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Trading Index Futures - a million different ways

Undressing the market. How the game is played. Who the opposition are. How they play. How they behave. Most trading sites offer specialised trading tools, which are only a part answer. see siteworks.

origins of this research
Had been trading for a few years, when a young guy in the office next door showed an interest in the trading screens. One day, as he was watching with me, I formed the view the market was going up. As I reached for the phone to place a buy order he commented that he thought it was going down. I withheld my order and watched. And he was right. It took 3 weeks to discover what it was he saw that I didn't. At first he couldnt articulate it. Eventually it came. It just so happened he was a serious blackjack player. So began an introduction to the concept of probability and the significance of high value and low value activity.
see   probability   law of large numbers   pareto's 80-20 rule

the futures game

Futures is a game of probability. A zero sum game. For every winner there is an equal and opposite loser. To win, someone else must lose. If you lose, someone else wins at your expense. So understand the context in which the game is played, together with the concept of probability.

quote:- The empires of the futures are the empires of the minds - Winston Churchill

the trading environment and its context

Factors to take into account are:

• No single organisation dominates the US market. Perfect forces of supply and demand operate.
• The size of the Australian market is small by comparison
• Average total value of trading on the ASX is approximately $aud 5 billion per day
• Most Australian broking houses trade on their own account and are active every day.
• The 2 largest brokers can each mobilise $aud 3 billion on any one day.
• Any one of the largest brokers has the financial strength to ambush the market on any day.
• There are approximately 20 large institutions who actively trade, rather than just invest.
• Own-account brokers and institutions comprise 80% of the total volume on the ASX.
• Perfect forces of supply and demand do not operate in the Australian share market.
• Can the largest participant be active without leaving any trace of their activity.
• With the power to ambush the market why wouldnt a large broker do so if they can make money out of it.
• The aftermarket auction can move the ASX200 by up to 30 points in one hit at 1610pm.
• The aftermarket auction enables the big hitters to hide their hand. If they can, why wouldn't they.
• Australian based Hedge funds became part of the Australian landscape from January 2003

see aftermarket auction explained

 


the trading bunker

Until the end of the tech boom it was common for many of the large insurance companies to operate trading rooms. These trading rooms would contain 5 people, be isolated from one another, and have a float of $30 million to trade with. Five groups per organisation. At the end of each month the group which had performed the worst would be terminated. So the pressure was on to perform. They could trade any market any time. Just so long as they made money. It was ruthless and made for extreme volatility in the SPI. Most, but not all, of these trading bunkers have been disbanded. But it gives you some idea of what you are up against. As the saying goes dont stand in the way of a speeding train.

bunkers are back with a vengeance. 2004
It is understood that since hedge funds arrived, starting 2003, the trading bunker has returned. Same methods.

see application and power of group decision making



the termite effect       sharks, sheep, sheep dogs, termites.

In the Market Depth Section it is stated commercial SPI traders never show their hand. Large orders appearing in the queue are placed there for a reason. What reason?. Should there be a reason?. Ask the right question.

Assume the market is going up. When a large order appears in the queue above the market, one of three responses can occur. (a) The market reverses, (b) comes to a stand still, or (c) goes straight through it. Usually, the market will trade up to but not touch the order, bouncing off it and retracing slightly. Then it has another look. And another. It will oscillate for some time, through a range of 5 to 6 points. Assume 5 points for the purpose of this discussion. During the oscillation process particular care needs to be exercised, examining the size of orders 5 points below. That's where the sheep dogs work. Sheep dogs are medium sized orders large enough to hold the market up. If the sheep dogs appear then look for a REVERSAL, otherwise look for a BREAKOUT.

THE BREAKOUT. If it is going to go through it, once that moment arrives, 1 of 2 things can occur. (a) the order is nibbled away in small chunks like termites, or (b) the large sell order will be pulled out. Once the termites start they dont stop. However whether it is pulled out, or taken out by the termites, the market will continue on through. Until the termites get to work, the market will oscillate, and the sheep dogs will not appear. So what are the sharks doing. They will feed during the oscillation process. If the commercial bid ask count is positive for this time period, they are buying, and, the sheep dogs will not appear. The termites will appear, eventually, after the sharks have had their fill.

