Algorithmic Trading Tips 15.
INTRADAY EMISSIONS TRADING.
HOW TO TRADE VOLATILITY BREAKOUTS PROFITABLY.
Trading of volatility breakouts on an intraday basis offers attractive opportunities in numerous markets. In this issue, we want to show you how to develop a profitable trading strategy for the emissions market by using the Day Range indicator and how to test its robustness.
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When it comes to energy trading the emissions market is one of the most liquid. It shows great trends and quite radical intraday moves. This months trading tip will give you some ideas and a full trading strategy to make use of the intraday volatility in this market.
Day Range: a simple but powerful indicator.
With the day range indicator you will see what a powerful and easily made indicator it is. Open a 15min intraday chart of emissions (CFI2Z5 on Reuters) and apply the day range indicator. This indicator does not need a lot of calculation; it just normalizes the daily intraday movement. Every day the indicator starts at 0, and then builds the bars exactly like a normal chart. If the market raises 10pts from the opening, the indicator will show a bar going from 0 to 10pts. That`s not a lot of maths, but it enables you to compare the intraday moves day by day, without being confused with the general trend or long term support and resistance on the chart.
Can this be enough to build a profitable trading strategy? Yes! Just have a look at a long history of the indicator and you will see where the money can be made. Sometimes you see high spikes standing out of the usual indicator noise. These are the days when the herd galloped in one direction and did not stop until the end of the session. And this will be the right environment for our strategy to cash in.
But first add two simple stop lines on the indicator. One at +0.2, the other at -0.2. You will see that this seems to be some kind of magic level in the emissions market. Every time the indicator crossed above or below this level, you had the chance to make money until the end of the session.
FIG. 1: DAY RANGE INDICATOR WITH FIXED RANGE.
The Range Day indicator normalizes the intraday movements by starting at zero each trading day.
In this way it allows a fast and precise comparison of individual trading days.
Deviation band enables application to different markets.
Of course there are no magic numbers in the market, so better let your software calculate the “breakout volatility level” on its own. Therefore you could just drag and drop a long term Bollinger band onto the indicator, or you use the altered version of the day range indicator that is included with this trading tip.
The enhanced indicator plots a two standard deviations band around the daily movements. This enables you to apply the indicator without adjustments to different markets, as emissions is not the only market with nice intraday breakouts.
FIG. 2: ENHANCED DAY RANGE INDICATOR WITH VOLATILITY BAND.
With the use of standard deviation as a measure of “normal” daily fluctuations, the enhanced version of the Day Range Indicator can be used in all markets.
Coding the strategy in Equilla.
Now we have got everything that is needed for the basic idea of the trading strategy. Go long when the indicator breaks above its upper band (or fixed level) and close the position at the end of the day. And it`s just the same on the short side; go short at the lower band, cash in at the end of the day.
As an experienced trader you will notice that this cannot be the whole truth. Some kind of profit protection and stop loss will be needed. Therefore I added a simple profit trailing stop. The default setting is two standard deviations. And I coded a condition that only allows one trade per day. This is meant as a simple protection against a market environment with high volatility but no direction. This might trigger several losing trades on one day.
The coding of the strategy is quite straight forward. First, all needed inputs and variables are defined:
Inputs: dev(2.0),period(500), traildev(2.0,1,10),trademode(breakout, reversalmode), fixedlevel(0.0);
Variables:oo( Invalid ),colour, std, endtime, starttime, tt;
In the next step all the things needed for the trading logic are calculated. When does the market open? When does it close? How many trades have occured? What is the standard deviation for the current bar? See the green comments in the code and you will quickly get how it is done. If you are not familiar with the used syntax, right click on any blue word to get help. If you are still stuck, don’t hesitate to contact firstname.lastname@example.org.
colour=black; // colour of indicator bars
If Date <> Date Then begin // first bar of day
oo = Open; //remember opening price
starttime=time; // timestamp of first bar of day
endtime=time; // timestamp of last bar of yesterdays session
tt=totaltrades; // number of trades in history
The following code calculates the standard deviation, the colouring of the bars and plots the enhanced Day Range Indicator.
