THE COMPOSITE SIGNAL APPROACH IN STOCKS P.

22

BEAR NECESSITIES:
Understanding
stock behavior
in down markets p. 14
SCALPING:
ZONING IN ON IPO Trading the tape,
opportunities p. 58 not the chart p. 28

VOLATILITY SYSTEM LAB:

and swap Testing the
spreads p. 42 double repo p. 46

THIS, TOO, SHALL PASS

(but when?)

$4.95 Printed in the U.S.A. www.activetradermag.com

 CONTENTS
® January 2009 • VOLUME 10, NO. 1
TRADING STRATEGIES FOR THE FINANCIAL MARKETS

Market Pulse
8 The bear and bull face-off
Understanding the stark differences between how the market
moves in bull and bear periods can help you navigate this
tough market.
By David Bukey

Trading Strategies
15 Combine and conquer: Testing a consensus approach
A recent academic study explains how trading rules from
multiple strategies can be combined to create more effective
signals.
By Camillo Lento

19 Scalping: Playing the lean

Leave your technical tools at the door — scalping is about
flipping, fake-outs, and other tricks of the trade. Scalpers
need to approach the market with a different mindset than
the typical technical trader.
By John Grady

24 Developing a trading system

Active Trader kicks off a year-long series of articles on system
development by mapping out a game plan for the coming
months.
By Active Trader Staff

In every issue…
57 Global Marketplace 63 Key Concepts
International market performance.
65 Trading Resources
3 Editor’s Note 59 ETF Snapshot New products, services, and books.
Volume, volatility, and momentum
4 Contributors statistics for exchange-traded funds. 69 Trading Calendar
5 Opening Trades 60 Stock & Futures 71 Upcoming Events
Trends and events moving
Snapshots
the markets.
Volume, volatility, and momentum
statistics for futures and stocks.

1 www.activetradermag.com • January 2009 • ACTIVE TRADER

 Contents continued

Contact Active Trader:

Editorial inquiries: editorial@activetradermag.com
25 Are options alternative Comments, suggestions:
ownership? Maybe not suggestions@activetradermag.com
A series of experiments show how options For advertising or subscription
stack up to positions in the underlying information, log on to: www.activetradermag.com

market.
By Keith Schap Inside the Market
47 Stagnant IPO, ETF listings reflect
battered market
A lack of new companies going public
speaks volumes about the current market
condition, but a new study shows IPOs
that survive a bad environment may be
stronger in the long run.
By Chris Peters

Advanced Strategies Other stories:

31 Volatility and swap spreads Carbon trading surge • Gold’s perplexing
The relationship between swap spreads, performance • Hedge-fund industry
the yield curve, and the term structure of woes • Central banks slash rates •
fixed-income volatility offers valuable Global numbers
insights into the direction of corporate
bonds and stocks. The Economy
By Howard L. Simons 61 U.S. economic briefing
Updates on economic numbers and
Trading System Lab the market’s reaction to them.
35 Double-repo systems
This approach waits for the double Technology for Traders
penetration of a forward-adjusted moving 68 Web Watch: Collective2.com
average following a price thrust. A community-based Web site tracks
By Volker Knapp thousands of trading systems and
matches traders with system developers.
The Face of Trading
41 Twists and turns Trade Diary
By Active Trader staff 72 Taking a gamble on a banking stock.

Q&A 73 Taking
42 Ken Grant on risk quick profits
Risk management expert Ken Grant and maintaining
discusses the current turmoil and the tight stops.
potential toll hedge-fund pullouts could
take on the market.
By Mark Etzkorn

2 www.activetradermag.com • January 2009 • ACTIVE TRADER

 Editor’s NOTE
This, too, shall pass…eventually
A s the level of hyperbole in
financial media commentary
exceeds the level of market
volatility itself, keep something in mind:
Nobody has a clue what’s going to hap-
pen. Not Warren Buffet, not George
Soros, not the guy next to you on the
train, and certainly not any of us in the
press or the people who share their
thoughts with us. People who claim they
do are liars or delusional.
We all have access to the same infor-
mation, although many people choose to
ignore it. The most logical, best-educated
guesses would extrapolate from similar
episodes in the past, adjust for the pres-
ent situation’s unique qualities, and pro-
vide a wide margin of error.
Fat lot of good that will do you. The
margin of error would account for out-
comes so disparate as to make any course
of implied action in the market woefully
limited — and risky. Even if that weren’t
the case, logic is of only limited use in
this situation, as it is an entirely psycho-
logical, emotion-driven phenomenon.
There really are few historical parallels
to the current situation, other than those
that fall under the general banner of
“Panic.” And aside from the observation
that panics tend to be buying opportuni-
ties — in the long-term — there’s not a
lot to say. “Tend to be” is a dicey concept
on which to hang your financial future.
After all, the market lost a hair less than
50 percent from high to low in the initial
1929 crash. More money was destroyed
when the market subsequently rallied 52
percent and then — between April 1930
and July 1932 — shed 86 percent of its
value.
The U.S. stock market has now lost
nearly half its value for the second time
3 www.activetradermag.com • January 2009 • ACTIVE TRADER
in less than a decade. This wasn’t sup-
posed to happen; 2000-2002 was sup-
posed to be the big flush-out. The speed
and severity of this drop makes the previ-
ous bear market look like an orderly cor-
rection.
Which is perhaps why we shouldn’t
As people lose their
capacity to be shocked
and return their
attention to the
mundane tasks of
everyday life, the day
draws nearer when
we will be able
to say a bottom is in.
hope for a quick, massive rebound (right
now that certainly doesn’t seem to be an
issue). It would simply be a sign the mar-
ket hasn’t exorcised its demons.
That’s what you call a catch-22,
because if it’s unhealthy for the market to
rally robustly right now, that means the
preferable alternative is for it to hang
around the October lows or even move
lower — and continue to erode stomach
linings and inflame blood vessels in the
process.
And with hedge-fund liquidations still
underway and a likely spike in unem-
ployment in our future, there’s plenty of
room for another downdraft.
But our culture’s famously short atten-
tion span could come in quite handy in
the months to come. People are already
showing signs of becoming numb to the
onslaught of negative news. The media
will eventually tire of the story, and could
be helped in this regard by the distraction
of a new president. As people lose their
capacity to be shocked, reconcile them-
selves to their trimmed-down balance
statements, and return their attention to
the mundane tasks of everyday life, the
day draws nearer when — in retrospect,
of course — we will be able to say with
some confidence that “a bottom is in.”
(The other thing that might help is pub-
licly beheading the financial masters of
the universe who helped get us where we
are, and the government that decided we
should foot the bill for them, but let’s not
hold our breath.)
One day, things will be different. Just
don’t ask me or anyone else when, exact-
ly. In “Ken Grant on risk” (p. 42) the
long-time risk-management expert notes,
“One of the things that separates the real
pros from the wannabes is the pros know
bad markets — and good markets, for
that matter — don’t last forever, and they
plan accordingly.”
I will make a bold forecast: 15 years
from now, the S&P 500 index will be
higher than it is today (Nov. 12, 2008).
Now I feel terrible, though, because
any time I make this kind of prediction,
I’m almost always wrong. But then, I have
plenty of company.
Mark Etzkorn, Editor-in-chief
 This Month’s
® CONTRIBUTORS

For all subscriber services:

Active Trader Magazine
P.O. Box 567 Howard Simons is president of Rosewood Trading Inc. and a
Mt. Morris, IL 61054-0567
• strategist for Bianco Research. He writes and speaks frequently on a
(800) 341-9384 wide range of economic and financial market issues.
•
www.activetradermag.com

Keith Schap is a freelance writer specializing in risk management

Editor-in-chief:
Mark Etzkorn and trading strategies. He is the author of numerous articles and sev-
metzkorn@activetradermag.com
eral books on these subjects, including The Complete Guide to Spread
Managing editor:
Molly Goad
Trading (McGraw-Hill, 2005). He was a senior editor at Futures maga-
mgoad@activetradermag.com zine and senior technical marketing writer at the CBOT.
Senior editor:
David Bukey
dbukey@activetradermag.com
Associate editor: Camillo Lento is a lecturer in the accounting department at Lakehead University
Chris Peters in Thunder Bay, Ontario, Canada. Before joining the faculty of business administra-
cpeters@activetradermag.com
tion, Lento obtained his Chartered Accountant (Ontario) Designation, while in senior
Contributing writers:
Thom Hartle, Howard L. Simons, positions in accounting, auditing, and business valuations. He holds a master’s degree
Marc Chandler, Keith Schap, Robert A. Green
in management and an honors bachelor’s of commerce degree (majors in accounting
Editorial assistant and Webmaster:
Kesha Green
and finance) from Lakehead University, and has marked non-comprehensive simula-

Art director:
tions at the ICAO’s School of Accountancy. Lento has various publications in journals
Laura Coyle such as the Journal of Applied Business Research and Applied Economics Letters, and has
lcoyle@activetradermag.com
presented original research at many international conferences.
President:
Phil Dorman
pdorman@activetradermag.com
Publisher, John Grady first learned the art of scalping while trading futures
Ad sales East Coast and Midwest:
Bob Dorman for a proprietary trading firm in Chicago. It was there he discovered
bdorman@activetradermag.com the importance of reading the order book and realized technical analy-
Ad sales
sis is typically more of a hindrance than a help in day trading. He is
West Coast and Southwest only:
Allison Chee the author of No B.S. Day Trading and currently trades from his home
achee@activetradermag.com
in southern Florida. For more scalping strategies and information on how to read the
Classified ad sales:
Mark Seger order book, visit www.NoBSDayTrading.com.
seger@activetradermag.com

Volker Knapp has been a trader, system developer, and researcher

Volume 10, Issue 1 Active Trader is published monthly
by TechInfo, Inc., 161 N. Clark Street, Suite 4915,
for more than 20 years. His diverse background encompasses
Chicago, IL 60601. Copyright © 2008 TechInfo, Inc. All
rights reserved. Information in this publication may not positions such as German National Hockey team player, coach of the
be stored or reproduced in any form without written
permission from the publisher. Annual subscription rate Malaysian National Hockey team, and president of VTAD (the German
is $59.40.
branch of the International Federation of Technical Analysts). In 2001
The information in Active Trader magazine is intended
for educational purposes only. It is not meant to rec- he became a partner in Wealth-Lab Inc. (www.wealth-lab.com), which he still runs.
ommend, promote or in any way imply the effective-
ness of any trading system, strategy or approach.
Traders are advised to do their own research and test-
ing to determine the validity of a trading idea. Trading
and investing carry a high level of risk. Past perform-
ance does not guarantee future results.

4 www.activetradermag.com • January 2009 • ACTIVE TRADER

 OPENING Trades

Stocks lurch around October lows

After testing the Oct. 10 panic low later in the month, the U.S. Virtually every day
stock market staged a pre-presidential election rally early in has been an exercise in
November — only to turn back down the day after Sen. Barack chest-clutching. The
Obama was elected the 44th President of the United States on median S&P daily range
Nov. 4. of 49.77 points between
Oct. 10 and Nov. 10 is
more than four times the
median of the preceding
Max. YTD four years, and the
Oct. Oct. Nov. Nov. decline median close-to-close
10 24-28 4 10 (thru
change is more than six
Index low low high close 11-10)
times larger. The market
S&P 500 (SPX) 839.8 845.27 1,007.51 919.21 -42.80%
has matched the former Source: TradeStation
Nasdaq 100 volatility level only twice
(NDX) 1,196.11 1,149.12 1382.65 1,251 -44.88%
(1987 and 1998) in the
Russell 2000 past 25 years, and has not reached the latter level in the past
(RUT) 467.92 441.92 551.02 493.27 -42.31%
quarter century.
Dow Industrials
The market’s volatility is a sign it is not yet out of the woods,
(DJIA) 7,884.82 8,143.59 9,653.95 8,870.54 -40.56%
and its reduced volume leaves it susceptible to continued
thrashing. “Ken Grant on risk” (p. 42) addresses some of the
challenges the market faces in the near future and the signs that
S&P 500 median daily moves may indicate it has found its bottom.
Daily range One-day closing change
10/10/08- 10/11/04- 10/10/08- 10/11/04- Sector ETF picture
11/10/08 10/9/08 Ratio 11/10/08 10/9/08 Ratio There were, perhaps surprisingly, a handful of areas that man-
aged to post gains in the month after the initial October lows,
49.77 11.95 4.16 3.13% 0.47% 6.64
mostly in the fixed-income arena. The iShares California Muni
Bond fund (CMF) was hot, but not particularly liquid. Other
The Nasdaq 100 and Russell 200 indices actually made lower top-returning exchange-traded funds (ETFs) included dividend-
lows in late October, while the S&P 500 and the Dow made yielding, energy, and biotech funds.
slightly higher lows. All the indices rallied briskly through Nov. “Stagnant IPO, ETF listings reflect battered market” (p. 47)
4 before putting in a huge post-election day loss. Nonetheless, looks at the state of the ETF market.
as of Nov. 10, the S&P was around 9 percent above its Oct. 10
low.
20-day 60-day
11/10 return on avg. daily
ETF Sym close 11/10 volume
Voices in the market: iShares S&P California Muni Bond CMF 102.99 12.07% 6,088
WisdomTree Earnings Top 100 Fd. EEZ 28.11 7.62% 10,654
“ I made a mistake in presuming the Vanguard Intermediate-Term Bond BIV 71.99 5.60% 59,328
self-interest of organizations, specifi- Vanguard Short-Term Bond ETF BSV 76.34 5.20% 138,097
cally banks and others, was such iShares Lehman Aggregate Bond Fd. AGG 95.91 5.06% 688,141
that they were best capable of pro- Europe 2001 HOLDRS EKH 47.14 3.83% 1,078
Biotech HOLDRS BBH 173.11 3.66% 199,549
tecting their own shareholders.””
iShares DJ US Oil & Gas IEO 42.29 3.42% 1,030,815
— Alan Greenspan, speaking Market Vectors-Gaming ETF BJK 16.70 3.09% 2,559
before Congress in October. SPDR Lehman Intl Treasury Bond BWX 49.20 3.04% 138,722

5 www.activetradermag.com • January 2009 • ACTIVE TRADER

 Voices in the market:
“ He underestimated the self interest of people — their
own self interest. They’re the greediest people on earth.
How can you underestimate them?””
--Radio personality Steve Dahl, on Greenspan’s comment

Source: eSignal

Metals swing to new lows

Crude falls below $60
Crude oil dropped below $60 in early November.
Despite OPEC’s intended output cutback for
November, December crude (CLZ08) hit a 22-
month low of $59.97 on Nov. 7, 60 percent below
its all-time peak in July.
December natural gas (NGZ08), heating oil
(HOZ08), and gasoline (RBZ08) also breached psy-
chological barriers in October. Natural gas broke
through $7.00 and fell as low as $6.24. Heating oil
futures dropped below $2.00 in late October before
bouncing as high as $2.20 in early November, while
gasoline futures traded near $1.40.
December gold futures (GCZ08) fell 18.5
percent in October, dipping briefly below
$700. After touching a 21-month low of
$681 on Oct. 24, gold jumped 10 percent
to trade at $750 by Nov. 10.
December silver (SIZ08) dropped 21
percent in October, part of a three-month,
46-percent drop to a multi-year low of
$8.40 on Oct. 28. By Nov. 4, however, the
market bounced back to $10.
December copper (HGZ08) dropped 36
percent in October, falling below $175
several times. After a short bounce back
Source: eSignal above $200, copper slipped to $169.70 by
Nov. 7.

Who says the dollar is dead?

The U.S. dollar was one of the few clear beneficiaries of the financial meltdown, as it proved — despite
America’s flagging international reputation in recent years and the advent of Asian economic superpow-
ers — that it is still a safe-haven in times of trouble.
The U.S. dollar index pulled back slightly in early November after capping its biggest rally in more
than seven years with a two-and-half-year high in October.

Source: TradeStation

Treasuries reach new highs

After hitting a six-month high on Sept. 16, December 10-year T-note futures (TYZ08) fell 6.2 percent by Oct.
14, the largest monthly decline in five years. But the 10-year rebounded quickly, climbing 3.5 percent in less
than two weeks. By Nov. 10, the market had dropped to 115 21/32.
Meanwhile, shorter-term Treasury futures hit multi-year highs. December 5-year T-note futures (FVZ08)
jumped 2.4 percent in the first week of November to a five-year high of 116. December 2-year T-note futures
Source: eSignal
(TUZ08) followed a similar trajectory.

ACTIVE TRADER • January 2009 • www.activetradermag.com 6

Opening Trades continued

Voices in the market:

“ I was in this game for the money. The low hanging fruit, i.e., idiots whose parents paid for prep
school, Yale, and then the Harvard MBA, was there for the taking. These people who were (often)
truly not worthy of the education they received (or supposedly received) rose to the top of compa-
nies such as AIG, Bear Stearns, and Lehman Brothers and all levels of our
government. All of this behavior supporting the Aristocracy only ended up making it easier for me to
find people stupid enough to take the other side of my trades. God bless America.””

— Hedge-fund manager Andrew Lahde of Lahde Capital, in a letter announcing

the dissolution of his very profitable hedgefund and his retirement from the industry.

Grains stabilize, softs weaken

Grain futures dropped in early October, and then traded flat for the remainder of the month. December
corn (CZ08) fell to a 21-month low on Oct. 16 before trading in a $0.50 range through Nov. 10.
Soybeans, wheat, and soybean products made similar moves, dropping to multi-month lows before sta-
bilizing.
January rough rice (RRF09) ended a four-week fall of 29 percent to $14.61 on Oct. 27, and then
bounced nearly 10 percent by Nov. 5.
Cocoa futures slid 20 percent in October and traded 43 percent below its July all-time high. After hit-
ting a 14-month low on Oct. 24, December cocoa futures (CCZ08) jumped 17.6 percent in the next Source for all charts: eSignal
three days, but then continued to fall in the first part of November.
December cotton (CTZ08) fell 23 percent in October after falling 18 percent in September. Cotton
then slipped another 5 percent in the first week of November.
December coffee (KCZ08) dropped 12 percent in the first five days of October, rebounded slightly,
and eventually hit a 17-month low of $105.05 on Oct. 27.

Livestock futures avoid slaughter

October was a tough month for livestock futures. December live cattle (LCZ08) dropped 13.22 percent
from Sept. 30 to Oct. 24, and December lean hogs (LHZ08) fell 8.9 percent during the same period.
However, December live cattle began to rebound in late October and early November as December
lean hogs continued to slip. By Nov. 10, live cattle climbed 7.4 percent from the six-month low it hit on
Oct. 24. But lean hogs fell an additional 6.5 percent.

Porsche beats hedge funds to finish line

Iconic car marker Porsche cashed in after revealing it controlled a majority stake in Volkswagen AG,
causing VW shares to jump nearly 500 percent within a few days. Porsche secretly built a 74.1-percent
investment in VW with cash-settled options, meaning that most shares were tied up and unavailable to
other investors.
When the news broke on Oct. 26, short sellers of VW stock struggled to find shares to buy back, and
the stock surged 376 percent to €1,005, causing VW to briefly become the most valuable firm in the
world. As a result, several prominent U.S. hedge funds lost money, including Steve Cohen’s SAC Capital
and David Einhorn’s Greenlight Capital.
German regulators are investigating whether VW stock was manipulated, but Porsche has not been
charged with wrongdoing.

7 www.activetradermag.com • January 2009 • ACTIVE TRADER

 MARKET Pulse
The bear and bull face-off
Examining how recent bull and bear periods influenced
the stock market’s short-term price behavior.
BY DAVID BUKEY
W ith nearly all stock markets mired in official
bear territory, many traders are trying to
make money by selling short. This seemed
incredibly compelling when the Dow Jones
Industrial Average plunged 27.35 percent in the first eight days
in October alone. But the immediate 20-percent rebound within
three days likely scarred many short sellers who entered toward
the end of the Dow’s initial drop.
Trading stocks from the short side is virtually always more
FIGURE 1: BEAR MARKET, 2000-2003
The S&P 500 tracking stock (SPY) fell 38.7 percent from March 1, 2000 to Feb.
28, 2003 – a very volatile period that resembles price action in 2008.
Source: eSignal
8 www.activetradermag.com • January 2009 • ACTIVE TRADER
difficult than trading from the long side. Statistics show market
volatility spikes when prices drop, making it a more challenging
environment in which to earn profits.
The first step in developing an approach tailored for a down
market is to measure the market’s typical price behavior during
bearish conditions. “Bull vs. Bear: The details matter” (Active
Trader, November 2002) compared the S&P 500 tracking stock’s
(SPY) daily price characteristics in bull and bear markets: 1998
to 2000 vs. 2000 to 2002, respectively. Here, we take a look at
SPY’s short-term behavior during more
recent bullish and bearish periods, focus-
ing on differences in its daily ranges,
close-to-close moves, and price runs of
different lengths and sizes.
Bull vs. bear showdown
Let’s compare SPY’s price behavior in two
distinct periods: the bear market from
March 1, 2000 to Feb. 28, 2003 and the
bull market from March 3, 2003 to Feb.
28, 2006.
Figure 1 shows a daily SPY chart during
the bear phase as it dropped 38.7 percent
within three years, a very volatile period
that resembles 2008’s price action. Figure
2 shows SPY during the study’s bull peri-
KC For more information about
the following concepts, go to
“Key concepts” on p. 63.
• Average and median
 FIGURE 2: BULL MARKET, 2003-2006

od, in which it gained 34.8 percent from

March 2003 to March 2006.
The market’s long-term trend is clear in
both figures. However, SPY rebounded
sharply on several occasions before
resuming the prevailing downturn in
Figure 1. And the market hit many rough
patches during its overall rally in Figure
2, including a prolonged flat period in
2004.
Clearly, traders could have made
money on either side of the market in SPY rallied 34.8 percent from March 3, 2003 to Feb. 28, 2006, although it
both periods. Let’s compare general mar- traded sideways in much of 2004.
ket characteristics between both periods Source: eSignal
on a day-to-day basis.
and bear markets. The first three columns list SPY’s close-to-
Bear markets are choppy close move, its largest up move (LUM, close to next day’s high),
Table 1 compares SPY’s average and median daily moves in bull continued on p. 1 0

TABLE 1: BEAR AND BULL DAILY STATISTICS

Daily range
Close- LUM LDM Overnight Open Open Open Daily as % of
to-close move to high to low to close range ($) midpoint
March 2000 Avg: -0.05% 0.97% -1.10% -0.01% 0.93% -1.02% -0.04% 2.24 1.96%
to Med: -0.05% 0.75% -0.87% 0.00% 0.73% -0.84% -0.05% 2.02 1.74%
March 2003 Pct. > 0: 48.74% 49.40% 48.60%

March 2003 Avg: 0.06% 0.59% -0.52% 0.04% 0.53% -0.53% 0.02% 1.16 1.06%
to Med: 0.09% 0.49% -0.40% 0.04% 0.43% -0.41% 0.06% 1.08 0.95%
March 2006 Pct. > 0: 56.03% 55.10% 53.25%

The market’s intraday moves were roughly twice as volatile during the last bear market (2000-2003) than during the
subsequent bull market (2003-2006).

TABLE 2: BEAR AND BULL OPENING GAPS

Opening gaps*
Drop Rise Opening Opening
below above Opening gap Opening gap
yesterday’s yesterday’s Inside Outside gap up gap down
low high days days up filled down filled
Bear market -
March 2000 to March 2003 51.80% 46.87% 10.25% 9.45% 42.21% 35.21% 42.88% 68.32%
Bull market -
March 2003 to March 2006 43.97% 54.04% 13.64% 12.05% 41.93% 65.30% 31.08% 68.51%
* opening gap >= .1% of yesterday's close

Opening gaps up were more likely to be filled in bull markets than bear markets. But opening gaps down were filled 68
percent of the time, regardless of market conditions.

ACTIVE TRADER • January 2009 • www.activetradermag.com 9

Market Pulse continued

FIGURE 3: BEAR MARKET DAILY RANGES

and its largest down move (LDM, close

to next day’s low). The middle columns
show SPY’s overnight and intraday moves
— open to high, open to low, and open
to close. The last two columns list SPY’s
daily (high-low) range and its daily range
as a percentage of each day’s midpoint.
Finally, the percentage of gains (Pct. > 0)
is shown for several periods.
From a directional standpoint, there
are no dramatic differences between the
bull and bear markets. Obviously, the SPY was much more volatile in the bear market, with a typical daily range
market was skewed toward losses during between $1.00 to $3.00. The largest number of high-low moves fell in the
$1.51 to $2.00 range.
the bear market and tended to post small
gains in the bull market. But Table 1’s
FIGURE 4: BULL MARKET DAILY RANGES
SPY was twice as
volatile during the
bear market.

real news is that SPY was twice as

volatile during the bear market.
For example, the median bear-market
LUMs and LDMs are 0.75 percent and
-0.87 percent, respectively, while their
bull-market counterparts are just half as
large (0.49 percent and -0.40 percent).
The same dynamic appears in SPY’s
open-to-high and open-to-low moves. SPY was much less volatile in the bull market; the majority of its moves ranged
Moreover, SPY’s daily range is twice as between $0.50 to $1.50, well below the typical bear market daily range.
large during the bear period than during
the subsequent bull period. TABLE 3: DAILY UP MOVES
Table 2 (p. 9) compares how often
Bear (752 days) HH HL HC HH+HC HH+HL+HC
SPY formed various one-day patterns in
# of times: 352 360 366 248 212
bull and bear markets. The patterns that
% of times: 46.81% 47.87% 48.67% 32.98% 28.19%
stick out are opening gaps, which form
when the market opens above or below
Bull (755 days) HH HL HC HH+HC HH+HL+HC
yesterday’s close. For example, when SPY
# of times: 407 418 422 329 263
gapped higher at the open, the market
% of times: 53.91% 55.36% 55.89% 43.58% 34.83%
was more likely to drop back to its open-
ing price, “filling” that gap, in a bull mar- SPY reached fewer higher highs, higher lows, and higher closes during the
ket, which seems counterintuitive. And bear market of 2000 to 2003 than during the subsequent bull market of 2003
after forming an opening gap down, SPY to 2006.

10 www.activetradermag.com • January 2009 • ACTIVE TRADER

 FIGURE 5: BEAR MARKET CLOSE-TO-CLOSE MOVES

climbed back to its opening price 68 per-

cent of the time, regardless of market
conditions.

Daily ranges and

close-to-close differences
Table 1 shows SPY formed larger daily
ranges in the bear market. Figure 3
shows the distribution of absolute values
for the daily ranges in the bear market
period. Figure 4 shows the same statistics
The majority of SPY’s close-to-close moves ranged from $0.01 to $1.50 in the
bear period, while less than 25 percent of its moves exceeded $1.00 in the
bull period (Figure 6).
The market tended
FIGURE 6: BULL MARKET CLOSE-TO-CLOSE MOVES to drop sharply after
hitting new five-day
highs in bear markets,
but the counter-rallies
can be surprisingly
strong.

for the subsequent bull market.

