AT May 2008 Issue PDF

DRAWDOWN VS. SYSTEM DEATH p.
20
SYSTEM TEST:
The 4-percent model p. 34
INTERVIEWS:
Vitaliy Katsenelson
on active value investing
p. 38
Ari Kiev
NIGHT AND DAY TRADING on handling trading
in the E-Minis p. 16 stress p. 44
TREASURIES AND
INFLATION PROTECTION:
What you see
isn’t what you get p. 28
GOLD AND COFFEE
on the run pp. 60,
60. 57
$4.95 U.S. / CANADA

Printed in the U.S.A. www.activetradermag.com
CONTENTS:
® MAY 2008 • VOLUME 9, NO. 5
TRADING STRATEGIES FOR THE FINANCIAL MARKETS
Trading Strategies
9 Night and day in stock index futures
Find out what the overnight futures action really portends
for the next day session in the E-Mini stock index futures.
By Active Trader Staff
13 System death: When good systems go bad

Autopsies of two trend-following systems offer clues about
when to abandon a losing strategy.
By Christian Smart, Ph.D.
Advanced Strategies
20 TIPS, treasuries, and insurance
Do TIPS really have any advantage over regular T-notes
and T-bonds?
By Howard L. Simons
Trading System Lab

24 The 4-percent model
Testing suggests “classic” system still has legs.
By Volker Knapp
In every issue…
39 ETF Snapshot 52 Global Marketplace
Volume, volatility, and momentum International market performance.
3 Editor’s Note statistics for exchange-traded funds.
58 Trading Resources
4 Contributors 40 Stocks & Futures New products, services, and books.
5 Letters Snapshot 60 Trading Calendar
Volume, volatility, and momentum
6 Opening Trades statistics for futures and stocks. 62 Key Concepts
64 Upcoming Events
1 www.activetradermag.com • May 2008 • ACTIVE TRADER

Contents continued
Contact Active Trader:

Editorial inquiries: editorial@activetradermag.com
Comments, suggestions:
28 Active Trader suggestions@activetradermag.com
Interview For advertising or subscription
Vitaliy Katsenelson: information, log on to: www.activetradermag.com
Market skeptic
This portfolio manager and
author of Active Value Investing explains
how to survive a possible long-term
range-bound market.
By David Bukey
34 Q&A
Ari Kiev on trading
stress and leadership
The fact that trading is a The Economy
high-stress profession is no 54 U.S. economic briefing
secret, but there’s more to Updates on economic numbers and how
understanding it — and the market reacted to them.
controlling it -— than you might think.
By Mark Etzkorn
Trading Basics
56 The maxi world of mini futures
38 The Face of Trading A review of the wide range of mini futures
Brushing up profits contracts available to U.S. traders.
By Active Trader staff By Steven Graubart
Inside the Market Trade Diary

By Jeff Ponczak 65 Catching a ride on the gold express.
41 Rogue trader shredded in wheat market 67 “Overbought” moment in the market offers a
MF Global trader racks up $141 million selling opportunity.
loss in wheat futures gambit.
By Chris Peters
Other stories:
Department of Justice advocates new
futures clearing structure • Coffee perks up
to multi-year high • Tempers flare over Wall
Street arbitration • Gold keeps teasing the
$1,000 mark • Managed money • Global
news • Quick scalps

Editor’s NOTE
Historic times
Thank goodness there’s
no inflation — if there
were, the U.S.’s flaccid
H
uman beings can adjust And all this after the commodity “bull”
currency would only
to just about anything. had supposedly hoofed it south for retire-
To wit, the price of exacerbate the ment. Gee, thank goodness there’s no
crude oil: When our inflation — if there were, the U.S.’s flac-
problem, having fallen
most important fuel source — a linchpin cid currency would only exacerbate the
of the global economy — costs 10 times
recently to new lows problem, having fallen recently to new
more than it did a decade ago and darn against most major lows against most major currencies.
near twice what it did a year ago, you One of the most laughable aspect of
have to marvel at our ability to recalibrate
currencies.
inflation tracking is that the official statis-
our psyches, and thus our economies, to that can explain its surge the past year or tics remove the “volatility” energy and
such a sea change. so. Nonetheless, it seems hell bent on food components from the so-called
But psyches are such fragile things reaching the $1K mark, although one can “core” inflation numbers. No, you
(just ask the stock market). At least our only guess at the tragicomedy that might wouldn’t want to food and energy to
cars haven’t increased tenfold in price. unfold after it does so. muddy the picture — who spends money
Oil’s one thing, but gold’s history-in- The grains — when was the last time on that stuff?
the-making run is something else. For the they were the “it” commodity sector? — Maybe gold’s rally isn’t so crazy
time being, we’re really dependent on oil are picking up 2008 where they left off in after all.
— it’s pretty difficult to completely erase 2007 (including rice!); ditto for the rest
your carbon footprint, regardless of how of the metals. And the soft commodities
much you might like to — but there’s no — coffee, cocoa, and sugar — have got-
industrial or commercial purpose for gold ten in on the fun, too. Mark Etzkorn, Editor-in-chief

