Archive for February, 2011
You are capable of controlling your whipsaws to some degree by monitoring you position size and adjusting it accordingly. This is true whether you run a computerized system or are a discretionary trader.
As volatility increases for the contracts you are long or short, you’re likely to see your equity get whipped around more. That can be trying on your nerves. If you don’t have a friendly, neighborhood Trading Tribe ™ to go visit in order to uncover what those nervous feelings are trying to teach you and where you may be feeling them in your body, you can read a little about them here.
If you are a systems trader, you are likely to be long several commodities listed in the chart. The “% Change ATR” column represents what has happened to the 20-Day ATR since February 1 through the 28th. If you are fully-loaded with cotton or crude oil, for example, you may find that your account equity is getting whipped especially due to either of these contracts. What to do?
Cut the position down to better keep a lid on your daily change in equity. You can do this by hand or you can program it to take effect once the ATR has increased by a specific percentage.
Did you say daily equity ? Yes, if you are going to approach an allocator, they will almost certainly ask to see your daily equity run. If it’s more that 0.50% you are considered very aggressive. It’s not bad, but it’s not likely to help you get an allocation. When I speak about his in the Mentoring Program, eyes start popping out of people’s heads. Allocators don’t need you to drive volatility: they can get that on their own without you and your fees. Low vol is an asset to an allocator as much as your alpha and small drawdowns.
If you are a discretionary trader, you are likely trading around core positions or swing trading. Seeing gigantic swings in your equity might be what trading is all about for you. Just keep in mind that if you see a one or a two-range day in the direction of your liking, you can absolutely see a two to four-range day against you. I have had them happen to me. Use your protective stops all you want, but when you wake up and the contract is off 2 big numbers, there’s not much you can do. Your first loss is your best loss at that point.
Regardless of your approach to risk management (what everyone else calls trading), the result and the shape of your equity curve that you garner can be controlled to some degree if you learn to “prune your hedges” and keep a position size on that if it goes against you, can’t kill you.Read More
[The Trader Mentoring Program starts March 1.]
So now that the trade is on, let’s see how the market moves in the respective contracts affect your trading equity. Here’s a chart of the spread through Wednesday’s close courtesy of FutureSource.com.
Short May Cotton
Long December Cotton
You can see how the May and December contracts traded on their own in the calendar strip above. One was up, the other was down. In this case, both moved in a favorable direction as far as the spread is concerned, but it doesn’t always work out that way…so don’t get your hopes up that this happens all the time because it does not.
You can derive the same spread chart at FutureSource, which I advise you learn to do.
Go to “Get A Chart” and enter the following syntax where it says “Symbol or Contract.” Then click the green button “Get Chart.” (There’s a graph below that shows you what to put where.)
= (‘CT Z1′ – ‘CT K1′)
There are spaces between the contract symbol and the expiration months in the equation above.
CT = Cotton
Z1 = December 2011
K1 = May 2011
It should look like this:
The spread widened approximately 5 points (3.70 + 1.36) which equates to $2,500 per spread. The margin for the spread is $2,800. I wouldn’t get hung up on making the big gains. I would, however, focus on how much the margin and the volatility mean to your account. You get paid to manage your downside and play good defense.
I need to get writing. Apparently I have a book coming out.Read More
Yesterday we looked at the spread and how it cut volatility in an otherwise very strong directional market. The spread itself was flat when all the contracts were off about 7 points.
Today, we’ll look at how to trade that spread courtesy of my friends at Moore Research Center, Inc (MRCI).
Long Dec Cotton (CTZ1)
Short May Cotton (CTK1)
Jerry Toepke at MRCI has done some backtesting and showed that over the last 15 years, had you bought December and sold May, you would have made money in 14 of those years. This is a two month spread trade from February 22 and you take it off on April 22. It is saying that the chart I put up yesterday is at it’s narrowest seasonally, and it will widen.
Here’s a look at the chart:
(click for larger and clearer chart)
A few other salient points to make:
The worst drawdown per single spread was $2,090 back in 2005, which was the only losing year. This spread model has the unique characteristic of being accurate and having positive mathematical expectation. The average profit from this spread over the last 15 years has been $971 per spread.
Looking at the entry prices, it doesn’t seem to matter whether cotton was a carry-charge market or one that was in backwardation in order for this spread to be profitable.
You can see in the graph that the solid black line is the current market. This is the same chart I put up yesterday.
Keep in mind that you are not trading the direction of cotton, but the direction of the differences between the two contract months. This is a relative value trade.
Can you count how many way you can win if you need the spread to increase (widen) in order to be profitable?
Chart and data used with permission courtesy of Moore Research Center, Inc. (MRCI).
Trade futures and spreads at your own risk. You can lose money trading spreads. Although it’s never happened to me, both legs of the spread can go against you.Read More
(click for larger and clearer image)
Seems there was some selling pressure in cotton Friday. Anyone who was long may have seen extensive volatility hit their equity. Hopefully, you had a small position on or got stopped out before it hit bottom.
But all this talk about cotton at historical highs got me thinking that there is another way to trade cotton with decent upside, less volatility, lower drawdowns, and the ability to avoid limit moves.
(click for larger and clearer image)
The May-December cotton spread has trended nicely. It’s almost doubled since the beginning of the year. What happened to the spread on Friday during all the selling pressure? Nothing. If you look close to the above chart, you’ll see a small horizontal line. That’s the net difference in the spread based on Friday’s trading. Both May and December were off 7.00, so the spread was flat or unchanged.
I don’t trade spreads that involve the front month. Look out much further and you can hold these positions for weeks or months.
More on cotton spreads tomorrow.Read More