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Sailing Through Volatile Waters
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Sailing Through Volatile Waters

by The MoleMarch 25, 2014

If you were hoping for continuation of the previous day’s direction then you once again will be squarely disappointed this morning. We continue our journey through rather turbulent and volatile currents and I suggest you batten down the hatches.

I often talk about market weather and how important it is to adjust your trading activities to the present conditions. It’s really no different than choosing an outfit before leaving the house – you wouldn’t want to hit the road wearing shorts and a t-shirt when it’s 10 below zero outside. Of course instead of facing rain, snow, strong winds, or relentless heat in the market we mostly deal with volatility and trend – in combination there are several market types we need to be cognizant of. Here’s a pertinent passage of a recent post Scott wrote two weeks back:

  • Another way of saying “choppy markets with lots of overlapping bars” is LOW VOLATILITY.
  • Another way of saying “few overlapping bars” is RISING VOLATILITY.
  • Sideways markets are INHERENTLY DIFFERENT from trending markets
  • Low volatility markets (on a daily timeframe) make day trading harder and swing trading and position trading easier. Think about all the “day traders” who could not trade after the dot.com boom ended.
  • In low volatility trending markets (like the low volatility melt up in the stock market the last few years) counter trend trades have a DRAMATICALLY LOWER chance of working.
  • Extremes in both HIGH AND LOW VOLATILITY are unsustainable and indicate a market with the potential to change character
  • Bull quiet markets last the longest time. Bear quiet markets last the shortest time and arguably it is not worth developing systems for these markets.
  • The highest probability for market phase following a low volatility sideways phase is a high volatility trending phase
  • The highest probability for market phase following a low volatility trending phase is a high volatility trending phase in the opposite direction.

I think this gives you a rough idea – guess what market period we are in right now?

This is again a plot of the E-Mini and in the panels below you see three indicators which I stole from Ken Long and which have become very handy to perform some sense of market classification (although all indicators are always lagging of course). The most important ones are stretchstat which simply measures trending direction and VolStat which converts ATR to a percentage of price, then adds a 100 period 1 standard deviation bollinger to it, to show in an objective sense whether volatility is comparatively high or low compared to the last 100 bars.

As you can see several combinations jump right out – in December we climbed in a strongly trending low volatility market. Those can be rather easy to handle if you are positioned right, especially if you are a trend trader. In January we switched to a strongly trending but high volatility market – that’s not unusual on the downside. I yet have to see a prolonged (meaning on a daily or weekly scale) low volatility strongly down trending market. Perhaps in 2007/2008 for a few days, but it’s the exception.

Which brings me to the period we’re in right now – we are bordering high volatility but the market direction has been effectively sideways for the past month. Of course our eyes see plenty of movement due to the volatility but we are no further from where we were at the beginning of this month and just a few handles above mid February. These types of markets (high volatile / sideways) are the most difficult markets to handle and market makers love them as participants get herded from one side to the other with plenty of opportunity for the wolves to jump on the strays.

If you recall from above – the highest probability for market phase following a low volatility sideways phase is a high volatility trending phase. If you look at the very first chart in this post then this becomes rather clear. Which is why I took that rather suspicious shooting candle short on the TF – I already earned my 1/2R and I’m less concerned with taking profits right now, instead my motivation is to catch the inevitable acceleration point into the next market phase.

The level of confusion is largely driven by the Forex side (the market’s dog with equities being its tail) and I’m seeing some rather wild swings on one of the popular carry trade pairs the GBP/JPY. All this screams to me – watch your six and keep your exposure limited.

And if you’re exposed on the EUR (or USD) side then you may want to be out in 2 hours from now as Draghi is scheduled to throw another market wrench into Forex (and probably equities).

A few short term setups below for my intrepid subs – please join me in the lair:

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About The Author
The Mole
Mole created Evil Speculator amidst the chaos of the financial crisis in early August of 2008. His vision for Evil Speculator is a refuge of reason, hands-on trading knowledge, and inspiration for traders of all ages and stripes. You can follow him and his nefarious schemes at various social media waterholes below.
  • Skynard

    Here we go, only the strong survive:)

  • Skynard

    Here we go, only the strong survive:)

  • Rightside_ot_trade

    Was looking at the same setup on meal /ZM 😉

  • Rightside_ot_trade

    Was looking at the same setup on meal /ZM 😉

  • https://twitter.com/#!/fresbee2010 fresbee

    mole what is the difference between stretchstat and slopestat? Sorry for the basic question but you seem to be putting these indicators on the charts quite often now. Normally we trade the bands and the inflexion point irrespective of trends but lately these two additional indicators are being used and hence the question.

