Why volatility dropped - PART II?

These two tables represent net open positions for two corresponding periods in 2008/09 and 2009/2010, with first table showing us 6-month open interest for period August 2009 – January 2010, while second table is highlighting 6-month open interest for period August 2008 – January 2009.

Let’s start by comparing first rows of both tables (net open positions of Index futures for given periods):

As I wrote in my previous post (Why volatility dropped) we saw that number of traded ALSI contracts over those two periods stayed the more or less the same. What happened with open positions?

It is obvious that open positions increased during last 6 months when compared with same period in 2008/09 – From approximately 338.000 contracts on average for 6 months period in 2008/09 to around 508.000 on average for corresponding period in 2009/10.

What we may conclude from last two posts is that more people are leaving their positions overnight, while daily volume, more or less, remains constant. That by itself can drop volatility and that is what was happening over last few months.

Trade with trend!

Why volatility dropped?

Last night I was browsing on JSE web site and I’ve found very nice documents showing monthly statistics for futures and options traded in South Africa. (More information could be found here: http://www.jse.co.za/Documents-and-Statistics/Marketstatistics/Equity-Derivatives-Market-statistics.aspx)

Posted above are just two tables from documents published on mentioned web site.

First table represents number of contracts traded from August 2009 to January 2010, while the second table represents number of contracts traded from August 2008 to January 2009.

If we compare first rows (Index futures) for those two tables we can see that volume is very much the same. Average for period August 2009 - January 2010 is 1.141.932 contracts per month. Average for period August 2008 - January 2009 is 1.140.761 contracts per month. In my opinion, this small difference could not take away volatility from our market.

If we compare second rows (Single stock future) for those two tables we can see that there is drastic change. Average for period August 2009 - January 2010 is 6.683.356 contracts per month. Average for period August 2008 - January 2009 is 41.635.729 contracts per month. This represents decrease of about 83%.

What we can conclude from those two tables is that ALSI traders are still out there, but traders in single stock futures are gone from the market.

How this influence volatility?

Trading ALSI, we often forget that ALSI is futures contract based on Top40 (J200) index. Top40 index is calculated as average for Top40 South African companies and cash value of Top40 is based on cash values of each stock that makes part of Top40. If trades in single stock futures dropped 83% year-on-year that means that volatility in cash market for stocks dropped by, more or less, the same margin (Remember that SSF issuer must hedge what it is sold to you by buying 100 shares for each contract for that specific share.). So, we have situation in which shares volatility dropped, causing Top40 volatility to drop, which is at the end causing ALSI volatility to drop.

Last two rows of these tables represent total number of futures and options traded on JSE. It is obvious that number of contracts traded for instruments dropped by quite some margin, especially over September and December (close out months). Such a big drop could have, for sure, caused volatility drop, which makes our systems underperform levels of return from year 2008 and early 2009.

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J200 15min chart

Hereto is presented Top40 (J200) 15min chart.

J200 was in the long down channel that broke around 22. January 2010. New steeper channel was formed and it was broken yesterday and backtested during morning session. Target for that channel is around 24700. At the same time, this target will test downtrend line which started early in January 2010. MACD showed positive divergences before this upsurge, pointing to us that bears are losing momentum.

Small falling wedge was formed as well and it was broken on Monday, with target being reached already.

Conclusion is that we can get another 300 points on this upside move.

Trade with trend!

J200 60min chart

Quick look at Top40 (J200) 60 minutes chart:

Top40 currently is very close to long term support around 24100-24200 (horizontal black line). This support going back all the way to August 2008 and in recent history was tested 5 times as resistance and then as support. 

Conclusion is that Top40 can bounce from here, especially if we take into consideration 2000 points drop from 11. January this year.

Trade with trend!

Top40 (J200) weekly chart

Last week produced biggest weekly drop since early September 2009 and that itself is a valid reason to evaluate charts.