The differences are striking. The
More than half of SPY’s close-to-close moves were less than $0.51 in the bull majority of bear-market daily ranges are
period. between $1.01 and $3, peaking from
$1.51 to $2. By contrast, most bull-mar-
ket daily ranges are between $0.51 and
TABLE 4: DAILY DOWN MOVES $1.50, culminating from $0.51 to $1.
Bear (752 days) LH LL LC LL+LC LL+LH+LC The average bear-market range was $2.24
# of times: 389 396 385 273 238 vs. just $1.16 in the bull period.
% of times: 51.73% 52.66% 51.20% 36.30% 31.65% Figures 5 and 6 show the same type of
distributions of close-to-close differences
Bull (755 days) LH LL LC LL+LC LL+LH+LC in the bear and bull markets, respectively.
# of times: 332 344 323 236 187 In the bear market, roughly 75 percent of
% of times: 43.97% 45.56% 42.78% 31.26% 24.77% all close-to-close differences were $0.51
or larger. In the bull market, however,
SPY formed lower highs, lower lows, and lower closes more often during the only about half of them fell into that
bear market than during the bull period. category.
continued on p. 1 2

ACTIVE TRADER • January 2009 • www.activetradermag.com 11

Market Pulse continued

TABLE 5: BEAR MARKET CONSECUTIVE HIGHS

Consecutive HCs
2 3 4 5 6 7
# of times: 170 72 31 11 5 2
% of times: 22.61% 9.57% 4.12% 1.46% 0.66% 0.27% Tracking uptrends and downtrends
Average move: 2.33% 3.49% 4.54% 4.14% 4.00% 4.36% One way to define an uptrend is to look for a string
Median move: 1.99% 3.03% 4.50% 3.58% 3.98% 4.36% of consecutive higher highs, higher lows, and high-
er closes. Downtrends would contain strings of
Consecutive HHs+HCs back-to-back lower lows, lower highs, and lower
2 3 4 5 6 closes.
# of times: 98 37 12 2 1 In theory, the market would seem more likely to
% of times: 13.03% 4.92% 1.60% 0.27% 0.13%
form a series of consecutive highs in bull markets
Average move: 2.73% 4.09% 5.94% 3.46% 3.98%
and a string of consecutive lows in bear markets.
Median move: 2.34% 3.45% 5.69% 3.46% 3.98%
Nonetheless, Figures 1 and 2 show that SPY’s
Consecutive HHs+HLs+HCs longer-term trends were broken up by frequent sell-
2 3 4 offs and counter-rallies.
# of times: 75 23 5 Table 3 (p. 10) compares the number of times
% of times: 9.97% 3.06% 0.66% SPY formed consecutive higher highs, higher lows,
Average move: 2.75% 4.39% 7.20% and higher closes in bull and bear markets. The
Median move: 2.35% 3.83% 7.13% table also shows the number of combinations of
higher highs and higher closes (HH+HC) and high-
The market closed higher up to seven days in a row in the bear
er highs, higher lows, and higher closes
market of 2000 to 2003. However, strings of higher highs and higher
closes formed less often and were shorter in length. (HH+HL+HC) in each period.
The market clearly reached
more highs during the bull mar-
TABLE 6: BULL MARKET CONSECUTIVE HIGHS ket than the bear market, which is
Consecutive HCs no surprise. SPY climbed to high-
2 3 4 5 6 7 8 9 er highs, higher lows, or higher
# of times: 227 130 71 37 18 9 4 1 closes at least 54 percent of the
% of times: 30.07% 17.22% 9.40% 4.90% 2.38% 1.19% 0.53% 0.13% time in the bull period, and it
Average move: 1.14% 1.69% 2.44% 3.26% 4.04% 5.18% 6.24% 5.31% reached either of these milestones
Median move: 1.07% 1.53% 2.14% 2.87% 3.31% 3.86% 4.98% 5.31% less than half the time in the bear
period.
Consecutive HHs+HCs Also, combinations of highs —
2 3 4 5 6 7 8
HH+HC and HH+HL+HC —
# of times: 143 71 34 14 5 3 1
formed more often in the bull
% of times: 18.94% 9.40% 4.50% 1.85% 0.66% 0.40% 0.13%
period. For example, HH+HC pat-
Average move: 1.26% 1.87% 2.53% 3.69% 5.33% 6.37% 5.22%
Median move: 1.18% 1.57% 2.21% 3.25% 3.86% 4.65% 5.22% terns occurred 44 percent of the
time in the bull market vs. just 33
Consecutive HHs+HLs+HCs percent of the time in the bear
2 3 4 5 6 7 8 market. And there is a similar, but
# of times: 103 40 17 7 3 2 1 smaller, difference between
% of times: 13.64% 5.30% 2.25% 0.93% 0.40% 0.26% 0.13% HH+HL+HC patterns in those
Average move: 1.29% 1.81% 2.25% 3.04% 3.65% 4.25% 5.22% periods.
Median move: 1.26% 1.58% 2.04% 3.24% 3.82% 4.25% 5.22% Table 4 (p. 11) resembles Table
3, but lists the number of times
The market closed higher up to nine consecutive days in the bull market of 2003 to
SPY formed lower highs, lower
2006. Although there were longer strings of higher closes in the bull market, the mar-
ket tended to gain more ground during consecutive highs in the bear market (Table 5), lows, and lower closes. As you
another sign of increased volatility. might expect, consecutive lows
were more common in the bear

12 www.activetradermag.com • January 2009 • ACTIVE TRADER

 TABLE 7: BEAR MARKET CONSECUTIVE LOWS
Consecutive LCs
2 3 4 5 6 7
# of times: 190 85 33 11 3 1
% of times: 25.27% 11.30% 4.39% 1.46% 0.40% 0.13%
period. SPY hit lower highs, lower lows, or lower Average move: -2.37% -3.62% -4.96% -6.47% -5.97% -5.41%
closes at least 51 percent of the time in the bear Median move: -2.13% -3.25% -4.58% -5.72% -4.95% -5.41%
market, while it formed those patterns much less
often in the bull market. Consecutive LLs+LCs
The same dynamic applies to combinations of 2 3 4 5 6
lows — LL+LC and LH+LL+LC patterns, which # of times: 120 46 14 6 1
were more common in the bear market. By con- % of times: 15.96% 6.12% 1.86% 0.80% 0.13%
trast, LH+LL+LC patterns occurred only 25 percent Average move: -2.64% -4.05% -5.98% -7.05% -8.43%
Median move: -2.39% -3.52% -5.32% -6.61% -8.43%
of the time in the bull market, the least frequent
pattern in Tables 3 and 4.
Consecutive LHs+LLs+LCs
2 3 4 5
Consecutive highs and lows # of times: 91 33 8 3
Table 5 lists runs of consecutive daily SPY highs % of times: 12.10% 4.39% 1.06% 0.40%
during the bear market from March 2000 to March Average move: -2.77% -4.20% -6.46% -6.50%
2003. The first section shows the number and per- Median move: -2.51% -3.54% -5.32% -6.28%
centage of times the market made consecutive
As expected, there were more consecutive lows in the bear market
higher closes from two to seven days in a row. For
than consecutive highs.
example, SPY formed back-to-back higher closes
170 times (22.61 percent), and it made seven con-
secutive higher closes only twice. climbed just half as far when it formed the same patterns in the
To find the exact number of runs of a specific length, subtract
the number of the next longest run from the length you are try-
ing to determine. For example, there were 31 cases of four con- TABLE 8: BULL MARKET CONSECUTIVE LOWS
secutive higher closes, but those runs are already included in the Consecutive LCs
72 runs of three consecutive HCs. As a result, there were 41 2 3 4 5
instances (72-31) of three consecutive HCs only. # of times: 131 49 14 2
% of times: 17.35% 6.49% 1.85% 0.26%
Table 5’s lower two sections show HH+HC and HH+HL+HC
Average move: -1.20% -1.84% -2.18% -2.15%
patterns of various lengths. For example, SPY formed up to six
Median move: -1.03% -1.66% -1.95% -2.15%
consecutive days of HHs and HCs, while it posted up to four
days of back-to-back HHs, HLs, and HCs. The final two rows of Consecutive LLs+LCs
each section show SPY’s average and median close-to-close 2 3 4 5
moves during each run. For example, the market jumped an # of times: 85 30 8 1
average 7.2 percent during its series of four consecutive % of times: 11.26% 3.97% 1.06% 0.13%
HH+HL+HC days in the bear market. Average move: -1.34% -1.91% -2.15% -1.53%
Table 6 is similar to Table 5, but it lists runs of consecutive Median move: -1.24% -1.98% -1.64% -1.53%
daily SPY highs during the bull market. If you compare Tables 5
and 6, you will notice several key differences between bearish Consecutive LHs+LLs+LCs
and bullish environments. First, SPY formed longer strings of 2 3 4
# of times: 62 21 5
consecutive highs during the bull market — up to nine days of
% of times: 8.21% 2.78% 0.66%
consecutive HCs and eight days of HH+HC and HH+HL+HC
Average move: -1.43% -1.98% -2.36%
patterns. And those bullish patterns were more common in the
Median move: -1.37% -1.76% -1.82%
bull market.
In the bear market, however, SPY rose further during consec- SPY rarely formed consecutive lows in the bull market,
utive highs. For example, SPY jumped an average 2.33 percent and these down moves were roughly half as large as their
during two back-to-back HC days in the bear market, but it bear market counterparts (Table 7).
continued on p. 14

ACTIVE TRADER • January 2009 • www.activetradermag.com 13

Market Pulse continued

bull market. In short, bear-market Related reading

uptrends were less common and shorter
“ Bull vs. Bear: The details matter ”
in length than their bull-market counter-
Active Trader, November 2002.
parts, but they were stronger, supporting
This comparison of bull- and bear-market characteristics provides concrete statis-
the conclusion that SPY is more volatile
tics upon which to base upside and downside trading strategies.
during bear markets.
Tables 7 (p. 13) and 8 list the number
“ Short-term stock market runs ”
of consecutive daily SPY lows in bear and
Active Trader, July 2008.
bull markets, respectively. SPY made
A detailed look at how markets have tended to move
longer strings of consecutive lows in the
following price runs of different lengths and sizes.
bear market — up to seven consecutive
days of LCs vs. a maximum of five in the
“ Analyzing the bear ”
bull market. Also, patterns of consecutive
Active Trader, June 2008.
lows were more common in the bear mar-
Measuring how the S&P 500 has responded to 20-percent drops in the past
ket, which is no surprise. Finally, SPY fell
offers clues about what could be in store for the market.
twice as far during bear-market patterns,
compared to their bull-market equiva-
“ Losing your shorts ”
lents.
Active Trader, September 2002.
Short strategies are influenced by bear-market volatility and the short squeeze.
Selling short-term highs
This study shows SPY has been more
“ Familiarity breeds profitability ”
volatile in bear markets than in bull mar-
Active Trader, September 2002.
kets, a fact that is obvious to anyone who
This study analyzes price patterns to determine the odds that different kinds of
has traded the markets recently.
price moves will occur.
In bear periods, traders often sell the
market when it hits a short-term high to
“ Know thy market ”
exploit its downward bias. Indeed, histor-
Active Trader, October 2001.
ical testing shows SPY tends to drop
Regardless of what kind of trader you are or what approach you use, knowing
sharply after hitting new five-day highs in
the typical price behavior for the markets you trade is essential. Here’s how to
bear markets (not shown). However,
do it.
Table 5 shows SPY’s counter-rallies can be
surprisingly strong if the market goes
You can purchase and download past articles at
against you.

http://store.activetradermag.com

14 www.activetradermag.com • January 2009 • ACTIVE TRADER

 TRADING Strategies
Combine and conquer:
Testing a consensus approach
Does technical analysis really work? Recent evidence shows combining different trading
strategies is more profitable than following just one method.
BY CAMILLO LENTO
M
any traders argue
that you shouldn’t
rely on a single rule
to make trading
decisions. However, multiple trading
rules can provide conflicting signals — a
significant, but common issue. For exam-
ple, on any given day, a 2-percent filter
rule may signal a buying opportunity,
while a 10/20-day moving average (MA)
crossover rule may suggest the opposite.
One solution is to combine individual
trading signals to form a consensus in
one direction. The following summary is
based on a recent academic study that
describes a Combined Signal Approach
(CSA) to technical analysis. The CSA
strategy weighs two or more trading rules
and calculates a combined signal that is
designed to be more effective than the
sum of its parts.
Strength in numbers
With a combined approach you buy the
15
market when a buy consensus emerges
among different trade signals, and you
sell the market when a sell consensus
appears. Combining multiple signals
reduces the risk of selecting and relying
on a single rule at any given time.
For example, you can use five trading
rules — e.g., two MA crossovers, a per-
centage filter rule, moving average con-
vergence divergence (MACD), and
Bollinger Bands — to develop a com-
bined signal that triggers a long signal
when three of the five rules are bullish.
Or you can also use a stricter version that
requires four of the five signals to agree
on a position.
A combined approach offers an oppor-
tunity to earn profits even when individ-
ual trading signals are unprofitable. The
CSA strategy’s appeal lies in synthesizing
individual rules into a more powerful
whole. It is likely a combined signal per-
forms better because information related
to future price moves is dispersed among
www.activetradermag.com • January 2009 • ACTIVE TRADER
various trading rules.
The mechanics
of the CSA trading model
Two empirical tests were conducted to
compare the profitability of the combined
signal approach to its individual trading
rules. Profitability was defined as gains
that exceeded buy-and-hold after adjust-
ing for transaction costs (bid-ask spreads
and commissions).
The first test used 12 trading rules
from four categories: MA crossovers,
price filters, trading range breakouts, and
Bollinger Band breakouts (see “Individual
trade rules” for more details).
The CSA strategy takes a long position
if “x” or more of the 12 trading rules
point higher, and exits when the same
number of rules trigger a sell signal.
When the system is out of the market, it
earns 3-percent interest. We tested it
using a consensus of seven and eight
continued on p. 16
 Trading Strategies continued
trade signals, representing more than 50
percent of the rules.
Testing the Dow
and the Nasdaq Composite
The first test used daily data of the Dow
Jones Industrial Average (DJIA) and the
Nasdaq Composite (COMP) indices from
May 9, 1995 to Dec. 31, 2004.
Table 1 (p. 17) shows the annual
returns for all 12 trading rules and com-
pares them to the buy-and-hold
approach. The final three columns com-
pare the average of all rules to the com-
bined approach (seven and eight signals,
respectively). The statistical significance
of the profits is determined using a boot-
strapping methodology. The combined
approach’s performance is shown with
and without transaction costs.
The combined signal approach earned
more than the average of all 12 individ-
ual trading rules, especially in the
Nasdaq Composite, which gained from
8.9 percent to 13.3 percent annually.
The Dow’s performance is most reveal-
ing: None of the individual trading rules
generated profits, but the combined
approach managed to gain ground. For
instance, the individual rules lost 8.5
percent per year, on average, but the
seven-signal CSA strategy posted a 2.7-
percent annual gain, including transac-
tion costs (vs. 6.1 percent without costs).
The eight-signal CSA strategy was also
profitable before transaction costs, and
although it lost money after fees, its loss-
continued on p. 17
16
Individual trade rules
1. 50-day MA crossover rules:
a. Go long at the next day’s open if price closes above its 50-day
moving average.
b. Exit at the next day’s open if price closes below its 50-day moving
average.
2. 200-day MA crossover rules:
a. Go long at the next day’s open if price closes above its 200-day MA.
b. Exit at the next day’s open if price closes below its 200-day MA.
3. 5-day/150-day MA crossover rules:
a. Go long at the next day’s open if a five-day MA closes above its
150-day MA.
b. Exit at the next day’s open if a five-day MA closes below its
150-day MA.
4. Bollinger Bands (20-day, two standard deviations):
a. Go long at the next day’s open if price closes above the upper
Bollinger Band.
b. Exit at the next day’s open if price closes below the lower
Bollinger Band.
5. Bollinger Bands: Same rules as no. 4, but with parameters of 20-day,
one standard deviation.
6. Bollinger Bands: Same rules as no. 4, but with parameters of 30-day,
two standard deviations.
7. One-percent filter:
a. Go long at the next day’s open if price rises by 1 percent,
without dropping below yesterday’s close.
b. Exit at the next day’s open if price declines 1 percent,
without dropping below yesterday’s close.
8. Two-percent filter: Same rules as no. 7 but use price moves of 2 percent.
9. Five-percent filter: Same rules as no. 7 but use price moves of 5 percent.
10. 50-day trading range breakout.
a. Go long at the next day’s open if price climbs above the most
recent peak, defined as the highest high of the previous 50
days.
b. Exit at the next day’s open if price drops below the most recent
trough, defined as the lowest low of the previous 50 days.
11. 150-day trading range breakout: Same rules as no. 10, except use
highest high and lowest low of prior 150 days.
12. 200-day trading range breakout: Same rules as no. 10, except use
highest high and lowest low of prior 200 days.
www.activetradermag.com • January 2009 • ACTIVE TRADER
 Trading Strategies continued

TABLE 1: DOW AND NASDAQ, 1995 TO 2004

Trading range Avg. of Combined signal

MA crossover rule Bollinger Bands rule Filter rule breakout rule 12 rules approach
Parameters Parameters Parameters Parameters
50 150 200 CSA CSA
Annual returns (%) 1/50 1/200 5/150 20/2 20/1 30/2 1% 2% 5% days days days (7/12) (8/12)
Dow Jones
Trading rules 2.3 0.5 2.6 4.6 4.3 5.5 -3 0.5 0.3 1.2 0.5 6.4 2.1
Buy & hold 10.8 8.6 10 10.8 10.8 11.3 11.7 11.7 11.7 11 10 8.8 10.6
Profit -8.5 -8.2 -7.4 -6.2 -6.5 -5.8 -15 -11 -11 -9.6 -9.5 -2.4 -8.5 2.7 -3.4
No transaction costs 6.1 1.5
NASDAQ
Trading rules 20.8 17.9 13.9 -12.3 -10.8 -8.2 6 -9.6 -1.6 15 18.4 18 5.6
Buy & hold 6.4 4.1 4.9 6.4 6.4 6 8.3 8.3 8.3 6.4 4.9 4.1 6.2
Profit 14.4 13.8 9 -18.8 -17.2 -14.2 -2.2 -18 -9.9 8.7 13.5 14 -0.6 13.3* 8.9*
No transaction costs 16.6* 15.1*

* returns that are significant at the 5% level of significance

The combined signal approach was superior to trading all 12 rules individually, especially on the Nasdaq Composite, which
gained from 8.9 percent to 13.3 percent annually.

es were smaller than the individual trad-
ing rules (-3.4 percent vs. -8.5 percent).
Longer test, fewer trade
rules on the S&P 500
The second test used a CSA model with
nine trading rules — all of the first test’s
rules except those based on Bollinger
Bands. The test spanned 50 years of daily
S&P 500 price data from Jan. 1, 1950 to
March 19, 2008. The approach was test-
ed with different numbers of consensus
votes triggering a trade signal: two of
nine, three of nine, etc., up to six of nine
rules. Testing a range of values provides
evidence for both a strict (6/9) and a
loose (2/9) system. (There are not enough
consensus signals to provide a robust test

TABLE 2: S&P 500, 1950 TO 2008

Trading range Avg. of

MA crossover rule Filter rule breakout rule 12 rules Combined signal approach
Parameters Parameters Parameters
50 150 200
Annual returns (%) 1/50 1/200 5/150 1% 2% 5% days days days (2/9) (3/9) (4/9) (5/9) (6/9)
No transaction costs
Trading rules 11 11.3 10.8 15 7.3 7.9 7.7 8.9 8.9 9.9
Buy & hold 9.7 9.5 9.7 9.8 9.8 9.8 9.7 9.7 9.5 9.7
Profit 1.3* 1.9* 1.1* 5.2* -2.4 -1.8 -2 -0.7 -0.5 0.2 3.2* 1.8* 1.9* 1.8* 0.0*
Transaction costs
Trading rules 7.7 10 10 7.1 0.9 7.5 7 8.7 8.8 7.5
Buy & hold 9.7 9.5 9.7 9.8 9.8 9.8 9.7 9.7 9.5 9.7
Profit -2 0.5* 0.3* -2.6 -8.8 -2.2 -2.7 -0.9 -0.7 -2.1 1.6* 0.0* 0.1* -0.2 -2.6

* returns that are significant at the 5% level of significance

The combined strategy generated profits on the S&P 500, while the average trading rule lost 2.1 percent annually after
trading costs.

17 www.activetradermag.com • January 2009 • ACTIVE TRADER

 KC For more information about Related reading
the following concepts, go to “Key
concepts” on p. 63. “ The profitability of technical trading rules:
A combined signal approach””
• Bootstrapping by Camillo Lento and Nikola Gradojevic. Journal of Applied Business Research
• Moving average 23(1): 13–27.
convergence-divergence (MACD)
• Bollinger Bands “ A combined signal approach to technical analysis on the S&P 500””
by Camillo Lento. Journal of Business and Economics Research, forthcoming.
Working paper available at http://ssrn.com/author=970955.

of a 7/9 system.) “ Combined signal approach:

Table 2 is similar to Table 1 and com-
pares the annual performance of each rule
to different versions of the combined
approach. Again, the individual rules led
to consistent losses in the S&P 500 as
they did in the Dow. The average trading
rule lost 2.1 percent annually after
trading costs.
However, the combined strategy gener-
ated profits. Before transaction costs, all
versions of the CSA approach beat the
market, and four of the five versions out-
performed the individual rules’ 0.2-per-
cent average gain. The results are similar
after adjusting for transaction costs,
although a significant portion of the prof-
its are eliminated. The 5/9 and 6/9 com-
bined techniques were the only systems
that lost money. This could be because its
parameters are too strict, resulting in too
few positions.
Both tests show a combined approach
significantly improves upon the individ-
ual trade rules’ performance; it also
removes problems associated with multi-
ple conflicting signals. Further analysis of
Asian-Pacific stock market indices
showed the CSA strategy was profitable in
further evidence from the Asian-Pacific equity markets””
by Camillo Lento. Applied Financial Economics Letters, forthcoming.
22 of 24 tests with annualized profits as
high as 28.3 percent on the Jakarta
Composite index.
The results are robust given that the
combined approach was profitable in
three different markets with various
parameters.
Customizing the technique
One of the most important features of the
CSA approach is its flexibility. You can
use different trading rules to develop a
combined signal, change the number of
rules that trigger it, and apply it to differ-
ent time intervals.
The examples used here look for inter-
mediate- and longer-term trends. But you
can also use shorter-term rules to develop
a day-trading strategy. In addition, this
study used only long signals, but you
can use a combined approach to also sell
short, instead of simply exiting the mar-
ket. Finally, although the CSA strategies
tested in this study use daily prices, you
can always apply a combined framework
to rules that work with shorter or longer
data frequencies (tick, intraday, or
weekly).
The idea is simple — add multiple
rules together so each one gets a direc-
tional vote, which avoids problems
caused by conflicting signals.
Additionally, a combined signal appears
to be more powerful than individual rules
alone. This framework likely reduces the
noise or imperfections of individual trad-
ing rules and synthesizes dispersed infor-
mation into a more potent signal.
The concept is supported by statistical-
ly significant profits in the Dow, Nasdaq
Composite, and S&P 500 in different
time periods going back 50 years. By con-
trast, most trade rules, taken individually,
were unprofitable during this period.

For information on the author see p. 4.

ACTIVE TRADER • January 2009 • www.activetradermag.com 18

 TRADING Strategies
Scalping: Playing the lean
It’s not about the charts, says this trader. Scalping requires an understanding of the
order book rather than support and resistance levels.
BY JOHN GRADY
I
f you’re a day trader who has
always approached the market
from a technical analysis perspec-
tive, you might want to contem-
plate spending a little less time looking at
the charts and a little more time learning
how to read the order book.
Major players tend to look at charts
very infrequently. They’re aware of major
support and resistance, but once they’ve
made a mental note of where these levels
are, they stop looking at charts and start
watching the bids and offers.
Contrary to popular belief, scalpers
generally are not looking to capture the
bid-ask spread. Although scalpers might
take one tick if that’s all they think they
can get, they are typically shooting for
anywhere from three to seven ticks,
depending on current volatility. If the
market is roaring in one direction, they
will certainly take 15 or 20 ticks, rather
than simply getting out just to take a
profit. However, such moves are few and
far between. In general, scalpers are look-
ing to exit as soon as they feel the
momentum has died.
19
The scalper does not use a trailing The following scalp strategy is based
stop. If he is fairly certain a move is over on the concept of “leaning” on bids and
and he’s sitting in a six-tick winning offers. It’s a setup scalpers look for every
trade, he sees no reason to risk three day — a setup that can lead to the infa-
ticks to capture another unlikely three mous false breakout.
ticks. He will take his six-tick profit, One important aspect of this type of
move to the sidelines, and watch. If the trading is that you must have access to a
move continues, he can always buy market-depth trading platform — that is,
again. If it doesn’t, he covered at the right one that shows multiple levels of bids
price. and offers — to execute any scalping
Strategy snapshot
Strategy: Leaning on the bid/offer.
Strategy type: Intraday/scalping.
Logic: If traders keep selling into a bid just below a major resistance
level (based on the order book, not just a chart) and the price
refuses to “go offer,” it’s usually a good indication of strength —
a sign someone is going to try to run that level. The opposite
would be true for an offer that refuses to go bid just above a
major support level.
Entry: In the case of a long setup, attempt to enter just below or at
the resistance level (no higher than a tick or two above).
Reverse for a short setup.
Exit: Within three to seven ticks, in normal volatility conditions.
www.activetradermag.com • January 2009 • ACTIVE TRADER
strategy. If you’re using an execution plat- FIGURE 1: INTRADAY T-NOTE
form that only shows the inside bid and
offer, you are operating at a huge disad-
vantage and you will probably never
make money as a day trader.

Trading the lean

When entering with this strategy, you
want to either go with the trend of the
day or with a range breakout. For exam-
ple, say the market has been fluctuating
between 5 and 15 over the past hour and
has slowly been narrowing toward 15.
You are looking to buy the break through
at 15 — as it occurs, not too long after
the fact.

The analysis follows the price action in the 10-year T-note futures on Aug. 25,
2008. After an early-session run-up after an economic report release, the
The longs tipped their market settled into a tighter range.
Source: TradeStation
hand before the break.
116-26.5 bid, 116-27 ask, it stopped and down and were using it as resistance.
No matter how many traded at those two prices for a while. In this situation, scalpers short at 26 or
There were 1,700 contracts offered at 27 are trying to limit their risk to two or
times sellers hit the 116-27.5 and it was obvious traders three ticks. If it looks like 27.5 is going to
would be leaning on that price — which go bid (i.e., become the current bid
represented resistance not because it was price), they will try to cover there.
26.5 bid, the price a line on a chart but because of the large Scalpers who are looking to get long will
offer. In other words, shorts were hoping also try to buy at 27.5 because they know
wouldn’t go offer. the offer at 27.5 would keep the market continued on p. 21

For example, on the morning of T-note futures prices

Monday, Aug. 25, 2008, the U.S. 10-year
T-note futures (TYU08) made a large
spike up after the release of economic
data (Figure 1). The market stopped at
116-27.5 (a clear resistance level on any
chart) and quickly sold off to 116-24.
After a few minutes, price started to grind
back up again. When the market reached
Treasury futures prices indicate a percentage of “par” price, which for any
Treasury bond or note is 100. T-bond prices consist of the “handle” (e.g.,
100) and 32nds of 100. For example, 98-14 is a price that translates to 98-
14/32nds or $984.38 for a $1,000 T-bond. T-notes (the market referenced in
this article) are priced in a similar fashion, except they can include one-half
of a 32nd — for example, 98-14+ is 98-14.5/32nds, or 984.53 in decimal
form. For simplicity, the prices in this article leave off the “/32” at the end.

