From the February 01, 2010 issue of Futures Magazine • Subscribe!

S&P 500 data: Three ways to profit

For many traders, the S&P 500 and the E-mini are their speculative vehicles of choice, with huge daily volume and open interest. These contracts present opportunities for day-trading profit and serve as a key tool for long-term equity investors and hedgers. The long-term investor is willing to overlook blips and corrections to achieve the big move when it occurs.

Long-term investors have different goals than short-term day-traders. The long-term investor may be interested in holding out for a big move, willing to overlook the blips and corrections along the way. These investors are typically satisfied with lower rates of success for the payoff of bigger profits when profits come. For these traders, the S&P 500 also offers significant opportunities.

The methods used to carve out those opportunities, however, may not be created equal. We will compare three models and see how much of the long-term moves we can catch. Our data set will be the closing price of the cash S&P 500 on a weekly basis. We will test a 52-week simple moving average model, a 105-week exponential moving average model and a price-action indicator with a one-year reference. Most charting vendors provide simple and exponential moving averages, so following the models should be simple.

The strategies are straightforward. On the first two, the market is sold if the current week’s close moves below the average and the market is bought if the current week’s close crosses above the average. The price-action indicator is computed by taking the current week’s close and subtracting from it the price one year earlier (52 weekly bars). A simple three-week moving average of these prices is used to generate signals.

We can reduce false signals with the same two restrictions on all three indicators. One, we require the reading to be at least one point higher or lower on the breakout (so, a reading of -0.79 would be insufficient) and two, any reversal within four weeks following the prior signal will be ignored because it is easy to have choppiness when these signals turn. Positions will be entered immediately on the positive signal and the trade will be maintained for four weeks regardless of a reversal signal.

Our data begins in 1950, but the three-point range of the first three years makes the effective start 1953. First, we equalize the three methods. They may begin trading when the first strategy signals a trade. That date and price are fixed as the start. In this case, it’s the close on Jan. 22, 1954, at 25.85

By way of a benchmark, the S&P gained a net of 1,076.57 points between 1954 and December 18, 2009 (see “Field of dreams”). Of course, it traded much higher in the interim reaching 1561.80 on a weekly closing basis for a maximum gain of 1,535.95 on the long side. Reversing to short at that price and holding to the present time would have brought the total gain possible from just two hypothetical trades to 1,968. But a steadfast buy and hold strategy from 1954 would have yielded 1,076 S&P points.

We require any successful system to exceed 1,076 points, and will judge a system a significant success if it achieves even 65% of our total ideal of 1,968 points, (i.e. 1,279 points before slippage). The fewer trades it takes to yield such points, the more successful the system will be, since every trade adds the potential for slippage and error.

A 52-week moving average should enable us to smooth out most of the chatter one might expect from a four- or eight-week moving average. Adding the filters we have imposed above also should help in theory. To our surprise, a simple 52-week moving average is a very poor system. It trades 80 times and only 45% of the trades are winners, including one open trade.The gross point gain is 1484.24 before slippage. If we add 0.30 points for slippage and commissions (i.e., $150), this reduces the gross gain to 1460.24 points. The model gave a buy signal on the close of July 24, 2009, booking a gain of 351 points from its sell signal on Jan. 4, 2008. Ironically, almost exactly 30% of the model’s gain was earned in the last closed trade. The best trade was a gain of 561 points from the trade between January 1995 and August 1998. This model, with 55% losing trades, was much worse than the accuracy level we desire, and we deem it a relative failure, although it did exceed the target of 1,279 points with an average gain of 18.25 points per trade.

The 105-week exponential moving average fared worse in accuracy and in net gain. It traded far fewer times: 26. There were 11 winners, or 42.3%. The gross point gain dropped to 1,369.84, including an open trade profit of 175.91 points. The net gain after slippage is 1,362.04. The average trade gained 52.38 points. Of the three models, the 105 EMA is the only one remaining short with a trade initiated on June 23, 2008, at 1278.38, and an open profit of 299.12. The EMA trades far less often and is less sensitive to chatter than the SMA, but also is slower to respond, in part due to its longer period. Almost all of the gain was earned in a single trade begun on Aug. 27, 1982, and culminating on March 16, 2001, for 1,033.42 points. The model stayed long for almost 19 years.

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