Archive for statistics
There are quite a number of patterns that work around the weekly STOPD price levels giving us a solid edge. This one is a classic bearish continuation setup.
Net gain chart below.
The bearish property of VIX that no one talks about.
If you need background information about the Volatility Index (VIX) please read The VIX Bullish Play. It has more background information about VIX that I do not want to repeat here. I am going to focus on the bearish trading setup here.
First, the net gain chart from day trading this VIX bearish bias.
This trading setup is kind of complement pattern of the one presented in The One Bullish Setup Everyone Must Know Daytrading Emini S&P. It is short only, strictly day trade from open to close. It has been profitable all these years. Yet no one ever talks about it.
Here is the dollar gain chart based on the setup.
As promised to my premium members I would publish my work here before they go into collections of ebooks. I have a slight change of plan now which delays the ebook publishing part and focus more on completing the library here first. In another words, I am accelerating the speed of posting various specific trading setups in coming weeks. i will deal with the ebook idea later as that slow me down quite a bit when I have to keep thinking about the organization issue.
The vision is that these specific trading edges or statistical biases that are useful for daytrading will be linked to automatically on the signal pages. Everyday after market close, you will be able to review and prepare yourself for next trading day knowing exactly which biases are triggered and how they perform historically.
This should complement the existing premium reports nicely.
If I am going to tell you that there is one simple day trading setup that works all these years you will probably think that I am kidding. What if I tell you that this setup is long only, strictly day trade from open to close? I must be joking, right?
Here is the dollar gain chart based on the setup. See it yourself.
This TedTalk by Maomi Klein was filmed back in December 2010. It focuses on the major events at the time like BP oil spill and the worldwide financial crisis. It is a talk longer than the other ones at about 20 minutes.
The perspective of this talk is very interesting as Ms. Klein asked some very interesting questions on how we get ourselves into these mess again and again. This lack of consideration of the potential consequence and the unwillingness to take action avoiding known disastrous outcomes have been the recurring reasons leading to all these problems. As a collective whole, humans have failed to stop one disaster after another because we gave a free pass to those at the top who are prone to reckless behaviour.
As a trader, however, you do have a choice to take action stopping yourself from engaging in reckless risk taking. It is not the aggressive stances you made in trading that keep you profitable. It is the voice of reason in your head that made you pull the plug on those very bad trades that save your behind.
I cannot emphasize enough the importance of thinking in terms of probability and how useful it is for anyone in making any kind of decisions that involve trade-offs and risks.
In this TedTalk, Arthur Benjamin provides some very good reasons why it is better to teach everyone statistics over calculus.
Personally, I find that it is never too late to learn statistics and think in terms of probability. It is not just a very good tool in making trading decisions. It is also a life skill that can transform your life and put you in better perspective of things happening around you and on you.
When I get the chance I will write about these interesting stories with the people I encountered whom I showed them how to think probabilistically. It is a life transforming experience for them. I learned a lot from sharing my thoughts with them too. It is something I always remember as it shows that a slight change of perspective in an individual can make all the difference.
Option expiration weeks offer a lot of trading opportunities that the other weeks do not because the option market makers (can be firms, professionals, or anyone who has enough capital doing it) have to adjust their positions fiercely so that they can come out ahead with a profit by the time the options expire. Many traders who are not aware of this change of participant mix are caught off guard and burnt. This guide is a short explanation to what option expiration weeks are and how to handle the market efficiently during these hectic weeks.
(Note: Long article)
Options Do Not Just Expire On A Specific Date
The common knowledge for most people is that stock market options in North America (and in some other places) expires on the third Friday each month. A general statement like this does no good to anyone who trades during the option expiration week. They would be looking for the wrong clues from the markets they are trading.
In short, the options on stocks, index, index ETFs and index future do not necessary share the same expiration date and time during option expiration week. The difference in their settlement times however is bounded within 24 hours. As all these markets are closely related to each other, the busy settlement schedule forces the market participants to take care of their positions in a haste.
Let’s take a look at the most important instruments on option expiration to see how they expire.
S&P 500 Cash Index Option
SPX cash index options (and other cash index options) expire on the Saturday following the third Friday of the expiration month. However, the last trading day is the Thursday before that third Friday. Hence if you are holding onto your SPY options by that Thursday close, you have to pray that by Friday morning, when the settlement price is calculated, is still in your favour.
Sounds very confusing, isn’t it?
Let me explain it by listing the events in chronological order:
1. By Thursday close, SPX options would stop trading under normal condition
2. By Friday morning, stock market opens, and a settlement price on the cash index SPX is calculated based on the 500 components opening price that morning
3. One full business day to work out which options are expired worthless (the easy part) and which options are settled with cash
4. All options disappear from the traders account after market close on Friday
So you see, the most important moment for SPX options is not how it traded all along during its life time. It is how the cash index open the Friday morning when your bet is already locked in the day before. The overnight changes to the underlying stock prices can change drastically for many reasons. Feels like gambling on a roulette table, isn’t it?
