear signs of strength or weakness before they buy or sell. A lot of the passive algorithms are programmed to take advantage of these tendencies by selling the new highs and buying the new lows. Now consider that there are thousands of these programs on thousands of computers, and each one is programmed to work offers at X period highs and work bids at X period lows--and if you imagine X as scalable across all time frames, then you can get a sense for what drives markets over the short time frame when directional, institutional traders are not active. Small wonder why the markets rarely trend, and are often range bound instead!

The predominant benchmark for AT is the VWAP or volume weighted average price. The VWAP is simply the average price of a security traded over a period of time. It is essentially a tool for investors that want to be passive in their execution, and are seeking the average price based on volume, i.e., a guaranteed VWAP execution. The implementation of the VWAP was in response to the decimalization of the market and the proliferation of algorithmic trading that resulted from this change, and became popular as a way to reduce transaction costs and the impact of large institutional orders on the market.

Knowing where we are trading during the day relative to that day's VWAP is very helpful in identifying the kind of day that we're in. The VWAP can be thought of as the market's evolving estimate of value. In a weak trending or non-trending market, we will tend to move away from VWAP to probe trader/investor interest. If that interest is lacking, we will tend to gravitate back toward that VWAP value level. In weak trending markets, you want to be fading moves away from VWAP. In a good range trade, we'll tend to see a narrow value area (volume will be transacted within a narrow price band) and moves away from value will tend to return back to (and usually through) VWAP. In a true range trade, we'll also see little slope to VWAP, as we transact volume relatively evenly above and below that average price. We can take advantage of this tendency for the market to move 1, 2, or 3 standard deviations away from the VWAP and then revert back to the mean, by fading the moves away from the VWAP and covering the trades when they return back to the VWAP.

MARKET ANALYSIS & COMMENTARY

WEDNESDAY - APRIL 6, 2011 -  MARKET ANALYSIS & COMMENTARY

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ES came within 2 ticks of reaching the 1337.00 target that I had been looking for since last Friday, and as anticipated, sold off early in the day filling the day gap to the tick at yesterday’s low of 1327.00. The market then staged a 7 point afternoon rally which tested the low of the opening range, only to sell off after the end of the cash trade to close in the lower half of the day’s range. Bonds were destroyed, as was the bearish sentiment in equities that I highlighted last night. In the latest Investor’s Intelligence survey, bears declined by 32% from 23.1% to 15.7%. As was mentioned in the Bespoke article, "Going back to 1975, there have now been just 16 other periods where bearish sentiment declined by more than 30% in a single week." The chart below illustrates the S&P’s performance following these large drops in bearish sentiment the past 11 times they occurred. The average performance over a 1-10 week period was -0.92% to -2.07%. I have also included a chart of the market leading TF to demonstrate a confluence of Fibonacci levels at the 860.00 level. Along with the 61.80 Fib extension that is shown in the chart, is an even more important 1.27 Fib extension, from the January lows to the February highs to the March lows, that comes in at 860.00 also. However, in direct opposition to the possible-market-top theory, is a chart of the 6J that shows a dramatically falling yen, which should insure the yen-carry-trade remains strong and further funding for the U.S. equities rally will continue. That being said, earnings season begins next week and it is still very early in the month of what is a seasonally bullish month. Therefore, there is still plenty of time for the bulls to assert their dominance. If indeed, this is not the top, then based on today’s price action I would expect a quick flush of the weak longs down to at least the weekly pivot @1320.00 if not all the way down to the low 1300’s, followed by an immediate bull reversal. 1300.00 should be the last line of defense for the bulls.

Justice Will Prevail !

Above consensus payroll numbers extended gains in equities as hope continued to spring eternal on Opening Day. Although, it was the first day of what is traditionally, a month associated with bullish seasonality, there is cause for concern that Mr. Market may be pulling an April Fool's joke on all the bulls. The rally continues to be on waning volume and flat open interest, while the bond market appears to be pricing in an end to QE2, as the yield curve continues to flatten in expectation of the Fed’s need to control inflation.

An end to QE2 followed by a Fed tightening would raise short term rates and as inflation concerns abated, long term rates would fall, flattening the curve even more. While we have only one marker to compare where the Fed cut back on quantitative easing, the results are not confidence inspiring for the bulls. Post QE1, the S&P dropped from 1217 down to 1064, and commodities and crude were also hit hard, while rates rose. Is the economy strong enough this time around, to continue it’s “growth” without stimulus? Or does the Fed, extend the easing cycle with QE3 and we see $150.00 crude and $5+ gas at the pumps this Summer? I'm betting on the former, which is going to make me ever so vigilant of the possibility, that this April's market could be a contra-seasonal one. 