THE REVERSAL. If it is not going to go through it then the large order will (a) never be touched, or (b) will be taken out entirely in 1 hit. If it is taken out suddenly in 1 hit the market rarely continues on up more than 1 or 2 points. If it is going to reverse (because it is a genuine top) it is likely that medium sized orders will appear 5 points below to keep the sheep penned in while the sharks get their fill. So what are the sharks doing. They will feed during the oscillation process. If the commercial bid ask count is negative for this time period, they are selling, and the sheep dogs will appear, and, will then disappear, after the sharks have had their fill. If the sheep dogs appear, then, the termites won't. And the large order will either (a) stay there, and not get touched or (b) get taken out in 1 hit. It's a probable top.

I have differentiated between a single hit and a nibble process. The single hit can be 1or 2 large hits. CAUTION: with low incidence, 1 or 2 hits can occur and the market continue on up. For the market going down, all of the above behaviour is true in reverse. Apologies for sharks feeding on sheep but it's easier than goldfish in a swimming pool with a shark and no dogs. If you read the battle of the elephants, you will realise the sharks feed on one another. Some sharks are just bigger than others. If the large order is ever pulled out it is usually a sign the sharks have had their fill and the market is going up. NB: Sharks must keep moving or they die.

All of this is null and void on ambush days, when anything can happen.

the above is achieved by use of the following orders in operation
iceberg orders
skyscraper orders
electronic scaled orders
automatic order replenishment



elephants = big hitters = smart money = major players

The term elephants is used to represent size and identify a group. The footprints are the signature. When watching elephants, remember, ½ of them will eventually be wrong. The secret is to identify the dominant group. The term "smart money" has been avoided as it denotes only the winning group, ie the ½ who will be right, and not the ½ who will be wrong. Whereas both groups leave their signature.


can you see the elephants

The eye only sees what the mind is prepared to comprehend. Henri L Bergson

battle of the elephants
Trading is a battle of elephants. They can't hide. A war of accumulation and distribution. It can't be hidden. When elephants fight, the grass gets trampled. Commercial traders constitute 80% of the total volume of the SPI. Because futures is a zero sum game, 80% of the activity becomes a battle of elephants trying to defeat one another. The remaining 20% represent the small traders. Commercial traders are elephants. They cant hide. They leave their footprints behind. Because of the psychological nature of sight, if you are not looking for elephants, you wont see elephants, and you wont see the footprints. see counting elephants

following the footprints
When elephants roam, follow the footprints (can you see the wind). Large elephants leave large footprints, small ones leave small footprints. When the market is quiet they disguise their presence by trading in small lots. They tread lightly. When the market is active they trade in larger lots. They tread heavily.

recognise the footprints
A computer can recognise the shape of an elephant. It can't identify a shadow. see mechanical systems. It can't identify the cause of a footprint. Shape, size or depth. Human perception can. Back to the grey-box solution.

Price is not a measure of size. What can be used to measure size?. Logically, it's the contract size of each tick.

the dancing elephant

can you see the wind

Yes. If you know what to look for. You can see the signs. In competition sailing it is necessary to "see" the wind. Windvanes and telltales do not help when there is no wind. In calm conditions the sailor watches the surface of the water. Localised eddies of wind disturb and darken the surface area. As the wind moves, the disturbance, and dark shadow moves accross the water. As the wind subsides, the surface disturbance subsides and the shadow disappears. The skill is to read where the wind is, its direction, and move toward it. Sailors know you cant predict the wind. After moving to the area of most disturbance (maximising probability) the next gust often occurs in the location just vacated. Electronic devices cannot detect these phenomena. Windvanes and telltales are useful only when there is wind.

telltails - telltales

 

see the wind





 

electronic order replenishment
order splitting, order scaling

telltale  a tell-tail.

Scaled Orders. Just another tell-tail.
Some trading platforms feature scaled orders. An order of 100 is entered into the brokers system, but presented to the SFE system 10 lots at a time. As each block is done, it is electronically replenished, instantly, until the order is exhausted. Orders can be scaled so they are not evenly distributed. Observers can detect this activity by an order being hit and replaced at electronic speed. At the same price, repetitively. That's an alert a large order is being disguised. A high probability there are 3 orders being done at the same time. It can be seen if you look for it. Think this through from the perspective of an order of 300 split over 3 brokers. Why split it. Why scale it. Then put yourself on the other side. It's a game. Large scale "gaming tactics"

telltale

related topics
data fragmentation
game theory, theory of games
iceberg orders
 		 



can you see the gorilla

source - University of California, Santa Cruz and Monash University
If you focus your attention on a basketball game -- for example, on the number of times the white team possesses the ball -- you will be unlikely to notice the person in a gorilla-suit who walks across the court (Simons & Chabris, 1999). This is an example of what Mack and Rock (1998) call "inattention blindness" (IB).