To make it clear, system is still long on weekly chart. Entry was in July 2009 around 21000 and trade is in profit so far with approximately 3500 points accumulated in 6 months.

Market turned its downslide in March 2009 and never looked back. After some 10000 points rally market progressed all the way to 25936, right up to 61.8% retracement level - if drawn from top in June 2008 to low of March 2009. Previous major high (August 2008) is very close to turning point. There is rising wedge on first chart that broke last week, with target around 20000, if it plays out as it should. RSI and Stochastic did not show some massive negative divergences on the way up, but trend line on RSI is broken for now.

Second chart shows bigger picture. Top 40 weekly chart (from mid 2002) is shown. There is long trend line (thick green line) from 2003 that was tested 4 times so far. In recent times this trend line played support in December 2008 and March 2009, and that stopped Top40 from drooping further. What else seems obvious on that chart - 26000 is not only double resistance based on first chart as there is even 23.6% retracement level for the bull market which started in April 2003 and ended in Jun 2008. That makes 26000 triple resistance and Top40 could not breach it first time. Finally, there is clear support just below 23000 (black horizontal line) that was tested 6 or 7 times so far.

Conclusion is that Top40 dropped a bit last week, but nothing yet suggests we are going to see similar drop to one from mid 2008. Healthy correction is very welcomed at this point of time. Will follow weekly perspective and report if something changes.

Trade with trend!

Top40 end of day chart

Today Top40 closed 1.61% down at 24823 and that was biggest single day drop from 26. November 2009. This drop can easily bring sleepless night to bulls but as it stands tonight up trend started the 3rd March 2009 is still intact.

Today close was exactly on trend line that is at the same time bottom of the rising wedge formed from the 3rd March. If we have red day tomorrow most likely wedge will break and target for that move is down to 21000 or some 3800 points or 15.3%. Off course nobody can expect to be straight line drop.

There is significant support just below 22000 (black horizontal line) but still far.

Indicators are not painting nice picture. Macd is in triangle formation but showing quite bad negative divergences. There are four recent tops in August, October, November 2009 and January 2010 not confirmed with MACD. Stochastic is very low around 20 but as we know stochastic not working well in trending market and can be overbought or oversold for quite some time.

At least we can look forward to increased volatility that will help us with our trading system

Trade with trend!

Average True Range and its effect to various simple systems

This table presents simple concept and it is related to 5 different trend following systems of which one is using 7/21 EMA combo on Top40 (J200) 15min chart; three are using different EMA or SMA penetrations on Top40 (J200) 5min chart and the fifth one is using one of the variations of HH/HL principle on ALSI 30min chart.

Basic idea of this post is to show how, despite having clear daily follow-through to the upside (please consult attached EOD Top40 (J200) chart from 01.July 2009. till 15.January 2010.), various trend-following systems are suffering during periods of low volatility, which was, in this case, measured by 5-day and 10-day Average True Range expressed in percentage terms. Note how volatility droped from October 2008 when was highest from 1998.

In order to clarify attached table I will explain what happened to system named ‘15min 7/21 C’:

• From 01. December 2008 till 14. January 2010 system made (after brokerage) total of 17088 points ouf of 221 trades or 77.32 points per trade.


• When 5-day ATR% was bellwo average ATR% value (after each close), sysem made 1720 points out of 75 trades, or 22.93 points per trade. This is leaving us with 15368 poitns that wre made out of remainiing 146 trades, or 105.26 points per trade

Note: ATR% value was calculated on Top40 (J200) EOD chart after each close.

It is clear that we have identified underperforming periods for five systems by using these simple ATR% metrics. Practical application, in terms of switching systems On/Off or position sizing is completely different matter and warrants in-depth analysis, which, for now, exceeds boundaries of this blog.

Trade with trend!

For more reading on ATR please go to:

http://stockcharts.com/help/doku.php?id=chart_school:technical_indicators:average_true_range_a