That being said, QE2 may end in June, but the Fed’s near ZIRP may continue ad infinitum, or at least until inflation is actually the result of income growth and economic growth instead of monetary policy. In the meantime, equities are still a better place to be than cash, and the real momentum chasing may still be forthcoming in April. If the powers-that-be can manipulate an entire market, and engineer one of the greatest bull market rallies of all time, during a time when the economic fundamentals have been absolutely horrid, and global headline news is about one disaster after another, then yes, they just might be able to perpetuate the current asset inflation a little while longer. 

Nevertheless, Keynesian money printing/credit creation has been substituted for actual wealth creation, once again. And just like before, it has led led to massive debt across private and public sectors, as nominal income not only remains flat, but in real terms is contracting at a 2.3% annual rate. True, corporate profits are up and are close to all-time highs as a percentage of GDP, but this does not necessarily reflect a robust economic recovery. Strong control over the balance sheet and cheap labor costs due to wage concessions and layoffs, has resulted in lower unit labor costs and higher productivity. While there has been an extraordinary recovery in corporate profits, top line growth has not been spectacular, and bottom line growth has not led to job creation.

When QE2 ends, and the business cycle returns to normal, logic dictates that profits will revert back to their mean, leaving nowhere for valuations to go, but down. The Fed can only use the “forward looking” rationale for so long, before the laws of supply and demand catch up, and mete out economic justice, once again.

CYRX - Ready To Rally!

Cryoport ( CYRX:OTCBB) appears to be poised to rally above $2.00 after having tested and held the 50 EMA on the daily chart @$1.25, and then rallying to close even on the day, but under the 20 EMA. A close above the 38.20% Fibonacci extension and intermediate term double-top @$1.55, would confirm the up move, which would carry with it a minimum measuring implication of $2.05

Seeking Additional Capital

Objective

Additional capital is sought by a seasoned trader to fund the scaling-up of existing strategies.

Experience

1976-1979  Equity Member/Floor Trader - Chicago Mercantile Exchange - Traded Livestock and Currency Futures 

1979-1982  Member/Floor Trader - Chicago Board Of Trade - Traded Soybean Futures

1982-2006  Equity Member/Floor Trader - Chicago Board of Trade - 30 Year Treasury Bond Futures - Traded front month bonds, calendar spreads, yield curve spreads and options on futures

2006- 2010  Private Equity Investor - Actively invested, sourced and managed a diversified portfolio of Private Equity investments.

Capital Markets Consultant - Wifi Wireless Inc., Aliso Viejo, CA - InterOcean Financial Group LLC, Chicago, IL

Licenses - Series 55, 63 & 7

2010- Present  Researched, developed, and implemented proprietary tools and short term indicators for trend following and mean reversion methodologies. Developed scalable intraday strategies, using micro structure analysis; including order flow, tick data, and various correlations, to identify short term mispricings and broader systematic price behavior. Trading emphasis on E-Mini S&P Index Futures and 10YR-30YR Yield Curve Spread (NOB-U.S. Treasury Futures).

Best Practice

The trader utilizes a multidisciplinary approach, implementing technical and macro economic analysis, with a risk averse initiative and disciplined money management philosophy. A top down approach to trading monitors the inter-market relationships between equities, bonds, currencies, and commodities and provides a framework for robust strategies with high positive expectancy. Technical and quantitative analysis fitted to current price drivers, generate relevant trades, while  risk is actively managed through the use of a volatility based position sizing model.

Performance 

P&L reflects the efficient use of capital with minimal volatility and deviation from the mean while following an upward trajectory year-over-year. Audited track record of past trading performance and profitability.

 Risk Model

 R (Stops) - 2 ATR 

 Gain Objective - 1.5-3.00 R-Multiple per trade   5% equity per 100 trades

 Optimal Risk (% Equity)  1%

  Adds -3 Max.

   Min. Distance - 1 ATR

  Quantity - .38% Descending Pyramid (13-8-5-3)
  Portfolio Size - 2 Instruments max. (negatively correlated)

 Max. Daily Ruin - 3%

Contact: gapcap1@gmail.com

MONEY MANAGEMENT

Money management is not only about where you place your stop in an effort to control your risk, but it also about the size of your position relative to the amount of capital you are trading, along with expectancy. At all times, given the risk you are taking, your account size, and the volatility of the market,  you must know the optimal number of contracts to be long or short.