This Month’s
® CONTRIBUTORS
For all subscriber services:

Active Trader Magazine
P.O. Box 567 Howard Simons is president of Rosewood Trading Inc. and a
Mt. Morris, IL 61054-0567
• strategist for Bianco Research. He writes and speaks frequently on
(800) 341-9384
• a wide range of economic and financial market issues.
www.activetradermag.com
Editor-in-chief:
Dr. Christian Smart is a mathematician, cost analyst, trading systems devel-
Mark Etzkorn
metzkorn@activetradermag.com oper, and part-time trader. He develops and sells trading systems through his Web
Managing editor: site, www.drsmarttrading.com. Dr. Smart has a Ph.D. in applied mathematics and
Molly Flynn
mflynn@activetradermag.com is the author of numerous technical publications in mathematics, reliability engi-
Senior editor: neering, cost analysis, and investing. He has presented the results of his latest
Jeff Ponczak research both in the U.S. and abroad.
jponczak@activetradermag.com
Senior editor:
David Bukey Thom Hartle (www.thomhartle.com) is director of marketing
dbukey@activetradermag.com
for CQG and a contributing editor to Active Trader magazine. In a
Associate editor:
Chris Peters career spanning more than 20 years, Hartle has been a commodity
cpeters@activetradermag.com
account executive for Merrill Lynch, vice president of financial
Contributing writers:
Thom Hartle, Howard L. Simons, Marc Chandler, futures for Drexel Burnham Lambert, trader for the Federal Home
Keith Schap, Thomas Stridsman, Robert A. Green,
Jim Kharouf Loan Bank of Seattle, and editor for nine years of Technical Analysis of Stocks &
Editorial assistant and Webmaster: Commodities magazine. Hartle also writes a daily market blog called hartle & flow
Kesha Green
(www.hartleandflow.com).
Art director:
Laura Coyle
lcoyle@activetradermag.com
Volker Knapp has been a trader, system developer, and
President:
Phil Dorman researcher for more than 20 years. His diverse background encom-
pdorman@activetradermag.com
passes positions such as German National Hockey team player,
Publisher,
Ad sales East Coast and Midwest: coach of the Malaysian National Hockey team, and president of
Bob Dorman
bdorman@activetradermag.com VTAD (the German branch of the International Federation of
Ad sales Technical Analysts). In 2001 he became a partner in Wealth-Lab Inc.
West Coast and Southwest only:
Allison Ellis (www.wealth-lab.com), which he is still running.
aellis@activetradermag.com
Classified ad sales:
Mark Seger Jim Kharouf is a business writer and editor with more than 10 years of experi-
seger@activetradermag.com ence covering stocks, futures, and options worldwide. He has written extensively
Volume 9, Issue 5 Active Trader is published monthly on equities, indices, commodities, currencies, and bonds in the U.S., Europe, and
by TechInfo, Inc., 161 N. Clark Street, Suite 4915,
Chicago, IL 60601. Copyright © 2008 TechInfo, Inc. All Asia. Kharouf has covered international derivatives exchanges, money managers,
rights reserved. Information in this publication may not
be stored or reproduced in any form without written and traders for a variety of publications.
permission from the publisher. Annual subscription rate
is $59.40.
The information in Active Trader magazine is intended

for educational purposes only. It is not meant to rec-
ommend, promote or in any way imply the effective-
ness of any trading system, strategy or approach.
Traders are advised to do their own research and test-
ing to determine the validity of a trading idea. Trading
and investing carry a high level of risk. Past perform-
ance does not guarantee future results.

