Stocks & Commodities V.

2:4 (142-145): NOVICE SPECULATOR: An Anti-COMMODEX System by John Sweeney

NOVICE SPECULATOR: An
Anti-COMMODEX System
by John Sweeney

O ne observation I made when starting technical analysis was that there were relatively few bits of data
to work with: price, volume, and open interest for a given futures contract and its related contracts and
indices. Thus, any "black box" I constructed to forecast price action would be dependent on these inputs.
I didn't want to repeat others' work (perhaps poorly), so my first thought was simply to find the advisory
service which had best exploited each one of these variables—or a combination of them—and sign up. I
figured years of experience would beat my novice's analysis.
I soon learned that almost all advisory systems are predicated on price action alone. The focus is natural
since most people intend to take their profits on price movement, not volume or open interest. The result
of this focus is a dearth of folks who integrate price movement with other "primary" data; open interest,
volume, etc.
One exception to this at the time was the COMMODEX system, which is unique in its long history of
application, use of volume and open interest along with price (through two moving averages), and a
completely mechanical application. It is a fully disclosed system, too, which meant I wouldn't be working
with a mystery machine. It covered every commodity in which I was interested and it gave daily signals, a
feature I thought important at the time. The price was right and I signed up the same day I got my
monitor, computer and printer!
[For those not familiar with COMMODEX, I've included a reproduction of a typical day's report. This is
published daily, with each day's trades indicated under the column for Sell, Buy and Closed. However,
given the inability of the U.S. Mail to deliver reliably, and the two to three days to receive it under the
best of conditions, you must count on calling daily to get telephone updates if you're tracking something
closely. You can also sign up for computer updates available twice daily.]
Being a trader in financials, I didn't track COMMODEX's performance in cows, pigs and breakfast juices.
Instead, I watched bonds, bills, GNMA, currencies, and precious metals—what I had started to call the
"rate-sensitive complex". I tracked trade by trade rather than by the PROFIDEX, COMMODEX's own
accounting of open trade equity. The PROFIDEX normally shows a substantial profit in open trades but I
wanted to know the results of each individual trade. For the period 4/25/83 - 11/3/83, here's what I found
based on closed trades:

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Stocks & Commodities V. 2:4 (142-145): NOVICE SPECULATOR: An Anti-COMMODEX System by John Sweeney

The 30% success ratio keeps popping up with COMMODEX. Commodity Traders Consumer Report
(January 1984) reports a similar ratio (31%). Of the eight commodities I tracked from April through
October 1983, only TBonds varied substantially from this ratio. It appears that this system consistently
enters trades which will be closed or stopped out at a loss, about 30% of the time.
How was COMMODEX trading to give such consistency? I plotted the entry and exit points to see.
Graph 1 (TBonds) and Graph 2 (DMarks) are typical results. In these graphs, "S" stands for "short", "C"
for "closed out", and "L" for "long."
Notice that COMMODEX typically gets on board one of the cyclical ups and downs about three days into
the move. Should the move turn out to be a minor reversal in a longer trend, COMMODEX gets nipped
with a small loss as its system reverses. COMMODEX doesn't get stopped out that much, since it uses a
20-day moving average or a money-management stop. Instead, it cycles from neutral, to long/short, to
neutral, to short/long, to neutral, endlessly. What probably makes it a consistent seller is that 31 futures
with two to three contracts each give a "trade-a-day" at a minimum—lots of action.
Given its strong sensitivity to short-term reversals, COMMODEX has trouble taking a big chunk out of a
long trend—unless the move is a rocket or a rock! In the end, this was what soured me on COMMODEX
used by itself. I preferred to use it as an entry or exit device after other signals had indicated a 6-8 week
trend reversal. Thus I found myself studying the actions of other indicators more intently and, four or five
days later, noting that COMMODEX had confirmed the longer-term reversal. After six months, I let the
subscription lapse.
My action isn't atypical but it is probably a novice's mistake. After all, if something works, you should
really discard it only for something that works better! I discarded it because it wasn't perfect, it had a high
loss ratio, and I got bored taking signals—a good example of ego getting in the way of profits!
Four months later, the phenomenal consistency of COMMODEX's success ratio still intrigued me.
Consistency was what I was looking for in futures. Also, a consistent success/failure rate is the single
most important variable in the successful trading system. What, I wondered, would a system designed to
exploit this fact look like? Why not just trade against it? Profits would be many small profits, of
(relatively) high probability. An average loss (a "win" to COMMODEX) would be about twice the size of

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Stocks & Commodities V. 2:4 (142-145): NOVICE SPECULATOR: An Anti-COMMODEX System by John Sweeney

the average win if allowed to go until the system reversed. Could the favorable probabilities of "success"
generate a profitable result despite the losses being bigger than the wins? I did the following rough
calculation:
P(success) x Avg. Win = .7 × $788 = $522
P(failure) x Avg. Loss = .3 × $983 = $295
Expected Outcome = $552 - $295 = $257
This seemed a so-so result, but probably a tradable edge, given enough trading. It should be reassuring
psychologically since so many trades will be winners. Of course, it violates the standard trading rule of
seeking big profits and small losses but the tradeoff in assurance is clear. This might be the ideal starter
system for a new and nervous trader!
The obvious thing to try next is to limit the size of the losses (i.e., COMMODEX's wins). This shouldn't
be hard to do given that our losses come from positions COMMODEX would hold for a long time. As an
operational test, I thought of a close-only stop loss equal to the average COMMODEX loss, plus its
standard deviation. For example, in DMarks the stop-loss would be $373 + $261 = $634. By attempting
to limit my losses (COMMODEX wins) to the size of my wins plus the standard deviation, I thought to
improve performance without materially altering the system of trading opposite COMMODEX. After
calculating the new close-only stop loss for each future I got an average loss of $745 (vs. $983
previously) with a standard deviation of $571. The expected outcome is now

(.7 × $788) + (.3 × -$745) = $325

instead of $257, a 26% increase in profitability. I believe other refinements are possible.
Looking back at my doings, what are the novice's lessons? First, when testing any idea, a vast amount of
data is needed together with time and, hopefully, hardware/software to massage it. To get decent levels of
statistical validity, I really needed 30 trades per contract, or about a year and a half's data. This was the
exercise that sent me on my uncompleted search for the perfect trading support system!

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Stocks & Commodities V. 2:4 (142-145): NOVICE SPECULATOR: An Anti-COMMODEX System by John Sweeney

This was my second system which turned the lessons of the masters (large gains, small losses) on their
heads. I was still generating ideas with high probability of success and low levels of profit. My
conclusion was that I was focusing on the wrong areas and needed to look at longer-term trading
indicators so that I could deal in an arena that held the promise of larger profits.
I decided to leave COMMODEX to others with a vaster store of COMMODEX back issues. They could

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Stocks & Commodities V. 2:4 (142-145): NOVICE SPECULATOR: An Anti-COMMODEX System by John Sweeney

test this concept thoroughly. It may be that COMMODEX can be traded with or against its signals—a
curious case of winning both ways!

Graph 1: Reprinted from Commodity Price Charts, 219 Parkade, Cedar Falls, lowa 50613.

Figures Copyright (c) Technical Analysis Inc. 5

Stocks & Commodities V. 2:4 (142-145): NOVICE SPECULATOR: An Anti-COMMODEX System by John Sweeney

Graph 2: Reprinted from Commodity Price Charts, 219 Parkade, Cedar Falls, lowa 50613.
Stocks & Commodities V. 2:4 (142-145): NOVICE SPECULATOR: An Anti-COMMODEX System by John Sweeney

Tables Copyright (c) Technical Analysis Inc.