A position sizing model  tells you ‘how big’ of a position to take, and can help determine where to place your stop. Improperly placed stops, whether they are fixed price-based stops, or trailing stops, will not only limit your risk, but will also limit your opportunity and thereby seriously degrade your performance.

Expectancy is the average amount you can expect to make (or lose) per dollar at risk. The key to expectancy is not only how you enter the trade, but how you exit it. Accuracy means having the patience to wait for good entries, and execution means having the ability to identify highly profitable opportunities and then take maximum advantage of them. How much and how often you add to a profitable trade, how long you are in the trade, and where you get out of a losing trade , is key to increasing profitability while controlling risk.

Proper money management optimizes the use of your capital. Risking too little doesn't give the market the opportunity to allow your profitable trade to take place and grow, and risking too much will quickly blow up your account. Most traders make the mistake of taking a reactive view of risk, in which their overriding concern is avoiding losses and protecting small profits,  in lieu of a more aggressive management of risk which would result in a more efficient use of capital.

NYSE $TICK and NYSE $ADD

TICK - First Panel

The NYSE TICK tells us how many stocks are trading at their offer price minus those trading at their bid. It is now available on NT with a live Kinetick feed, and goes under the symbol ^TICK.

It is a great measure of very short-term sentiment, because it captures the degree to which the broad market reflects aggressiveness of bulls (lifting offers) vs. bears (hitting bids). A 10-13 period moving average of the NYSE TICK removes much of the noise from the one-minute values. In the attached chart of Friday’s trading, a few things stand out:

1)You can often identify strong days to the upside and downside when the first hour's TICK is persistently positive or negative. This means we have skewed sentiment, with stocks aggressively trading on upticks or downticks. When TICK MA pullbacks can't even go into positive or negative territory you know that the sentiment is quite negative or positive. That's a hallmark of a trending day.

2) You can see the 13 MA of TICK is spending more time below the zero line, which tells us that the Cumulative TICK is running negative. The possibility of a trend day is evident because we're persistently below the zero line in the TICK MA. The moving average of TICK also helps us identify intraday turns in sentiment and trend, when markets shift from primarily above/below zero to primarily below/above. Non-trending markets will generally spend more balanced time above and below the zero level.

3) In a weak market, pullbacks in the 13 MA of TICK are often good short-term entry points. Notice that each time the 13MA (blue line) pulled back to the zero line it created a perfect selling opportunity. Even in a market that is about to change direction, we'll often get a retest of previous highs/lows after one of these TICK pullbacks/bounces, making it much easier to scratch trades.

Also note the distribution of TICK values over time. In the attached chart, we see the first hour of trade for Friday’s market. The center green horizontal line is placed at zero, and the blue horizontal lines are a 4 standard deviation regression channel. Notice that the bars are distributed more below the zero line and that the extreme bullish TICK readings peak at 600, while the extreme bearish readings peak at the -800 level. Clearly, the net distribution of TICK is skewed negatively, and we're seeing more bouts of significant selling than buying.

On average, the one-minute high value for TICK is around +250 and the average one-minute low value is around -250. The standard deviation is approximately 450. That means that two-thirds of all TICK values will fall between +700 and -700. About 95% of all TICK values will fall between +1040 and -1040, making values greater than +1000 or less than -1000 the exception.

Please note that while we are looking at a single days picture of the TICK, it's readings has implications several days out. Very positive trader sentiment over a several day period tends to generate strength over the next several days, and very negative sentiment tends to lead to reversals.

ADD - Second Panel

A very effective tool for identifying trend environments vs. range ones is the intraday NYSE advance-decline line. It tracks the difference between advancing and declining stocks on an intraday basis; and is now available on NT with a live Kinetick feed, and goes under the symbol ^ADD

Friday’s ADD opened flat and was -530 in the first 15 minutes, it then pulled back to the zero line and failed and was - 1570 within a relatively short period of time. In Friday's case we had the ES break below it's opening range, accompanied by a rapidly falling ADD, which signaled a possible trend day down.

The opening value for $ADD correlates with the value at the end of the first half hour of trade by .56. The median opening value for $ADD has been -1, with a standard deviation of 81. So when we see $ADD open at +150 or greater or at -150 or less, it is an indication that we might be in a trend day. By the end of the first half hour of trade, the median value for $ADD has been -346, with a standard deviation of 1378. So, within the first 30 minutes of trading, we should have a pretty good idea of what kind of trading day is ahead of us. If we're seeing $ADD with readings of +1500 or more or -1500 or more (negative), then there is a high probability of a trend day.