A new version of this option is introduced that behaves like the SPY Options below. The goal for the new version is to resolve this awkward timing problem. After all, if the options are not available there to be traded with the underlying for distribution of risk, it essentially defeats the purpose of having the options available in the first place.
S&P 500 ETF (SPY) Option
Although SPY Options expire similarly to SPX Index Option, SPY Option’s last trading day end right until the end. The settlement price is determined at the same time. Hence the option expiration Friday 4 pm market close on SPY is the single all important price determining the winners and losers for the options expiring that day.
S&P 500 Index Future Option
S&P 500 Index Future Option is the one taking the confusion to the next level.
First the last trade day is the third Friday of the month like the other 2 index based options, but the time is different for quarterly end and the other months. For quarterly ends (March, June, September, December) the last trade time is market open at 9:30 am for the expiring future contracts only. For all other cases including the other months, trading goes all the way to the end of the trading day by 4:15 pm.
Weekly options on the emini index futures are smartly designed to not expire in the same week with the monthly ones to avoid further confusion and complexity issues.
When There Is A Structure You Know Patterns Would Emerge
As I mentioned many times, when there is a predictable structural behaviour, patterns in the price actions would emerge. In this case, since option expiration is putting a deadline on the options, it will affect not only the price of the options themselves but also the related indices and stocks too. The interesting thing though is most people will just stop at the point of understanding the option expiration mechanisms instead of looking for regularities in the price behaviour in the affected instruments.
The behaviour during option expiration week is actually quite predictable overall. It is a surprise description to many people who claimed that option expiration is so complex that it is a losers’ game. What they failed to see is that while majority of retail traders playing the option markets are losing money, the market making firms are consistently making money year after year. If the option expiration is so unpredictable they should not be able to make money overall for so long and so consistently.
The Famous 10-Point Swings On Steroid
When emini S&P making a reasonably strong move, it goes by about 10 points and then pause. It is a well known behaviour.
The interesting thing with option expiration weeks is that as oppose to going in one direction continuously with 10 points move and then followed by pullback with a few points only, emini can easily swing up 10 points and then down 10 points with no warning whatsoever from the price actions. The reason for this to happen is that option market makers are actively adjusting their open positions across many instruments at the same time using buy and sell programs.
Traders who are not aware of this activity are often caught off guard when they thought a direction for the day is defined and trying to hop onto the boat for a continuation ride. What they failed to realize is that after one group of market makers is done adjusting their positions, another group of market makers may have to hedge in the opposition direction. Those who trade in between the strike price levels with stops near the strike price will be stopped out quickly with no good reason.
If you are a scalper who look for pullback setups off the swing trend, during option expiration week, especially the last 2 trading days, will likely be your nemesis. If you do not believe me, check out your trading records for days where you have many trades stopped out. It is likely many of them fall within the option expiration week.
General Option Expiration Price Target
There is no secret that stock market indices like to anchor at strike price by expiration. The problem with the US stock markets however is that the index options like SPX, NDX, OEX, etc. have a different time for the calculation of the settlement price. So there are two fights to nudge the settlement price on the indices. First, the 9:30 am prints for the underlying stocks, which can be affected greatly by the index future markets that trade overnight non-stop. Then, after the morning settlement is done, another fight starts to push the indices towards the targets mainly driven by the index futures and index ETF options.
Notice that for index future options that is about to expire during the quarter ends, they stopped trading in the morning together with the settlement price determined with the
During the option expiration weeks, the indices often swing to one extreme over the range already established in the past three *3) weeks and then swinging all the way to the other end. Option expiration week starting out like that often close near the midpoint of this range.
For option expiration weeks that breakout of the prior established range earlier onward, they tend to double the range of the initiation process (i.e. the first week of the month) as prescribed in STOPD. Due to the non-sequential nature, this property is seldom mentioned anywhere including option textbooks.
Bad Practice Becomes Functional
Due to the 2-way volatile price swings, some traders who usually struggle in other times would score major winnings during the option expiration period.
Who are these traders? They are the ones who average down on losing positions. By averaging into their positions and fearlessly fading the market at potential extremes, these traders would make majority of their profit every month within the option expiration week.
There is this fine line between someone who knows what they are doing and those who don’t on how to average down.
Those who know what they are doing would not be sweating. They would not suffer the emotional swings when their positions look extremely bad going against them because they know from experience and historical behaviour that their average down method will work out most of the time and giving them the expected pay off. When it is not working out, they would take partial losses at the prescribed equity drawdown and continue with the strategy. They would also take partial profits at predetermined price levels to workout the cost of their open positions.
What these traders are doing is essentially a version of the market makers’ strategy in a smaller and more selective scale. The more selective nature makes it possible to average down fewer times so the total capital requirement is greatly reduced.