ACTIVE TRADER • January 2009 • www.activetradermag.com 20

Trading Strategies continued

the shorts are leaning on that offer.
This is an ideal situation because it
represents a spot where new money is
buying and scared money is exiting. That
combination is what causes sharp price
moves in one direction.
In contrast, the average trader might
be looking to make a trade once there is a
breakout through 27.5. A scalper is not
looking to buy or sell the breakout. He’s
looking to buy or sell before the breakout
or catch the breakout itself.
In this situation, the longs tipped their
hand before the break. No matter how
many contracts were sold into 26.5, the
price wouldn’t go offer: sell 500, stays 26.5
bid; sell 500 more, stays 26.5 bid; sell 300,
stays 26.5 bid. If traders keep selling into
a bid and “they” keep buying and bidding
that price, it’s usually an indication of
continued on p. 22

Order depth
The accompanying charts show snapshots of the 10-year T-note order book from Friday, Sept. 12, a day on
which the market’s momentum was to the downside. The middle columns show price levels (116030 represents
116-3/32, and so on). The blue columns to the left show bids; the red columns to the right show offers.
The market sold off sharply — 213 contracts traded at 116-01 and then heavy buying took place at 116-
01.5 (6,828 traded). This buying stopped the sell-off and the market retraced back to 03. However, the retrace-
ment was short-lived and the market couldn’t stay bid at 02.5 (notice the 10,381 contracts traded at this price);
no matter how many bids hit into 02.5, the market would not go up.
Finally, the longs lost the battle. The 1,336 at 01.5 traded and the market went 01.5 offer (Figure B).
Anyone leaning on that price was up the creek. The 01s got slammed and the market went straight to 115-31.

FIGURE A: SEPT. 12, BEFORE THE BREAKOUT FIGURE B: SEPT. 12, AFTER THE BREAKOUT

Source: X Trader

21 www.activetradermag.com • January 2009 • ACTIVE TRADER

Trading Strategies continued
serious strength. When this type of action
takes place just below a major resistance
level, it’s probably a sign someone is
going to try to run that level.
In this case, you want to buy at 26.5 or
27 or catch the break at 27.5 or 28
(maybe 28.5, tops). You don’t want to
buy at 29, 30, or 31 because this is where
big money will exit. If someone was long
3,000 contracts going into that break, he
is not looking for 10 ticks — he will try
to cover on the immediate move up and
will work offers between 29 and 31.
Otherwise, if the market suddenly stops
and he tries to dump 3,000 contracts, he
could end up pushing the market against
himself. Even if his selling doesn’t stop
the market, you don’t want to buy when
someone is dumping 3,000 contracts. You
want to buy when everyone is buying —
at 27.5.
The notion “Don’t follow the herd” is
nonsense. The saying should be “Follow
the herd and make a sharp right just
before you reach the edge of the cliff.”
Following the herd is a great way to
make money. The herd often includes
major players who have access to millions
of dollars and who buy and sell thou-
sands of contracts or shares — traders
who can actually move the market. You
have to anticipate what the herd is going
to do and then do it with them.
Of course, you don’t want to follow the
herd if it means you’ll be the one holding
the bag. This is why you shouldn’t buy at
30 or 31. But you certainly don’t want to
be standing in front of a stampede; you
don’t want to sell at 27.5 or 28 in this sit-
uation. If you know traders are leaning
on a price, don’t join the offer in an
22
attempt to keep the market down. You
will lose that battle.
Flipping
This scenario also offers an opportunity
for really big traders to hammer the
shorts. It’s quite possible the offer at 27.5
is not real — someone might be showing
size with no intention of actually selling.
The notion “Don't
follow the herd” is
nonsense. The saying
should be “Follow
the herd and make
a sharp right just
before you reach
the edge of the cliff.”
The trader who is long 3,000 contracts
at 26 might be the 1,700 offer at 27.5.
When the market gets heavily bid at 27,
he will pull his 1,700 offer and bid 2,000
at 27.5. This is called “flipping.” In one
instant, the player has transformed the
immediate market from a bearish to a
bullish condition. Traders who are
unaware of such tactics will be in for a
rude awakening.
However, no flipping has to take place
for the shorts to get hammered. What
www.activetradermag.com • January 2009 • ACTIVE TRADER
often happens is someone with a lot of
money buys everything in sight, which
was what happened on Aug. 25.
There were 1,700 contracts offered at
27.5 and 2,000 offered at 28 — and they
were all taken out at once. A huge trader
just plowed through the market —
bought 3,700 contracts and bid for 2,000
more at 28. No one even had a shot at
27.5 or 28. Shorts scrambled for the door
and the market was instantly 29.5 bid, 30
offer.
How will you know if an offer is real or
not? You won’t. How will you know if
someone is going to buy everything in
sight? You won’t. All you can do is look
for the kind of action described at 26.5
(no matter how many contracts were sold
into that bid, the market just wouldn’t go
down) and go long somewhere between
26.5 and 28.
No chasing
Although this was not one of those times,
there are plenty of times you can catch
the breakout as it’s happening. If you miss
the break and the market is suddenly
trading 29.5 bid by 30 offer as it did this
day, don’t go long. If you miss it, you
miss it. You can be sure the guy who
bought 3,700 contracts at 27.5 and 28
already had offers at 29, 29.5, and 30
before he bought. His whole intention
was to cause a sharp upward spike and
cover as people panicked. Other longs
who were waiting for that rally were also
covering at those prices. This is why you
see many “false” breakouts (as if there is
such a thing), and why technical analysis
kills many day traders.
On this day, the market touched

If traders are leaning
on a price, don’t join
the offer in an attempt
to keep the market
down. You’ll lose that
battle.
116-31 and then dropped all the way
back to 116-25. If you’re long in a sce-
nario like this, you want to cover when
the big money is covering. If you’re long
at 27 and the market spikes up, under no
circumstance should you let it come all
the way back to you. You might not want
to have an offer working at 29 as the mar-
ket is pushing up, but if you see it touch
31 and sell off back to 29.5, then you
want to get out at 29.
The technical trader who likes to buy
support and sell resistance will short at
27.5, and if his risk-control rules call for
a five-tick stop-loss and a 10-tick profit
target, he’ll exit the trade at 30 for a five-
tick loss and curse profusely while watch-
ing the market fall right back to 25.
The technical trader who likes to play
breakouts will buy at 30 with the idea
that resistance should become support, so
when the market falls back to 27 (below
the initial resistance of 27.5) he will exit
for a six- or seven-tick loss. He’s cursing
twice as much as the short trader because
he doesn’t understand why the breakout
didn’t work — and he has to watch as
the market touches 25 and then trades
ACTIVE TRADER • January 2009 • www.activetradermag.com
Related reading
“ Harris Brumfield: Pit trader gets wired””
Active Trader, December 2003.
Harris Brumfield, a pit trader turned screen trader turned technology
entrepreneur, talks about pushing the volume envelope and the future
of electronic trading.
“ Mark Oryhon: DAX scalper””
Active Trader, December 2005.
This active trader has developed the specialized skills necessary for integrating
fast-moving market data on the fly.
“ Momentum scalper””
Active Trader, August 2006.
A one-page Face of Trading profile of Richard Lopez, a 30-year-old trader
who uses a scalping technique.
“ Of molecules and markets””
Active Trader, June 2003.
A one-page Face of Trading profile of Andrew Ackerman, a 34-year-old trader
and former molecular biology research associate who uses a scalping
technique.
You can purchase and download past articles at
http://store.activetradermag.com
all the way back up through 30. are, but because he knows how to read
Neither of these traders know what the volume in the order book, he also has
happened because they don’t understand a good feel for whether the level will hold
the mindset of scalpers. or if a breakout will occur. Quite often,
he is the volume. The average trader can
Trading beyond the chart only buy or sell maybe five or 10 futures
Knowing where the numbers are is not contracts or a few hundred shares of
the problem for most day traders. It takes stock. He cannot move markets.
a minute to look at a chart and make a If you want to make money day trad-
note of major price levels. The problem ing, you have to think like the traders
for most day traders is that they do not who buy and sell thousands of contracts
know how to read the order book. Their and shares. And if you want to know
decision to buy or sell a certain price is what they are thinking, you have to
based upon nothing more than the fact watch the bids and offers, not the
the price is a “support” or “resistance” charts.

level on a chart.
A big scalper knows where the levels For information on the author see p. 4.
23
 TRADING Strategies
Developing a trading system
A look at systematic trading, warts and all.
BY ACTIVE TRADER STAFF
T rading strategies are typically
offered up in books and mag-
azines as sets of crisp rules or
programming code — neatly
packaged, off-the-shelf commodities
ready for consumption by the trading
public. However, little light is shed on
the process that went into arriving at
those trade rules — even if the results of
historical testing are discussed at length.
The next 11 issues of Active Trader will
attempt to remedy this situation in a
series of articles outlining our staff’s
development and implementation of a
mechanical trading system. The goal of
the series is to fully illustrate the process
of designing and trading a systematic
strategy and, more importantly, show the
realities of putting that strategy to work
in the markets by risking money on it.
We will embark on this journey with
as few preconceived notions as possible
and we will fully disclose all the steps we
take and the mistakes we make. We will
develop the trading idea from scratch.
And although we will make every effort
to develop a profitable strategy that will
perform well in the future — and we
have more than a casual interest in this
goal, since we will be risking our own
money on it — we have no guarantee of
success. (Also, we will be constrained by
certain realities, including the fact that as
full-time journalists we can trade only
part-time, and that we have only a small
amount of capital to risk.) We will pres-
ent the articles to our readers so they can
walk through the process with us and
learn from our missteps — and hopefully,
our successes.
The following topics will be covered
in the article series, but they do not rep-
resent everything it will touch upon. We
don’t know what direction our research
24
We hope to challenge
notions regarding the
ease and simplicity
of systematic trading,
and how different
trading is from both
historical testing and
“paper trading.”
will take us and we will report on the
process as it develops; there are many
other avenues this project might travel.
1. What market(s) we’ll trade,
and why.
2. The type of approach we’ll use,
and the practicalities that will
define it (amount of time available
to execute trades, etc.).
3. Defining the initial trade setup
and determining its performance
characteristics.
4. Developing a testing regimen.
5. Initial testing.
6. Fleshing out the system:
exit rules, money management,
and risk control.
7. Retesting.
8. Interpreting the test results.
9. Preparing to trade.
10. Trading the system.
11. Comparison to historical
performance and to simultaneous
paper trading.
In chronicling the good and the bad,
we hope the series will shed some light
www.activetradermag.com • January 2009 • ACTIVE TRADER
on the difficulties of system design and
systematic trading. More specifically, we
hope to challenge popular notions
regarding the ease and simplicity of trad-
ing in general — and systematic trading,
specifically — and how different trading
is from both historical testing and “paper
trading.” As we have noted many times in
Active Trader, the gap between analysis
and actual trading is a wide chasm
indeed.
As we start, it is apparent there are
many basic questions that appear easy to
answer but are quite complicated — and
which will have important repercussions
for the project as a whole. For example,
to begin research and testing, we have to
decide which instrument or instruments
we want to trade. That decision will
reflect certain assumptions and biases on
our part, and will shape the subsequent
research and trading. If we trade stocks,
which stocks, and why? Why futures, or
why forex? By opening one door we
automatically close others. We have to
make choices.
This might not be the case if we had a
large capital base to access, but we —
like many individual traders — do not.
Portfolio diversification is not a tool that
will be at our disposal. Nor are we con-
vinced a system must or should be traded
on a portfolio basis (one of the more
interesting concepts we will eventually
address).
Finally, we hope to solicit feedback
from our readers about the experiment as
it unfolds, and will launch a blog on our
Web site (www.activetradermag.com) for
that purpose.

Next month: Market selection and the
general trading approach or type of strategy
we want to trade.
 TRADING Strategies

Are options alternative ownership?

Maybe not
Outright option positions shouldn’t be thought of as casual substitutes for stock
or futures positions. They have advantages, but only in specific conditions.

BY KEITH SCHAP

Y
ou may have heard people
talk about options as an
alternative way to own a
stock, gold, a Treasury
note, or corn. The idea, these people say,
is that where an ounce of December gold
might cost $780 per troy ounce ($78,000
for one 100-troy-ounce contract), and
require $5,500 initial margin, a
December 800 call option might cost
only $31 per troy ounce, or $3,100 for
one contract. Buying a call option, then,
seems to be an inexpensive way to own
whatever it is you want to buy.
Table 1 displays a sample of futures
prices, a stock price, the cash-equivalent
value of one contract or round lot, the
initial margin requirement, a relevant
option strike price, the option quoted
price, and the dollar price for one options
contract. In every case, the call price is
well less than the margin requirement, to
say nothing of the cash-equivalent value.
However, this is short sighted because
it fails to take into account the true char-
acter of options and how they differ from
futures or stocks.
For one thing, when you buy a stock,
gold, corn, or a Treasury note, you can
hold your asset for a relatively long time
in anticipation of a price increase. This is
not the case when you buy a call option.
Time is the enemy of options buyers.
KC For more information about
the following subjects, go to
“Key concepts” on p. 63.
• Option greeks
(delta, gamma, theta, and vega)
• Implied volatility
• Out of the money
• At the money

TABLE 1: COMPARING FUTURES, STOCK, AND OPTION PRICES AND VALUES

Cash
Futures equivalent Initial Option Option Option
price value margin price price ($)
Gold $780/oz $78,000 $5,500 800 call $31/oz $3,100
Corn 433.50 ¢/bu. $21,675 $2,025 440 call 37.50 ¢/bu. $1,875
10-year T-note 111-24 $111,750 $2,970 112 call 1-51 $1,797
FedEx stock $59.67 $5,967 60 call $6.40 $640

The option prices may be less than the margin requirements, but this is only part of the picture when comparing options
to their underlying instruments.

25 www.activetradermag.com • January 2009 • ACTIVE TRADER

 TABLE 2: TIME DECAY’S IMPACT ON THE 112 CALL
Futures price Time IV Initial rate 112 call Change (64ths) Delta Gamma Theta Vega
111-24 90 7.8% 1.5% 1-38 0.4832 0.2870 -0.6098 14.1125
80 1-32 4
70 1-26 6
60 1-18 8 0.4771 0.3516 -0.7495 11.5258
50 1-11 7
40 1-02 9
30 0-56 10 0.4641 0.4964 -1.0649 8.1388
20 0-45 11
10 0-29 16

Repricing a 112 call option at 10-day intervals, assuming no futures price, IV, or interest rate changes, isolates the
time factor.

Further, the interaction of time decay, FIGURE 1: TIME DECAY

implied volatility (IV) change, and under-
lying futures or stock price change affects
options prices in ways futures or stock
traders simply do not have to contend
with.

Nailing down option pricing factors

Accounting for the interaction of these
pricing factors in terms of the option
greeks (delta, gamma, theta, and vega)
can seem complex and daunting, but a
few simple experiments can make it con-
crete and easy to understand.
First, consider the effect time has on an
option price. Assume 10-year T-note
futures (TY) are trading at 111-24, IV for The rate of decay accelerates, especially during the last three repricing periods.
the near-the-money 112 call is 7.8 per-
cent, the interest rate is 1.5 percent, and Two things are obvious. The 112 call theta value, the greater the effect of time
there are 90 days to option expiration. loses most of its initial value; the ending decay.
Given all this, a 112 call option will cost value is roughly 28 percent of the initial These numbers are negative to show
1-38 ($1,593.75). value. Also, the loss accelerates through- the passage of time erodes option value.
To isolate the time factor, reprice this out the entire period and especially dur- Notice the 60-day theta is roughly 0.14
option at 10-day intervals (down to 10 ing the last three repricing periods. greater than the 90-day theta. The 30-day
days until option expiration) assuming no The table includes the greeks at 90, 60, theta is 0.315 greater than the 60-day
futures price, IV, or interest-rate changes. and 30 days. For now, consider only the theta. This squares with the observation
Table 2 displays the results of this experi- theta column. Theta values represent the of an accelerating loss of option value.
ment and Figure 1 graphs them. option’s sensitivity to time; the larger the continued on p. 27

ACTIVE TRADER • January 2009 • www.activetradermag.com 26

Trading Strategies continued

TABLE 3: TABLE 4:
WHAT FUTURES PRICE BALANCES THE TIME DECAY? WHAT IMPLIED VOLATILITY BALANCES THE TIME DECAY?
Futures price Time 112 call price Implied volatility Time 112 call price
111-24 90 1-38 7.8% 90 1-38
111-30 80 1-38 8.2% 80 1-38
112-05 70 1-38 8.8% 70 1-38
112-11 60 1-38 9.5% 60 1-38
112-18 50 1-38 10.4% 50 1-38
112-25 40 1-38 11.6% 40 1-38
113-01 30 1-38 13.4% 30 1-38
113-08 20 1-38 16.4% 20 1-38
113-15 10 1-38 23.2% 10 1-38

The futures price changes required to offset The IV at 10 days must be almost three times
time decay are nearly the same, averaging greater than the IV at 90 days to hold the 112
7/32. call price at 1-38.

Now let’s look at how much the change in IV will change the option
futures price must rise at each 10-day price. Notice the vega values decrease in Toward the real
interval to neutralize the effect of time contrast to the increasing theta values. options trading world
decay and hold the 112 call price at 1-38. Clearly, an option with a 14 vega is more In the real world, none of these things
This experiment assumes no change in IV sensitive to IV change than an option happens in isolation. The market condi-
or the interest rate. Table 3 shows the with an 8 vega. As a result, it will take a tions driving futures price changes also
results. The futures price changes are all greater IV change to have the same effect tend to result in IV shifts. All these
nearly the same, averaging 7/32. Figure 2 on the option price, as apparent in Table options pricing factors — futures price,
graphs this information and again shows 4 and Figure 3. IV, and time decay — work together in
the futures price changes to be essentially
linear. FIGURE 2: THE INTERACTION OF FUTURES PRICE CHANGE AND TIME
A third experiment considers how
much the IV must increase at each 10-
day interval to neutralize the effect of
time decay and hold the 112 call price at
the initial 1-38 level. This experiment
assumes a constant 111-24 futures price
and no change in the interest rate. Table
4 and Figure 3 show the results of these
repricings.
Notice the IV at 10 days must be
almost three times greater than the IV at
90 days to hold the 112 call price at 1-
38. As the passage of time becomes
increasingly erosive, it takes greater IV
increases to achieve this balance.
The vega column in Table 2 sheds light The findings in Table 3 reflect an essentially linear relationship.
on this. Vega indicates how much a

27 www.activetradermag.com • January 2009 • ACTIVE TRADER

 FIGURE 3: THE INTERACTION OF TIME AND IMPLIED VOLATILITY CHANGE
(IN TERMS OF PERCENT CHANGE)
shaping options prices.
Two versions of another experiment
illustrate this interaction. Assume similar
initial market conditions as before, the
one exception being 7.5 percent IV
instead of 7.8 percent. Also, now assume
the 10-year T-note futures price trends
higher in regular 8/32 increments at each
10-day repricing moment. In the first
version of the experiment, IV increases
in quarter-percent (0.25 percent)
increments; in the second version, it
increases in half-percent (0.50 percent)
increments.
Table 5 displays the results of these
As time passes, it takes increasingly larger IVs to maintain the call price. continued on p. 29

TABLE 5: THE INTERACTION OF FUTURES PRICE, IV, AND TIME

Futures price Time IV 112 call price Change (64ths) IV 112 call price Change (64ths)
111-24 90 7.50% 1-34 7.50% 1-34
112-00 80 7.75% 1-39 5 8.00% 1-43 9
112-08 70 8.00% 1-44 5 8.50% 1-50 7
112-16 60 8.25% 1-48 4 9.00% 1-57 7
112-24 50 8.50% 1-52 4 9.50% 1-62 5
113-00 40 8.75% 1-55 3 10.00% 2-02 4
113-08 30 9.00% 1-57 2 10.50% 2-04 2
113-16 20 9.25% 1-58 1 11.00% 2-04 0
113-24 10 9.50% 1-58 0 11.50% 2-00 -4

The resulting call price changes yield relatively paltry returns.

TABLE 6: OTM CALLS ARE POOR CHOICES FOR LONG-TERM TRADES

Futures price Time IV 115 call price Change (64ths) IV 115 call price Change (64ths)
111-24 90 7.50% 0-34 7.50% 0-34
112-00 80 7.75% 0-36 2 8.00% 0-38 4
112-08 70 8.00% 0-37 1 8.50% 0-42 4
112-16 60 8.25% 0-37 0 9.00% 0-45 3
112-24 50 8.50% 0-37 0 9.50% 0-46 1
113-00 40 8.75% 0-35 -2 10.00% 0-46 0
113-08 30 9.00% 0-32 -3 10.50% 0-43 -3
113-16 20 9.25% 0-26 -6 11.00% 0-37 -6
113-24 10 9.50% 0-17 -9 11.50% 0-24 -13

With 10 days to option expiration the call price has decreased enough to result in a net loss.

ACTIVE TRADER • January 2009 • www.activetradermag.com 28

Trading Strategies continued

TABLE 7: BIG FUTURES PRICE AND IV CHANGES DURING A SHORT TIME MAKE FOR BIG OPTION RESULTS
Initial values $ value Ending values $ value $ result ROI
10-year T-note futures 111-24 113-24
Days to option expiration 90 80
Implied volatility 7.5% 8.5%
Interest rate 1.5% 1.5%

10-year T-note 112 call 1-34 1,531.25 2-51 2,796.875 1,265.625 82.65%
Delta 0.4820
Gamma 0.2985
Theta -0.5863
Vega 14.1108

10-year T-note 115 call 0-34 531.25 1-16 1,250.00 718.75 135.29%
Delta 0.2255
Gamma 0.2252
Theta -0.4432
Vega 10.6552

A shorter time frame minimizes the effect of time decay and maximizes the impact of futures price and IV increases.

two experiments. In both tables, the 112
call price increases, but the rate of the call
price increase slows, and in the case of
the larger IV increases, reverses direction.
Notice the paltry returns resulting from
these call price changes. In the case of the
smaller IV increases, the gain is only
24/64 ($375). The case of the larger IV
increases generates better results, but not
by much. The move from the 1-34 initial
call price to the 2-00 final call price
results in a 30/64 gain ($468.75). The
move from 1-34 to the 2-04 peak call
price amounts to a 34/64 gain, or
$531.25. These gains pale in the face of
the 2-00 ($2,000) futures price gain.
Option trading specialists frequently
recommend using out-of-the-money
(OTM) options rather than at-the-money
options such as the 112 call. Table 6 (p.
28) repeats the experiment of Table 5,
substituting the 115 call for the 112 call.
In both cases, the call price increases
slightly and then decreases enough to
result in a net loss at the repricing 10
days to option expiration. Clearly, this is
not a trade any rational trader would
want to make.
A better deployment of options
But the people who recommend using
OTM options rank among the best profes-
sional traders. The long, drawn out
sequences of Tables 5 and 6 must not be
what they have in mind. The inescapable
conclusion, it would seem, is that long
options positions are best suited to situa-
tions where you anticipate both a signifi-
cant futures price shift and a sharp IV
increase — preferably in a relatively short
time.
Suppose you were to buy either the

TABLE 8: IN THE RIGHT CIRCUMSTANCES, OPTIONS CAN OUTPERFORM FUTURES

Contract Initial No. of Position Position Net gain
cost ($) delta contracts delta cost ($) ($)
10-year T-note 2,970.00 1 10 10 29,700.00 20,000.000
112 T-note call 1,531.25 0.4820 21 10.12 32,156.25 26,578.125
115 T-note call 531.25 0.2255 44 9.92 23,375.00 31,625.000

When the trades are set up to have roughly matching exposures, in terms of position deltas, the options improve
considerably on the futures result.

29 www.activetradermag.com • January 2009 • ACTIVE TRADER

112 or the 115 call option given the ini-
tial market conditions from Table 5. Now
suppose the futures price rose two points
to 113-24 and IV rose to 8.5 percent with
80 days to option expiration. Table 7 dis-
plays the details of these two trades.
The shorter lifespan of these trades
minimizes the effect of time decay, and
the futures price and IV increases result
in larger gains. The net result of the 112
call trade is $1,265.625, which amounts
to an 82.65 percent return on investment
(ROI, which is derived by dividing the
dollar result by the initial dollar value:
1,265.625 / 1,531.25 = 0.8265). The net
result of the 115 call trade is $718.75,
which amounts to a 135.29 percent ROI.
Still, these dollar results fall significant-
ly short of the $2,000 futures gain. But
look at the deltas of these two calls. The
0.4820 delta of the 112 call indicates this
option has slightly less than half the
upside exposure of a futures contract (by
definition, the delta of a futures contract
is one). The 0.2255 delta of the 115 call
indicates this option has roughly 22.5
percent as much upside exposure as a
futures contract.
This means it requires a position long
21 of the 112 calls to have roughly the
same upside exposure as a position long
10 T-note futures, given these market
conditions (10 / 0.4820 = 20.75).
Further, it requires a position long 44 of
the 115 calls to have roughly the same
upside exposure as 10 futures contracts.
Table 8 shows the initial futures margin
and option prices for one contract, the
delta, the position cost (although margin
isn’t really a cost), the position delta, and
the net gain for positions long 10 T-note
futures, 21 of the 112 calls, and 44 of the
115 calls.
ACTIVE TRADER • January 2009 • www.activetradermag.com
Related reading
“Optionality: Why options are better than insurance”
Active Trader, November 2007.
Getting the most out of an options trade requires looking beyond the clichés
and understanding how these tools really work.
“Trading a trend: Adding options to futures”
Active Trader, March 2007.
Options can make it easier to take advantage of a longer-term trend, but you
have to get the details right.
“Keith Schap: Options Strategy Collection, Vol. 1”
This collection contains articles from 2005 and 2006 written by Active Trader
and Futures & Options Trader contributor Keith Schap, author of The
Complete Guide to Spread Trading (McGraw-Hill, 2006). In these articles, he
explores different options spreading techniques, seasonal trading strategies,
and ways all types of traders can use volatility to their advantage.
“Keith Schap: Futures Strategy Collection, Vol. 1”
This collection contains articles from 2005 and 2006 written by Active Trader
and Futures & Options Trader contributor Keith Schap, author of The
Complete Guide to Spread Trading (McGraw-Hill, 2006). These articles discuss
a variety of futures (including single stock futures) spreading techniques,
seasonal trading strategies, and using implied volatility in futures trading.
You can purchase and download past articles at
http://store.activetradermag.com
Once the trades are set up to have simple substitution.
roughly matching exposures in terms of Instead, outright call or put options
position deltas, the options improve con- should be the market tool of choice when
siderably on the futures result. Notice traders anticipate very particular underly-
also the lower cost of the 115 call; it’s ing price and IV developments within rel-
even lower than the futures margin. atively short time horizons. This use of
options allows you to capitalize on the
The bottom line inherent “optionality,” especially of an
Clearly, options should not be thought of OTM call. Taking advantage of the way an
as simple substitutes for futures or stock OTM call value accelerates under these
positions. The complex interaction of circumstances is the primary reason for
time decay and IV change, which does trading options in the first place.

not play a role in futures or stock
pricing, makes them ill-suited for this For information on the author see p. 4.
30
 ADVANCED STRATEGIES
Volatility and swap spreads
No market exists in a vacuum; each provides clues to where the others are going.
BY HOWARD L. SIMONS
F or those of you who wish to
become masters of counterin-
telligence, here is a surefire
method of interrogation to sep-
arate financial professionals from pre-
tenders: Start talking about swap spreads,
the shape of the yield curve, and the term
structure of fixed-income volatility. The
pros will remain interested while the
FIGURE 1: THE YIELD CURVE LEADS VOLATILITY
Bond traders get nervous when yields plunge to what they think are unsustainably
low levels. A steeper yield curve produced by Federal Reserve stimulus is viewed as a
temporary situation; bond traders start to buy insurance against its unwinding, push-
ing volatility higher.
31
poseurs will run out of the room scream-
ing for mercy.
This is a shame, for the intersection of
the market indicators provides valuable
insights into the direction of corporate
bonds and, by extension, stocks. A swap
spread is nothing more than the differ-
value of the yield curve.
Here is a chain of causation commonly
seen in the many financial crises of the
past fifteen years:
1.To the extent increased credit
stress induces a monetary response
ence between the Treasury rate and the from the Federal Reserve, a
fixed-leg of a swap, which is the present flight-to-quality leading to both a
steeper yield curve and to
higher short-term interest rate
volatility will ensue.
2.Higher short-term volatility
expands swap spreads (the
difference between Treasuries
and LIBOR-based interest
rate swaps).
3. As money flees to the safety
of the short-end of the yield
curve, swap spreads expand
faster there than at the
long-end of the yield curve,
thus leading to an inversion
of swap spreads, which lead
in turn to wider credit spreads
for corporate bonds and their
underperformance relative to
Treasuries; and finally pressure
on stocks.
As they say at quitting time,
that’s enough damage for one day.
As these relationships go a long
way toward narrating the demoli-
tion derby that was financial mar-
kets between January and
September 2008, let’s take a look
www.activetradermag.com • January 2009 • ACTIVE TRADER
 FIGURE 2: THE TERM STRUCTURE OF INTEREST RATE VOLATILITY

at how they link together.