    Thanks again.

  • https://twitter.com/#!/fresbee2010 fresbee

    mole what is the difference between stretchstat and slopestat? Sorry for the basic question but you seem to be putting these indicators on the charts quite often now. Normally we trade the bands and the inflexion point irrespective of trends but lately these two additional indicators are being used and hence the question.

    Thanks again.

  • Skynard

    Treasuries on buy, chow:)

  • http://evilspeculator.com molecool

    I explained it in the post actually 😉

  • Rightside_ot_trade

    /CT a little caution if you got short yesterday on a that continuation inside hour
    Bullish hammer on the hourly at the daily 25 SMA. Cotton bulls entering the shop

  • Ronebadger

    Ciao (baby)

  • http://evilspeculator.com molecool

    I think he’s getting lunch…

  • https://twitter.com/#!/fresbee2010 fresbee

    yes you did for stretchstat. But you are also using another indicator called slopestat which I believe is also Ken Long but does it not do the same job as Stretchstat itself?

  • https://twitter.com/#!/fresbee2010 fresbee

    yes you did for stretchstat. But you are also using another indicator called slopestat which I believe is also Ken Long but does it not do the same job as Stretchstat itself?

  • Harry Coin

    There is a good summary at http://kansasreflections.wordpress.com/tradestation/ .
    If you follow the links to the ‘Bundle 2’ videos, you can likely figure out how to use/build them on your tools.

  • Rightside_ot_trade

    Shorts puked em up near the high of yesterday inside shooting star ~$92
    Likely reversed given the volume on this 15 minute candle

  • Skynard

    A ha, div 5 min. hang tough! That chow tasted swell:)

  • http://evilspeculator.com molecool

    Slow here tonight! What’s happening crew?

  • Skynard

    Slow grinding tape. Just like you say.

  • Rightside_ot_trade

    New high, limit up for a few minutes. I’m sure this “classical analyst” with 16k twitter followers is right (given how thorough and detailed are his posts)
    @PeterLBrandt: #COTTON $CT_F Getting set for a major breakout to upside http://t.co/vJ3qjZ3xAT

  • Ronebadger

    chop zone…BBs inside the Keltners … waiting

  • Billabong

    Interesting idea using the keltner/BB combination … does it work well for your style?

  • Billabong

    Acronym RBT? Thanks…

  • captainboom

    Rule Based Trading system

  • http://evilspeculator.com molecool

    good show carry on

  • http://evilspeculator.com molecool

    Ivan enjoys a well balanced acronym diet.

  • Ronebadger

    My style?!?!? That’s funny! Anyway, I’ve only just looked into this lately, I believe the Gerb mentioned this lately, and then there is this:
    http://tradetrekker.files.wordpress.com/2014/03/screen-shot-2014-03-25-at-7-23-00-am.png

  • Billabong

    Thanks for taking the time to put the image up … I see what you mean … interesting. Since I trade stocks, I’m working on simplicity but I’m always open to changing out one measurement for another if it’s practical and works with my trading personality. If you decide to continue using it, down the road, I would be interested in your thoughts on its advantages and short comings.

  • http://evilspeculator.com molecool

    BB compressions are a symptom of sideways tape – it’s just another way of visualizing the underlying market conditions. Eventually we will see a release and most likely it’ll be big.

  • http://evilspeculator.com molecool

    Yeah, they’re pretty easy to code.

  • Billabong

    Just like 15-23 Jan compression? So now we wait for a directional trend?