Now for those who do not understand what they are doing and yet choose to average down, the expectancy does not look good. When they get a lucky break from option expiration volatility, they thought it is their nerve of steel and their brilliant insights are paying off. When they failed badly, they would blame the market is out to get them. Due to this ignorance, and the lack of a plan on how to average down properly, these traders are the primary ones who will be wiped out even though they may have huge equity gains from time to time.
It is not that complex to trade the option expiration weeks. The most important thing is the awareness of its existence and have a prepared mind in deal with the volatility properly.
If you find the difference in price behaviour during option expiration is not your cup of tea (or coffee), just stay away. You can always choose to do something else as oppose to wasting your time. Remember that if your trading style cannot profit from option expiration weeks for years on a net basis, there is no reason to believe your style will perform in the future either. Not trading during option expiration week is a strategy too because it saves you the frustration, time and commission.
If you choose to play option expiration week, you need to have a specific trading plan in place. For those who prefer to trade with tight stops and not averaging down, you need to switch your game plan to something more flexible during option expiration. For those who want to play the market making game, meaning that you will average down all the time, you have to put in place an exact strategy how it is done with the proper capital requirement fully worked out.
The specifications for the options mentioned in the article are listed below.
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Written by Lawrence Chan
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Most of the time, we see traders focus heavily on higher winning rate and at all cost keeping it that way by various measures. System traders and rookie system creators are also obsessed with higher win rate. Is higher win rate really that important?
In mathematics, pigeonhole principle tells us that given a small number of classifications available, with a big collection of data, it is bounded to produce some unexpected results at times.
Normally, it is not a problem. For statisticians and mathematicians who have dealt with all kinds of raw data, they know very well what pigeonhole principle is and will do the necessary steps to further analyze their results to remove the "noise" from their statistics. (Of course there are researchers paid to paint the results they’ve obtained but that is something outside of the scope of this article.)
However, when the study is conducted by casual researchers, like traders / programmers trying to find statistical bias from the price data, many would fall straight into one of the two traps. Believing in results that are too good to be true is one of them. Curve-fitting their models to produce higher win rate at the cost of stability is the other.
The Problem Lies In The Borderline Cases
A nudge of a trading model’s parameters giving it a boost of 10% more winning trades is not necessarily a good thing if the winning amount of most of the winning trades has been reduced. In another words, a shift of the median winning amount closer to zero. It is the first sign that the change is not helping the model.
On the other hand, changing the parameters to get a drop of of winning trades to near 50% winning rate is not necessary a bad thing. It is especially true if the median winning amount has moved higher and improvement in the overall performance is observed.
As you can see from the 2 scenarios I mentioned above, the problem is that nudging the parameters of a trading model can easily move borderline trades switching from winners to losers, and vice versa. Depending on the sensitivity of your model to these changes in the parameters, it is bounded to show sudden boost in win rate at times. In many of these situations, the change means nothing to the core driver of the model.
There Are Winners, Losers And Noises
To solve this problem, you need to classify the trades in a trading model into three categories instead of just two. There are the winners and losers that are not affected by mild nudging of the parameters. There are also the noise that are sensitive to the parameter nudging.
Optimization and parameter nudging should focus on the improvement of the real winners and losers, not the noise. The trades in the noise category, at times, may tilt towards mild winning thus boosting overall historical performance. But due to the fact that there are many more winning trades with low winning amount, the median and average winner will be reduced. Now you know a way to identify the good optimization results from the bad ones.
Do Not Try To Remove Noises By Curve-Fit
There is absolutely no point trying to remove the noise trades from a system by just parameter nudging or optimization. If your model does not have independent filters for the purpose of filtering noise trades, curve-fitting your core driver to avoid noise trades usually damages the performance of the real winners. So don’t even try.
The good winners and the noise trades are likely results from two distinctly different pre-conditions. By changing your original parameters to nudge the noises into winners, you are also changing the conditions for which you get those good winners in the first place. Hence, the model is no longer the one you have in the first place after you modified the parameters to squeeze out more winners.
For example, many people would nudge their breakout models to delay their breakout entries with stop-in price further away from the reference price. That, in turn, cut deep into the real winners for the purpose of getting more lame winners. Such changes is not a solution to obtain better trading models.
Reduce Impact of Noises By Filters Independent of Original Drivers
This is the part that most rookie system designers hate the most. It is also what separate great traders from good ones. By paying attention to the minute details of the pre-conditions and the initial development phase of the trades, there can be subtle signs that a trade may not workout. Great traders are good at what they do because they observe and dissect the information dispassionately while average traders having their emotional roller coaster ride.
The discovery of pre-conditions that are independent from the original drivers will give you filters to remove, reduce or early terminate the noise trades.
Filters can come in all forms. Some can be time based. Some can be chart patterns (from higher timeframe). It is important to think in terms of what the oppose side would do when looking for signs to jump in. These signs are usually the best warning signal that a trade has gone bad.