The yield curve

The steeper yield curve as measured
by the forward rate ratio between
two and 10 years (FRR2,10), the rate
at which we can lock in borrowing
for eight years starting two years
from now, divided by the 10-year During the 2000-2002 and 2007-2008 steepenings of the yield curve, the one-
rate itself, leads the implied volatili- and especially the two-year note’s implied volatility shot higher, and by September
ty on zero-coupon two-year they reached levels seen for Third World countries during currency crises.
Treasuries by thirteen weeks on
average. An FRR2,10 greater than
1.00 indicates a positively sloped FIGURE 3: TEN-YEAR NOTE YIELDS AND SWAP SPREADS
yield curve; an FRR2,10 less than
1.00 indicates an inverted yield
curve.
The relationship broke in June
2008, marked with a green arrow
in Figure 1, when Federal Reserve
Chairman Ben Bernanke indicated
he was inclined toward raising
short-term interest rates, but then
it resumed in force.
This relationship should not be
surprising at all; bond traders get
nervous when yields plunge to
what they consider to be unsus-
tainably low levels. A steeper yield
curve produced by Federal Reserve
stimulus is viewed, correctly, as a
temporary situation, and bond
traders start to buy insurance
against its unwinding. This is why
volatility rises in such a cycle.

Term structure of volatility

Thanks to the successive efforts of Swap spreads tend to rise in times of financial stress as investors move from the
former Fed Chairman Alan counterparty credit risk of the LIBOR world to the perceived safety of Treasuries. This
Greenspan and Bernanke in pro- relationship is likely to be distorted in the future as the bond market grapples with
continued on p. 33 the astounding levels of federal debt created during the various bailouts of 2008.

ACTIVE TRADER • January 2009 • www.activetradermag.com 32

Advanced Strategies continued

FIGURE 4: U.S. SWAP SPREADS SINCE JAN. 22, 2008

viding us with two grand social experi-
ments in rapid and violent steepenings
and flattenings of the yield curve, we can
map how the term structure of volatility
changes during these events.
Most bond traders regard the long end
of the yield curve, 10- and 30-year bonds,
as being more volatile because their tick
movements and dollars per trade move
more. It takes a little bit of training to
remind ourselves the opposite is true; the
shorter the maturity of an interest-rate
instrument, the more volatile the change
in its yield even though the dollar impact
of that volatility will be less.
During the 2000-2002 and 2007-2008
steepenings of the yield curve, the implied
volatility term structure distorted in
response to this verity (Figure 2, p. 32).
The more stressed the markets become, the more inverted the term of swap The one- and especially the two-year
spreads. The shorter-dated swap spreads moved to levels well over their note’s implied volatility shot higher, and
longer-dated counterparties — a trend that exploded higher during the by September reached levels seen for
September 2008 financial crisis. (Each color band = 5 basis points.) Third World countries during currency
crises, not to cast aspersions
on our beloved Federal
Reserve. The volatility of the
FIGURE 5: RISING SWAP SPREADS RAISE CORPORATE CREDIT SPREADS longer-dated bonds, the 10-
and 30-year issues, rose in
both instances, but nowhere
near as much.

Impact on swap spreads

Swap spreads tend to rise in
times of financial stress as
investors move from the coun-
terparty credit risk of the
LIBOR world to the “safety”
of Treasuries — safety being
a relative term when the
after-tax constant-dollar yield
on Treasuries spent much
of early 2008 in negative
territory.
We can map the paths of
10-year Treasuries and swap
spreads over time (Figure 3,
p. 32). The 1998 Long Term
Capital Management crisis and
the 2007 subprime crisis, both
Rising swap spreads reflect increased stress in the financial system, which should be
highlighted with a green verti-
reflected in credit spreads rising after swap spreads.
cal line, have a similar look.
This relationship is likely to be

33 www.activetradermag.com • January 2009 • ACTIVE TRADER


distorted in coming years as the bond
market grapples with the astounding lev-
els of federal debt created during the
various bailouts of 2008.
Term structure of swap spreads
Swap spreads also have a term structure.
The lesson here is quite parallel to that
seen for the volatility market, which
makes sense given their similar impetus-
es from risk and sustainability considera-
tions: The more stressed the markets
become, the more inverted the term of
swap spreads.
If we map swap spreads across a range
of tenors, or maturities, from the Jan. 22,
2008 panic low, we see how the shorter-
dated swap spreads moved to levels well
over their longer-dated counterparties
(Figure 4). This trend exploded higher
during the September 2008 financial cri-
sis. These inversions are hardly a sign of
market health; they indicate banks are
less willing to trade with each other than
with the Treasury and demand a higher
spread in recompense.
Impact on corporate bonds
Finally, let’s see how swap spreads affect
corporate bonds, both investment-grade
and high-yield. If rising swap spreads
reflect increased stress in the financial
system, then we should expect the credit
spreads to rise after swap spreads do.
If we map the option-adjusted spreads
for both investment-grade and high-yield
corporate bonds led by the same 13
weeks we used before in discussing the
relationship between volatility and the
yield curve, we should see a tight rela-
tionship, and we do (Figure 5).
Following the money
There you have it: Enough to bore the
KGB into submission, but enough to
know when to buy or avoid corporate
bonds and, by extension, stocks. No
capital market exists in a vacuum, and
each one provides clues to where the
others are going.

For information on the author see p. 4.
ACTIVE TRADER • January 2009 • www.activetradermag.com
Related reading: Other Howard Simons articles
“ REITs as macro indicators””
Active Trader, December 2008.
Take a look at the sometimes surprising performance of REITs over the past
several years.
“ Deconstructing the commodity surge””
Active Trader, November 2008.
Analysis of the factors driving the commodity boom offers insight regarding the
appropriate way to approach futures markets.
“ The flight-to-quality trade””
Active Trader, October 2008.
The rule has seemingly always been: Don’t ever be short bonds when stocks are
getting clobbered. Is it still valid?
“ Nothing could be finer than being a data miner””
Active Trader, September 2008.
Analysis of large moves in three markets has interesting implications for system traders.
“ Putting the put-write right””
Active Trader, August 2008.
Looking for a different edge in the stock market? See what comparing the Buy-Write
(BXM) and Put-Write indices (PUT) reveals about the path of least resistance in the stock
market.
“ Crush spreads in a biofuel age””
Active Trader, July 2008.
Take a look at how the biofuel industry is changing the soybean market crush spread.
“ Energy stock movers and shakers””
Active Trader, June 2008.
The surprising results of analyzing the connection between oil and natural gas prices
and the performance of energy stocks.
“ TIPS, treasuries, and insurance””
Active Trader, May 2008.
Do TIPS really have an advantage over regular T-notes and T-bonds?
“ Gold: Sound and fury, signifying nothing””
Active Trader, April 2008.
Gold has burst to new highs as the U.S. stock market and dollar have tanked, but don’t
believe the easy explanations about the yellow metal’s role as an inflation barometer or
hedge.
“ Had enough of the dollar and stuff? ”
Active Trader, March 2008.
Analysis shows the relationship between the dollar and commodity prices isn’t what
most people think.
“ Oil prices and global petroleum inventories””
Active Trader, February 2008.
Is an oil shock — and even higher prices — a real possibility?
“ Bonds and the first rule of trading””
Active Trader, January 2008.
Where do we stand after a 25-year bond bull market? Get ready to adjust your T-bond
and T-note strategies.
“ Howard Simons: Advanced Currency Concepts, Vol. 1””
A discounted collection that includes many of the articles listed here.
You can purchase and download past articles at http://store.activetradermag.com
34
 TRADING System Lab

Double-repo systems
Double repenetration
FIGURE 1: SAMPLE TRADE
of a simple moving
average sets up both
long and short
positions.

BY VOLKER KNAPP

Market: Futures.

System concept: In his book

Trading with DiNapoli Levels, Joe
DiNapoli describes the double
repo indicator, which represents
the double repenetration of a spe-
cialized short-term moving aver-
age. The system was initially
designed to trade from the short
side. Here we will test both short-
In this ideal scenario, corn peaks in summer 2008, quickly creates a triple top, and
side and long-side versions of the
then turns south.
system, the former on futures and
Source: Wealth-Lab Developer 5.1
the latter on stocks.
The trade setup begins when a
price thrust occurs. The definition of thrust is flexible; DiNapoli
does not provide a systematic definition in his book. In these 1. Setup:
tests, it is defined as a move that exceeds the high 10 days ago a) Detect thrusting market action when today’s high
by a multiple of the average true range (ATR). This makes the is more than four times the 10-day ATR above the
parameter responsive to market volatility. high 10 days ago.
In a proscribed amount of time of the up thrust, price must
close below a displaced simple moving average (SMA), which is b) Within 10 days of this thrust, identify when price
a moving average shifted forward a certain number of bars; close closes below a three-day displaced SMA.
back above the displaced SMA; then close a second time (the
double repo) below the displaced SMA. DiNapoli uses a three- c) Wait for the closing price to cross back above the
day simple moving average (SMA) displaced by three days; other three-day displaced SMA.
moving average lengths could be tested.
The technique as DiNapoli originally described it also includ- 2. Entry (futures): When price closes below the
ed Fibonacci levels, profit objectives, and specific displaced three-period displaced SMA a second time, enter short
moving averages. The version tested here is a limited, objective tomorrow on a stop at today’s low.
representation of the pattern.
Note: The entire setup and trade signal must occur
Strategy rules: within a 10-day span.
The setup rules are identical for the short (futures) and long
(stock) versions of the systems. The entry and exit rules differ 3. Exit: Cover short at the market tomorrow when
for each market. the 13-day SMA crosses above the 26-day SMA.

35 www.activetradermag.com • January 2009 • ACTIVE TRADER

 FIGURE 2: EQUITY CURVE
KC For more information about the
following concept, go to “Key concepts”
on p. 63.

• Average true range

• Fibonacci levels
• Simple moving average

The sample trade in Figure 1 illus-

trates a model case where the moving
average crossovers happen relatively
quickly.

Money management: Allocate 3

percent of account equity per position.

Starting equity: $1,000,000.

Deduct $2.5 commission and one tick
of slippage per trade.
The equity curve can be divided into three periods: two quick profit-earning
Test data: The system was tested on periods separated by a long drawdown from 2001 to 2007.
the Futures & Options Trader Standard Source: Wealth-Lab Developer 5.1
Futures Portfolio, which contains the
following 20 contracts: British pound
(BP), soybean oil (BO), corn (C), crude FIGURE 3: PERCENT DRAWDOWN
oil (CL), cotton 2 (CT), E-Mini Nasdaq
100 (ND), E-Mini S&P 500 (ES), 10-
year T-Notes (TY), Euro currency (EC),
gold (GC), Japanese yen (JY), coffee
(KC), wheat (W), live cattle (LC), lean
hogs (LH), natural gas (NG), sugar
(SB), silver (SI), Swiss franc (SF), and
T-Bonds (US).

Test period: October 1998 to

September 2008.

Test results: The results were not

very encouraging — the system gener-
ated a profit of just less than 52 per-
cent over the course of a decade. It sig-
naled only 121 trades and had a win-
ning percentage of just 45 percent.
However, the low market exposure An extended drawdown and low activity were big challenges for this system.
(around 7 percent) suggests risking a Source: Wealth-Lab Developer 5.1
bit more than we did (3 percent equity
continued on p. 37

ACTIVE TRADER • January 2009 • www.activetradermag.com 36

 Trading System Lab continued

STRATEGY SUMMARY: PROFITABILITY

STRATEGY SUMMARY: TRADE STATISTICS Profitability
Trade statistics Net profit: $591,842
No. trades: 121 Net profit: 51.98%
Win/loss: 45.45% Profit factor: 1.62
Avg. profit: 0.76% Payoff ratio: 1.76
Avg. hold time: 43.65 Recovery factor: 2.27
Avg. profit (winners): 5.24% Exposure: 6.96%
Avg. hold time (winners): 51.76 Commission paid: $598
Avg. loss (losers): -2.97% Drawdown
Avg. hold time (losers): 36.89 Max DD: -17.52%
Max consec. win/loss: 5/4 Longest flat period: 1742 bars

per position) could have brought in more profit.
On the bright side, the average profit per trade was a solid
0.76 percent, or about $4,300 — enough to not have to worry
about trading costs.
The equity curve (Figure 2) can be divided into three periods.
The first one lasted until 2001 and was marked by increasing
equity. In these three years, the system was able to earn nearly
30 percent. The next phase was an extremely prolonged draw-
down (seven years), which bottomed out in March 2004 and
finished near the end of 2007. The profits were essentially flat
these years, moving back and forth. Finally, 2008 began another
major profitable period — similar to the first in amplitude,
but much more volatile.
On the whole, the system appeared to profit cyclically, gain-
ing in short bursts after excruciating waits. Although Figure 3
shows the actual loss was never greater than 17.5 percent, it’s
hardly possible to use a trading system that generates no signs of
life for so long.
The worst time for trading, emphasized in Figure 4, was 2001
to 2003 as commodities bottomed out before beginning a multi-
year rise. However, the system did virtually nothing in 2005 and
2006.
Figure 5 reveals out-of-balance net profit with lean hogs (LH)
and corn (C) contributing the vast majority of profits.

PERIODIC RETURNS
% profitable Max consec. Max consec.
Avg. return % Sharpe ratio Best return % Worst return % periods profitable unprofitable
Monthly 0.39 0.03 13.18 -7.57 44.17 5 9
Quarterly 1.20 0.02 20.55 -5.00 47.50 5 4
Annually 4.22 0.09 21.20 -4.52 54.55 2 3

LEGEND ning trades. Avg. hold time (winners) — The average holding time

Net profit — Profit at end of test period, less commission. Profit factor for winning trades. Avg. loss — The average loss for losing trades.

— Gross profit divided by gross loss. Payoff ratio — Average profit of Avg. hold time (losers) — The average holding time for losing trades.

winning trades divided by average loss of losing trades. Recovery fac- Max consec. win/loss — The maximum number of consecutive win-

tor — Net profit divided by maximum drawdown. Exposure — The ning and losing trades.

area of the equity curve exposed to long or short positions, as opposed
to cash. Max. DD — Largest percentage decline in equity. Longest flat
period — Longest period, in days, the system is between two equity
highs. No. trades — Number of trades generated by the system.
Win/loss — The percentage of trades that were profitable. Avg. profit
— The average profit for all trades. Avg. hold time — The average
holding period for all trades. Avg. win — The average profit for win-
Avg. return — The average percentage for the period. Sharpe ratio
— Average return divided by standard deviation of returns (annualized).
Best return — Best return for the period. Worst return — Worst
return for the period. Percentage profitable periods — The percent-
age of periods that were profitable. Max consec. profitable — The
largest number of consecutive profitable periods. Max consec. unprof-
itable — The largest number of consecutive unprofitable periods.

37 www.activetradermag.com • January 2009 • ACTIVE TRADER

 FIGURE 5: PROFIT CONTRIBUTION
FIGURE 4: ANNUAL RETURNS

The system suffered three consecutive losing years as the commodities

Lean hogs and corn were responsible for
markets bottomed out.
the majority of profits.
Source: Wealth-Lab Developer 5.1
Source: Wealth-Lab Developer 5.1

Bottom line: This system was not optimized. We tested the Nonetheless, trading this pattern from the short side, as taught
double-repo signal across a wide range of exit and parameter by the author, although profitable, lacked consistency as well as
combinations — mixing channel breakouts, profit-taking stops, an attractive rate of return.

and time-based exits — and found some profitable results.

Test 2: Stocks
In tests of the regular double repo pattern on various stock port- tomorrow on a stop at today’s high.
folios (not shown), the short-side system was always a loser —
no wonder, given the multi-year stock market uptrend that last- Note: The entire setup and trade signal must occur
ed until late 2007. within a 10-day span.
As a result, the following stock test reverses the signals — i.e.,
the setup remains the same, but the system now goes long 3. Long exit: Sell at the market tomorrow when the
instead of short. continued on p. 39
1. Setup: FIGURE 6: SAMPLE TRADE-TEST 2
a) Detect thrusting market
action when today’s
high is more than four
times the 10-day ATR
above the high 10 days
ago.
b) Within 10 days of this
thrust, identify when
price closes below a
three-day displaced
SMA.
c) Wait for the closing price
to cross back above the
three-day displaced
SMA.

2. Entry (stocks): When price

closes above the three- This example of a failed double-repo pattern occurred during a prolonged uptrend
period displaced SMA a and resulted in a nearly 100-percent profit.
second time, enter long Source: Wealth-Lab Developer 5.1

ACTIVE TRADER • January 2009 • www.activetradermag.com 38

Trading System Lab continued

13-day SMA crosses below the

26-day SMA. FIGURE 7: EQUITY CURVE-TEST 2

Figure 6 shows a signal in Freeport

Moran (FCX) that captured a long
uptrend and generated a nearly 100-per-
cent profit.

Money management rules:

Allocate 10 percent of account equity per
position.

Starting equity: $100,000. Deduct

$2.5 commission and 0.10 percent slip-
page per trade.

Test data: The system was tested on

the S&P 500 stocks as well as the Active
Trader Standard Stock Portfolio, which
contains the following 17 stocks: Apple
Inc. (AAPL), Boeing (BA), Citigroup (C),
Caterpillar (CAT), Cisco Systems
(CSCO), Disney (DIS), General Motors The system produced a consistent equity curve throughout most of the test
(GM), Hewlett Packard (HPQ), period.
International Business Machines (IBM), Source: Wealth-Lab Developer 5.1
continued on p. 40

STRATEGY SUMMARY: PROFITABILITY STRATEGY SUMMARY: TRADE STATISTICS

Profitability Trade statistics
Net profit: $241,841 No. trades: 1,080
Net profit: 241.84% Win/loss: 40.09%
Profit factor: 1.62 Avg. profit: 2.44%
Payoff ratio: 2.70 Avg. holding time (days) 27.20
Recovery factor: 4.63 Avg. profit (winners): 13.60%
Exposure: 60.86% Avg. hold time (winners): 43.13
Commission paid: $5,393 Avg. loss (losers): -5.03%
Drawdown Avg. hold time (losers): 16.53
Max DD: -14.32% Max consec. win/loss: 10/16
Longest flat period: 374 bars

PERIODIC RETURNS
% profitable Max consec. Max consec.
Avg. return % Sharpe ratio Best return % Worst return % periods profitable unprofitable
Monthly 1.10 0.60 23.05 -6.00 57.50 6 6
Quarterly 3.33 0.62 26.78 -5.84 60.00 5 3
Annually 12.73 0.52 47.26 -5.21 81.82 5 1

39 www.activetradermag.com • January 2009 • ACTIVE TRADER

 FIGURE 8: PERCENT DRAWDOWN-TEST 2
Trading System Lab continued

Intel (INTC), International Paper (IP), J.P.

Morgan Chase (JPM), Coca Cola (KO),
Microsoft (MSFT), Starbucks (SBUX),
AT&T (T), and Wal-Mart (WMT). Data
source: Yahoo.com.

Period: October 1998 to September

2008.

Test results: Tested on the small Active

Trader portfolio, the system was spiritless
and produced too few trades (around 50).
To generate more trades, the system was
next applied to all of the S&P 500 stocks.
This resulted in 1,080 trades; 390 signals
were rejected because of money manage-
ment constraints.
The equity curve in Figure 7 shows Most of the system’s drawdowns were short and shallow.
steady gains for almost the entire test peri- Source: Wealth-Lab Developer 5.1
od, with low drawdowns from which the
system recovered quickly (374 bars at
FIGURE 9: ANNUAL RETURN-TEST 2
worst).
The exit rule (after a SMA crossunder)
resulted in some quintessential trend-fol-
lowing numbers, including the 40 percent
winning percentage and the 2.70 payoff
ratio.
The manageable maximum drawdown
of -14.3 percent (Figure 8) makes it possi-
ble to cope, and the strong 4.6 recovery
factor leaves no doubt that the strategy can
overcome future drawdowns. The portfo-
lio's exposure is moderate at about 61 per-
cent, leaving room for an uncorrelated sys- The system was profitable all but two years.
tem to further reduce the risk of trading. Source: Wealth-Lab Developer 5.1
Overall, the system gained 13 percent
on an annualized basis, slightly outper-
forming the buy-and-hold strategy overall (241.8 percent vs. influenced by the fact that the test period was dominated mostly
231.6 percent net profit). The average profit (2.4 percent) was by a strong bull trend.

enough to eliminate execution issues, since the system trades on
stop orders. For information on the author see p. 4.
On an annual basis, as Figure 9 illustrates, only two years Trading System Lab strategies are tested on a portfolio basis (unless otherwise
(2002 and 2008) were losers, and relatively small ones, at that noted) using Wealth-Lab Inc.’s testing platform. If you have a system you’d
(-5.2 percent and -3.7 percent, respectively). like to see tested, please send the trading and money-management rules to
editorial@activetradermag.com.

Bottom line: The double repo, essentially a countertrend pat-
tern that resembles a double top following an upward thrust,
seems best traded from the long side in the stock market.
Although it barely outperformed buy-and-hold, its risk was
much lower. Coupled with a trend-following exit, it creates a
strategy with a moderate risk level. However, the results are
Disclaimer: The Trading System Lab is intended for educational purposes
only to provide a perspective on different market concepts. It is not
meant to recommend or promote any trading system or approach.
Traders are advised to do their own research and testing to determine
the validity of a trading idea. Past performance does not guarantee
future results; historical testing may not reflect a system’s behavior in real-
time trading.

40 www.activetradermag.com • January 2009 • ACTIVE TRADER

 The Face of TRADING Trading setup
Hardware: PC: Intel Quad core 2.4 GHz
with 3 GB RAM, two 19-inch flat panel monitors.

Twists and turns Laptop: Pentium 1.7 GHz with 1.23 GB RAM.
Software: TradeStation, Interactive Brokers,
Button Trader.
BY ACTIVE TRADER STAFF Internet connection type: Redundant DSL
and cable for back-up.
Brokerage type: Interactive Brokers.

Name: Nolan Marchand and had been running as a youth hostel.
Age: 40 He left New Orleans and resettled in
Lives/works in: San Clemente, Calif. Portland, Ore., where he began dabbling
in currency trading. However, he mostly
just bought and held the Euro, riding the
I’ve learned through expensive trial and
error that if I deviate from my plan and
start taking more aggressive trades, I lose
money.”
Marchand has also learned the impor-

N
olan Marchand first gained
exposure to trading through a
summer job during college as
a runner on the options floor
at the Pacific Stock Exchange in San
Francisco.
“This was back when it was still an
open outcry auction,” he says. “It was
very exciting, even though I didn’t know
the first thing about options. The firm I
worked for traded their own account and
didn’t share many details about their
methodology. The only thing I really
learned was that if there is a flu bug
going around on the trading floor, every-
body gets it.”
His next exposure came after college
while working in Italy for two years as
Europe switched over to its new common
currency, the Euro. Marchand, a high-
school math teacher at an American
School in Rome, was paid in lira.
Interested in how the changeover would
impact his savings, he held some money
in Euros and watched exchange rates and
the fluctuations in his account. From
there, he started reading books on trad-
ing, the markets, and technical analysis.
However, Marchand’s career took sev-
eral twists and turns. He returned to the
U.S. and taught high-school math a few
more years. Then he ventured into the
mortgage brokerage business for four
years, and he also rehabbed real estate in
New Orleans.
Marchand was living in New Orleans
when Hurricane Katrina hit and devastat-
ed an old rooming house he had restored
major uptrend that occurred in recent
years.
After deciding to relocate to a better
climate in California in early 2008,
Marchand took the leap to full-time trad-
ing, with very little experience under his
belt. Marchand had set aside enough
money to pay his living expenses for a
year, so he didn’t have to support himself
through trading. He was attracted to the
flexibility a trading lifestyle could offer.
Initially, Marchand admits his trading
was “schizophrenic” as he attempted to
chase individual stocks based on chat
room tips. However, through attending
trading seminars and meeting a mentor,
he has developed the very specific trading
style he now implements.
Trading Methodology: Marchand is
a purely technical trader, scalping in E-
Mini stock index futures. He puts on
roughly three to five trades per day,
which last approximately one to five min-
utes. He monitors 1-, 2-, 5-, 15- and 60-
minute and daily charts as he seeks to
trade with the trend, entering on pull-
backs. He trades both the long and short
side.
“I buy the first pullback from a base
breakout, making sure there is support
below and [no resistance above],” he
says. “I hold my first contract for 10 ticks
and my second contract gets trailed bar-
by-bar on the one-minute chart. It may
sound boring, but it works over and over
again. I may only get three setups in a
day. I may get 10. I may not get any. But
tance of stepping away from trading
intraday.
“If I put on a trade and [it becomes] a
losing trade, I set my kitchen timer and I
don’t make another trade for 15 min-
utes,” he says. “That’s how I’ve gotten
through my revenge-trade mentality.”
Marchand has a set dollar amount for a
daily goal. If he hits his goal and keeps
on trading, but then gives back a third of
profits, he’ll stop trading for the day. Or,
if he is down $400 for the day, he’ll stop
trading.
Became profitable when: He
developed a rule-based trading plan,
wrote it down, and taped it to his moni-
tor.
“In between trades, I force myself to
re-read these rules.”
Most important lesson learned:
“Don’t look for excitement. I look for bor-
ing, predictable patterns.”
Best thing about trading: “If I hit
my daily goal and it’s an hour into the
morning, I can do other things.”
Best trading books: Pristine course
textbooks, Trading in the Zone by Mark
Douglas.
When not trading: Marchand gar-
dens, spends time with his girlfriend,
cooks, and swims in the ocean. He takes
care of his health through yoga, medita-
tion, and vitamins.

