InVivo.Stops for TradeStation 8.x OR eSignal 10

Teresa, October 31, 2007 @ 12:00AM ET | Link | RSS | Read via Email | Start a Discussion  

Stops cannot be eyeballed. A trader that places stops arbitrarily or uses stops calculated incorrectly is destined to always exit too early and miss the home run, or exit too late after a change of trend.

Many systematic traders spend the majority of their time searching for good places to initiate. It just seems to be part of human nature to focus on the most hopeful point of the trading cycle. Our research indicated that liquidations are vastly more important than initiations. If you initiate purely randomly, you do surprisingly well with a good liquidation criterion. — William Eckhardt

Stops can be used in two ways:

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They establish the appropriate price to exit a trade.

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They can also establish the appropriate price to enter a trade.

InVivoStops Provide The Definitive Edge

If you make a bad trade and you have money management you are really not in much trouble. However, if you miss a good trade there is nowhere to turn. If you miss good trades with any regularity you’re finished. — William Eckhardt

Stops must be placed strategically, yet nearly all commercially available stops have serious flaws.

In Engineering Better Bollinger Bands and Thoughts on the Kase Dev-Stop, I demonstrated that InVivo.Stops accurately reflect volatility and range. This is a must, because we never, ever place stops based on what we can afford to lose. Stops must be placed where they ought to be, and we reduce our trading size as required to manage risk to the account. This is our definitive edge.

Used alone, InVivo.Stops is known as a stop and reverse system, that is, it is always in the market long or short. In practice, traders require additional conditions (such as a time filter, trend filter, a moving average filter, etc.) and impose restrictions to qualify trades. In addition, they must also decide on the amount of leverage to use and calculate the position size based on the foregoing.

There may be many moving parts, but make no mistake, the stop is the backbone of any trading system or method. In fact, InVivo.Stops is the heart of InVivo.System for TradeStation.

Using InVivo.Stops

InVivo stops are engineered to reflect actual volatility and range, providing users with a real edge over other so-called volatility-based indicators or bands.

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Use InVivo.Stops according to the following two rules:

While the math behind InVivo.Stops is complex, using this indicator is easy as 1-2-3. InVivo stops shows you the exactly where your stop is at all times. The stops can also be used to buy and sell options, particularly our “Plan B” bull call or bear put spreads.

Lifetime License for TradeStation 8.x (or eSignal 10)

InVivo.Stops for TradeStation** is a must-have for any trader. This indicator can be applied to tick, volume, intraday and daily charts. It is available for individual traders only for a donation appropriate for your personal situation.

**Requires a valid subscription to the TradeStation platform. TradeStation is now FREE for most active traders!

Engineering Better Bollinger Bands

Teresa, October 14, 2007 @ 5:18AM ET | Link | RSS | Read via Email | Start a Discussion  

Pete asked me what I thought about “Sigma Channels” by Hamzei Analytics. I had never heard of this indicator, but on first glance, it reminded me of Bollinger Bands. It didn’t take long to figure out that they were Bollinger Bands with two additional “standard deviations” plotted. [PDF]

BIDU Daily Chart with Bollinger Bands
The example used in their presentation was the daily chart of BIDU ending October 9, 2007. Here, I applied Bollinger Bands right out of the can in TradeStation 8. The indicator plots +/- 2 standard deviations of the closing prices from the last 20-bars around the 20-period moving average. You can see that the upper band, lower band and moving average all match those found on the chart from the Hamzei presentation.

BIDU Daily Chart with Hamzei Sigma Channels
In addition to the Bollinger defaults, Hamzei Sigma Channels also plots +/- 1 and +/- 3 standard deviation of price. Again, all values match the ones found on the chart from the Hamzei presentation.

BIDU with Hamzei Channel Width
Next up was the Hamzei Sigma Channel Width. The indicator subtracts the value of the lowest band from the value of the highest band and divides it by the value of the moving average. It is then converted to percent. In this case, $378.48 - $195.83 = $182.65/$287.15 = 0.6360787 * 100 = 63.60787%

The width of the band is 63.61% of the 20-day average closing price. What this implies is that 99.73002% of prices are expected to fall between $195.83 and $378.48. This type of information wouldn’t help me unless I was trading blindfolded. Or playing pin-the-tail-on-the-donkey.

OBSERVATIONS AND COMMENTS
Bollinger Bands and Hamzei Sigma Channels suffer from the same type of flaws as the Kase Dev-stops. To repeat, there are obvious procedural problems in terms of how the numbers are handled. I could go into details, but it’s not my mission to fix other people’s products. Suffice to say that the numbers are wrong. Better yet, I will prove it.

Since volatility can be precisely determined only after the fact, the point of using indicators like these is presumably to provide the best estimate ex ante. This is good news for us, since we can directly compare historical volatility vs. Bollinger Bands a.k.a. Hamzei Sigma Channels. If the curves are not a good match, we have our answer.

Historical Volatility BIDU
This chart shows the actual historical volatility values. We use a 20-day window to match the moving average used in Bollinger Bands. Historical volatility is a standard indicator in TradeStation.

