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

Using moving average envelopes in the S&P

Results over time

Since May 23, 1994, this system would have traded 86 times. It shows a hypothetical profit of 1,211.4 gross S&P points, the average is 14.08 S&P points. Allowing 0.30 points for slippage and commissions ($150), that is a net profit of $592,801, or roughly $6,893 per trade. Fifty-five of the 86 (63.9%) trades were profitable. Because the S&P 500 futures contract generally trades at some variation from the cash index, slippage may be more than 0.30. The typical trade lasted 4.67 weeks, counting the weeks of entry and exit as full weeks.

Fifteen of 23 short trades (65.2%) were profitable, producing an average of 28.23 net S&P points. Forty of 63 (63.4%) of the long trades were profitable, yielding an average of 9.2 S&P points. The worst trade loss was 74.91 S&P points, while the best gain was 295.68 points. Eleven trades (12.8%) lost more than 40 total S&P points, while 20 gained more than 40 S&P points. Half of the trades gained at least 6.27 S&P points after slippage and commissions.

Four of the losses that exceeded 50 points resulted from the initial stop being hit, and in each of those cases the stop minimized a greater potential loss. The worst series of losses (five) resulted in a 94.52 S&P point drawdown, or $56,711 before slippage.

This is an excellent system for the intermediate term position trader willing to withstand some significant drawdowns (see “A nice run,” below). There is a substantial likelihood of being profitable in the next trade and roughly a one-in-five chance of hitting a $20,000 profit. For the smaller trader, similar results can be achieved using a mini-S&P futures contract, reducing the maximum drawdown to $11,342 and still yielding $118,560 in hypothetical profit.

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Shorter horizons

For short-term traders, the same methodology, with minor modifications, can be employed using nearest futures data. Daily data based on the pit session prices can be used to signal an entry or exit for the next day. The entry stop is placed immediately following the open of the S&P futures at 9:30 a.m. EST and is good through the pit session close. If triggered, the initial stop loss is expanded to 6.0 times the key span.

Once the trade is in progress, a second contract in the same direction is permitted as a scalp trade if the underlying signal is repeated on any subsequent day. The second signal is executed in the same manner as the initial entry -- that is, a stop of the open price plus or minus the key span. However, once triggered, a profit target is entered equal to theoretical entry price plus twice the key span. If the scalp trade is successfully completed, another may be entered on any following day provided the underlying trade is still in place. The initial stop is used for both positions, as is any subsequent exit stop.

Trade data were kept from Aug. 20, 2007 forward. It is necessary to maintain duplicate data starting roughly 30 days prior to each contract expiration. For example, begin recording both March and June contract data starting mid-February. Use one master spreadsheet, and extend it for both contracts. As March expires, roll forward into June using the new spreadsheet and the various moving averages will be reasonably accurate. Don’t roll too soon because the opening price and daily range of the outer months tend not to reflect the true daily range until volume begins to increase for the next contract. chart

This system traded 104 times between Aug. 20, 2007, and Jan. 26, 2010 . The average trade gained 7.42 S&P points before slippage, and 73.8% of the trades were winners (see “Inside the number,” right). Using the mini-S&P and allowing one point for slippage and commission, that is a profit of $33,384 in roughly 30 months -- about $321 net per trade. Half the trades had net profits in excess of 9.72 gross points. The worst loss was roughly 51 points. The best gain was just more than 85 points. About 10% of the trades lost 20 or more points, while 17.5% gained 20 or more. More than 85% of the scalp trades were profitable and may merit two mini contracts each, depending upon a trader’s risk tolerance.

The average trade lasts about three full days, with the longest taking 14 to complete. The scalp trades often enter and exit on the same day. Time involvement for the trader is relatively minimal. Daily data are recorded after the 4:15 p.m. EST close, and the key span is computed for the following day. About 35% of the time, a trade warning is given. At 9:30 a.m. EST, the opening price of the pit session S&P is recorded, and the entry stop computed and entered. The stop loss also can be entered at this time as a day order, and converted to an open order if the trade occurs. If a scalp trade is possible, the entry, stop loss and profit targets all can be entered immediately following the pit session open.

All data are based on the large S&P 500 contract. Allowance must be made for the variation between the mini-S&P and its larger cousin if a trader prefers the smaller contract. It is suggested all stops be placed at least 0.50 points beyond the trade signal because the E-mini often experiences more volatility. Even then, it is possible a stop is hit in the E-mini market, which is not triggered in the big contract. Traders must watch for this. Consequently, a trader who is not focused on the market throughout the day may wish to allow even more slippage in the E-mini executions to avoid a false entry.

Arthur M. Field, Ph.D., is a former commodities broker and co-manager of Fidelity’s Pacific Fund. He wrote “The Magic 8: The Only 8 Indicators You Ever Need to Make Millions.” E-mail him at TheMagicEight@hotmail.com.

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