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>Since you know the system, do you think it could be applied to daytrading
the
S&P?
I seriously doubt it. Long term trend following systems have a
fundamental economic reason why they are profitable, and will continue to be
profitable in the future as long as there remains a reasonable balance
between commercial and speculative interests. It has to do with the
'synergy' between commercial interests and trend followers. Commercials want
to buy low, sell high since they are actually users of the underlying
commodity. If you are General Mills you use corn to make cereal then
obviously you want to buy as low as you can. You are not so much interested
in making money by predicting the direction of the corn market. The lower
the market goes, the more corn you want to buy. Of course this is a gross
simplification, but I'm trying to illustrate a principle as simply as
possible. Hence, commercials become more and more net long as the market
falls because the prices are getting so attractive to users and unattractive
to producers (farmers in this case). Similarly, they become more and more
net short as the market rises. It turns out that trend followers are the
group that fills the imbalance created by the commercials behavior. Trend
followers willingly sell low (to the commercials) in a falling market with
the hopes of covering their shorts at an even lower price. As a result, they
are net long in a rising market, net short in a falling market. Presto,
trend following profits. In this way, money flows from commercials to trend
followers.
Another way of thinking about all this that adds credibility to this model
of the futures markets is the idea that trend followers are providing a
service to the commercials in that they meet the imbalance created by the
commercial's natural behavior in a free market. Or you can think of it as
the commonly understood risk transfer mechanism that is provided by specs.
The inherent return theory of futures markets says that specs, as a group,
must be compensated for bearing the risks that commercials want to lay off.
Otherwise, there would be no specs in the market.
It turns out that long term trend following techniques naturally capture
this inherent return.
The good news is that an extraordinarily simple long term breakout system
will capture this inherent return on an unleveraged portfolio. Case in point
is the MLM Index. (I have found it hard to find info on this
index) The index is an unleveraged portfolio that goes long and short on a
basket of 24 (not positive on the number) domestic futures markets. The long
/ short decision rule is simplicity defined. It is a 12 period channel
breakout on monthly data (Might actually be a 12 period ROC deal on monthly
data...ie buy if price higher than 12 months ago vs buy if price is higher
than the highest (monthly) high of the last 12 months. Shorts opposite.)
Interest income is included on portfolio, consistent with real life.
However, no transaction costs are included. This is significant. However,
the risk/reward characteristics of this index are (remarkably) in the same
ballpark as other major asset classes like equities, bonds, real estate. But
as a group, very uncorrelated to these other classes.
The thing I love the most about the futures markets is the control over how
much leverage you want to use within margin constraints. This allows me to
start with an asset with an inherent return that I have ultimate confidence
will continue in the future *in the long run*, (like the US economy
(equities), the rent value of money (bonds) or the risk transfer premium of
the futures markets) and use money management, betsize selection, or
whatever you want to call it, to lever it according to my specific goals. If
I want rapid equity growth, I can easily get it. But of course I must pay
the price is increasing variance of returns as well as an increasing risk of
ruin. The return/risk ratio is inherent in the asset class. Leverage is just
a wonderful tool that allows me to choose whatever return I want, within
reason, if I am willing to pay the price of a proportional increase in risk.
If I just want the diversification benefit of an uncorrelated asset class, I
can easily get that too by trading an unleveraged futures portfolio such as
the MLM index.
Sorry for the long post. But it is my feeling that daytrading off floor has
no fundamental economic reason as to why money should flow to the off-floor
daytrader. There is a very valid economic reason as to why money should flow
to floor traders, as a group. Of course it has to do with liquidity. I think
off-floor daytraders are just competing with other daytraders. There is no
synergy, no valuable service being rendered to the economy that that isn't
already supplied by the on-floor traders. And of course on-floor traders
have an almost insurmountable advantage over the off-floor trader in terms
of low commissions, info on order flow to the pits, and speed of execution.
Off-floor daytraders may be able to make money by being very much smarter
than everybody else, but I believe this is *very much* more difficult than
relying on the simple commercial-trend follower money flow model I talked
about earlier.
Scott Hoffman
Issaquah, WA
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