ACTIVE TRADER • January 2009 • www.activetradermag.com 41

 Q& A
Ken Grant on risk
It’s no time to gamble, according to this top risk manager. Until things settle down,
traders on both sides of the equity market are likely to get burned.

BY MARK ETZKORN FIGURE 1: AFTER THE 1987 CRASH

K en Grant, founder of New York-based risk-

management firm Risk Resources, concluded
his Oct. 23 newsletter with an observation
and a request: “The next several weeks are
likely to resemble the last several weeks, which is to say
that they will be murder to endure. I think that low or no
risk is the way to go, but I guess you probably have sur-
mised that already. But this time is different; this time I’m
not asking, I’m begging you to be careful.”
Volume dropped sharply after the 1987 market crash, and it took
Although this might sound like shutting the corral door
years for trading activity to return to earlier levels.
long after the bull has made its exit, Grant had begun
sounding warnings about the high level of risk in the mar-
FIGURE 2: CONTRACTING VOLUME
kets 15 months earlier in 2007 — long before what many
thought would be a market correction turned out to be a
full-blown collapse.
Grant is not just another talking head warning of the
perils of the current market. Risk Resources, the 12-
employee firm he launched three years ago, specializes in
hedge-fund risk management, and also consults for institu-
tions, including the Chicago Mercantile Exchange, on risk
matters.
“We create and manage hedge funds’ reporting plat-
forms,” he says. “I think we’re the only firm around that’s
doing bona fide outsourcing of risk management.”
Grant started the firm after a career in the risk-manage-
ment trenches that included stops at the Merc and French
bank Sociétié Générale, capped by several years with Steve Volume has already dropped in the stock market in the aftermath
Cohen’s SAC Capital and Paul Tudor Jones’ Tudor of the September-October flush-out.
Investments — firms at which he was in charge of design-
ing and maintaining the risk infrastructure that dictated how already been pulled out of the market (see “Hedge-fund industry
much traders could risk, the firms’ exposure, and how to maxi- shrinks by $210 billion in Q3,” p. 53), Grant pointed out there
mize trader profitability. (See “Ken Grant: Confessions of a risk was much more liquidation on the horizon — and the market’s
manager,” Active Trader, December 2004.) high volatility and contracting volume promised to make the
Grant was in no small part responsible for breaking the story of remaining redemptions more, not less, problematic than those
the hedge-fund redemption situation as the market sell-off that had already occurred. (However, he believes the situation is
reached a crescendo. Although billions of hedge-fund dollars had manageable.)

42 www.activetradermag.com • January 2009 • ACTIVE TRADER

 FIGURE 3: RECORD VIX
High volatility and low volume are part
and parcel of a crash or flush-out. Volume
contracted for more than a year after the
1987 stock market crash, and didn’t recov-
er to pre-crash levels for nearly three years
(Figure 1). A volume drop-off manifested
itself immediately after the initial Oct. 10,
2008 panic low (Figure 2), and volatility
in the S&P 500 index in October and early
November reached historic levels (see
“Opening Trades” on p. 10 for details).
I spoke with Grant in the hour leading
up to the Federal Reserve’s interest-rate
announcement on Oct. 29. He elaborated
on his assessment of the financial crisis
and the unique situation the markets were The CBOE volatility index (VIX) came
in as the year was winding down. close to 90 as the market tumbled in
October. The VIX’s median daily close
AT: You pretty much laid it on the line over the past five years is a little
in your last newsletter. below 15.
KG: I’ve quite consistently recommended Source: TradeStation
people cut risk for about 15 months, and
at every leg of the current situation I’ve
tried to be a little more emphatic.
Around the time of the Lehman bankruptcy I basically said,
“Look, we’re in uncharted territory — don’t trade. There’s no road
map here. Whatever skill set has gotten you to where you are is
not likely to serve you in good stead here. An environment in
which people can use investment-type analytical tools and insight
to produce returns with consistency has utterly disappeared.”
After I put that report out, the VIX pounded its way toward 90
(Figure 3). The market still seemed completely broken to me and I
wanted to be on record saying conditions were still deeply sub-
optimal.
“ The short side is probably even more
treacherous than the long side.”
AT: What did you see 15 months ago that made you advise
people to dial down their risk?
KG: I had absolutely no idea this was going to become what it
has, but it was fairly clear to me there were very significant, con-
centrated risks the market couldn’t handle. I thought the risk pre-
mium would continue to rise until we knew the extent of the
credit problems in the economy.
ACTIVE TRADER • January 2009 • www.activetradermag.com
In August 2007 when the market really
started to look pretty bad — multi-billion-
dollar quant strategies started having dou-
ble digit monthly drawdowns, which were
unheard of, and every week there was more
bad news out of the credit space — I
thought a couple of things would happen:
Banks would write off many billions of dol-
lars of credit losses and the Fed would
flood the market with liquidity. Both those
things came to pass. But I’m not claiming I
had any huge foresight here — what I
thought could happen was a small fraction
of what actually transpired.
For instance, I made a pretty aggressive
negative call on equities on Dec. 31 in my
quarterly newsletter. I said there were two
things that were going to push this market
down. First, the market couldn’t rally until
the banks came clean and, second, the mar-
ket wanted cheaper money and would get
it — but this wouldn’t rally equities. I
thought that was a reasonably bold call, but
what has happened in 2008 has been about five times as bad as
my worst-case scenario.
It also was pretty clear to me in, say, December, there was a lot
of “tape-painting” going on. When the markets rallied in
December it didn’t make any sense. People were obviously pro-
tecting their books so they could get paid.
AT: You mean money managers were buying to keep the
market propped up through the end of the year?
KG: Unfortunately, I think something akin to that was indeed
going on. Wall Street paid itself record bonuses in 2007, and they
knew more about the extent of their problems than the outside
world. In retrospect, it looks to me like they decided to take one
last, massive payday, before the deluge.
When I started telling people to cut risk last August, at every
point — and this includes through today (Oct. 29) — I was just
trying to model the next six or eight weeks. And it just so hap-
pened that at every point along the way things looked bad. When
I reiterated this in February, I didn’t say we’d be on the verge of
collapse in October, I was simply looking at the rest of the first
quarter.
Something else worth mentioning is that I went out of my way
to say the short side was probably even more treacherous than the
continued on p. 44
43
 Q&A continued
long side. That’s what I believed then; that’s what I believe now.
The things that have been most disastrous to hedge funds have
been the government interventions. The really bad months earlier
this year were March, when the market was tanking and the Bear
Stearns [bailout] caused everyone to feel a bit better; and July,
when crude was going up toward $150 barrel and banks were
tanking. Then the government announced the groundwork for the
Fannie-Freddie [takeover] and energy started to reverse.
If you look at charts of most of the major risk factors, you see a
major inflection point around July 15 in equities, energy bench-
marks, and credit benchmarks. It was an absolute turn-on-a-dime
on the charts, which is not good for hedge-fund investments. (The
July low is marked with an arrow in Figure 3.)
I don’t know what’s going to happen right now, but I sure don’t
think the upside justifies the downside, no matter what you do.
“ The market should recover, but it’s
going to take several quarters.”
AT: What do you say to the argument that whenever things
seem to be at their worst, that’s when there’s the greatest
opportunity?
KG: I agree, but there are a couple of reasons it doesn’t dilute my
current opinion in any way. First, the market is exceedingly
treacherous — long and short. Do I think the market is cheap
here? Yes. And I think a lot of the problems right now are driven
by a combination of technicals and panic.
But the point is this: It is still a market in deep disrepair. In
terms of investment, it’s my very strong belief the market should
recover, but it’s going to do so over several quarters. There’s a
great deal to be said for waiting until the volatility comes out of
the market.
If you’re Warren Buffet, this is a good time to buy. If I had an
unlimited amount of capital, sure, I’d buy a bunch of companies
— and I’d probably buy a few condos in Florida, too. But since
most people are trying to manage their returns, I think the
[opportunities] will be no worse when the markets are function-
ing more normally and there’s more clarity. If you want to make
some money as an investor in this market, [that’s going to hap-
pen] over a period of years.
By contrast, I think it’s going to be very easy to get completely
rolled over while the market is still broken, no matter what you
do. One of the reasons we’re in this mess is because some very
44
smart people tried to pick the bottom, and they’ve been burned
and lied to. And we have to shake that out.
The big examples are the financings that have occurred over
the past six to nine months in the financial services sector —
where, say, an investment fund comes in and lays money into a
Merrill or a Lehman. The Mitsubishi UFJ episode was just a joke:
They negotiated a 20-percent purchase [of Morgan Stanley] at $25
and a week and a half later the stock was at $7. And that weekend
[Morgan Stanley CEO] John Mack was still saying the deal is
going to go through under its normal terms.
AT: Do you interpret a day like yesterday (Oct. 28, when the
S&P 500 tested the Oct. 10 low but rallied to close up more
than 10 percent on the day) as a good thing or evidence the
market is still broken?
KG: One of my strongest opinions is the path toward a healthy
capital market will not take the form of a v-bottom in the equity
market. I was probably as happy as most people that the market
rallied like it did, because at least it put some space between
where I think the lows are and current levels. It could continue to
go up — although I would guess it’s going to close down hard
today because no matter what the Fed does [regarding interest
rates], it’s going to be a sale for equities: If they don’t cut rates, the
market will probably crash; if they cut 25 basis points, it will drop
very deeply; if they cut 50 points, the market will want to signal
to the Fed they want even cheaper money; and if they cut 75,
everyone will say, “Look, they’re in full panic mode.” (Note: The
Fed cut rates 50 basis points and the S&P — after trading higher
much of the day — closed down 1.9 percent.)
My primary scenario is there may be at least one more 10- to
20-percent down move before we can see where things are, and it
would be driven by a combination of [rising] unemployment and
a deeper consumer recession that’s not priced into the market. But
until that happens, people will be sniffing around down near the
October lows. If the S&P can rally 90 points yesterday, the next
wave of selling isn’t going to crash through where I think the sup-
port is.
I don’t root for the market to go up in an aggressive way right
now because I don’t think there’s a framework for a sustained
rally. Whenever I feel compelled to make a prognostication, it’s
based on fund flows — not on a lot of fundamental analysis or
financial analysis. When you look at approximately 400 portfolios
every day, you start to get an idea of people’s decision factors. And
in my opinion, everyone is waiting for a group consensus — that,
say, corporate earnings in the U.S. can start to build from a worst-
case scenario and that it’s a good time to funnel capital into [equi-
www.activetradermag.com • January 2009 • ACTIVE TRADER
ties]. I certainly don’t see that right now.
I don’t want to be a buzz-kill guy — I’m probably a little less
pessimistic than most people I talk to. I think we can get out of
this thing. The equity markets ought to be the first to recover, and
they can recover quickly — over the next year. But they’re not
going to recover just because everyone is in desperation sell mode
and then one day decides they’ve had enough. I just don’t think
that’s plausible.
AT: I know you’ve stated the market has priced in a certain
increase in unemployment, and the last number came in at
6.5 percent. How high do you expect the rate to go, and do
you think there’s a tipping point — a certain-sized increase in
the next few months that would really knock the market for
a loop?
KG: The big fundamental overhang on the markets at the
moment is unemployment and consumer spending declines, both
of which I expect to accelerate over the next several months.
Industries like technology are going to be hit with a double
whammy, with their biggest source of clients — the financial serv-
ices sector — taking spending down to zero, combined with a
deep decrease in exports due to the sharp rise in the dollar.
I don’t see how they can manage through this without deep job
cuts, which in my opinion have barely begun. Remember, the
global economy took a sharp negative turn after Labor Day, and
this paradigm shift has not hit the labor markets yet. I suspect it
will — dramatically — in the next couple of months, as corporate
managers undertake 2009 planning cycles, recognize some dire
realities, and start to reduce work forces in earnest.
All of this translates into a deepening consumer recession,
which should be the last big blow the equity markets take, but it
will be a substantial one, as over 70 percent of U.S. GDP is driven
by consumer spending.
Bottom line: I see unemployment and declining consumer
spending as the big catalysts for the last leg down in the markets,
and I expect these events to transpire over the next two quarters.
When we get there, the equity markets will be dirt cheap. But we
ain’t there yet.
AT: What do you see going on in terms of hedge-fund
redemptions? Have you seen more straightforward investor
pullouts, or are funds getting crushed in their trading, too?
KG: It’s a combination of the two. There’s been some alarmingly
poor performance. But this was the first time in a long time a dis-
aster wasn’t really [centered around] a hedge-fund trade. As this
crisis has deepened there was virtually radio silence out of the
ACTIVE TRADER • January 2009 • www.activetradermag.com
hedge fund space; their involvement, compared to previous crises,
was entirely tangential.
Although they’ve been buffeted very badly, two things have
kept hedge funds out of the spotlight. One, they report their
numbers only monthly and, two, they tend to have — at most —
“ The path toward a healthy capital
market will not take the form of
a v-bottom in the equity market.”
quarterly liquidity (i.e., investors can withdraw funds only on a quar-
terly basis).
Risk reduction in the hedge-fund arena is just catching up. Let’s
assume the whole world is trying to deleverage by 30 to 50 per-
cent. Because of their lockups (the minimum period investors must
agree to leave their capital in a fund), hedge funds didn’t liquidate
when, say, Lehman went bankrupt. My best guess is that around
25 to 30 percent of hedge-fund assets under management (AUM)
— several hundred billion dollars — will go out the door by year
end.
AT: And you claim, all things considered, the hedge-fund
redemption process is relatively stable?
KG: I’m tracking this very carefully and it doesn’t appear the
redemption process is any worse than I initially feared. [The
money is] coming out in a relatively orderly fashion because, for
instance, no counterparty risk has manifested itself.
The fact that the hedge-fund industry has been reasonably
proactive in recognizing the problems over the past year and a
half and has reduced its risk has actually made things worse for
people who are trying to reduce risk now.
Non-invested hedge funds aren’t making markets, and they’re
not the only ones. The sell side isn’t making markets, either; vol-
umes have dropped. The [market] is not particularly well
equipped to accommodate the late liquidators. I just don’t see
how it will end until into the first quarter, when everyone should
know what their redemptions are and the dust should start to set-
tle.
Also, there’s a lot of uncertainty in the redemption process. One
of the perennial problems in the hedge-fund space is that they
raise capital very inefficiently — through fund of funds, capital-
intro organizations, and similar channels. I’d estimate the average
continued on p. 46
45
 Q&A continued
dollar is intermediated at least a half-dozen times. That’s how the
industry got to $2 trillion under management, but when the
arrows are pointing the other way, there are a half-dozen points of
redemption risk. It’s been a very uncertain process.
The other big problem is many fund of funds have mismatched
their funding. Some of them trotted across Europe and raised a lot
of money. The Europeans wanted quarterly liquidity, so the fund
of funds gave it to them. But on the other side, the fund-of-funds
managers invested in hedge funds with two- or three-year lock-
ups; they were giving quarterly liquidity when they didn’t have
the same liquidity on the other side.
I know several fund of funds that have put in full redemptions
to every one of their managers because they had to. They’re hop-
ing that when they find out what their redemptions are, they’re
going to be able to cancel those redemptions or at least reduce
them in size.
My message to my hedge-fund and fund-of-funds clients is that
fourth-quarter performance is not anywhere near as important as
franchise risk. I’m begging them to figure out what their Jan. 2
AUM is and to make sure they can adjust to the point where on
Jan. 2, their portfolio reflects that AUM.
AT: If they don’t, they’ll be massively over-leveraged, right?
KG: Yes, but there’s a worse outcome than that, which is that
they may find themselves unable to meet even their year-end
redemptions without causing enormous further damage to their
returns.
The late liquidators could lose significant amounts of money
just raising cash to meet Dec. 31 redemption flows, and if this
happens, it’s likely their remaining investors will cry uncle them-
selves. This is why it’s so important to get in front of the liquidity
management process.
I think I can summarize by saying that hedge funds are seeing
the same deleveraging by investors that every other pool has had,
but it’s been orderly — much more orderly than, say, the liquida-
tion of Lehman Brothers or the deleveraging of Citigroup. I find
some irony in that since I’ve been listening for a decade to lectures
from the [banks] about what we didn’t know about risk manage-
ment.
But it’s a painful process. Its biggest impacts are causing some
very, very deep disruptions in the pricing patterns of the markets,
but I think the industry can easily accommodate $500 to $600
billion of redemptions and rebuild from there.
My last point is that when people do want to start taking risk
again — when capital pools are seeking risk — a lot of money is
going to come back to the hedge funds.
46
There are thousands of hedge funds that are down maybe 10
percent right now, but I’d say anyone down 10 percent is having
one of the best alpha years they’ll ever have. But that’s not the
message investors are taking right now.
AT: Is sentiment worse or better than the beginning of the
month?
KG: There’s a justifiable sense here in New York that something is
gone for good. I think they’re probably overreacting, but you’re
looking at the hedge-fund industry alone losing tens of thousands
of jobs, and the financial services industry is going to lose many
more. It’s people’s livelihoods and their investments.
To use a very tired cliché, it’s very much a gut-check time. As I
said, I’m probably a little more upbeat than most people, partly
because it’s not the worst time to be selling risk-management serv-
ices to multiple risk takers.
But I believe one of the things that separates the real pros
from the wannabes is the pros know bad markets — and
good markets, for that matter — don’t last forever, and they plan
accordingly. And the people who survive this are in a position
to make a fortune.
Right now people are very emotional; they’re not making par-
ticularly good decisions. And that’s what makes this the game it is:
Sometimes it will break your heart.
Also, somewhere down the road we’re going to have to pay the
piper if [the bailout plan] works. Because everyone knows, at least
from a karma perspective, that it’s not good when the govern-
ments of this world have to throw trillions of dollars at a problem.
That can’t be costless. We can’t use TARP (the Troubled Asset Relief
Plan) and make a profit on it and have the Chinese continue to
fund our debt — it’s just not likely.
AT: How might paying the piper manifest itself, other than
paying taxes through the nose?
KG: Myriad ways: slow growth for years to come, less innovation,
etc. All of this could make America a less lively and interesting
place in which to live for a while.
On the whole, though, I’m optimistic we will climb out of this
mess, slowly, doggedly, but surely. The U.S. still has the best
mechanism for monetizing innovation than any country in the
history of the world. It has great people and vast natural
resources. This year has been a real blow to us, but I think even-
tually, it will bring out the best in this country.
Let’s just hope the Chinese don’t decide to dump our debt dur-
ing the recovery process; that’s something I don’t even want to
contemplate.

www.activetradermag.com • January 2009 • ACTIVE TRADER
 INSIDE the Market

Stagnant IPO, ETF listings In this section…

Carbon trading on the rise 51

reflect battered markets Gold update 51

A lack of new companies going public speaks Hedge funds take hit 53

volumes about the current market condition, Central banks slash rates 54

but a new study shows IPOs that survive a bad

Managed money 55
environment may be stronger in the long run.
Global numbers 56

BY CHRIS PETERS

I n the biggest drought since mid-

2003, initial public offerings (IPOs)
in the U.S. market have ground to
a halt over the past few months.
October and September were devoid of
IPO activity — the latest signs of the stag-
nant market.
But it’s not a U.S.-only phenomenon. A
PricewaterhouseCoopers survey showed a
62-percent decrease in IPOs offered on
European exchanges in the third quarter
of 2008 compared to the same period in
2007. Meanwhile, the Toronto Stock
Exchange had no new IPOs in Q3 and
only 10 from January through September,
compared to 17 during the same period
last year.
that extended through 2003.
Following through on the momentum
of 2004-2007, 2008 started out strong
with 13 IPOs priced in January. But as the
year progressed and the economic crisis
began to accelerate, each new month
Table 1 shows the number of IPOs in returned a bleaker picture for companies
the U.S. market for each month back to thinking of going public.
1998. Notice the sudden increase in total
IPOs between 1998 and 1999 as the tech Filings and withdrawals
bubble inflated and the sudden drop-off Figure 1 compares the number of compa-

TABLE 1: MONTHLY IPOS

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
January 8 9 14 3 1 0 3 9 11 10 13
February 31 29 55 6 8 3 17 22 25 25 6
March 26 21 59 8 7 1 12 6 16 24 3
April 26 33 35 3 6 0 12 10 18 16 4
May 34 48 22 8 13 1 14 13 14 32 7
June 44 52 34 15 10 1 26 25 21 26 3
July 36 61 42 7 5 8 26 19 14 21 4
August 16 39 67 5 0 6 16 33 8 17 3
September 1 40 25 0 0 6 14 18 16 7 0
October 3 60 24 7 7 10 32 17 22 33 0
November 7 57 21 9 9 15 15 21 28 39 n/a
December 15 37 8 12 4 18 30 21 30 23 n/a

Total 247 486 406 83 70 69 217 214 223 273 43

The recent lack of IPO activity is reminiscent of the period following the dotcom crash.
Source: Renaissance Capital’s IPOhome.com

47 www.activetradermag.com • January 2009 • ACTIVE TRADER

 FIGURE 1: IPO FILINGS AND WITHDRAWALS

nies filing IPOs with the Securities and

Exchange Commission (SEC) in the past
24 months with the number of filed com-
panies that are either postponing or with-
drawing their IPOs. The former has
declined significantly over the past year
as the latter hit a recent high in October.
Through October, 84 IPOs had been
withdrawn or postponed, compared to
only 17 during the same period last year.
The IPO retreat is no surprise consid-
ering the market conditions of late. IPOs
The number of IPO filings decreased over the past year and cancellations
thrive in expanding markets and tend to
rose to a recent high in October.
pop up in the fastest-moving sectors.
Source: Renaissance Capital’s IPOhome.com
There were 573 technology IPOs in 1999
and 2000, more than the total number of
IPOs from 2006 through October 2008 new IPO pricings are down 80.1 percent Only the strong survive
combined. compared to last year, while filings with An October report released by
Table 2 shows IPOs separated by the SEC have declined 53.7 percent. Greenwich, Conn.-based research and
industry. Even after the dotcom bubble Although also down in number, non- investment-management firm Renaissance
burst, the tech industry remained one of U.S. IPOs have gained prominence, com- Capital compared the current IPO
the strongest in the field, producing a prising 28 percent of all IPO proceeds in drought to those in the past. Renaissance
solid percentage of IPOs each year. Other 2008. Last year non-U.S. IPOs comprised found only two other periods in recent
resilient industries were the health care, 19 percent of the total, a significant history against which to measure today’s
energy, and (until 2008) financial indus- increase from 2002 and 2003 when they market: the three years following the
tries. comprised only 6 percent. burst of the dotcom bubble and the eco-
Overall, year to date through Nov. 4, continued on p. 4 9

TABLE 2: IPOS BY SECTOR

Industry 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
Business services 15 6 5 1 8 19 6 8 14 2
Capital goods & services 10 0 3 0 1 7 5 5 6 3
Communications 46 41 0 2 6 9 12 8 10 0
Consumer 23 8 7 12 6 20 20 20 11 1
Energy 4 19 10 2 1 10 20 33 32 7
Financial 23 7 12 14 17 42 31 28 29 3
Health care 13 80 24 13 8 50 34 35 42 4
Materials 2 4 1 2 3 2 9 8 2 2
SPAC 0 0 0 0 0 1 22 28 58 12
Technology 344 234 19 19 15 49 32 34 59 5
Transportation 1 0 2 4 4 6 20 15 9 2
Utilities 2 2 0 0 0 2 3 1 1 2

Total 483 401 83 69 69 217 214 223 273 43

Technology IPOs in the dotcom bubble era dwarfed the number of total IPOs launched since 2006.
Source: Renaissance Capital's IPOhome.com

ACTIVE TRADER • January 2009 • www.activetradermag.com 48

 Inside the Market continued

The extended
FIGURE 2: THREE-YEAR IPO PERFORMANCE

performance of IPOs

released during the

economy’s current

downturn remains

to be seen.

released at a discount — sometimes up to

15 or 20 percent of what prices would
normally be.
The extended performance of IPOs
IPOs released during market downturns have tended to perform better in
released during the economy’s current
the long run because of the sound fundamentals required to make it
through a turbulent market and the discounts at which the stocks are fre- downturn remains to be seen. The
quently offered. Renaissance IPO Index is a float-adjusted
Source: Renaissance Capital and Jay Ritter, University of Florida market capitalization-weighted index rep-
resenting all IPOs capitalized with at least
$50 million. They are added to the index
FIGURE 3: S&P VS. IPO INDEX at the close of their first day of trading
and removed on the second anniversary
of their listing. Figure 3 compares the
index’s cumulative monthly moves to
those of the S&P 500 from January 2003
through October 2008.
The figure highlights the correlation
between IPOs and the broader market.
The IPO index took off relative to the
S&P 500 in 2004 and from July 2004
until October 2007, when both indices
peaked, the IPO index outperformed the
S&P 70 percent of the time on a monthly
basis. From the end of October 2007
The cumulative monthly performance of the Renaissance IPO index com- through October 2008, however, the IPO
pared to the S&P 500 shows the IPO index outperformed the S&P for the
index has lost 49 percent while the S&P
past three years.
500 has dropped 37.5 percent.
Source: Renaissance Capital's IPOhome.com and eSignal

ETF releases slow down in Q3

nomic recession of the 1970s.
Figure 2 compares the yearly total of
IPOs with the cumulative three-year aver-
age returns of the stocks. Although years
of contraction yielded the fewest number
of IPOs, those that were released during
these periods tended to fare better in the
intermediate term than those released in
other years. According to a Renaissance
spokesperson, this is because investors
tend to be more discriminating during
these times and the IPOs are often
Through the third quarter, 173 new
exchange-traded funds (ETFs) entered the
U.S. market. And although Q3 had the
lowest quarterly increase in two-and-a-
half years, 106 ETFs launched in Q2,
helping to bring the year-to-date total just

49 www.activetradermag.com • January 2009 • ACTIVE TRADER

 FIGURE 4: ETF QUARTERLY INCEPTIONS

12 shy of last year.