  • Skynard

    /ES, next res. Critical juncture

  • RUFCrazy2

    Risk of Ruin ruminations – So I have built these Es based RBT models. I’ve done annual
    walk-forwards on the models covering 1/1/2007 to date and have
    downloaded the individual trade data to a spreadsheet. To evaluate risk of
    ruin, I thought it would be cool to look at the Firsy Year chance of loss and avg
    returns/drawdowns etc by randomly resorting all 7+ years of trades and storing
    the results for 1,000 Simulations (using an Excel macro) and looking at One
    year’s worth of trade data – summing the results, calculating max drawdowns,
    average returns in R and Worst return in R. It has given me a bit of a warm
    fuzzy. Basically in 1,000 sims of the strategy it had only 1 small loss for the year. Thoughts
    on the robustness of the models and methodology?

  • RUFCrazy2

    Oh and 2008 was so much better than the other years (made $82K that year) I pulled it out so it wouldnlt skew the analysis…

  • http://www.ProfitFromPatterns.com/ Ivan K

    Essentially you are talking about Monte Carlo simulations of outcomes … very valid approach if you adhere to Random Theory

  • http://www.ProfitFromPatterns.com/ Ivan K

    The internal stats are far more important that just the end result.

  • RUFCrazy2

    A poor man’s Monte Carlo, but it’s what I can muster at present. I was really trying to come up with some way to calculate Risk of Ruin better than the Kelly formula et al.. I do think this is valid for what it is. But you probably can’t beat a stochastic process, I just don’t have the platform to do it in.

  • http://www.ProfitFromPatterns.com/ Ivan K

    Nice ‘work’ … great to see ‘we’ are not alone!

  • RUFCrazy2

    Yes towards that line of thought, I have been looking closely at chained trade drawdown recovery time as a key metric and think it is crucial (assuming you have closed tarde data). Next step for me is to look at that the related distributions. But this proces is certainly giving me more confident to swing away. I have taken quite a few “discretionary interfered- with” trades since I have completed the models 6 months ago, but it is getting tiresome and I am getting a lot closer to taking the plunge and letting them ’em have at it without my babysitting. Thanks !

  • http://www.ProfitFromPatterns.com/ Ivan K

    One challenge with all / any stats is that they are based on a closed-end sample … the future will never be the same … it will be the degree of difference that will decide the outcome walking forward … hence downplay the rewards and exaggerate the losses … both in terms of size and duration.

  • http://www.ProfitFromPatterns.com/ Ivan K

    Regarding your RBT rules … it is always interesting to take out one rule (at at time) to see what the effect is on the outcome … another way of testing the robustness of a RBT … freedom-loss is what I am referring to here.

  • http://www.ProfitFromPatterns.com/ Ivan K

    Given your sample … looking at Longs vs Shorts should be enlightening as to the longevity of your RBT’s.

  • Billabong

    Inside day /SI and SLW yesterday.

  • http://evilspeculator.com molecool

    Obviously your strategy does very well in high volatility tape – worth noting especially if it’s an always-on system. I see it hasn’t done as well in the past years and it’s possible that a low volatility trend is less favorable. It is difficult to predict which type of market we will encounter going forward but as only you know what drives your system this could be very valuable in optimizing results. Also look at the MFE/MAE distribution – is your campaign management optimized accordingly?

  • DollarChaser

    nzd/jpy trade progressing well. thanks mole.

  • http://evilspeculator.com molecool

    Yeah, that one was sugar – you’re still in it, good! Do this – advance your stop to each new spike low. The last one was at 87.856.

  • DollarChaser

    roger that, stop at 87.856. thanks mate, i was wondering if i should adjust my campaign management for this one, looking at 9 blue candles in a row on the hourly.

  • http://evilspeculator.com molecool

    Here’s the chart – I leave it in your capable hand but we may have a runner here and if you like take partial profits and then use every new spike low for your stop. You know what a spike low is, right?

  • DollarChaser

    a low lower than the low before and after it yeah?

  • http://evilspeculator.com molecool

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    ¨°º¤ø„¸F R E S H „ø¤º°¨

    ¸„ø¤º°¨ M E A T“°º¤ø„¸

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  • http://evilspeculator.com molecool

    Exactly, which means you are always at minimum three candles away (counting the ongoing one).

  • RUFCrazy2

    Thanks – no it isn’t explicitly optimized for MFE/MAE but the R distribution show some reasonably long positive tails and much shorter loss tails which is desired. I am working hard now on Scott’s suggestion as to adding some more exits – most trades are currently closed out by a reversing strategy which does limit the left tails…