Hamzei Channel Width vs. Historical Volatility
The Hamzei Channel Width was compared to historical volatility. The shape of the curves are not even close.

WYNN
Let’s look at some others, starting with WYNN.

POT
POT

GLD
GLD

JAVA
JAVA

The test that we devised and conducted provides no evidence that Bollinger Bands (and Hamzei Sigma Channels) can estimate volatility with any level of confidence.

MAKING BETTER BANDS
I re-engineered the bands according to standard statistical principles. While I have no doubt that Paul Wilmott would cringe at my handiwork, the fact is that with just a little bit of elbow grease, we got quite a bit closer to The Promised Land.

Making Better Bands
First, we play with the data in an appropriate manner. Next, we cut up the deviations with no assumption of normal distribution. Using BIDU as an example, we could say after the close on October 9 that we expect BIDU to trade within a band between $304.88 and $354.00 the next day.

$354.00 - $304.88 = $49.12/$328.77 (October 9 close) = 0.1494053 * 100 = 14.94053%. This is a noticeable improvement over an estimate that amounts to $182.65/$328.77 = 0.555555 * 100 = 55.55555% of the October 9 closing price produced by Bollinger Bands or Hamzei Sigma Channels. People can trade options with this information.

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Next, we calculate the Better Band width and compare it historical volatility to see how the curves match up.

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Next up is WYNN.

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Then POT.

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GLD

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JAVA

That wasn’t so bad, was it?

SUPER DUPER BANDS
Next, I created bands using the stops in my trading system and plotted the band width vs. historical volatility. Modeling volatility is critical because in doing so, we can mark out where we expect price to be on the next bar. This allows us to place stops in a strategic place.

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BIDU

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WYNN

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POT

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GLD

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JAVA

My trading system’s volatility estimator is very close to the actual historical volatility. This is my edge.

RANGE EXPANSION AND CONTRACTION
To top it off, I made an indicator based on Better Bands that should be useful in deciding when to day-trade and when to position-trade. Let’s come back to the present day and look at some charts. A reading above zero indicates volatility expansion while a reading below zero indicates volatility contraction.

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BIDU

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WYNN

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POT

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GLD

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JAVA

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ES

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ER2

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NQ

This “expansion/contraction” indicator could be very useful as a first cut for a scanner. For example, contrary to what they say on TV, markets going straight up and straight down are typically not that volatile. A trending market is suitable for swing trades and gives the trader amazing opportunities to compound his money. Contrast this to a high-range, high-priced, volatile market where day-trading could be more appropriate, especially in terms of controlling risk.

But as far as traders’ practices are concerned, it still involves deformations of Black-Scholes, with possibly local volatility. In the end, in spite of the fact that all research teams have devoted a lot of effort to stochastic volatility and jumps, there is a striking divergence between the evolution of research groups and the non-evolution of traders as a whole. Probably because it is better to have a simple tool, and know the limits of its application, in order to adapt it to fit the market. — Bruno Dupire

If you wish to read more on modeling volatility, check out this interview with Bruno Dupire, the recipient of the 2006 “Cutting Edge Research” award from Wilmott magazine.

Expectancy, Performance and The “R” Word

Teresa, October 8, 2007 @ 8:10PM ET | Link | RSS | Read via Email | Start a Discussion  

I did an interview with Dave Mabe of Stocktickr a couple of weeks ago. Dave was kind enough to provide me with a tour of StockTickr. He’s done a great job and I think his trading journal service could be of use to a lot of traders.

The functionality that caught my eye was the ability to examine the overall stop placement strategy: are they too loose or too tight? And then I saw that they were in “R”.

R and “expectancy” go hand in hand. It is the brain child of Van Tharp. If you google this word, you see right away that there isn’t much written about it, mainly because in the world of probability and statistics, it is simply known as the “expected value”. [DOWNLOAD PDF]

In Chance, Aczel devotes 4 out of 160 pages to the expected value:

Let’s look at an example to show you what this means. Suppose someone offers you an investment that has a thirty percent chance of earning you one thousand dollars, a twenty percent chance of earning you two thousand dolloars, and a fifty percent chance of losing you four hundred dollars. How much is this investment worth? Asked in a different way, what do you expect to make on this investment? The answer is: 0.3 x 1,000 + 0.2 x 2,000 + 0.5 x (-400) = $500. This is not to mean that, on a one-time basis, you should do it — there is a fifty percent chance of losing four hundred dollars here. But long term, if you had the opportunity of making such an investment everyday, it would be worthwhile, since, on average, you make five hundred dollars every time.

Since I was already digging up information on the Kase Dev-stop and Bollinger Bands, I decided to do the same for R. [DOWNLOAD PDF] I completely agree that the trader ought to know the expect value of his trading strategy.

Once again, the problem is in the execution. And it all goes back to where the stop ought to be; that is, “R” must account for the natural range for whatever market and time-frame the trader operates in. “R” should never be calculated by dividing how much the trader can afford to lose by the number of contracts or shares traded.