Trading With Jeet Kune Do (Part 1)
Wednesday, June 2, 2010 at 12:51PM
Beat Those High Frequency Traders
Let's face it. We little guys are at a significant disadvantage
compared to those institutions that are paying millions of dollars to
put powerful computers on the trading floor. Milliseconds of time
saved translates into billions of dollars in profits for Goldman Sachs
and other High Frequency Trading (HFT) companies.
Now what would Bruce Lee do? According to Bruce, relying on a
weapon in combat, any weapon, is a limitation. It is a limitation
because it prevents you from using other techniques that may be more
effective in downing your opponent. Likewise, HFTs using
computers are limited. They are limited to pre-programmed
algorithms that are only as good as the programmer. These HFTs
also deal with large amounts of capital, much more than us little guys
are handling. The limitations of HFTs became readily apparent
with the recent Flash Crash where some select stocks were going for
pennies on the dollar.
So how can the little guy capitalize on HFTs? Well, I recently
discovered one phenomenon that may help. Late in the day (after
3:30 Eastern Time) is my favorite time of day - this is when major
swings often occur. This is particularly the case during
extermely volatile times (such as now). Often when there is a
significant gap down at the opening bell it translates into a major
sell-off late in the day. I suspect this is due to mutual fund
redemptions. People panic and sell their mutual funds. The
adjustments are made by the mutual fund company at the end of the
day. They can't avoid it.
By studying late-in-the-day trading I found a very simple S&P500
market characteristic that I would like to share with my readers.
It is quite simple and powerful - all you have to do is watch the last
15 minutes of trading prior to market close, from 3:45 to 4:00
PM.
By studying the last 6 months of intraday data for the S&P500 index
I found some simple rules that vastly improve the odds of success for
day trading. Here are the rules:
First lets define the parameter %DeltaIndex
which is the index percent change over the last 15 minutes of
the day.
%DeltaIndex = 100 * (Index at 4:00 - Index at 3:45) /
Index at 3:45
In English, the rules would be as follows:
(1) if %DeltaIndex is small
(i.e. less than +/- 0.33%) then continue with the trend established in
the last 15 minutes.
(2) if %DeltaIndex is large
(i.e. greater than +/- 0.33%) then reverse the trend established in the
last 15 minutes.
Mathematically the rules are written below:
(1)
If %DeltaIndex
> 0% AND
%DeltaIndex < 0.33%
Then
Go Long
(2) If
%DeltaIndex >= 0.33% Then Go Short
(3) If
%DeltaIndex < 0%
AND
%DeltaIndex > -0.33% Then
Go Short
(4) If
%DeltaIndex <= -0.33%
Then
Go Long
If you were to buy (or sell) the index at market close according to the
above rules then you would capture about 30% profit versus the index
over the last 6 months as shown in the graph below.
It isn't practical to buy at market close while making the above
calculations. You can however anticipate the closing index value
and probably make a good return doing so. Alternatively you can
buy (or sell) at the next market open and still realize approximately
90% of the returns.
I am currently doing some (proprietary) experiments using the VIX chart
to predict the next day's stock market action with even better
results. By 50%!! I'm also in the process of ordering
several years of intraday data so I can further my research.
Stay tuned and be happy. Don't let the markets get you down.
Steve