Example of perception blindness, attention blindness and illusion see the gorilla puzzle in action


the accumulation effect

Granville, an economist, was one of the first modern day American technical analysts. In his book "New Strategy for daily market timing for maximum Profit" 1963, said "accumulation cannot be hidden". It shows up in volume.

Example: An institution wants to buy 500 contracts at 3900.
There are two options. (a) market order or (b) limit order. Internal broker-exchange rules prevent single large limit orders sitting in the queue. A market order could be executed at that price, only if there was an accumulation of smaller orders aggregating to 500 on the offer. Which doesnt happen. .. Its done this way .. Even a part order to buy 200 would not be placed at 3900 as this would immediately signal to the market that an institution is in the market, and sellers would immediately retreat and the institution would not get filled. A single order for 500, buy, or sell will never be "seen". To accumulate a large number of contracts at a particular price of say 3900, the executing broker would place a large sell order of 100 at 3901, another 100 at 3902, another 100 at 3903. They would then place a buy order of 10 at 3900, and a buy order of 20 at 3899. The presence of the large sell orders will induce traders to sell at 3900, ie below the 3 large sell orders sitting in the sell queue. As soon as the 10 buy at 3900 is done, it is immediately replaced by another order of 10, and again, and again until filled. The constant replacement of 10 on the bid at 3900 is obvious. Like feeding the chooks. As soon as the buy order is filled, the sell orders at 3901, 3902, and 3903, not surprisingly, disappear. When this happens you know where the market is about to go.

The mechanics of this are further explained in
broker splits, scaled orders, and electronic auto-replenishment. above
knock-for-knock off market orders also known as the "upstairs market".

the distribution effect

The reverse of the accumulation process. Done exactly the same way.




CSPA - ASX after market auction

The 1610 market. Closing Single Price Auction "CSPA".
1545pm is a critical time for the SPI. To appreciate this we must visit the physical market of the ASX. The ASX conducts an aftermarket auction at 1610 everyday. Periodically after-market auctions can move the ASX200 index up or down 10 points in one hit ie 11 pts 3Nov04. Not often but frequently enough. Back to the SPI. Interesting, each time a large move at 1610 occurs, it is preceded by a surge in the SPI starting about 1545pm. Be carefull of unexplained moves in the SPI between 1545 and 1600 that are not accompanied by a corresponding move in the ASX200 cash index. ie the premium or discount suddenly expands. It is highly probable the corresponding move will materialise at 1610pm. If one side of the market in any one of the top 10 stocks is particularly thin, the cash index can be moved significantly by an attack on the "thin" side of the market at 1610 at lower than normal cost. If it feels like, looks like, and smells like insider trading it probably is. If the move is against you get out. You wont win. It will get worse after 1610pm. attacking the thin side of the market

On the last trading day of a quarter the pre-open period prior to the CSPA is extended by 5 minutes to 1610 with the CSPA from 1610-1611. eight pages of explanation by ASX [ASX has removed this article] are required to explain the mathematics, without mention of its purpose. A basic business rule is the more complicated a scheme is, the more likely it will be abused. The cspa is a forum for large trades only, where king elephants wrap up the day. Why would a large order be any more successful at this time, a 5 minute window, than any other time of the day, unless, by pre-arrangement, there is certainty it will be met. It may be argued to post a large order during the normal session, and leave it sitting there would lead to a "disorderly market". Knowing the cspa is available enables large orders to be executed "elsewhere". Consequently the normal session is "thinner" that it would otherwise be. Which in turn creates the conditions conducive to an ambush. Hobson's choice. A disorderly market or an ambush.

It is understood (in broker circles) if one particular broker trades spi futures aggressively during the "cspa" pre-open, that particular broker will have been a heavy buyer/seller in the cash after market, with a flow on effect on the futures. see broker statistics data screen

Footnotes:

November 2005. The 1605 match was extended to 1615. Don't know why. No explanation.
March      2006. The 1615 match was reduced to 1610. Don't know why. No explanation.
NB: Periodically, at calendar quarter endings, for one day, the match can be extended out to 1620 hours.
NB: 2008 cspa auction now at 1610

The ASX200 (XJO) index works hard to achieve a range of 16+ points on any day. In ½ point increments.
On 3 November 2004 the ASX200 surged 11 points in one hit, at 1605, in the closing "cspa"
On 9 December 2004 the ASX200 rose 11 points in two hits at 1558. Whereas the SPI rose 13 points between 1550 and 1605. One broker was the only buyer. Both times. Same time, same broker, same action.
Intel travels faster than speed of light through paper walls. Arrives 10 minutes before leaving. Mental telepathy.