std=stdev((high+low+close)/3 - oo,period); // standard deviation of day range
if fixedlevel>0 then std=fixedlevel; // if level is set overwrite standard deviation
if high-oo>dev*std then colour=darkgreen; // green above band
if low-oo<-1*dev*std then colour=red; // red below band
drawline(0+dev*std); // upper band
drawline(0-dev*std); // lower band
Drawline( 0, "Zero Line" ); // zero line
DrawBar( Open - oo, High - oo, Low - oo, Close - oo,colour,colour); // day range bars
Now the trading logic is programmed. The aim of this strategy is to enter long positions when the indicator breaks above the upper volatility band (The inverse rules are applied to short entries.). The following prerequisites are also required:
- the current time is at least one hour after market open
- the market close is at least one hour away
- we are not in a position and have not traded today
// if in core trading time (open+1h - 1 bar before end of session)
if time>starttime+100 and time<endtime and
marketposition=marketpositionflat and // and currently no position
totaltrades=tt then begin // and no trade today then ...
if trademode=breakout then begin // breakout mode
buy next bar at oo+dev*std stop; // buy at upper band,
short next bar at oo-dev*std stop; //short at lower band
if trademode=reversalmode then begin // (*) reversal mode
short next bar at oo+dev*std limit; // short at upper band
buy next bar at oo-dev*std limit; // buy at lower band
After the entry is done the exits automatically kick in. The first exit condition is simply the end of the day. The second exit is the trailing stop. It protects your profits and limits the possible losses.
FINDING ROBUST PARAMETERS BY USING THE OPTIMIZER.
All inputs of this strategy can be changed after optimisation:
- Deviation(2.0): Multiplier for the standard deviation.
TIP: Multiplier for the standard deviation.
- Period(500): Number of bars needed for the calculation of the standard deviation.
- TrailDeviation (2.0, 1,10): Number of standard deviations used for the trailing stop.
TIP: It can be optimized between one and ten standard deviations.
If necessary, a further parameter called „FixedLevel“ enables you to use absolute bands for the Day Range indicator instead of standard deviation.
BY THE WAY:
If you add the following commands to the strategy code, some additional points will show you the actual entry and exit levels. So you already know in advance the level at which you will be active.
if time=endtime then exitposition this bar on close; // exit trade at end of day
// set profit trailing stop
FIG. 3: TRADING STRATEGY “DAY RANGE VOLATILITY BREAKOUT”.
The breakout on September 23rd generated a short entry, while a long trade was triggered on October 8th. As expected, the price move continued until the end of trading, so gains were recorded.
With these possibilities to optimize the strategy it should work well on all liquid energy markets that show nice and sharp intraday moves. On the optimization chart you see a heatmap representing the calculations for an optimization of the CFI2Z4 contract. I optimized the width of the volatility band and the width of the trailing stop. As you can see you get a nice and stable green area.
In general, everything above 2 standard deviations should give you a positive result. And that`s exactly what we where expecting. The herd does not gallop every day, so we also will have to select a wider band to separate the galloping herd from the directionless area.
FIG. 4: OPTIMIZATION HEATMAP.
Areas above two standard deviations deliver positive results in the trading strategy.
INVERTING THE STRATEGY FROM BREAKOUT TO REVERSAL MODE.
One last point. Sometimes markets just do not listen to what analysts write. Therefore I added a switch in the input section of the strategy that lets me switch the trading logic from breakout to reversal. In reversal mode the strategy does not buy when the indicator touches its upper band, it goes short. So if you are unable to find a stable setting for the breakout mode, just try the reversal mode. Let the market select by itself which strategy is the right one.
I hope this months trading tip will give you some new ideas on how to use a systematic approach in trading emissions and volatility breakouts in general. Let the indicators inspire you, and test your ideas systematically. It might not give you a free lunch, but you can expect a great meal with little cost.