Figure 4 shows the ETF quarterly
release totals going back to 2000. If the
economic slowdown in the earlier part of
the millennium is any indicator, the next
few quarters will most likely produce far
fewer ETFs than we’ve seen recently.
Exchange-traded funds have come a
long way since the S&P 500 Depository
Receipts, or SPDRs (SPY) and Qs
(QQQQ) launched 15 and 9 years ago,
respectively. Since these instruments first
revolutionized the way traders gained The rate at which ETFs have entered the market has increased dramatically
broad exposure to the S&P 500 and over the last few years.
Nasdaq 100 indices, the ETF market has Source: Yahoo Finance
expanded dramatically, encompassing
everything from individual equity sectors
and international indices to short-selling TABLE 3: PERFORMANCE OF Q3 RELEASES
portfolios and commodities. The number 1-month
of ETFs has expanded from around 136 performance
Name Symbol through Nov. 5
at the end of 2003 to more than 800
MacroShares $100 Oil Down DOY 14.31%
today.
SPDR S&P International Utilities IPU 9.06%
Not surprisingly, the most recent
SPDR S&P International Energy IPW 7.57%
releases from Q3 have had a rough time
PowerShares Global Agriculture PAGG 6.29%
returning profits. One-month returns
ELEMENTS BG Large Cap ETN BVL 3.78%
through Nov. 5 averaged -1.11 percent
Market Vectors RVE Hard Assets Prod. HAP 3.40%
for all 26 ETFs with inception dates
SPDR S&P Intl. Tech. IPK 1.48%
between July and September (Table 3).
SPDR S&P Intl. Consumer Disc. IPD 1.24%
The fledgling ETF that has fared the best
iShares MSCI All Country Asia ex Jpn. AAXJ 0.98%
during the period has been the
PowerShares MENA Frontier Countries PMNA 0.53%
MacroShares $100 Oil Down (DOY) ETF,
SPDR S&P Intl. Consumer Staples IPS 0.31%
which tracks the inverse dollar price
ELEMENTS BG Total Market ETN BVT -0.43%
movement of crude oil. In 2008 nearly
SPDR S&P International Materials IRV -2.09%
one-third of the ETFs released have been
ELEMENTS BG Small Cap ETN BSC -2.20%
those offering exposure to specific com-
Claymore/Raymond James SB-1 Equity RYJ -2.21%
modity markets such as metals and ener-
PowerShares Global Wind Energy PWND -2.45%
gy.
SPDR S&P International HealthCare IRY -2.54%
When NYSE Euronext acquired the
WisdomTree Middle East Dividend GULF -2.70%
American Stock Exchange, they became
SPDR S&P International Industrial IPN -3.30%
the front-runner in ETF and exchange-
Claymore/Delta Global Shipping SEA -3.60%
traded note (ETN) listings, representing
NETS Tokyo Stock Exchange REIT Index JRE -4.71%
61 percent of U.S. assets under manage-
SPDR S&P International Financial IPF -5.31%
ment. (Exchange-traded notes are ETF-
SPDR S&P International Telecom IST -5.38%
like securities that represent debt instru-
Market Vectors Gulf States MES -9.09%
ments, such as bonds.) The acquisition
Market Vectors Africa AFK -14.07%
allowed the exchange to add the former
MacroShares $100 Oil Up UOY -17.77%
AMEX’s portfolio of more than 400 ETFs
Sector-based ETFs appear to be faring the best for young releases while regional
and ETNs to its NYSE Arca trading plat- ETFs have struggled.
form and to expand its listings to more
Source: Yahoo Finance and eSignal
than 700 total.

ACTIVE TRADER • January 2009 • www.activetradermag.com 50

Inside the Market continued

Counting carbs
Carbon trading gains popularity
Where there’s smoke, maybe there’s fire: Carbon debuts on the London Stock Exchange while
volume on the climate exchanges grows.
FIGURE 1: 2009 CFI CONTRACT PRICES

C
arbon began trading on the
London Stock Exchange
(LSE) as an exchange-traded
commodity (ETC) on Oct.
30. The ETFS Carbon (CARB) ETC tracks
the performance of the ICE Futures
Europe exchange’s ECX EUA futures con-
tract, which offers European investors
direct exposure to the European Climate
Exchange (ECX), emissions index.
ECX volume reached a monthly record
in October and experienced a 283-percent
volume increase on the exchange over CFI prices spiked dramatically earlier this year, and the number of contracts
October 2007. The exchange’s stateside traded has increased substantially from last year.
relative, the Chicago Climate Exchange
(CCX), and its futures market, the Chicago As interest in the carbon trading mar- a new contract low.
Climate Futures Exchange (CCFE), have ket has increased, so has the price activi- The exchange’s monthly report for
also seen increases in activity. ty. As Figure 1 shows, CCX’s 2009 vintage October highlighted a 244-percent year-
The CCX Carbon Financial Instrument CFI contract’s price action was fairly tame to-date increase in CFI contract volume
(CFI) futures and option contracts have heading into 2008. However, from the over 2007. Combined with the CFI
increased in open interest from 1,689 beginning of the year to June 2008 CFI futures and options, 2008 has seen over
contracts to a record high of 11,584 open contract prices increased 289.5 percent, 100 million metric tons of CO2 traded on
contracts by the end of October. before falling over the next five months to the exchange.

Gold’s perplexing performance

Gold’s ascension to all-time highs earlier this year was followed by a sharp drop — when
stock really went into the gutter. Several factors are playing out in the market right now.
BY ACTIVE TRADER STAFF

2 008 was a historic year for the
gold market, which hit an all-
time high in March as front-
month futures topped
$1,030/ounce and the soon-to-expire
December 2008 futures (GCZ08) charged
to $1,048 (Figure 1).
But despite market chatter that $1,500
or even $2,000 gold would be next, the
market abruptly reversed as the commod-
ity bubble burst and a dollar rally
emerged as the stock market began to
crumble in earnest. As a result, instead of
pushing gold to the stratosphere, the
October Massacre in stocks was accompa-
nied by the yellow metal falling as low as
$681 late in the month.
Dollar action
Because gold is denominated in U.S. dol-
lars, the bear market in the greenback
since 2002 was actually a bullish factor
for the yellow metal.
Figure 2 shows a monthly chart of con-
tinuous gold futures from January 2001
to November 2008. After nearly a decade
of trading sideways from $275 to $400,
gold bulls awoke in late 2002. The subse-
quent bull market pushed gold from
$276 at the beginning of 2002 to $1,014

51 www.activetradermag.com • January 2009 • ACTIVE TRADER

 FIGURE 1 ALL-TIME HIGH

in March 2008. Meanwhile, crude oil ral-

lied to an all-time high of $147/ barrel in
July 2008, helping drive inflation con-
cerns — a fundamental underpinning to
the gold rally in recent years. This fall,
crude oil fell sharply, removing inflation
concerns, which took away some impetus
to buy gold.
Also, it was no coincidence that the
U.S. dollar index plunged from 125.50 in
January 2002 to 70.69 in March 2008.
The buck’s recent upturn has acted as a
major catalyst for some deflation in gold,
crude oil, and other commodity markets
this year.
Gold topped out in March, and some of its sharpest losses since then
occurred in October as the stock market collapsed.
Impact of high prices
Source: TradeStation
Gold’s rally above $1,000 understandably
affected both supply and demand of the
physical gold market. FIGURE 2: GOLD FUTURES, 2001-2008
“We saw a sharp increase in scrap recy-
cling,” says James Steel, senior vice presi-
dent and metals analyst at HSBC. “A lot of
gold that is held above ground is stored
in jewelry or other forms that can be
mobilized quickly, especially in the
Middle East and India. $1,000 gold
brought a lot of scrap to the market,
which added greatly to supply.
“$1,000 gold priced out a lot of jewel-
ry purchases, so you had a reduction in
demand. Jewelry is 70-75 percent of the
physical gold demand,” he adds.
According to World Gold Council sta-
tistics, global jewelry consumption fell 24
percent in Q2 2008 vs. Q2 2007.

Financial system instability

Other factors that dominated the gold
trade in 2008 were the global credit
crunch, financial system turmoil and
sales, and bailouts and closures of a num-
ber of major players in the gold market.
“There was a big push to be in cash
and away from risk,” says Frank Cholly,
senior market strategist at Lind-Waldock.
“A lot of it had to do with strength in the
U.S. dollar and the U.S. economy not
Gold climbed from $276 at the beginning of 2002 to $1,014 in March 2008.
However, it has fallen sharply in the past six months.
Source: eSignal
doing well, which eroded demand for all tions because of customer withdrawals
commodities including gold.” (redemptions), position squaring, and
During September and October, hedge overall risk aversion.
funds were forced to close out many posi- continued on p. 5 3

ACTIVE TRADER • January 2009 • www.activetradermag.com 52

Inside the Market continued
Trimming the hedge
Hedge-fund industry shrinks by $210 billion in Q3
The hedge-fund industry faces its worst year ever as poor performance and investor
outflows peak.
T
he hedge-fund industry is
poised to post its worst year
ever according to Chicago-
based Hedge Fund Research’s
(HFR) third-quarter report. The hedge
fund industry’s total capital shrank 11
percent from $1.93 trillion at the end of
Q2 2008 to $1.72 trillion in Q3. The cap-
ital outflow of $210 billion in Q3 exceed-
ed 2007’s entire capital inflow of $194 bil-
lion.
“I think it’s a capitulation issue,” says
Ken Heinz, President of HFR. “People
indiscriminately want to be in cash at all
costs and they don’t really care whether a
fund’s doing well or doing poorly.”
More than $31 billion of the loss was
due to investor withdrawals, the single
largest net capital withdrawal in the histo-
ry of the industry. As of Nov. 7, indices
Gold continued from p. 52
George Gero, vice president at RBC
Capital Markets Global Futures, says gold
futures open interest fell from 415,000
positions on Aug. 15 to 303,000 on
Nov. 4.
“That tells me there has been a major
liquidation,” he says. “Hedge funds had to
liquidate to meet margin calls in stocks.
Nobody cared about inflation or deflation;
they were being forced [to liquidate] by
[their] prime brokers. Cash was needed
by hedge funds, but a lot of gold traders,
including Bear Stearns, Lehman Brothers,
and AIG, are gone. In the short-term, you
have lost a big part of the speculative
audience.”
Coins and bars
Amid the financial market turmoil, physi-
53
TABLE 1: HEDGE FUND STRATEGY PERFORMANCE
YTD through
Sub indices Oct.
tracking hedge-fund perform-
Convertible Arbitrage Index -26.33%
ance for the year were down by
Distressed Securities Index -19.65%
double digits. The Barclay
Emerging Markets Index -37.87%
Hedge Fund index was down
Equity Long Bias Index -24.48%
18.8 percent year-to-date
Equity Long/Short Index -10.38%
through October, while HFR’s Equity Market Neutral Index -1.07%
Fund Weighted Composite Equity Short Bias Index 37.85%
Index showed a 10.5-percent European Equities Index -10.51%
loss. Event Driven Index -12.97%
If the trend continues Fixed Income Arbitrage Index -18.27%
through the end of the year, Fund of Funds Index -16.76%
this could be the hedge fund Global Macro Index -3.09%
industry’s first negative yearly Healthcare & Biotechnology Index -12.62%
performance since 2002, when Merger Arbitrage Index -1.50%
the average hedge fund Multi Strategy Index -13.48%
declined by 1.45 percent. In Pacific Rim Equities Index -15.86%
September this year, hedge Technology Index -10.15%
funds lost nearly 5.5 percent on Short-biased strategies are among the only to
average — the industry’s sec- experience gains in 2008.
Source: BarclayHedge
ond-worst month. In August
cal gold brokers saw the demand for gold banking system to relieve the credit bot-
coins and bars increase. tleneck and the hefty cuts in official mon-
“In October, we’ve seen a tremendous etary policy rates by central banks around
off-take in physical gold,” says Andrew in the world. After all, an increase in
Montano, director of precious metals at money supply is generally thought to be
Scotia Mocatta in Toronto, a gold dealer. inflationary.
“We’ve had real big demand in that area.” “Next year it may be a totally different
Montano found increased retail interest picture because all this bailout money all
in owning physical gold during the equity over the world will inflate the currencies,”
meltdown in October. Gero says. “Inflation will rear its head and
“It was a run away from feared curren- people will get back to looking at gold for
cies,” he says. “Gold is no government’s fundamental reasons, not trading rea-
IOU. Gold is the ultimate reserve or store sons.”
of wealth. However, gold bulls may need to bide
their time.
Monetary injections “Before we have inflation, we have to
Some say inflation will ultimately reap- have a serious round of deflation,”
pear in the wake of the billions of dollars Montano says. “Housing prices and com-
that have been injected into the global modity prices are still collapsing.”

www.activetradermag.com • January 2009 • ACTIVE TRADER
1998 hedge funds lost 8.7 percent, large-
ly precipitated by the liquidation of the
Long-Term Capital Management fund.
Performance turned around that year,
however, and funds overall still managed
to end the year with a 2.6-percent gain.
Although 1998 produced the worst-
performing month, the actual drawdown
lasted only about four months, whereas
the current drawdown has already been
much longer, stretching back nearly 11
months. Also, the circumstances are
much different from a decade ago.
“One interesting contrast is in 1998
the liquidation of a [single] fund precipi-
tated poor performance and volatility at
banks and financial institutions,” Heinz
says. “[This time], the liquidation of
banks and brokerage firms created a
volatile, negative environment for hedge-
fund performance.”
Table 1 shows the year-to-date per-
formance for each of Barclay Hedge’s
hedge-fund sub-indices. According to
this data, mirrored in HFR’s performance
indices, short-biased hedge funds have
returned the best performance this year,
returning profits in a sea of red, despite
certain Securities and Exchange
Commission (SEC) injunctions restricting
some short sales.
Funds focused on emerging markets
appear to be hit the worst. As of Nov. 7,
the Barclay Hedge Emerging Markets
Index was down 37.76 percent year-to-
date through October. HFR’s emerging
markets indices, which split the data into
specific regions, show the worst perform-
ing to be those focused in Asia (except
for Japan) and Russia/Eastern Europe.
As the year heads toward becoming
the worst in history for the hedge fund
industry, the outlook for the first few
quarters of 2009 is none too bright as
investors continue to jump ship.
“The consolidation, which is ongoing,
will continue into 2009,” Heinz says.
For more information on implications
of the hedge-fund contractions, see “Kent
Grant on risk” on p. 42.

ACTIVE TRADER • January 2009 • www.activetradermag.com
Central banks slash rates
to prime markets FIGURE 1: U.S. DOLLAR INDEX
As the world financial system
sputters, finance ministers
across the globe attempt to
grease the wheels with lower
interest rates.
I
n early October, the U.S. Federal
Reserve, the European Central Bank
(ECB), the Bank of England (BOE),
and the Swiss, Canadian, and The U.S. dollar surged from
August through October after a
Swedish central banks jointly announced two-and-a-half-year slide.
emergency 0.5-percent rate cuts. The Source for all bar charts: eSignal
Bank of Japan (BOJ) joined in support of
the statement, but at the time did not
participate in the coordinated rate cut. FIGURE 2: YEN VOLATILITY
As the month wore on, the U.S. dollar,
which had already begun to climb off the
generational low it hit in March, acceler-
ated to the upside (Figure 1). The U.S.
dollar index (DXY) made some uncertain
moves after hitting its all-time low in
March, but by Oct. 28 had reached a
nearly two-and-a-half-year high. On that
day the U.S. Fed announced another 0.5-
percent rate cut, dropping the fed funds
rate to 1 percent.
A worrisome yen
It was the strength of another currency,
however, that had some people worried. October’s yen volatility pro-
Oct. 24 capped a surge in the Japanese mpted the G7 nations to re-
lease a statement of concern.
yen (JPY) to a 13-year high against the
dollar. This move prompted the Group of
Seven (G7) finance ministers to release a low rates, the BOJ decided to decrease its
statement saying “We are concerned overnight lending rate from 0.5 to 0.3
about the recent excessive volatility in the percent on Oct. 31.
exchange rate of the yen and its possible On Nov. 6, the ECB decided to cut
adverse implications for economic and rates by another 0.5 percent, dropping its
financial stability.” rate to 3.25 percent. The Bank of England
Figure 2 shows the erratic behavior in also cut rates, as did the Swiss National
the USD/JPY in October as well as the Bank and the Danish central bank.
dollar’s drop to its lowest point vs. the Figure 3 displays the monthly average
yen since July 1995. Despite its already continued on p. 5 5
54
Inside the Market continued

FIGURE 3: G7 INTEREST RATES

of interest rates among G7 countries back U.S. dollar in four
to the beginning of 2005. Rates peaked in months through
the summer of 2007, but as the economic October following an
crisis grew, rates began to fall sharply, AUD/USD peak at
especially in September and October of 0.9849 in July. The
this year. Reserve Bank of
Australia lowered
A worldwide issue rates by 0.75 percent
Currency volatility has prompted many on Nov. 4 to 5.25.
other countries to intervene as well. Mexico and Brazil
Australia’s Central Bank began buying its have also had to step
Interest rates among G7 nations have dropped significantly
currency in an attempt to prop it up in in and support their in 2008 as nations across the globe attempt to inject cash
the wake of a decline to the lowest level currencies. Mexico’s into frozen markets.
vs. its U.S. counterpart in five-and-a-half Central Bank sold
years. Figure 4 shows the Aussie dollar nearly $1 billion on Oct. 23 to support lion plan to provide liquidity by selling
fell as much as 37 percent against the the peso, while Brazil unveiled a $50-bil- currency swaps.
Meanwhile, spot trading in the
Icelandic krona halted in October after
Barclay Trading Group’s September 2008 managed futures performance: the nationalization of the island nation’s
Top 10 traders ranked by September 2008 return managing top three banks. The Central Bank of
more than $10 million as of Sept. 30. Iceland quickly lowered rates 3.5 percent
September 2008 YTD $ Under to 12 percent. However, in a deal with
Trading advisor return (%) return (%) mgmt. the International Monetary Fund (IMF),
1. Pere Trading Group 99.87% 336.68% 30.3 the rate was raised by 6 percent to 18
2. Edge Inv Mgmt (Gl Diversified) 22.36% 74.84% 13.1 percent for a $2 billion loan.
3. John W. Henry & Co. (Gl. Analytics) 20.40% 47.56% 148.1 The IMF has also announced loan
4. R.G. Niederhoffer (Negative Corr.) 17.24% 37.59% 852.7 deals with Hungary, the Ukraine, and
5. Drury Capital (Diversified) 16.95% 27.06% 131.2 Pakistan, while several other struggling
6. R.G. Niederhoffer (Divers.) 14.76% 38.30% 893.8 emerging economies, such as Poland,
7. Amplitude Dynamic Trading Fund 14.48% 31.25% 800.0 Turkey, and Brazil, are expected to make
8. Hyman Beck (Global) 12.26% 26.06% 423.1 pleas for assistance as well.

9. Aisling Analytics (Merchant Comm.) 12.10% 9.60% 2017.0
10. R.G. Niederhoffer (TrendHedge) 12.09% 26.83% 72.4 FIGURE 4: AUSSIE DOLLAR
Top 10 traders ranked by September 2008 return managing
less than $10 million as of Sept. 30.
1. Capital Alt. Invest. Mgmt 44.85% 123.99% 9.3
2. District Capital Mgmt. (Divers.) 28.95% 4.24% 3.4
3. Ashley Capital Mgmt. 24.50% 8.76% 2.2
4. Attain Portfolio Advisors (Modified) 23.71% 41.37% 6.1
5. Beechdale (Negative Gamma) 21.38% 30.08% 7.0
6. T4T S.r.l. (System) 16.50% 87.76% 1.4
7. Somers Brothers Capital (Divers) 15.01% 52.69% 3.6
8. Parizek Capital (Futures) 14.68% 45.72% 1.1
9. MarketEthos (ME Plus 3X) 14.48% 24.49% 6.7
10. Valu-Trac Invest. Mgmt Strategic (2.5) 13.78% -4.90% 2.0
Based on estimates of the composite of all accounts or the fully funded subset method. Australian officials
announced an aggressive
Does not reflect the performance of any single account.
plan to buy back the
PAST RESULTS ARE NOT NECESSARILY INDICATIVE OF FUTURE PERFORMANCE. Australian dollar following a
Source: Barclay Hedge (www.barclayhedge.com) steep four-month slide.

55 www.activetradermag.com • January 2009 • ACTIVE TRADER

 Gross Domestic Product*
Release 1-year Next Release 1-year Next
Period date Change change release Period date Change change release
AMERICAS AFRICA
Argentina Q2 9/17 20.0% 24.2% 12/18 S. Africa Q2 8/19 5.0% 16.2% 11/25
Brazil Q2 9/10 7.7% 12.9% 12/9
Canada Q2 8/29 2.5% 5.2% 12/1 ASIA AND SOUTH PACIFIC
EUROPE Australia Q2 9/3 0.3% 2.7% 12/3
France Q2 8/14 0.1% 3.5% 11/14 Hong Kong Q2 8/15 -2.3% 4.2% 11/14
Germany Q2 8/14 -0.1% 4.4% 11/13 India Q2 8/29 -3.0% 16.3% 11/28
UK Q2 9/30 0.4% 4.4% 12/23 Japan Q2 8/13 0.9% -0.6% NLT 11/19
Singapore Q2 8/11 -6.0% 2.1% NLT 11/21

* Final estimates, at current prices, seasonally adjusted

Unemployment
Release 1-year Next Release 1-year Next
Period date Rate Change change release Period date Rate Change change release
AMERICAS
Argentina Q2 9/22 8.0% -0.4% -0.5% 12/22 ASIA AND SOUTH PACIFIC
Brazil Sept. 10/23 7.6% 0.0% -1.4% 11/19 Australia Sept. 10/9 4.3% 0.2% 0.1% 11/6
Canada Oct. 11/7 6.2% 0.1% 0.4% 12/5 Hong Kong July-Sept. 10/20 3.4% 0.2% -0.6% 11/18
EUROPE Japan Sept. 10/31 4.0% -0.2% 0.0% 11/28
France Q2 9/4 7.6% 0.0% -0.8% 12/4 Singapore Q3 10/31 2.2% 0.0% 0.5% 10/31
Germany Sept. 10/30 7.1% -0.1% -1.1% 11/27
UK June-Aug. 10/15 5.7% 0.5% 0.4% 11/12

Consumer Price Index (CPI)

Release 1-year Next Release 1-year Next
Period date Change change release Period date Change change release
AMERICAS AFRICA
Argentina Sept. 10/10 0.5% 8.7% 11/11 S. Africa Sept. 10/29 0.2% 13.1% 11/26
Brazil Oct. 11/7 0.5% 6.4% 12/5
Canada Sept. 10/24 0.1% 3.4% 11/21 ASIA AND SOUTH PACIFIC
EUROPE Australia Q3 10/22 1.2% 5.0% 1/28
France Sept. 10/14 -0.1% 3.0% 11/13 Hong Kong Sept. 10/23 3.0% 4.6% 11/20
Germany Sept. 10/15 -0.1% 2.9% 11/14 India Sept. 10/31 0.7% 9.8% 11/28
UK Sept. 10/14 0.5% 5.2% 11/18 Japan Sept. 10/31 0.0% 2.1% 11/28
Singapore Sept. 10/23 0.0% 6.7% 11/24

Producer Price Index (PPI)

Release 1-year Next Release 1-year Next
Period date Change change release Period date Change change release
AMERICAS AFRICA
Argentina Sept. 10/10 0.7% 11.6% 11/11 S. Africa Sept. 10/30 -3.5% 16.0% 11/27
Brazil Oct. 11/6 1.4% 14.7% 12/8
Canada Sept. 10/30 -1.2% 8.0% 11/28 ASIA AND SOUTH PACIFIC
EUROPE Australia Q3 10/20 2.0% 5.6% 1/27
France Sept. 10/30 -0.4% 6.1% 11/28 Hong Kong Q2 9/12 1.7% 6.6% 12/12
Germany Sept. 10/20 0.3% 8.3% 11/20 India Oct. 11/7 -0.9% 11.0% 12/12
UK Sept. 10/13 -0.3% 8.5% 11/10 Japan Sept. 10/14 -0.4% 6.8% 11/13
Singapore Sept. 10/30 -4.2% 9.9% 11/28

All data as of Nov. 7

LEGEND Change: Change from previous report release NLT: No later than Rate: Unemployment rate

ACTIVE TRADER • January 2009 • www.activetradermag.com 56

 Global MARKETPLACE
FOREX (VS. U.S. DOLLAR)
Current
price vs. 1-month 3-month 6-month 52-week 52-week Previous
Rank* Country Currency U.S. dollar gain/loss gain/loss gain/loss high low rank

1 Japanese yen 0.01007 5.98% 8.85% 5.94% 0.011 0.0087 1

2 Chinese yuan 0.14683 0.36% 0.51% 2.46% 0.14683 0.1339 4

3 Hong Kong dollar 0.12903 0.24% 0.69% 0.57% 0.12903 0.1279 3

4 Indian rupee 0.02105 -1.36% -11.11% -14.57% 0.03842 0.01843 13

5 Singapore dollar 0.67779 -1.72% -6.72% -7.77% 0.7434 0.6594 7

6 Taiwanese dollar 0.03049 -1.96% -6.44% -7.10% 0.03335 0.02974 6

7 Thai baht 0.02887 -2.07% -3.70% -9.19% 0.03396 0.02775 2

8 Russian ruble 0.03726 -2.99% -12.29% -11.50% 0.04334 0.03652 10

9 Swiss franc 0.85814 -3.10% -9.76% -9.55% 1.0375 0.8471 8

10 Brazilian real 0.4731 -4.34% -25.66% -21.89% 0.6414 0.394 17

11 Euro 1.29369 -6.06% -16.62% -16.36% 1.6038 1.2329 12

12 Canadian dollar 0.8652 -6.37% -9.98% -12.01% 1.1038 0.768 9

13 Swedish krona 0.12979 -8.51% -20.69% -21.60% 0.1718 0.1235 14

14 New Zealand dollar 0.60431 -8.73% -16.76% -22.86% 0.8214 0.5349 11

15 British pound 1.59487 -9.98% -18.53% -19.15% 2.1161 1.5276 5

16 Australian dollar 0.69334 -10.46% -24.78% -26.29% 0.9849 0.6005 16

17 South African rand 0.10332 -12.84% -24.47% -21.83% 0.1555 0.0841 15

As of Nov. 6 *based on one-month gain/loss

ACCOUNT BALANCE
+
Rank Country 2007 Ratio* 2006 2008+ Rank Country 2007 Ratio* 2006 2008
1 Singapore 39.157 24.269 29.765 37.099 13 Mexico -5.813 -0.568 -2.231 -15.882
2 Switzerland 70.797 16.577 57.192 45.731 14 France -30.588 -1.179 -15.439 -83.488
3 Hong Kong 28.038 13.534 22.936 26.191 15 India -15.494 -1.408 -9.8 -34.58
4 China 371.833 11.336 249.866 399.325 16 UK -105.224 -3.752 -82.975 -101.454
5 Taiwan 32.979 8.603 26.3 33.09 17 U.S. -731.214 -5.296 -788.115 -664.125
6 Sweden 38.797 8.53 33.297 33.041 18 Australia -56.342 -6.198 -40.362 -52.555
7 Germany 252.501 7.603 177.664 279.017 19 South Africa -20.557 -7.262 -16.602 -23.908
8 Netherlands 52.522 6.758 55.874 51.107 20 Spain -145.141 -10.079 -110.14 -169.209
9 Russia 76.163 5.906 94.34 115.286 Totals in billions of U.S. dollars
10 Japan 210.967 4.815 170.437 194.269
*Account balance in percent of GDP +Estimate
11 Canada 12.726 0.886 17.838 14.803
Source: International Monetary Fund,
12 Brazil 1.712 0.13 13.621 -29.215 World Economic Outlook Database, October 2008