On Friday 30 May 2004 between 10:00am and 14:00pm the SPI rose 14 points. Between 14:00 and 15:45 it fell 15 points. The following week, the "market place" section of the AFR reported an email had circulated among brokers on that afternoon about the pending disposal of a $200 million portfolio. The sale took place at 16:05 in the after market auction. The cash index effect was only 4.40 points. The SPI recovered all its loss after 1610.

On 24 August 2005, the ASX200
Fell 2.5 points after the market closed at 16:00 on completion of the cspa
Then fell a further 8.9 points sometime after 16:30 and after the cspa

On 25 August 2005, the ASX200
Fell 3.6 points after the market closed at 16:00 on completion of the cspa
the cspa did not conclude until 16:20
Then fell a further 12.7 points sometime after 16:30 after (an extended) cspa
Most news reporting systems did not report the fall until 07:30 the next day, 26 August 2005

No explanations. No announcements. Un-reported facts.


occam's razor

The preference for simple explanations is ancient. This principle, known as Occam's Razor, after William of Ockham (Occam), who, in the 14th century stated : "(Plurality should not be posited without necessity.)" or "keep things simple", or "simplicity is better". "Occam's Razor Proper" states if two models make equivalent predictions, the simpler is preferred. Jacob Eliosoff and Ernesto Posse at http://cgm.cs.mcgill.ca/~soss/cs644/projects/jacob/

Eliosoff & Posse's introduction is an excellent example of pattern recognition.

The rules of simplicity stated in Occam's razor appear to come from Ockham's work in comprehensive logic, based in turn on Aristolian Logic. See below.

In his book The Options Edge 1998, Willian R Gallacher, comments on the "impenetrable logic" of the famous Black-Scholes formula, and provides a reduced formula which he calls "Ockhams Equation". The book's flyleaf quote : "What can be done with fewer is done in vain with more". William of Ockham.


darwins blade

Quote by Dr. Darwin Minor Phd from Darwins Blade by Dan Simmons.
Darwins Blade states that "all things being equal, the simplest solution is usually stupidity" examines causes and effects after the event. (ie the simplest explanation for most acts of stupidity is stupidity). see Darwin Awards posthumously given to "those who improve our gene pool, by removing themselves from it" darwinawards.com
Occams "all things being equal, the simplest solution is usually the correct one" examines alternatives before the event.



logic

Logic is defined as the relationship between elements, and, between an element and it's set of objects, or events. Logic is concerned with what is true and how we can know whether something is true.
Paradox. see anatomy of a chart where technical indicators acquire a similar definition.

Aristotle (384-322 BC) the "father of logic" established a set of rules for deductive evaluation.
Abelard (1079-1142) and Ockham (1285-1349) extended Aristolian logic to comprehensive logic.
G W Leibniz (1646-1716) extended comprehensive logic to symbolic logic.
George Boole (1815 - 1864) founder of mathematical logic, developed boolean logic.


logic applied
exclusive banner

Using trade classification symbols/mnemonics "a"=ask-hit ="buy", and "b"=bid-hit = "sell".
Then using the rules of logic ask the following questions in relation to an executed trade
1. does a single trade of 1b lot have the same weight as 20b lots at the same price
2. does a single trade of 1a lot have the same weight as 20a lots at the same price
3. does a single trade of 1b lot carry the same weight as 20a lots at the same price
4. Are 150a lots the same as 150b lots, at the same price.

Example - market bidding 130 @ 3900 and offering 20 @ 3901
Look at 3 sequential trades. 50b done at the bid, 50b done at the bid, then 1a done at the ask, 1 point higher.
Picture the three tick points on a chart. Bid price and ask price did not change. Price ticked up on the 3rd trade. Now consider the effects of graphics illusion and gestalt principle of continuity. Visually price is rising, while the underlying numbers are logically saying selling pressure exceeds buying pressure.

related topics
computers - a logic device - below, and
decision tables modeling complicated logic
probabalistic reasoning under pattern recognition
trade classification



pareto's principle: the 80-20 rule

quantitative versus qualitative
The qualitative rule, the 80-20 rule, connection with auditing, surveys, sampling, computing and trading.

source - Arthur W. Hafner, PhD, at www.public.asu.edu/~dmuthua/pareto's_principle.html
Pareto's rule states that a small number of causes is responsible for a large percentage of the effect, in a ratio of about 20:80. In 1906, Vilfredo Pareto (1848-1923) an Italian economist, observed twenty percent of the people owned eighty percent of the country's accumulated wealth.

