|
PureBytes Links
Trading Reference Links
|
Hi,
I'm writing to ask for assistance from any of you guru
code-writers out there.
I wrote to Equis support to ask if they could provide me with
the necessary formulas for Larry Williams' "Volatility Breakout System". I
provided them with a description which I found on the web (reproduced below).
Equis wrote back with the message below. What I need to know is:
1) Have Equis come up with accurate English-language
descriptions? (Any Williams experts out there? I do not have the knowledge to
judge the accuracy.)
2) Can anyone save me $60 and benefit other group members also
by taking up the challenge to code relevant explorations, indicators, experts
etc.?
There follows the description found on the web, and the reply
from Equis.
Cheers
Nick
**************************
DESCRIPTION FOUND ON WEB
As far as we are aware, the early groundwork for volatility-based
tradingsystems was laid by Larry Williams in the early 1970's. He sold at
leastthree systems based on the same technique, each at successively
higherprices (one of them was called the Million Dollar System). Welles
Wilder, inhis 1978 book New Concepts in Technical Trading Systems,
reiterated theessential principles, as did Perry Kaufman in Commodity
Trading Systems andMethods.After Williams a number of vendors sold
systems based on the method, thebest known of which is probably the
Volatility Breakout System offered byDoug Bry of Lakewood, Colorado. Anyone
who is interested in reproducingand/or testing any of these volatility based
systems should be aware of avery reasonably priced software package, Steve
Notis' Trader’s Powerkit,that incorporates most, if not all, of the trading
logic of the systems thatsold for many thousands of dollars.The
Basics - Measuring VolatilityThe volatility-based trading systems all
use the concept of range to definethe extent of recent market movement. The
simplest definition of range isthe distance from high to low of any given
time period. This is usually aday, but it could be a week or a month or even
an intraday period measuredin minutes.This simple definition of
range works fine most of the time, but it doesn'ttake into account days of
extreme price movement. Limit days, for example,may have a very narrow
range, but the market is obviously very volatile andvolatility is
increasing. Similarly, a day when there is a gap opening andthe day's
trading takes place outside the prior day's range is an example ofincreasing
volatility, even if the actual range of the day is lessthan that of the
prior day.Wilder recognized this problem and defined the True Range (TR)
as thegreatest of the
following: 1. The
distance from today's high to today's
low. 2. The distance
from yesterday's close to today's
high. 3. The distance
from yesterday's close to today's low.By itself, the True Range is still
just an isolated number. To make itmeaningful, we must take a number of past
days and find the mean, giving usan Average True Range (ATR). This is a
direct measurement of marketvolatility. If the ATR is increasing, the market
is becoming more volatile.If the ATR is decreasing, the market is becoming
less volatile.How many days to use to produce the "best" ATR is a matter of
conjecture.Wilder's original volatility formula (to be explained later) uses
14 days,but most of the modern system sellers have optimized this variable
and foundthat anywhere from 2 to 9 days was better. The most profitable (as
measuredby Futures Truth) of these systems, the Volatility Breakout System,
normallyuses only two days.How the Volatility Systems
WorkAll of the popular volatility-based trading systems work on the
principlethat a breakout or price spike outside of the recent Range or
Average TrueRange is significant and should be used as a point at which to
enter themarket. For example, let us say that the ATR for the last five days
in theNYSE Composite futures is 1.00 points. We would be interested in a
pricemove that is a percentage, say 150%, of the ATR from the prior day's
close.This means that we would be buying or selling if prices moved 150% x
1.00,or 1.50 points. If the prior day's close was 190.00, we would buy at
191.50or sell short at 188.50.The two variables of the system
are: 1) the number of days
used to find the ATR 2) the
percent move from the prior day's close that constitutes avalid
breakout.Most of the system vendors and the presently available software
rely onoptimization to decide which values to be used for each
variable.As you may have deduced, the basic volatility breakout system
is a reversalsystem that is always in the market. Each day after the close,
calculate theATR, and then multiply it by the percent move necessary to
trigger a trade.Add the result to the close, and you will get the point at
which a buy willbe triggered the next day. Subtract the result from the
close, and you willget the point at which a sell will be triggered. Enter
both orders the nextday and you are in business.Comments and
VariationsOne of the significant strategies of the basic system is that
since you areeither long or short, there is no neutral area. The risk on any
one trade issimply the difference between the entry point and the reversal
point. Ifthey are both triggered on the same day or very close in time to
oneanother, a whipsaw is the obvious result. Perhaps more importantly,
the risk on a trade depends entirely onrecent market volatility, which may
or may not agree with a trader's walletsize or money management techniques.