57 www.activetradermag.com • January 2009 • ACTIVE TRADER

 NON-U.S.-DOLLAR FOREX CROSS RATES
Currency 1-month 3-month 6-month 52-week 52-week
Rank pair Symbol Nov. 6 gain/loss gain/loss gain/loss high low Previous
1 Franc / Pound CHF/GBP 0.53824 7.63% 10.79% 11.90% 0.5677 0.4147 5
2 Real / Aussie $ BRL/AUD 0.68278 6.76% -1.13% 6.00% 0.7391 0.6171 15
3 Real / Pound BRL/GBP 0.29677 6.25% -8.72% -3.36% 0.339 0.2441 19
4 Euro / Yen EUR/JPY 1.86711 4.87% 10.90% 13.50% 169.958 113.614 14
5 Canada $ / Pound CAD/GBP 0.54274 4.00% 10.54% 8.85% 0.5427 0.482 6
6 Franc / Canada $ CHF/CAD 0.99239 3.45% 0.27% 2.81% 1.1152 0.8044 4
7 Franc / Euro CHF/EUR 0.66342 3.13% 8.24% 8.16% 0.6992 0.5969 2
8 Real / Canada $ BRL/CAD 0.54711 2.13% -17.40% -11.21% 0.6719 0.4726 18
9 Real / Euro BRL/EUR 0.36575 1.78% -10.84% -6.61% 0.4197 0.3124 17
10 Canada $ / Euro CAD/EUR 0.66889 -0.38% 7.97% 5.19% 0.7476 0.6164 3
11 Aussie $ / Pound AUD/GBP 0.43493 -0.54% -7.64% -8.81% 0.4895 0.3786 13
12 Pound / Euro GBP/EUR 1.23315 -4.21% -2.28% -3.33% 1.4418 1.2181 1
13 Aussie $ / Canada $ AUD/CAD 0.80181 -4.40% -16.42% -16.22% 0.9833 0.7568 10
14 Aussie $ / Euro AUD/EUR 0.53633 -4.67% -9.73% -11.83% 0.6411 0.4725 7
15 Aussie $ / Franc AUD/CHF 0.80818 -7.65% -16.64% -18.52% 1.0629 0.712 12
16 Franc / Yen CHF/JPY 85.21795 -8.65% -17.11% -14.64% 105.071 78.73 9
17 Real / Yen BRL/JPY 46.97731 -9.83% -31.73% -26.30% 69.3981 40.999 20
18 Canada $ / Yen CAD/JPY 85.91263 -11.74% -17.32% -16.98% 124.527 72.8508 11
19 Pound / Yen GBP/JPY 158.388 -15.10% -25.17% -23.70% 239.811 139.276 8
20 Aussie $ / Yen AUD/JPY 68.83476 -15.59% -30.93% -30.45% 107.167 55.1876 16
GLOBAL STOCK INDICES
1-month 3-month 6-month 52-week 52-week
Rank Country Index Nov. 6 gain/loss gain/loss gain/loss high low Previous
1 South Africa FTSE/JSE All Share 20,125.27 -4.27% -25.31% -36.97% 33,232.89 18,363.69 6
2 Canada S&P/TSX composite 9,555.41 -6.60% -28.97% -33.71% 15,154.80 8,537.34 15
3 UK FTSE 100 4,272.40 -6.90% -22.12% -31.26% 6,610.90 3,665.20 5
4 Italy MIBTel 16,715.00 -7.01% -24.60% -35.85% 30,403.00 14,521.00 7
5 Switzerland Swiss Market 5,924.90 -8.26% -17.82% -21.46% 8,918.80 5,265.90 2
6 France CAC 40 3,387.25 -8.75% -23.85% -32.80% 5,795.22 2,959.29 3
7 Australia All ordinaries 4,106.50 -9.64% -18.17% -28.93% 6,741.40 3,693.90 1
8 Mexico IPC 19,650.86 -9.65% -28.13% -37.06% 32,292.90 16,480.00 11
9 Germany Xetra Dax 4,813.57 -10.64% -26.64% -31.40% 8,117.79 4,014.60 4
10 Brazil Bovespa 36,362.00 -13.63% -36.81% -48.20% 73,920.00 29,435.00 12
11 U.S. S&P 500 904.88 -14.38% -29.81% -36.20% 1,523.57 839.80 13
12 Japan Nikkei 225 8,899.14 -15.03% -32.86% -36.90% 16,107.70 6,994.90 10
13 Singapore Straits Times 1,819.20 -16.10% -36.98% -44.00% 3,632.76 1,473.77 9
14 India BSE 30 9,734.22 -17.52% -35.42% -43.97% 21,206.80 7,697.39 14
15 Hong Kong Hang Seng 13,790.04 -17.93% -37.61% -47.49% 29,962.90 10,676.30 8
GLOBAL SHORT-TERM INTEREST RATES
Country Interest rate Rate Last change May 08 November 07
U.S. Fed funds rate 1 0.5 (Oct. 08) 2 4.5
Japan Overnight call rate 0.3 0.2 (Oct. 08) 0.5 0.5
Eurozone Refi rate 3.25 0.5 (Nov. 08) 4 4
UK Repo rate 3 1.5 (Nov. 08) 5 5.75
Canada Overnight funding rate 2.25 0.25 (Oct. 08) 3 4.5
Switzerland 3-month Swiss Libor 2 0.5 (Nov. 08) 2.75 2.75
Australia Cash rate 5.25 0.75 (Nov. 08) 7.25 6.75
New Zealand Cash rate 6.5 0.5 (Oct. 08) 8.25 8.25
Brazil Selic rate 13.75 0.75 (Sept. 08) 11.75 11.25
Korea Overnight call rate 4 0.25 (Nov. 08) 5 5
Taiwan Discount rate 3 0.5 (Oct. 08) 3.5 3.25
India Repo rate 7.5 0.5 (Nov. 08) 7.75 7.75
South Africa Repurchase rate 12 0.5 (June 08) 11.5 10.5
GLOBAL BOND RATES
Rank Country Rate Nov. 6 1-month 3-month 6-month High Low Previous
1 UK Short sterling 96.325 1.86% 2.26% 1.71% 96.41 93.60 5
2 Germany BUND 117.52 0.30% 4.14% 2.89% 118.5 109.65 1
3 Australia 10-year bonds 94.85 -0.03% 0.92% 1.30% 95.18 93.18 4
4 Japan Government Bond 137.84 -0.76% 0.43% 1.06% 141.90 132.09 3
5 U.S. 10-year T-note 115.43 -2.15% 0.83% 0.51% 120.03 110.83 2
All data as of Nov. 6

ACTIVE TRADER • January 2009 • www.activetradermag.com 58

 ETF Snapshot
Date: Nov. 6
The following table summarizes the trading activity in the most actively traded exchange-traded funds. The information does NOT constitute trade
signals. It is intended only to provide a brief synopsis of each market’s liquidity, direction, and levels of momentum and volatility. See the legend
for explanations of the different fields.
1-year 10-day 20-day 60-day Volatility
Market Symbol Sector Volume return move/rank move/rank move/rank ratio/rank
Positive one-year performance
UltraShort Nasdaq 100*** QID Leveraged inverse index 50.74 M 89.27% -6.28% / 44% -11.24% / 67% 84.05% / 98% .66 / 60%
UltraShort S&P 500*** SDS Leveraged inverse index 58.46 M 68.72% -5.96% / 33% -14.00% / 93% 44.71% / 93% .84 / 80%
UltraShort Russell 2000*** TWM Leveraged inverse index 10.03 M 54.56% -10.13% / 86% -15.04% / 86% 67.89% / 94% .88 / 75%
UltraShort Dow 30*** DXD Leveraged inverse index 13.28 M 51.21% -7.23% / 33% -14.90% / 94% 29.23% / 88% 1.04 / 83%
UltraShort Financials*** SKF Leveraged inverse index 24.87 M 46.26% -5.21% / 29% -20.47% / 88% 14.08% / 35% .89 / 80%
UltraShort Real Estate*** SRS Leveraged inverse index 6.06 M 36.46% -9.38% / 25% 2.50% / 13% 64.84% / 92% 1.18 / 82%
UltraShort Oil & Gas*** DUG Leveraged inverse index 20.32 M 0.24% -13.00% / 25% -35.86% / 93% 15.76% / 19% .78 / 70%

Negative one-year performance

Ultra Financials** UYG Leveraged index 121.01 M -82.24% -7.29% / 12% -4.76% / 22% -60.39% / 96% .20 / 28%
Ultra Oil & Gas** DIG Leveraged index 15.23 M -71.55% 1.03% / 0% -10.85% / 21% -63.48% / 89% .14 / 8%
Ultra Nasdaq 100** QLD Leveraged index 48.03 M -70.40% -1.78% / 0% -9.23% / 4% -63.05% / 100% .17 / 10%
Ultra S&P 500** SSO Leveraged index 74.28 M -67.23% -1.61% / 6% -5.39% / 14% -54.32% / 98% .22 / 30%
FTSE/Xinhua China 25 Index FXI Index 44.80 M -63.94% -5.65% / 16% -19.54% / 73% -47.11% / 96% .29 / 13%
Ultra Dow 30** DDM Leveraged index 13.61 M -60.49% -2.92% / 0% -0.18% / 0% -47.14% / 97% .29 / 60%
Brazil EWZ Regional 26.89 M -58.26% 9.33% / 80% -2.81% / 3% -49.28% / 84% .22 / 28%
Emerging Markets EEM Emerging Markets 132.59 M -56.31% 3.12% / 33% -14.10% / 57% -44.05% / 92% .32 / 38%
Hong Kong EWH Regional 7.76 M -53.93% -2.15% / 6% -5.39% / 13% -38.21% / 94% .26 / 30%
Financial XLF Financial 226.83 M -53.68% -3.66% / 13% 1.97% / 36% -32.13% / 95% .37 / 53%
Taiwan EWT Regional 19.24 M -50.99% -3.17% / 11% -9.86% / 27% -41.80% / 98% .30 / 67%
Oil Services OIH Energy 12.21 M -50.13% 2.15% / 0% -6.69% / 17% -50.92% / 87% .17 / 7%
Dow Jones U.S. Financial Sector IYF Financial 8.54 M -49.95% -2.22% / 6% 0.62% / 16% -30.38% / 94% .37 / 52%
EAFE* EFA Index 35.21 M -49.25% -0.07% / 0% -9.62% / 53% -34.77% / 95% .30 / 62%
Dow Jones U.S. Real Estate IYR Real Estate 21.17 M -46.89% -3.11% / 11% -15.62% / 48% -41.17% / 98% .30 / 18%
Semiconductor SMH Technology 15.43 M -45.51% -2.18% / 7% -12.52% / 36% -40.95% / 100% .27 / 33%
KBW Bank KBE Banking 10.07 M -43.25% -0.75% / 0% 5.84% / 42% -16.05% / 43% .55 / 75%
Consumer Discretionary XLY Consumer 8.34 M -41.57% 0.78% / 0% -4.20% / 18% -31.71% / 98% .38 / 47%
Materials XLB Materials 17.19 M -41.08% 2.26% / 50% -6.96% / 39% -38.33% / 95% .27 / 33%
Technology XLK Technology 16.19 M -40.70% -2.53% / 27% -3.75% / 4% -34.36% / 100% .29 / 38%
Industrial XLI Industrial 15.52 M -40.59% 0.64% / 20% -3.00% / 12% -33.21% / 97% .31 / 47%
Retail XRT Retail 7.43 M -39.97% 2.36% / 100% -10.47% / 23% -32.25% / 95% .30 / 3%
Nasdaq 100 QQQQ Index 288.13 M -38.88% 0.23% / 0% -3.05% / 4% -35.93% / 99% .26 / 17%
S&P Midcap 400 Index MDY Index 11.10 M -38.82% 2.43% / 25% -2.75% / 15% -35.55% / 97% .31 / 30%
S&P 500 Index IVV Index 10.28 M -38.33% -0.22% / 0% -1.08% / 6% -29.56% / 98% .33 / 45%
S&P 500 Index SPY Index 478.92 M -37.40% -0.91% / 0% 0.18% / 8% -29.33% / 97% .34 / 42%
Energy XLE Energy 54.71 M -37.24% 2.26% / 14% 5.19% / 100% -35.24% / 86% .27 / 27%
Russell 2000 Index IWM Index 118.06 M -36.19% 1.22% / 25% -8.94% / 43% -33.27% / 97% .36 / 5%
Japan EWJ Regional 41.37 M -35.67% -2.16% / 15% 1.89% / 0% -24.45% / 88% .37 / 82%
S&P Home Building Index XHB Index 7.46 M -35.65% 2.91% / 100% -11.51% / 24% -29.31% / 87% .32 / 28%
Silver SLV Metals 7.32 M -35.25% 5.54% / 75% -17.15% / 40% -33.06% / 71% .14 / 10%
Utilities XLU Utilities 9.05 M -33.60% -1.35% / 0% 3.69% / 100% -25.04% / 84% .23 / 25%
Dow Jones Industrial Average DIA Index 40.18 M -33.14% -0.98% / 8% 1.85% / 46% -24.50% / 95% .45 / 78%
United States Oil Fund USO Energy 10.81 M -32.93% -11.40% / 25% -27.95% / 83% -46.51% / 97% .11 / 3%
U.S. Natural Gas UNG Energy 4.23 M -27.30% 4.89% / 100% -1.63% / 4% -25.45% / 23% .12 / 47%
Retail RTH Retail 8.49 M -21.36% 3.30% / 17% -2.26% / 8% -24.25% / 100% .43 / 47%
Gold GLD Metals 18.52 M -12.12% 2.22% / 50% -19.67% / 100% -11.45% / 71% .18 / 0%
*Europe, Australasia, and the Far East ** Tracks twice the move of this index. *** Tracks twice the inverse, or opposite, of this index.
Legend 60-day move: The percentage price move hundred-twenty 60-day moves. A reading of
Vol: 30-day average daily volume, in thou- from the close 60 days ago to today’s close. 100 percent means the current reading is larger
sands (unless otherwise indicated). The “rank” fields for each time window (10-day than all the past readings, while a reading of 0
OI: Open interest, in thousands (unless oth- moves, 20-day moves, etc.) show the percentile percent means the current reading is smaller
erwise indicated). rank of the most recent move to a certain num- than all previous readings. These figures provide
ber of the previous moves of the same size and perspective for determining how relatively large
1-year return: The percentage price move or small the most recent price move is compared
in the same direction. For example, the rank for
from the close one year ago (250 trading days) to past price moves.
to today’s close. 10-day move shows how the most recent 10-
day move compares to the past twenty 10-day Volatility ratio/rank: The ratio is the short-
10-day move: The percentage price move moves; for the 20-day move, the rank field term volatility (10-day standard deviation of
from the close 10 days ago to today’s close. shows how the most recent 20-day move com- prices) divided by the long-term volatility (100-
20-day move: The percentage price move pares to the past sixty 20-day moves; for the 60- day standard deviation of prices). The rank is
from the close 20 days ago to today’s close. day move, the rank field shows how the most the percentile rank of the volatility ratio over
recent 60-day move compares to the past one- the past 60 days.

59 www.activetradermag.com • January 2009 • ACTIVE TRADER

 STOCK & FUTURES Snapshot
The following tables summarize the trading activity in the most actively traded stocks and futures contracts. The information does NOT consti-
tute trade signals. It is intended only to provide a brief synopsis of each market’s liquidity, direction, and levels of momentum and volatility.
Volume figures are for the most-active contract month in a particular market and may not reflect total volume for all contract months.
For a more extensive futures snapshot, see Futures & Options Trader magazine (www.futuresandoptionstrader.com).
Note: Average volume and open-interest data includes both pit and side-by-side electronic contracts (where applicable).
Price activity for CME futures is based on pit-traded contracts, while price activity for CBOT futures is based on the highest-volume contract (pit or electronic).

Stock snapshot as of Nov. 6

1-year 10-day 20-day 60-day Volatility
Negative one-year performance Symbol Volume return move/rank move/rank move/rank ratio/rank
Morgan Stanley MS 61.48 M -71.61% -14.88% / 44% 23.61% / 100% -61.67% / 94% .16 / 0%
Merrill Lynch MER 40.89 M -69.53% -7.31% / 29% 21.85% / 100% -36.60% / 62% .25 / 53%
Vale RIO 61.50 M -66.44% 4.63% / 0% -1.72% / 2% -53.76% / 86% .18 / 33%
Citigroup C 149.13 M -65.20% -12.13% / 39% -10.90% / 42% -35.32% / 97% .39 / 43%
Research In Motion RIMM 37.45 M -57.64% 3.81% / 33% -18.75% / 18% -62.21% / 97% .12 / 12%
Bank of America BAC 116.44 M -54.25% -12.52% / 36% 2.50% / 16% -30.28% / 76% .30 / 43%
Petroleo Brasileiro PBR 37.43 M -53.90% 3.11% / 25% -9.97% / 24% -51.85% / 88% .22 / 20%
General Electric GE 142.72 M -52.21% -2.45% / 18% -3.52% / 16% -37.43% / 100% .24 / 43%
EMC Corporation EMC 38.55 M -47.41% 11.26% / 43% 0.29% / 0% -30.15% / 94% .34 / 62%
Intel INTC 96.34 M -44.85% -4.41% / 25% -11.09% / 13% -42.50% / 100% .28 / 23%
Time Warner TWX 38.76 M -44.61% 0.63% / 0% -5.35% / 5% -38.47% / 100% .25 / 2%
Chesapeake Energy CHK 43.26 M -43.98% 5.03% / 14% 27.22% / 100% -52.18% / 74% .13 / 10%
Cisco Systems CSCO 84.40 M -40.73% -1.74% / 19% -1.45% / 0% -30.32% / 100% .29 / 27%
Apple AAPL 61.71 M -40.07% 0.89% / 15% 11.67% / 85% -44.73% / 95% .19 / 18%
Microsoft MSFT 123.32 M -38.10% -6.45% / 31% -6.37% / 44% -25.19% / 100% .41 / 27%
AT&T T 44.32 M -33.70% 2.89% / 10% 13.00% / 93% -16.96% / 60% .48 / 88%
Pfizer PFE 73.94 M -28.30% -4.27% / 27% 4.47% / 59% -16.65% / 93% .68 / 82%
Exxon Mobil XOM 56.50 M -19.45% -0.61% / 0% 2.88% / 85% -10.50% / 48% .58 / 68%
Oracle Corporation ORCL 55.20 M -12.96% -0.59% / 10% 3.95% / 24% -26.77% / 100% .48 / 47%
JPMorgan Chase JPM 69.50 M -9.57% 1.08% / 29% 4.31% / 24% 3.66% / 17% .75 / 68%
Wells Fargo WFC 66.37 M -9.13% -8.17% / 55% 5.58% / 31% -1.78% / 2% .49 / 52%

Futures snapshot as of Nov. 6

10-day 20-day 60-day Volatility
Market Symbol Exchange Volume OI move/rank move/rank move/rank ratio/rank
E-Mini S&P 500 ES CME 3.42 M 2.83 M -1.17% / 0% -0.88% / 10% -29.58% / 98% .35 / 42%
10-yr. T-note TY CME 654.5 1.39 M -0.10% / 0% 1.75% / 61% 0.02% / 4% .53 / 48%
E-Mini Nasdaq 100 NQ CME 498.3 364.9 -1.04% / 0% -2.48% / 4% -36.11% / 99% .28 / 15%
5-yr. T-note FV CME 450.5 1.38 M 1.05% / 54% 2.71% / 100% 3.59% / 89% .61 / 70%
Mini Dow YM CME 294.5 99.4 -0.84% / 0% 1.19% / 33% -24.49% / 95% .45 / 78%
Crude oil CL NYMEX 258.5 243.6 -10.42% / 25% -29.82% / 85% -47.61% / 96% .11 / 3%
30-yr. T-bond US CME 239.1 758.5 -0.90% / 27% 0.08% / 0% 0.20% / 11% .65 / 55%
2-yr. T-note TU CME 229.3 729.9 0.80% / 75% 0.97% / 92% 1.91% / 94% .32 / 48%
E-Mini Russell 2000 TF ICE 204.3 488.5 1.99% / 33% 1.78% / 22% -33.53% / 96% .38 / 8%
Eurocurrency EC CME 199.8 154.5 -0.91% / 0% -7.11% / 81% -14.70% / 86% .16 / 3%
Corn C CME 128.0 460.7 -3.13% / 19% -13.74% / 57% -29.87% / 75% .14 / 10%
Gold 100 oz. GC NYMEX 105.9 174.5 2.45% / 100% -17.41% / 93% -11.53% / 69% .16 / 0%
Soybeans S CME 84.9 110.4 1.70% / 17% -8.22% / 33% -29.59% / 71% .11 / 7%
Natural gas NG NYMEX 61.9 88.9 8.72% / 100% 2.26% / 43% -17.47% / 16% .18 / 85%
Wheat W CME 36.0 154.0 -0.11% / 0% -13.60% / 40% -38.56% / 99% .16 / 3%
E-Mini S&P MidCap 400 ME CME 35.4 106.9 2.45% / 25% -2.04% / 12% -35.28% / 97% .32 / 32%
*Average volume and open interest based on highest-volume contract (March 2008).
This information is for educational purposes only. Active Trader provides this data in good faith, but it cannot guarantee its accuracy or timeliness. Active
Trader assumes no responsibility for the use of this information. Active Trader does not recommend buying or selling any market, nor does it solicit orders
to buy or sell any market. There is a high level of risk in trading, especially for traders who use leverage. The reader assumes all responsibility for his or
her actions in the market.

ACTIVE TRADER • January 2009 • www.activetradermag.com 60

 THE Economy
FIGURE 1: QUARTERLY GDP PERFORMANCE

U.S. economic briefing

FED CONTINUES RATE CUTS GDP fell 0.3 percent in the third quarter, according to advance (first) esti-
Meeting: Federal Open Market Committee mates. In addition, revised estimates show GDP dropped 0.2 percent in the
fourth quarter of 2007.
(FOMC)
Source: Bureau of Economic Analysis
Date and time: Oct. 29 at 2:15 p.m.
Seasonally adjusted * Advanced estimate
Summary: The Fed cut its target fed funds
interest rate 0.5 percent to 1 percent, its lowest
FIGURE 2: PAYROLLS VS. UNEMPLOYMENT RATE
level in four-and-a-half years. The deepening
economic slowdown was attributed mainly to a
drop in consumer spending, while the contin-
ued weakening of foreign economic activity
has hurt exports.
The FOMC continues to expect inflation
will moderate over the next few quarters as
energy and commodity prices stabilize.
The following tables compare the S&P 500’s
daily and weekly reactions to economic releas-
es as well as historic behavior since 1997 (or
earlier).
Average
Scheduled S&P 500 historical moves
rate changes reaction since 1994
Report day -1.11% 0.34%
Five days later 6.94% 0.15%
The unemployment rate has risen 1.7 percent in the last 12 months, an
increase of 2.8 million people.
Source: Bureau of Labor Statistics Seasonally adjusted
ECONOMY CONTRACTS IN Q3
Report: Gross domestic product for Q3 2007
(adv.) FIGURE 3: OVERALL VS. CORE INFLATION
Date and time: Oct. 30 at 8:30 a.m.
Actual: -0.3 percent
Previous: 2.8 percent
Consensus: -0.5 percent

S&P 500 Historical moves

GDP reaction since 1994
Report day 2.58% -0.01%
Five days later 2.44% 0.35%

CPI UNCHANGED, PPI DECLINES

Report: Consumer Price Index (CPI) CPI and PPI year-over-year growth fell in August and September, largely
Date and time: Oct. 16 at 8:30 a.m. because of dropping energy costs.
Actual: 0.0 percent (core 0.1 percent) Source: Bureau of Labor Statistics Not seasonally adjusted
Previous: -0.1 percent (core 0.2 percent)

61 www.activetradermag.com • January 2009 • ACTIVE TRADER

 FIGURE 4: ISM MANUFACTURING INDEX

Consensus: 0.1 percent (core 0.2 percent)

S&P 500 Historical moves

CPI reaction since 1980
Report day 4.25% 0.09%
Five days later -0.78% 0.18%

Report: Producer Price Index (PPI)

Date and time: Oct. 15 at 8:30 a.m. The manufacturing index fell to a 15-year low of 38.9 in October.
Actual: -0.4 percent (core 0.4 percent) Source: Institute of Supply Management Seasonally adjusted
Previous: -0.9 percent (core 0.2 percent)
Consensus: -0.4 percent (core 0.2 percent)

S&P 500 Historical moves

PPI reaction since 1994
Report day -9.03% 0.06%
Five days later -4.30% 0.38% FIGURE 5: S&P PERFORMANCE
The S&P 500 swung widly
in October and early
November.
MANUFACTURING INDEX DROPS
Report: ISM manufacturing index
Source: eSignal
Date and time: Nov. 3 at 10 a.m.
Actual: 38.9
Previous: 43.5
Consensus: 42.0

ISM S&P 500 Historical moves

manufacturing reaction since 1997
Report day -0.25% 0.29% FIGURE 6: S&P 500 REACTION TO NEWS
Five days later -3.61% 0.35%

UNEMPLOYMENT JUMPS TO 14-YEAR HIGH

Report: Employment
Date and time: Nov. 7 at 8:30 a.m.
Non-farm payrolls
Actual: -240K
Previous: -284K
Consensus: -200K
Unemployment rate
Actual: 6.5 percent
Previous: 6.1 percent
Consensus: 6.3 percent

S&P 500 Historical moves

Employment reaction since 1994
Report day 2.86% 0.11% Most economic releases coincided with large moves in the S&P 500 in
Five days later 0.71% -0.22% October and November, including a 9.3-percent drop when the PPI
report was released on Oct. 15.

