Profiting in Today's Dangerous Markets

 

 

The markets have never been so dangerous. If you’ve been invested in the S&P500 over the past five years you’re down by 31.5%. The classic investing for your future using buy and hold is dead. If you want to make your investments grow with less risk, you need to develop mechanical trading strategies and back test them over time. Do not invest all your money in one strategy, use multiple strategies to trade the same markets and spread the risk. This way if one strategy is in a drawdown another might be making profits.

 

In the past if you wanted to be able to profit from both sides of the market you needed to trade futures. ETFs have now grown up and you can profit from both sides of the market. You could use the same type of system you use to trade the S&P500 futures with a holding period of 4 to 10 days and trade using ETFs or Mutual Funds.

 

In the case of the S&P500, SPY has been around since 1993 while SH has been around since September 2006. SH is negatively correlated to the S&P500. We can also use the Rydex Mutual Funds to trade the S&P500 from both sides. ETFs and mutual funds exist to trade the NASDAQ, DOW and Russell from both sides of the market. You can also trade Long Bonds from both sides of the market. In addition you can trade crude or even Gold both long and short.

 

Let's look at a classic S&P500 system on Futures. We’ll use our classic inter-market divergence model. Let's briefly review this concept.

 

In John Murphy's first book, published in 1991 on inter-market analysis he used the crash of 1987 to lay out his inter-market hypothesis. The problem was that until I had built and published the inter-market based trading systems in 1994; no one had yet confirmed his work in a public forum. Many institutional traders used the concepts, but the rules of the mechanical trading systems which used the inter-market analysis, were not generally publicly available.

 

I had developed a very simple concept for inter-market based systems as follows:

 

For positively correlated markets

 

 

You can use various concepts to define an up and down trend. In most of my work I used the price relative to a moving average.

 

For negatively correlated markets we have as follows:

 

 

One of the classic relationships which I originally built mechanical systems on way back in 1994 was the relationship between the S&P500 and long bond futures. S&P500 and long bond futures are positively correlated so we’ll use the positive correlated inter-market divergence model. The rules for our simple S&P500 trading system are written in TradersStudio^®:

 

TrLen = 10

IntLen = 10

 

Sub SPBondSystemFutures(TrLen,IntLen)

 

Dim TrOsc As BarArray

Dim IntOsc As BarArray

 

TrOsc = Close – (Average(Close,TrLen,0))

IntOsc = Close Of independent1 – (Average(Close Of independent1,IntLen,0))

 

If ((TrOsc < 0) And (IntOsc > 0)) Then Buy("LE",1,0,Market,Day)

 

If ((TrOsc > 0) And (IntOsc < 0)) Then Sell("SE",1,0,Market,Day)

 

End Sub

 

We’re using Pinnacle^® data, US symbol for bonds, which is the 24 hour composite market including electronic and the S&P500 pit contract. We are also using $250.00 per point for the whole period and no deduction for slippage and commission, so we can see the bias produced by the system.

 

 

 

Performance Summary: All Trades

Dates: 01/29/1993 to 03/17/2009:

 

 

Let us look at the Yearly Breakdown Results:

 

 

You can see that overall we’ve made over 280 points in 2008, if we just bought the S&P500 on Jan. 1 and held to the end of the year 2008 we would have lost about 560 points. This means we out performed the S&P500 by 840 points!

 

We’ll use ETFs data from CSI^® using a split adjusted, unadjusted and dividend only adjusted data streams. This is called a TradersStudio Stock Session. TradersStudio handles splits and dividends; it will even handle paying dividends on a stock or ETF, if you are short.

 

Now we can create a system from this to trade ETF’s. We’ll show an example of the ETFs bull system modifications as follows:

 

Sub SPYBondSysBull(TrLen,IntLen)

 

Dim TrOsc As BarArray

Dim IntOsc As BarArray

 

TrOsc = Close of independent1 – (Average(Close of independent1,TrLen,0))

IntOsc = Close Of independent2 – (Average(Close Of independent2,IntLen,0))

 

If TrOsc < 0 And IntOsc > 0 Then Buy("LE",1,0,Market,Day)

 

If TrOsc > 0 And IntOsc < 0 Then exitlong("SE","LE",1,0,Market,Day)

 

End Sub

 

This system has the same logic as our futures system except that we replaced the sell condition with “exitlong”. We’ll set this system up with SPY ETFs and this is what we are trading. We also made SPY the main (mom series) which are trading but we don’t use it in the rules, signals are generated off of the S&P500 futures and thirty year bonds.