However, the market does not care aboutconforming to your money management
techniques. If you can not tolerate thehistorical volatility and
potential drawdown of a certain stock or futuresmarket, then you should
trade smaller lots or mini-contracts.Good trading systems are designed
first to make money, and then, onlysecondly, to make the process as
comfortable as possible by smoothing outpotential drawdowns. These two goals
are always at odds. Less risk (e.g.tighter stops) always produces less
profit. There is a limit to howcomfortable you can make a system and
still show a profit.Another interesting aspect of volatility systems is
that the entry point andthe reversal point will move away from each other if
short-term volatilityincreases. It is easy to see how this could happen: the
market moves, therange increases, and the stops are positioned farther and
farther away fromeach other. This might tend to reduce whipsaws, but it can
also increase theinitial risk on a trade after the trade has been
entered.Volatility breakout systems are trend following systems.
They are notdesigned for short term scalping for limited objective
trading. They aredesigned to get in on the really big moves and stick
with them until theend. As such it is necessary to expand the stops
when the market heats up –even if that means increasing your initial
stop. The alternative is to bethrown out of a strongly developing move
and then being faced with thedifficult task of finding a low-risk re-entry
point. The stronger the moveis the harder it will be to get back in,
because a pull-back may not occuruntil it’s too late to catch the bulk of
profits. Therefore the best policyis to let the market determine the
optimal placement of stops.Professionals trade many markets concurrently to
achieve a smoother overallequity and reduce drawdown.Suggestions
on Making It Work - FiltersThere is no question that they should always
be in the right direction whena market is trending with enough volatility to
be worth trading at all. Thereal difficulty, common to most trend-following
approaches, is whipsaws whenthe markets have no trend and low
volatility.Over a long period, markets will be alternately stagnant and
dynamic withmost of the time spent in the stagnant mode. Similar to moving
averagesystems, a volatility system set up for a trending market will not
work wellin the sideways periods.Obviously, a filter is needed. We
can suggest several. First, it is possibleto cut down the considerable
initial risk on each trade by creating aneutral zone between long and short
entry points.The simplest way to do this is to set a percentage risk
stop that is smallerthan the percentage of the ATR that triggers the entry.
For instance, in ourearlier example we had an ATR of 100 point in the NYSE
Composite, and wewould buy on a move upward of 150% of this, or 150
points.A tighter stop could be set by subtracting a smaller percentage
of the ATRfrom the entry point. We are afraid that anything less than 100%
of the ATRmight be classified as too close and subject to almost random
whipsaws, butusing a number like 125% still gives a tighter stop level than
our reversalpoint. If the risk stop is triggered, the system is now neutral
until thesell reversal at 150% is hit, or until a new buy entry is
reached.Another possible improvement might be to avoid trades when a
market isacting poorly, especially when the volatility is unusually low.
There maywell be 'windows' of optimum profitability for the ATR of each
commoditywhere it is within acceptable boundaries, neither too high or too
low. It issafe to assume that a stagnant market with a relatively small
range willresult in losing trades, while a more volatile market will tend to
be moreprofitable. The usual impulse is to re-optimize when the markets
becomestagnant, but it might be more profitable in the long run to sit
outcompletely during the quiet markets and wait until the ATR becomes more
inline with what your system normally needs to be successful.A third
possibility is to add an external filter, something that
identifiesconditions that must be met before a breakout is taken. There are
at leasttwo possibilities for this among readily available technical
studies:DMI/ADX and CCI. Our regular readers are aware that we often mention
that anupturn in Wilder's ADX signals that a market is trending. Try
tradingvolatility breakouts only when the 18-day ADX is rising. (Up-Down
Volatilityand Percent V serve a similar function).Similarly, a
20-period CCI based on either monthly or weekly signals willalso tell you to
what extent a market is trending over the longer term. Lookfor rapid
acceleration of the CCI from its null or zero line; if thiscondition exists,
the market is probably moving rapidly enough to makevolatility based trading
highly profitable. (CCI and Bollinger Bands aredifferent views of the same
study formula.)"
END
********************
REPLY FROM EQUIS
"Nick,I have read the article you
supplied and have pulled from it the followingconditions. Please read
them and verify they are what you want to usefor your entry and exit
conditions.Entry conditions:18-period ADX is risingtoday's
high is some percent of the ATR greater than yesterday's high (for buys )
ORtoday's low is some percent of the ATR lower than yesterday's low (
forshorts )Exit conditions:an entry condition in the other
directions ( a short signal when long ora buy signal when short ) ORthe
price moves a percentage of the ATR against the position you are in.The
article did not give set values for several of the factors
listedabove. These are:1) the percentage of the ATR required for
the entry signal2) the number of periods used in calculating the ATR3)
the percentage of the ATR used for the stopDo you have values you want to be
used, or would you rather the systembe written to optimize on these
values. If you want it to optimizebased on these values, I will need
you to specify the range you wantthem to cover (ie. check ATR time periods 2
through 28).I need you to verify and respond to the above information
because we arenot licensed financial consultants. Writing trading
systems can beconsidered offering financial advise so we err on the side of
caution.After you have responded, I can most likely provide the system to
youwithin a day or two. The fee for this system will be around $60,
unlesssome unforeseen technical difficulties arise."
END
***************************
|