ACTIVE TRADER • January 2009 • www.activetradermag.com 62

 Key CONCEPTS
At the money (ATM): An option whose strike price is identical (or
very close) to the current underlying stock (or futures) price.
Average and median: The mean (or average) of a set of values is the
sum of the values divided by the number of values in the set. If
a set consists of 10 numbers, add them and divide by 10 to get
the mean.
A statistical weakness of the mean is that it can be distorted
by exceptionally large or small values. For example, the mean of
1, 2, 3, 4, 5, 6, 7, and 200 is 28.5 (228/8). Take away 200, and
the mean of the remaining seven numbers is 4, which is much
more representative of the numbers in this set than 28.5.
The median can help gauge how representative a mean really
is. The median of a data set is its middle value (when the set has
an odd number of elements) or the mean of the middle two ele-
ments (when the set has an even number of elements). The
median is less susceptible than the mean to distortion from
extreme, non-representative values. The median of 1, 2, 3, 4, 5,
6, 7, and 200 is 4.5 ((4+5)/2), which is much more in line with
the majority of numbers in the set.
Bollinger Bands: Bollinger Bands are a type of trading “envelope”
consisting of lines plotted above and below a moving average,
which are designed to capture a market’s typical price fluctua-
tions.
The indicator is similar in concept to the moving average
envelope, with an important difference: While moving average
envelopes plot lines a fixed percentage above and below the
average (typically three percent above and below a 21-day sim-
ple moving average), Bollinger Bands use standard deviation to
determine how far above and below the moving average the
lines are placed. As a result, while the upper and lower lines of a
moving average envelope move in tandem, Bollinger Bands
expand during periods of rising market volatility and contract
during periods of decreasing market volatility.
Bollinger Bands were created by John Bollinger, CFA, CMT,
the president and founder of Bollinger Capital Management (see
Active Trader, April 2003, p. 60). By default, the upper and
lower Bollinger Bands are placed two standard deviations above
and below a 20-period simple moving average.
Upper band = 20-period simple moving average + 2
standard deviations
Middle line = 20-period simple moving average of clos-
ing prices
Lower band = 20-period simple moving average - 2
standard deviations
Bollinger Bands highlight when price has become high or low
on a relative basis, which is signaled through the touch (or
63
The option “Greeks”
Delta: The ratio of the movement in the option price for every
point move in the underlying. An option with a delta of 0.5
would move a half-point for every 1-point move in the
underlying stock; an option with a delta of 1.00 would move
1 point for every 1-point move in the underlying stock.
Gamma: The change in delta relative to a change in the under-
lying market. Unlike delta, which is highest for deep ITM
options, gamma is highest for ATM options and lowest
for deep ITM and OTM options.
Rho: The change in option price relative to the change in the
interest rate.
Theta: The rate at which an option loses value each day (the
rate of time decay). Theta is relatively larger for OTM than
ITM options, and increases as the option gets closer to its
expiration date.
Vega: How much an option’s price changes per a one-percent
change in volatility.
minor penetration) of the upper or lower line.
However, Bollinger stresses that price touching the lower or
upper band does not constitute an automatic buy or sell signal.
For example, a close (or multiple closes) above the upper band
or below the lower band reflects stronger upside or downside
momentum that is more likely to be a breakout (or trend) signal,
rather than a reversal signal. Accordingly, Bollinger suggests
using the bands in conjunction with other trading tools that can
supply context and signal confirmation.
Bootstrapping: A method for estimating results from a data set by
creating multiple series of random samples and comparing them
to the original set. This approach is used to confirm the statisti-
cal significance of back-tested performance.
Moving average convergence-divergence (MACD): Although it is often
grouped with oscillators, the MACD is more of an intermediate-
term trend indicator (although it can reflect overbought and
oversold conditions).
The default MACD line (which can also be plotted as a his-
togram) is created by subtracting a 26-period exponential mov-
ing average (EMA) of closing prices from a 12-period EMA of
closing prices; a nine-period EMA is then applied to the MACD
line to create a “signal line.”
www.activetradermag.com • January 2009 • ACTIVE TRADER

MACD = EMA(C,12)-EMA(C,26)
Signal line = EMA(MACD,9)
Out of the money (OTM): A call option with a strike price above the
price of the underlying instrument, or a put option with a strike
price below the underlying instrument’s price.
True range (TR): A measure of price movement that accounts for
the gaps that occur between price bars. This calculation provides
a more accurate reflection of the size of a price move over a
given period than the standard range calculation, which is sim-
ply the high of a price bar minus the low of a price bar. The true
range calculation was developed by Welles Wilder and discussed
in his book New Concepts in Technical Trading Systems (Trend
Research, 1978).
True range can be calculated on any time frame or price bar
— five-minute, hourly, daily, weekly, etc. The following discus-
sion uses daily price bars for simplicity.
ACTIVE TRADER • January 2009 • www.activetradermag.com
True range is the greatest (absolute) distance of the following:
1. Today’s high and today’s low.
2. Today’s high and yesterday’s close.
3. Today’s low and yesterday’s close.
Average true range (ATR) is simply a moving average of the
true range over a certain time period. For example, the five-day
ATR would be the average of the true range calculations over the
last five days.
Volatility: The level of price movement in a market. Historical
(“statistical”) volatility measures the price fluctuations (usually
calculated as the standard deviation of closing prices) over a cer-
tain time period — e.g., the past 20 days. Implied volatility is
the current market estimate of future volatility as reflected in the
level of option premiums. The higher the implied volatility, the
higher the option premium.
64
 TRADING Resources
NEW PRODUCTS & SERVICES
The Quote.com team at eSignal has redesigned RagingBull.com.
The revamp includes new navigation tabs and content place-
ment as well as access to real-time quotes. The redesigned site
includes a discussion search tool to find archived keywords,
member names, board names, data ranges, and the latest rele-
vant discussions; the ability to share favorite members’ lists and
forum lists; and market screeners that allow users to join the lat-
est talk about stocks using 24 different criteria on five
exchanges. For more information, visit www.RagingBull.com.
Adaptrade Software’s Market System Analyzer (MSA) version 3 is
available. MSA software for futures and stock traders applies
position sizing, Monte Carlo analysis, dependency analysis,
equity curve crossover trading, and other money-management
methods. Version 3 includes full portfolio analysis, portfolio
optimization, correlation analysis, support for non-US traders,
and more. The software works with any trading system or
method and requires only a list of profits and losses as input. An
EasyLanguage interface to TradeStation is included. A 30-day
trial can be downloaded from www.Adaptrade.com.
Vhayu Technologies has partnered with Alphacet, Inc., a developer
of software for quantitative analysts, portfolio managers, and
traders, to provide customers with an integrated tick database
and alpha generation solution. It enables quants to create, back-
test, and analyze multi-layer models in hours-to-days instead of
weeks-to-months. This partnership combines Vhayu Velocity,
which can process, analyze, and store tick and bar data, with
Alphacet Explorer, a codeless historical backtesting engine
designed specifically for Vhayu Velocity for use across asset
classes and instrument types.
Option-industry denizen and author Dan Passarelli launched a
new mentoring company designed to educate option traders.
Market Taker Mentoring (http://markettaker.com) offers an edu-
cational service to do-it-yourself traders as well as seasoned pro-
fessionals. Passarelli’s new organization takes a personal
approach to mentoring. In the six-week course, students receive
one-on-one time with Passarelli in a program tailored to their
specific educational levels. For more information and a free
excerpt from Passarelli’s book Trading Option Greeks, visit
http://markettaker.com/FREE_Book_Excerpt_.html.
Smartstops.net has introduced BrokerLink, a portfolio-protection
65
service allowing trades to be automatically executed when at-
risk stock and ETF prices fall enough to trigger their daily
SmartStop. Smartstops.net has teamed up with TD Ameritrade,
offering free subscriptions to the firm’s 6.8 million customer
accounts. Calculated daily on most U.S.-listed stocks and ETFs,
SmartStops are based on an approach that considers current
technical indicators, historical trends, and a combination of exit
methodologies optimized for the prevailing market direction.
BarclayHedge and Global Fund Technologies, LLC announced the
launch of MyFundFinder.com, a capital introduction platform
designed to match hedge fund managers with institutional and
high net worth investors. MyFundFinder.com is a web-based
platform designed to provide hedge-fund managers with a capi-
tal-raising tool and to provide investors free access to search
online through more than 1,900 hedge funds, funds of funds,
and managed futures funds (CTAs) to discover, match, and con-
nect with those that meet their investment needs. Additional
platform features include industry discussion forums, geographi-
cal mapping, and new fund launches, all centered on a commu-
nity-driven site.
HedgeCo Networks, LLC has launched its online analytical and
reporting tool, the Hedge Fund Calculator. Available as a month-
ly or annual subscription service, the Hedge Fund Calculator
was designed for hedge funds and funds of hedge funds, and
facilitates the computation of quantitative statistics, net perform-
ance numbers, and the creation of branded marketing materials.
Key features of the Hedge Fund Calculator include: online
access, branded and customized tearsheets, a contact manager,
and benchmark analysis. To view a demo or sign up for a free
Webinar, visit HedgeFundCalculator.com.
Dow Jones has signed a strategic alliance with Agencia EFE to
develop a joint Spanish-language news service — EFE Dow
Jones News — to serve financial professionals, corporations,
media, institutions, and private investors in Spain. The new real-
time newswire will draw upon coverage of Spanish companies
and policy-making in EFE’s economic service, EFECOM, and the
international financial and market reporting of Dow Jones en
Español to offer clients expanded coverage of Spanish business,
including regional reporting and analysis of small- and mid-cap
stocks. For more information about Dow Jones Newswires, visit
www.dowjonesnewswires.com.
www.activetradermag.com • January 2009 • ACTIVE TRADER
Deutsche Bank’s retail online foreign exchange trading platform,
dbFX.com, has introduced decimalised pricing on its foreign
exchange prices. Also known as fractional pips, all prices on the
dbFX.com platform are now provided in tenths of a pip.
Launched in 2006, dbFX.com is available in multiple languages,
has 34 currency pairs, and is accessible in more than 70 coun-
tries around the world.
BOOKSHELF
Stock Trader’s Almanac 2009
By Jeffrey A. Hirsch and Yale Hirsch
Wiley, 2009
Hardcover, 193 pages
$39.95
This annual almanac, first published
in 1967, is composed of years of mar-
ket history arranged on a calendar. It
analyzes cycles and patterns in the
stock market and examines seasonal tendencies. This trove of
yearly, monthly, weekly, daily, and intraday data stretches back
for decades, highlighting a wide range of best and worst per-
formances. It offers event-specific studies such as post-election
and end-of-quarter data, and analyzes many market maxims
such as the January barometer and the Santa Claus rally.
The Stock Market Philosopher:
Insights of a Soviet-Born New York-Bred
Hedge Fund Trader
By Gennady Favel
W&A Publishing, 2008
Hardcover, 142 pages
$19.95
This book provides a look at one man’s
path from young immigrant to hedge-
fund trader. Favel writes about the mar-
kets from his own perspective, drawing on his experiences
growing up in the Soviet Union trading Bazooka Joe gum wrap-
pers, his young-adulthood trading comic books and gambling,
and on through college and his professional career. He discusses
how his experiences have shaped his view of the markets and
offers insights into how they work.
ACTIVE TRADER • January 2009 • www.activetradermag.com
Cognotec has partnered with Market News International (MNI) to
enable access to forex market news from around the world.
Users of Cognotec RealStream Margin trading solution can now
access MNI’s FX Bullet Points newsfeed on their desktops from
within the RealStream Margin trading platform.
continued on p. 6 7
The Art of the Trade: What I Learned
(and Lost) Trading the Chicago Futures
Markets
By Jason Alan Jankovsky
Wiley, 2008
Hardcover, 183 pages
$29.95
This book is a reworking of Jankovky’s
first book Dancing With Lions published under the pseudonym
“Trader X.” Drawing upon more than 20 years in the futures and
options business, Jankovsky recounts his journey to success,
clawing his way through the Chicago financial ecosystem.
Through his account, Jankovsky exposes the seedy underbelly of
an industry where “drug use, financial irresponsibility, and per-
sonal vendettas are commonplace.”
Keynes and the Market: How the World’s
Greatest Economist Overturned
Conventional Wisdom and Made a
Fortune on the Stock Market
By Justyn Walsh
Wiley, 2008
Hardcover, 209 pages
$27.95
Walsh’s book looks at the life and the-
ories of famed economist and prof-
itable stock trader John Maynard Keynes. The author looks at
Keynes’ methods to see why he was so successful, how investors
like Warren Buffet have adapted his principles, and how average
traders can benefit from his methods in today’s markets.
66
 Trading Resources continued
ICAP has launched its Global Currency Data Feed, a proprietary
feed of real time streaming prices from a selection of sources,
including ICAP’s electronic spot FX broking platform EBS and
ICAP’s internal pricing systems. The feed comprises prices for
more than 155 currency pairs and cross currency pairs from
more than 180 countries. Market participants can obtain the
data feed via direct connection or selected vendor partners.
ICAP Market Information and Commentary offerings include
real-time, end-of-day, and historical market data, as well as
research and commentary from economists and analysts.
Wave59 Technologies released Wave59 RT 3.0, an update of its
real-time technical market analysis program. Version 3.0
includes the ability to design, backtest, optimize, and automate
custom trading systems using Wave59’s QScript language.
Wave59 RT is a charting and analysis program designed around
versions of classical technical tools, as well as a suite of propri-
etary algorithms. For additional information on Wave59 RT 3.0,
contact Jonn Millarkie at (866) 494-7613 or visit
www.wave59.com to download a 30-day free trial.
CME Group and BM&FBOVESPA announced the order routing of
BM&F derivatives products on CME Globex. The order routing
linkage enables customers using the CME Globex electronic
trading platform to trade BM&FBOVESPA products directly,
including futures and options on one-day Inter-Bank Deposits,
the Bovespa Stock Index (pending regulatory approval), and
commodities such as Arabica coffee, live cattle, and corn.
BM&FBOVESPA customers will have the ability to trade CME
Group products directly through their BM&FBOVESPA connec-
tions, including CME Group futures and options on interest
rates, equity indices, foreign exchange, commodities, and energy
and metals products. More information on the agreement can be
found at www.cmegroup-bmfbovespa.com. CME Group also has
launched the latest version of CME E-quotes, a real-time stream-
ing market data application offering quotes, charting, advanced
analytics, and news on CME Group-traded products, including
interest rates, equity indices, foreign currencies, commodities,
energy, metals, and alternative investments. It also offers access
to prices for products listed on the Minneapolis Grain Exchange
and the Kansas Board of Trade, which are available for electronic
trading on CME Globex. For more information and a free two-
week trial, visit www.cmegroup.com/e-quotes.
Invesco PowerShares Capital Management LLC has listed an
emerging markets infrastructure portfolio on NYSE Arca. The
PowerShares Emerging Markets Infrastructure Portfolio (PXR) is
an exchange-traded fund (ETF) based on the S-Network
Emerging Infrastructure Builders IndexSM. The index is
designed to measure the overall performance of securities of
companies involved in infrastructure construction and develop-
ment in emerging market countries. Industries include construc-
67
tion and engineering, construction machinery, construction
materials, diversified metals and mining, heavy electrical equip-
ment, industrial machinery, and steel.
CQG, Inc., the charting, analytics, and trade-routing platform for
global electronically traded futures markets, has added SEB
Futures to its list of Futures Commission Merchant (FCM) part-
ners. CQG has teamed with SEB to connect traders to Euronext,
Globex, ICE, and Eurex. Traders clearing through SEB have
access to CQG’s market analysis tools and advanced order exe-
cution software.
optionMONSTER introduced trade MONSTER, an online brokerage
designed by professional traders for self-directed investors. Co-
founded by Jon “DRJ” Najarian and Pete Najarian, the
optionMONSTER group of companies provides tools and educa-
tion for individual investors in options and stock markets. trade
MONSTER allows you to customize how trade, position, and
market information is displayed. trade MONSTER’s educational
content is embedded throughout the site and ranges from basic
glossaries to detailed discussions of sophisticated option strate-
gies. In addition, trade MONSTER offers webinars from the
Najarians and invited guests.
FX Solutions, LLC (www.fxsolutions.com) announced its merger
with IFX Markets Inc. Both companies are wholly owned sub-
sidiaries of City Index Group. IFX Markets customer accounts
will transfer to FX Solutions, which provides foreign exchange
trading capabilities to retail customers, introducing brokers and
white label partners in more than 50 countries worldwide. IFX
Markets customers who trade on the GTS platform will find fea-
tures such as fixed spreads, streaming interbank market prices,
automatic execution, multiple order types, and integrated risk
management allowing up to five stops and limits per order,
including trailing stops.
John Bollinger’s BBForex.com, which provides Bollinger Band
analytics for the forex community, has a new feature merging
technical analysis with forex news from various news publishers.
Users can monitor forex charts and the latest news relating to
specific symbol pairs as it occurs. To assist new forex traders, a
basics section has also been added. It provides general forex
information, currency pricing factors, forex trading instruments,
investment common sense, and a forex glossary. The Web site is
free.

Trading Resources is a forum for industry businesses to announce
new products and upgrades. Listings are adapted from company
press releases and are not endorsements or recommendations from
the Active Trader Magazine Group. E-mail press releases to
editorial@activetradermag.com. Publication is not guaranteed.
www.activetradermag.com • January 2009 • ACTIVE TRADER
 Web WATCH

Web Watch: Collective2.com

REVIEWED BY ACTIVE TRADER STAFF

FIGURE 1: PORTFOLIO MAKER

C
ollective2.com tracks the performance of
thousands of trading systems. System
developers publish their systems on the
site, which enables people to “subscribe” to
systems on a case-by-case basis.
Developers can provide as little or as much information
as they like about their trade rules, but for subscribers
the systems are essentially “black boxes” — opaque
instructions telling them when to trade.
The site provides equity curves and performance statis-
tics calculated using live quotes. Along with statistics such
as average trade length, profitability over time, and win
percentage, Collective2 also calculates each system’s “real-
ism factor,” which it says indicates how likely hypotheti-
cal results are to be repeated in real-world trading. This
The order entry window resembles an online broker’s entry
includes factors such as slippage, trade size, and liquidity. window and sends trade signals directly to subscribers.
Collective2 tracks stock, futures, options (but not Source: Collective2.com
options on futures), and currency systems. After someone
subscribes to a system, the vendor sends trade signals to free trial periods. Subscribers pay in one of three ways: a recur-
the site for subscribers to act upon. They can also send alerts to ring charge, a charge on profitable periods, or a charge on indi-
subscribers regarding market conditions or advising them to be vidual profitable trades.
prepared for upcoming trades. Collective2 takes 30 percent of all subscription fees. Also, sys-
Figure 1 shows Collective2’s order entry window, which han- tem designers pay the site $98 every six months to publish an
dles stop and limit orders and more advanced order types. initial system, with a reduced fee for additional systems. But
System designers can use the order entry screen to post signals designers can post a system and enter up to five trade signals for
or, alternately, send signals directly to subscribers from plat- free.
forms such as TradeStation, TradeBullet, Interactive Brokers, After a system is registered, designers can see who has paid,
MetaTrader, and NinjaTrader. In addition, more advanced pro- when they paid, and when the next payment is due.
grammers can trade signals directly to the site using Almost every section of the site includes detailed, step-by-
Collective2’s signal entry application programming interface step instructions, and some sections also include instructional
(API). videos. Many pages are accompanied by a small window offer-
Subscription fees are determined by the designers; some offer ing advice or helpful links.

ACTIVE TRADER • January 2009 • www.activetradermag.com 68

TRADING Calendar
January 2009
LEGEND
1 FDD: January crude oil, natural gas futures (CME)
CPI: Consumer price index
2 December ISM manufacturing report
ECI: Employment cost index FDD: January gold, silver, and copper futures (CME)
FDD (first delivery day): The first
day on which delivery of a commodity 3
in fulfillment of a futures contract can
take place. 4
FND (first notice day): Also known
as first intent day, this is the first day 5 December employment report
on which a clearinghouse can give November construction spending
notice to a buyer of a futures contract December ISM non-manufacturing report
that it intends to deliver a commodity
in fulfillment of a futures contract. The FND: January heating oil and RBOB gasoline futures (CME)
clearinghouse also informs the seller.

FOMC: Federal Open Market

6 November factory orders
Committee
7
GDP: Gross domestic product

ISM: Institute for Supply Management

8
LTD (last trading day): The final 9 November wholesale inventories
day trading can take place in a futures FDD: January heating oil and RBOB gasoline futures (CME)
or options contract. LTD: January currency options
PMI: Purchasing managers index
10
PPI: Producer price index
Quadruple witching Friday: A day 11
where equity options, equity futures,
index options, and index futures all
expire.
12
13 November trade balance
CME: Chicago Mercantile Exchange
14 November business inventories
OC: OneChicago December retail sales
LTD: February crude oil options (CME)

15 December PPI

16 December CPI
December production and capacity utilization
S M T W T F S January U of M consumer sentiment (prelim.)
LTD: January equity and index options; January single stock futures
28 29 30 31 1 2 3
(OCX)
4 5 6 7 8 9 10

11 12 13 14 15 16 17 17
18 19 20 21 22 23 24 18
25 26 27 28 29 30 31
19
20 LTD: February crude oil futures (CME)

69 www.activetradermag.com • January 2009 • ACTIVE TRADER

 Report times
21 Economic Release
release time (ET)
22 December housing starts
FND: February crude oil futures (CME) GDP 8:30 a.m.

CPI 8:30 a.m.

23 LTD: February treasury options (CME)
ECI 8:30 a.m.

24 PPI 8:30 a.m.

Productivity and costs 8:30 a.m.

25
Employment 8:30 a.m.
26 December existing home sales
Personal income 8:30 a.m.

27 LTD: February natural gas, heating oil, gold, silver, and copper Business inventories 8:30 a.m.
options (CME) Durable goods 8:30 a.m.

Retail sales 8:30 a.m.

28 LTD: January gold, silver, and copper futures (CME); February
natural gas futures (CME) Trade balance 8:30 a.m.

Housing starts 8:30 a.m.

29 December durable goods
December new home sales Chicago Fed
FND: February natural gas futures (CME) national activity index 8:30 a.m.

Production
30 Q4 GDP (adv.)
Q4 employment cost index & capacity utilization 9:15 a.m.
January U of M consumer sentiment (final) Leading indicators 10 a.m.
January Chicago PMI
Consumer confidence 10 a.m.
FND: February gold, silver, and copper futures (CME)
LTD: February heating oil and RBOB gasoline futures (CME) Univ. of Michigan
consumer sentiment 10 a.m.
31 Wholesale inventories 10 a.m.

February Philadelphia Fed survey 10 a.m.

Existing home sales 10 a.m.

1 FDD: February crude oil, natural gas futures (CME)
Construction spending 10 a.m.
2 January ISM manufacturing report Chicago PMI report 10 a.m.
December personal income
FDD: February gold, silver, and copper futures (CME) ISM report on business 10 a.m.

ISM non-manufacturing report

3 FND: February heating oil and RBOB gasoline futures (CME) on business 10 a.m.

New home sales 10 a.m.

4 January ISM non-manufacturing report
Factory orders 10 a.m.
5 Q4 productivity and costs (prelim.)
Federal budget 2 p.m.

6 January employment report Consumer credit 3 p.m.

The information on this page is subject to

change. Active Trader is not responsible
for the accuracy of calendar dates beyond
press time.

ACTIVE TRADER • January 2009 • www.activetradermag.com 70

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71 www.activetradermag.com • January 2009 • ACTIVE TRADER

 TRADE Diary

A hard-hit — but still standing —

banking stock is available at
a deep discount.

TRADE

Date: Oct. 6-10.

Entry: Long Citicorp (C) at an average price

of 14.68.

Reason(s) for trade/setup: This long-term

investment position was taken because of the
broader market meltdown, the especially bad
meltdown in banking stocks, and the fact that
C had survived the banking purge that
culminated around the time the government’s
financial bailout plan was announced. Furthermore, C took
an extra stumble after it lost a fight with Wells Fargo to acquire
another failed bank, Wachovia, allowing the opportunity to buy
shares at an immediately discounted price (less than a third of
where they were a year ago).
Initial stop: N/A.
Initial target: N/A.
RESULT
Exit: Position still open.
Source: TradeStation
stocks we’ve picked up recently at “bargain” prices.
Such moves have to be put into perspective given the historic
nature of the current market, though — at one point the
position was up 17 percent. The last few bars of the weekly
chart inset hint at the extreme volatility that preceded and
followed this trade.
Buying a banking stock is indeed a gamble — the discount
at which we purchased C testifies to the extent the market fears
them — but C (along with JPMorgan Chase and Bank of
America) survived the October massacre, and we put on a rela-
tively small position to hold as an investment. In the short-term,
the position is a disaster. On a decade or longer time frame, the
statistics indicate the purchase price will be quite favorable.
That, anyway, is the rationale.

Profit/loss: -3.16 (21.5 percent).
Trade executed according to plan? Yes.
Outcome: Down approximately 9 percent on Oct. 28, this
position has actually fared better than any of the other
Note: Initial targets for trades are typically based on things such as the histor-
ical performance of a price pattern or trading system signal. However, indi-
vidual trades are a function of immediate market behavior; initial price tar-
gets are flexible and are most often used as points at which a portion of the
trade is liquidated to reduce the position’s open risk. As a result, the initial
(pre-trade) reward-risk ratios are conjectural by nature.

Trade Summary
Initial Initial
Date Stock Entry stop target IRR MTM Date P/L LOP LOL Length

10/6/08 C 16.34 N/A N/A N/A 11.52 11/6/08 -3.16 (21.5%) 2.57 -2.68 8 days
10/7/08 15.50
10/10/08 13.45
Legend — IRR: initial reward/risk ratio (initial target amount/initial stop amount). LOP: largest open profit (maximum available profit during lifetime of
trade). LOL: largest open loss (maximum potential loss during life of trade). MTM: Marked to market (trade’s open profit or loss at a given time).

ACTIVE TRADER • January 2009 • www.activetradermag.com 72

 TRADE Diary

Volatile conditions call

for cautious trading.

TRADE
Date: Monday, Oct. 20.

Entry: Long the S&P 500 tracking stock (SPY)

between 94.90 and 95.80.

Reason(s) for trade/setup: With the market hav-

ing bounced (on Oct. 16) after making a semi-
challenge to the Oct. 10 low, SPY is poised to fol-
low through on Friday’s “stealth” up day — higher
low, higher high, and slightly lower close.
The goal is to play the day from the long side,
taking small profits in stages, raising stops quick-
ly to remove risk, and re-entering on additional pullbacks as
appropriate. We initially bought at three prices — 95.80, 95.20,
and 94.90 — as price was moving down after a strong open.
Initial stop: 93.04, 1.31 below the morning’s swing low.
Initial target: 96.46.
Second target: 96.80.
RESULT
Exit: Multiple exits — see summary table.
Profit/loss: +5.27.
Trade executed according to plan? Yes.
Source: TradeStation
We caught a good point — after the smallest of dips below
the entry price the market turned up, making only one notable
pullback for the remainder of the session. We took off part of
the new trade at the secondary target (96.80), raised the stop to
95.88, and put in an order to sell another portion at 97.75 — a
level we thought had only a small chance of getting hit.
The market ultimately blew through that level, and we held
the remainder of the position overnight. Instead of following
through the next day, though, the market turned back down,
stopping out the remainder of the trade.
Looking at the chart may leave the impression we could have
saved ourselves a lot of trouble by not raising stops and holding
the initial position longer, but this is only obvious in hindsight.
Anyone who has been in the market lately knows this kind of
day has been the exception to the rule — sharp intraday retrace-
ments are de rigueur on most up days, and down days have
been more prevalent in general.

Outcome: Not executed perfectly, to be sure, but one of the
more satisfying days recently.
After taking partial profits at 96.46, we raised the stop to
above breakeven (at 95.73) for the entire three-part initial posi-
tion. The stop was hit, but when the market failed to follow
through, we re-entered at 95.65.
Note: Initial targets for trades are typically based on things such as the histor-
ical performance of a price pattern or trading system signal. However, indi-
vidual trades are a function of immediate market behavior; initial price tar-
gets are flexible and are most often used as points at which a portion of the
trade is liquidated to reduce the position’s open risk. As a result, the initial
(pre-trade) reward-risk ratios are conjectural by nature.

Trade Summary
Initial Initial
Date Stock Entry stop target IRR Exit Date P/L LOP LOL Length
10/20/08 SPY 95.80 93.04 96.46 0.24 96.46 10/20/08 +0.66 (0.69%) 3.31 -0.55 4-5 hours
95.20 0.58 95.73 +0.53 (0.56%)
94.90 0.84 95.73 +0.83 (0.87%)
95.65 96.80 96.80 10/21/08 +1.15 (1.2%) 3.46 -0.11 1 days
97.75 +2.10 (2.2%)
Legend — IRR: initial reward/risk ratio (initial target amount/initial stop amount). LOP: largest open profit (maximum available profit during
lifetime of trade). LOL: largest open loss (maximum potential loss during life of trade).

73 www.activetradermag.com • January 2009 • ACTIVE TRADER