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alphability

Published in Automated Trader Magazine Issue 12 Q1 2009

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.

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.

Figure 1: Peak Reversal (short entry)

Figure 1: Peak Reversal (short entry) - Copyright CQG Inc 2008

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.

Figure 2: Daily Trend Alphability - top five Dow stocks

Figure 2: Daily Trend Alphability - top five Dow stocks

Last time it was AIG, this time it was General Motors making all the running. At least that private jet trip to the Senate hearing helped a few Automated Trader readers to capture some alpha.

Figure 3: Daily Trend Alphability - bottom five Dow stocks

Figure 3: Daily Trend Alphability - bottom five Dow stocks

Still bringing up the rearguard is old faithful Johnson & Johnson, though it must be said that on October 9th 2008 it looked as if J & J was trying to give GM a run for its money. Until you glance at the scale on the chart that is…

Figure 4: Daily Trend Alphability - stock index futures

Figure 4: Daily Trend Alphability - stock index futures

In the Q4 2008 issue it was Lehman Brothers' demise, in this issue it was mass bailouts. No prizes for guessing the direction of those mega trend days in October and November.

Figure 5: Daily Trend Alphability - bond futures

Figure 5: Daily Trend Alphability - bond futures

In late November it looked like T-Bonds had pretensions to become a stock index; the highest value Trend Alphability stats to date for a bond future. There was gold in them thar hills…

Figure 6: Daily Reversal Alphability - top fi ve Dow stocks

Figure 6: Daily Reversal Alphability - top five Dow stocks

As we have frequently remarked, a high Trend Alphability score doesn't preclude a high Reversal Alphability one too. In the case of GM, a range bound multi-reversal November 19th was immediately followed by a hyper-trendy November 20th.

Figure 7: Daily Reversal Alphability - bottom fi ve Dow stocks

Figure 7: Daily Reversal Alphability - bottom five Dow stocks

Nice to see that Johnson & Johnson has seen off upstart 3M's pretensions to the bottom slot, after a shock result in Q4 2008. 3M couldn't even make the bottom five this time - amateur or what?

Figure 8: Daily Reversal Alphability - stock index futures

Figure 8: Daily Reversal Alphability - stock index futures

While Q4 2008 was a major ramp up from Q3 in terms of stock index Reversal Alphability, Q1 2009 took off at nearly double the pace - before dozing off.

Figure 9: Daily Reversal Alphability - bond futures

Figure 9: Daily Reversal Alphability - bond futures

Another example of Trans-Atlantic euphoria, with T-Bonds jumping and jiving in style; plus a brief spurt of enthusiasm from the Long Gilt in late January to round things off.