 

 

FUND OBJECTIVE

 

The SPDR S&P500 ETF is a fund; which before expenses generally corresponds to the price and yield performance of the S&P500 Index. Its symbol is SPY and it is marginal as well as shortable. But there is no need to short this ETF because, as we will see later, we now have a negatively correlated ETF also.

 

Our approach is designed to provide portfolios with low portfolio turnover, accurate tracking, and lower costs. Ordinary brokerage commissions may apply.

 

Let us look at our results on SPY using this system. SPY started in 1993. We’ll deduct 0.01 per share for commissions and 0.01 for slippage.

 

We’ll show our results on a 1 share basis.

 

 

You can see that we made slightly less than double the buy and hold during this period just by trading from the long side only. TradersStudio stock format also allows us to see the effects of dividends and as you can see that we made $12.14 per share in dividends during this period.

 

Let us now look at profiting from the short side of the market. We’ll use the short ETF fund also called symbol SH. This fund seeks to return the inverse of the S&P500. This fund is on of the ProShare family of funds and started in June, 2006.

 

Let’s use this fund for our analysis. Our short ETF S&P500 system is as follows:

 

Sub SPYBondSysBear(TrLen,IntLen)

 

Dim TrOsc As BarArray

Dim IntOsc As BarArray

 

TrOsc = Close Of independent1 – (Average(Close Of independent1,TrLen,0))

IntOsc = Close Of independent2 – (Average(Close Of independent2,IntLen,0))

 

If ((TrOsc) < 0) And (IntOsc > 0)) Then exitlong("LE","SE",1,0,Market,Day)

 

If ((TrOsc > 0) And (IntOsc < 0)) Then Buy("SE",1,0,Market,Day)

 

End Sub

We made two logical changes to create a short system, first is that Sell becomes a Buy, and Exitshort becomes ExitLong.

Once again we will use the following:

 

TrLen = 10

IntLen = 10

Slippage = 0.01

Commissions = 0.01.

 

Our results are as follows from 6/21/2006 to 3/17/2008

 

Performance Summary: All Trades

 

 

During this period we produced a profit of $37.98 on a single share of SH. Our first trade occurred on 09/25/2007 at 67.37. The market during this period did not do well, sell and hold would have made $31.87. We outperformed the short side during the period when we’ve had the biggest bear markets of all time. When we combine these results for both the long and short side our results are very impressive.

 

Let’s look at the following strategy. We’ll start with $100,000 on 06/21/2006. We’ll either have all of our money in:

a)       SPY if the long strategy is in the market or

b)       SH if the short is in the market.

 

These systems are designed so they can’t be in the market at the same time. During a period when the S&P500 from 06/21/2006 to the close of 03/18/2009, the S&P500 was down 35.56% so your $100,000 investment would become $64,440. During this same time our basic strategy turned your $100,000 into $149,632.96. You can see that during this same period as follows:

 

Period	Trades	Winning Trades	Win%	Open Trade	Net Profit	Return %	Running %
2006	9	6	66.67%	1	$6,007.19	6.01%	6.01%
2007	26	19	73.08%	1	$19,308.17	18.21%	24.22%
2008	29	23	79.31%	1	$36,318.10	28.98%	53.20%
2009	4	3	75.00%	1	($12,000.50)	(7.42%)	45.78%
Total	68	51			$49,632.96

 

You can also see that during 2008, which was a very bad year for the market, you made 28.98%.

 

This article is a starting point for developing ETF based trading strategies. So  when the many new ETFs historical data period increases, more of the many new ETFs will become tradable, without basing the system on Trading Futures.

 

Our analysis showed a very simple system. If you use a better S&P500 system like our S&P500 Market Insider, available at www.TradersStudio.com you can get even better results. In today’s markets you need to develop well tested scientific strategies to be profitable. TradersStudio is the perfect tool to develop a diverse portfolio of ETF strategies.

 

 

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Hypothetical Disclaimer

Notice: Hypothetical performance results have many inherent limitations, some of which are described below.  No representation is being made that any account will or is likely to achieve profits or losses similar to those shown.  In fact, there are frequently sharp differences between hypothetical performance results and the actual results subsequently achieved by any particular trading program.  One of the limitations of hypothetical performance results is that they are generally prepared with the benefit of hindsight.  In addition, hypothetical trading does not involve financial risk, and no hypothetical trading record can completely account for the impact of financial risk in actual trading.  For example, the ability to withstand losses or to adhere to a particular trading program in spite of trading losses are material points which can also adversely affect actual trading results.  There are numerous other factors related to the markets in general or to the implementation of any specific trading program which cannot be fully accounted for in the preparation of hypothetical results and all of which can adversely affect actual trading results.