Year4 - Term1

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 specialized trading tools, which are only a part answer.

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 couldn't 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.

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 organization 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 mobilize $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 wouldn't 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

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 organization. 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 don't 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.

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.

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.

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.

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.

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 organizations financial transactions represent 80% of the value, greater emphasis is placed on sampling within the 20% high value, low quantity, transactions. An organization with $100 million assets and $20 million turnover, main focus is on verification of assets. An organization 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. Don't need to sample. The 20% identify themselves. They don't 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. 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. 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 i.e. 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 neutralizing effect.
In other words a large number of small items can be ignored or discarded.

revolving door

Trading is like a revolving door. You see the direction. You see the speed. The trick is to judge the speed, enter at the right time, move in sync with it, and exit at the right time. Get it wrong and you're stuck inside, come out facing the wrong way, or get trapped when the power goes off.

vacuum effect = zig-zag effect

when the selling stops

Assume a down move. Reverse for an up move.

An implicit (charting) assumption is each price point has a uniform (constant) value i.e. the force of a 5 point rise is equal to the force of a 5 point fall. That's wrong. It's a natural visual illusion. The majors know it and take advantage of it.

Price can change for a number of reasons. A large price fall is often the result of an aggressive sell action by one or two brokers. It's never continuous. They stop and start. When the program is complete, the pressure ceases. Leaving a vacuum in its wake. And price immediately rises back into the vacuum. The magnitude of the retreat is usually, 1 unit of the root of the controlzone. If the move was swift and unexpectedly large, the magnitude of the retreat will be, two units of the root of the controlzone. A retreat into the vacuum is identified by an absolute lack of commercial participation in the rise. If they are participating, the fall is over.

The fall is due to selling pressure exceeding buying pressure. Once the sellers have completed their program, they are (obviously) not selling any more. The selling pressure stops cold. The buyers who took the other side were sitters. They're not chasing. Thus they are not the cause of any subsequent price rise. They're buyers at lower levels (below the cessation point), not higher levels. It is the jobbers who now step in and play in the vacuum.

reversal versus pullback

Understand the section above and identify the difference between a reversal and a pullback.

markets fall for 3 reasons

economic recession
profits recession
an economic event

trading rules

Basic themes extracted from the site in the form of a set of rules in order of priority
with a comparative list of the common rules found elsewhere (on the net).

camron rules	develop a trading plan
standard rules learn the rules of the game know how the game is played know who the opposition are learn to read the market, in order to .. know when conditions are favourable know when conditions are unfavourable recognize changing conditions, mid-game • understand repetition practice, practice, practice • money management • et cetera •	money management cut losses, ride profits follow the trend et cetera • • examples common rules 1 at tradingpicks.com/basic_rules.htm common rules 2 at refcoexpress.ca/50rulesoftrading.refco

trading plans

The fallacy of having "a" trading plan is having just one.
It is more realistic to have 365 trading plans. One for each day.
The challenge is - which one do you use.
Same as the challenge of selecting the right tool for the day.

hardware v software v wetware

source - Greg Iles - Dark Matter - 2003
"The human brain is slow in terms of computing speed. But it is massively parallel. For processing, it is capable of making 100 trillion calculations simultaneously. Together with the equivalent of twelve hundred terabytes of memory".

the surfing plan

The best explanation of a plan is "the surfer" who goes surfing. Goes down to the sea. Checks the weather conditions. Is the surf up?. Is the breeze on-shore or off-shore?. If the conditions are right, jumps on the board and paddles out 300 meters. And waits. Waits for the right wave. There are many waves. The key is to pick the right wave. Don't want to pick one too soon or too late. The choice of wave comes from seasoned experience. Not a surfing plan. A surfer does not go out surfing with a surfing plan in mind. The conditions of the moment on the day will dictate the play. Depending on the conditions, what was a good wave yesterday might well be a poor wave today.

camron.com.au