ATR on chart

What we have here are two end of the day Top40 charts with 5-day Average True Range which is expressed in percentage terms.

First chart is Top40 chart from 01. January 2000 while second one is going back to early 2007.

Trading was very easy in 2008 and early 2009. Trend following systems based on 5 minutes and 15 minutes charts made 3000-5000 points per month and if one could catch only 60% of that he would, at least, be 2000 points (or so) up for the month. Unfortunately, trading is not easy anymore due to changes which happened around June 2009.

So, what happened to our market during early days of winter last year?

If we check first chart we can see massive spike in ATR (volatility) as from early 2008 till about June 2009 ATR was way above 2.5% and in some instances it was climbing to levels around 6%.

Second chart tells more, as it is easier to observe what happened: In early 2008 ATR broke above 2.5% and stayed there till 01. April 2008. Then, from 01. April 2008 till 01. August 2008 ATR stayed below 2.5% (red box). After that lower ATR period we had 10 months of extreme volatility during which systems made lots of points. Finally, period with ATR above 2.5 has ended around 01. Jun 2009 and from then on systems are producing significantly decreased number of points. (Systems that used to make 2000 points per month are now producing, on average, 500 points each month.)

Good idea is to find what a norm for various systems is:

If we look back, first chart is showing us that from 01. January 2000 ATR spent much more time bellow 2.5% line than above. Time above 2.5% is plotted (quick spikes) and if one can back test those periods, he would certainly see that systems were performing better during these extreme times than for the rest of the sample. Conclusion is that 5-day ATR bellow 2.5% is the norm for Top40.

What traders can conclude from here?

If you made your budget with 2000 points per month (per contract) I have to disappoint you: Further projection for system should be in the region of 500 points per month and I would advise for review of monthly targets and wishes.

It is advisable to find faster system (shorter time frame; shorter moving averages or faster price break out channels) or much slower systems (longer time frame; longer moving averages or slower price break out channels). Please be careful, in order to avoid creating faster systems that produce more points but from way too much trades. Also, average trade is to be watched and have in mind that even end of the day system can work well in conditions like this.

Increasing trading size (number of contracts) may be viable option, but again be very careful not to be caught undercapitalized by big drawdown, as that will take even more of your capital and probably will cause massive emotional stress.

Keep an eye on ATR and once you see increased reading you may reconsider reverting to systems that worked during time of higher or extreme volatility.

Hope this will help you to make better decisions when looking forward, especially for readers who are trading for living and trying to make their bottom line numbers more appropriate.

Trade with trend!