The Gateway to Algorithmic and Automated Trading

Automated Trader's proprietary tradability metrics

Published in Automated Trader Magazine Issue 10 Q3 2008

Automated Trader’s proprietary tradability metrics are environmental statistics intended to assist those building trading models/systems in determining which markets and timeframes are most favourably responsive to which generic types of model.

alphability

Trend Alphability

The Alphability stats for determining the 'trend friendliness' of markets shown here are based upon determining the amount of noise around a hypothetical trend. The simplest variant of Trend Alphability depicted here consists of the R2 (coefficient of determination) of a linear regression line plotted through the data points between the bars on which the low and high of a trading session were made (or the reverse if the high was made first). The calculation is based on the mid point of price bars in a variety of time frames. Multiplying this daily Alphability metric by the high/low range for the day (expressed as a percentage change) gives a ratio of 'trendiness' to the maximum available reward.

Reversal Alphability

Reversal Alphability follows similar general principles to Trend Alphability in that it provides a metric for the ease or difficulty of capturing a hypothetically optimal alpha. As the name implies, the differences lie in the generic types of model used. The variant of Reversal Alphability shown here is based upon two very simple reversal patterns, the short entry version of which is illustrated in Figure 1. For a short position the reversal entry logic is a bar (Bar 3) with a mid value greater than the preceding and succeeding bars (vice versa for a long entry).

To calculate the metric, the number of reversals in a day are calculated and divided into the sum of the percentage change of the moves from each reversal to the next. (Trend and Reversal Alphability are not necessarily mutually exclusive; it is perfectly possible for an instrument to have simultaneous high/low scores for both.)

Score significance

Trend Alphability:

Stocks and stock index futures - above 2 extremely benign, 1-2 acceptable, below 1 (and especially below 0.5) adverse. Commensurate categories for bond futures are typically a third of these values.

Reversal Alphability:

Stocks and stock index futures - above 0.4 extremely benign, 0.3-0.4 acceptable, below 0.3 (and especially 0.2) adverse. Commensurate categories for bond futures are typically a third of these values.

For more information on Alphability, please see page 56 of the Q3 2007 edition of Automated Trader or visit http://www.automatedtrader.net/Alphability.xhtm

Figure 2: Daily Trend Alphability - top five Dow stocks

Figure 2: Daily Trend Alphability - top five Dow stocks

General Motors heads the top five Trend Alphability Dow stocks for the second issue running. Unfortunately for GM shareholders, since early May both intraday and daily trends have been pretty much all one way - down. (As they have for all the other stocks in this group.) Interestingly, the intraday trends among the Top Five have as group been noticeably weaker in this issue than in the previous one, when the overall picture was rather more positive.

Figure 2: Daily Trend Alphability - top five Dow stocks

Figure 3: Daily Trend Alphability - bottom five Dow stocks

Another stellar performance from Johnson & Johnson, which in terms of trending probably counts as clinically dead. A particularly fine example of this was its extended flatline period in late April and early May. Mind you, in the current market environment, boring is the new sexy - unless of course you're trying to build trend following models for Johnson & Johnson.

Figure 4: Daily Trend Alphability - stock index futures

Figure 4: Daily Trend Alphability - stock index futures

Overall, stock index futures were less trendy than in our previous issue, markedly so in the case of the DAX. The one obvious exception to this for all of them being the market collapse on June 6th.

Figure 5: Daily Trend Alphability - bond futures

Figure 5: Daily Trend Alphability - bond futures

Bond futures were similarly less inclined to trend. However, one interesting development was that for the first time the Long Gilt displayed significantly greater tendency to trend than the Bund. As usual, the T-Bond showed the strongest intraday trends overall.

Figure 6: Daily Reversal Alphability - top five Dow stocks

Figure 6: Daily Reversal Alphability - top five Dow stocks

For the first time ever, Automated Trader's top five Trend Alphability Dow stocks are the same as the Reversal Alphability Top 5. While AIG, Amex, JPM, Citi and GM showed strong trends and volatility, there were clearly plenty of tradable reversal signals within those trends.

Figure 7: Daily Reversal Alphability - bottom five Dow stocks

Figure 7: Daily Reversal Alphability - bottom five Dow stocks

Another clean sweep for Johnson & Johnson, bringing a whole new meaning to the word 'tedium'. Intraday volatility in the stock is so depressed that even when it twitches spasmodically from one reversal to the next there is minimal alpha to be captured. However, the bottom five Reversal Alphability stocks did as a group offer slightly more reversal trading opportunities than in our previous issue.

Figure 8: Daily Reversal Alphability - stock index futures

Figure 8: Daily Reversal Alphability - stock index futures

A very notable shift this issue, with all stock index futures proving far less amenable to reversal models. While the average scores for both the DAX and FTSE declined appreciably, the biggest fall was in the S & P Emini where the average Reversal Alphability score for the period fell from 0.453 in our previous issue to 0.256.

Figure 9: Daily Reversal Alphability - bond futures

Figure 9: Daily Reversal Alphability - bond futures

A similar (though far less pronounced) shift in bond futures, with the average Reversal Alphability scores for the period all declining slightly.