The Pareto Principle states a small subset ("vital few") affecting a common outcome tends to occur more frequently than the remainder ("useful many"). Pareto Curves graphically illustrate data concentration. Pareto Charts can be used to evaluate the relative importance of any subset.

The SPI displays exactly those characteristics. Strange that.
20% of trades executed comprise 80% of total volume / value.
80% of total volume arises from 20% of executed trades
Approximately 30,000 contracts (lots) traded each day
Approximately 12,000 trades are executed each day, an average of 3 lots per trade.
Approximately   2,000 trades comprise 10,000 lots, an average of 5 lots per trade
The remaining 10,000 trades comprise 20,000 lots, or 2 lot per trade. A lot of smoke and noise.

data fragmentation The number of ticks is an illusion.
cluster effect demonstrates pareto curve data concentration.


audits, surveys, polls, and quality control
Are activities which use random sampling on the basis the selection is representative of the whole. In auditing and quality control, if members of the sample are unusual, greater focus is placed on those items and the area of examination expanded and intensified. In auditing, if 20% of an organisations financial transactions represent 80% of the value, greater emphasis is placed on sampling within the 20% high value, low quantity, transactions. An organisation with $100 million assets and $20 million turnover, main focus is on verification of assets. An organisation with $20 million assets and $100 million turnover, main focus is on verification of revenue. While sampling remains random it is directed. Toward a specific class. If abnormalities are detected within the sample, enquiry escalates, and a full examination conducted.

With SPI data we can do better than that. Dont need to sample. The 20% identify themselves. They dont hide. Just buried among the main data set.

computers, the lot, the many, or the few
A computer is a logic device. Computers perform repetitive tasks well. As stated in mechanical systems section, computers cannot perform the human skill of perception. A computer is best used performing quantitative tasks of extracting the 20% from the main body of data. Enabling the trader to use the grey-box-system and perform the qualitative decision making task using the smaller 20% data set. The 80% can be down-weighted (ignored) as stated in Law of Large Numbers below. By focusing on the high quality 20%, time and effort are reduced by 80%, and performance is enhanced.

Is the SPI any different?. Ask this question. Does a single trade of 1 lot carry the same weight as a single trade of 20 lots?. Logically, considerably less weight. A single trade of 1 lot will not move price. A single trade of 20 lots can. It is not necessary to examine 3000 items of data. Single lot trades occur progressively during the day. High value trades occur periodically and in clusters. see cluster effect. Observation can be restricted to the action within the smaller number of high value trades. Single lots can move price only when a sustained program, feeding one lot at a time, is undertaken over a short period of time. In which case all trades will hit the same side. ie sweeping the market.


law of large numbers

source - Professor Richard G Lipsey. Phd. Economics. Queens University UK.
A law relating to a large quantity of numbers, as distinct from numbers containing large values. Successful predictions about the behaviour of large groups are made possible by the statistical "law" of large numbers. Roughly stated this law asserts that random (abnormal) movements in a large number of individual items tend to offset one another. The larger the group, the more likely the neutralising effect.
In other words a large number of small items can be ignored or discarded.

see
information compression the validity of working with less.
Ockham's what is done with more is done in vain. Keeping it simple.
fragmentation a form of creating large numbers.
defragmentation a form of data compression.




technical analysis - pivots

One technical tool which does work consistently are pivots. They work on the night session of the SPI, based on the high, low and close of the day session. Pivots work because everyone uses them and knows where they are. The institutions and hedge funds are not noticably active in the night session which more or less leaves the technicians as the main participants. Day session pivots work if calculated using the High, Low and Close from the pre-open session (0940-0949). That requires a data-feed that provides them. Not many do. BourseData's feed does.


published June 2003
updated january 2005
reviewed January 2010


These methods and analytics can be used with and applied to any futures products including DOW, FTSE100, S&P500, NasDaq, 10year Bonds, 3 year bonds, 90 day bills, Currencies, GB British Pound, US Dollar, Australian Dollar, Euro, Treasuries, emini, e-mini, mini-dow, mini dow.

finish