LETTERS
Diary of a hedge fund manager Oscillator coding

My name is Ali Meshkati. I am currently rebuilding after having my I have tried to match the results displayed in “The
macro hedge fund “blow up” at the end of 2005. I was formerly ranked Aroon oscillator” (Active Trader, March 2008) with
no. 1 in my field (http://trackrecordlive.com/wp- an Aroon oscillator I've put into TC2007. The
content/uploads/2007/12/sp32-20031106-114131.gif) author uses five bars as the [look-back] period.
I started my hedge fund with $1 million in 2002 and by the begin- Can you tell me the exact settings your staff used
ning of 2004 had over $10 million under management in my fund and to get these results, please? StockCharts.com says
in private managed accounts. While being small relative to other funds, the standard setting is 25 bars, and TC2007 asks
I was on the fast track until I became enthralled by my own success and for a smoothing average time period.
broke every trading rule in the book — the same trading rules that led
to my success for more than a decade in the markets. —Bob Baron
I started a Web site www.trackrecordlive.com that will serve as a
trading diary during my attempt to climb back, illustrating the We don't know what the “smoothing average
combination of capturing large gains in the markets with a newfound time period” is; it might simply be the term the
approach that controls volatility and limits risk to the absolute program uses for look-back period. You’ll have to
minimum. contact the software vendor directly on that one.
On the site I have taken the pen name “Captain Ahab,” which I felt At any rate, the only parameter we’re familiar
was very fitting given that Captain Ahab in the book Moby Dick sought with is the look-back period — i.e., the number of
revenge on the whale that destroyed his ship. Similarly, the market bars used in the indicator’s calculation. This num-
destroyed my vessel and took my leg — now I am seeking revenge. ber, of course, is modifiable. No look-back period
The market is my Moby Dick. is carved in stone, although default settings might
Unfortunately for me, I had to suffer a fall from grace before these be suggested.
lessons became ingrained within me as a trader. Now that they are, I
think the lessons and insights will be extremely valuable to all.
—Ali Meshkati
Everybody is a star
I am very inspired by reading “The Face of Trading” section and am
requesting to submit a short excerpt from my trading history and expe-
riences. I am a self-taught trader who has branched into options, cur-
rency, and futures. I have established myself as my own trading entity
part time as I transition out of full-time [work] to become a stay-at-
home trader. Please advise on how I can submit a request to be fea-
tured.
—S. Biddle
We always want to hear from traders. You can send information to editori-
al@activetradermag.com — be prepared to document your trading with bro-
kerage statements!
ACTIVE TRADER • May 2008 • www.activetradermag.com 5

OPENING Trades
Stocks: Status quo Gold fever: 1,000˚

— to the downside and…?
Confounding bull holdouts and Gold spent most of the first half of March
traders looking for at least a bounce, consolidating and teasing traders by
in March the U.S. stock market broke approaching the $1,000 mark — twice
down below its February consolida- rallying above $990 — before pulling
tion and positioned itself to make a Source: TradeStation back into the $960s and $970s, and
run at the January low. finally leaping up to $1,001.00 on
After selling off to 1,270 on Jan. 23, the S&P 500 index (SPX) bounced back nearly March 13.
10 percent to 1,396 by Feb. 1. After that it moved sideways, eventually falling 8.3 per- In response to feverish speculation in
cent from the Feb. 27 high to the March 10 low below 1,273. gold prices, Deutsche Bank recently
The picture around the globe was equally bearish; few major equity markets gained introduced three exchange-traded notes
ground in 2008 through mid-March. Reviewing exchange-traded funds (ETFs) based (ETNs) to let traders make leveraged,
on country stock indices revealed one ETF — the iShares MSCI Taiwan Index Fund inverse, or inverse leveraged bets on
(EWT) — that was in positive territory intraday in the 20 trading days up to March gold.
10, but it eventually closed the day in the red. However, the market roared to the
upside on March 11 in response to the Fed’s latest liquidity injection.
ETF Sym +/-

iShares Silver Trust SLV 35.29%
StreetTRACKS Gold Trust GLD 21.30%
iShares COMEX Gold Trust IAU 21.26%
DB Commodity Index Tracking Fund DBC 19.52%
iShares FTSE/Xinhua China 25 FXI -23.95%

PowerShares Golden Dragon USX China PGJ -26.24% Source: TradeStation
The two weakest international ETFs were mainland China-based: the PowerShares All three ETNs — DB Gold Double
Golden Dragon USX China and the iShares FTSE/Xinhua China 25 were both down Long (DGP), DB Gold Short (DGZ), DB
around 25 percent. Gold Double Short (DZZ) — track the
In terms of U.S. sectors, the one area of unequivocal strength was metals. Three of DB Liquid Commodity Index-Optimum
the four ETFs boasting double-digit 20-day returns on March 10 were gold and silver Yield Gold by various percentages. The
based, and the fourth was a broader commodity index. short ETN attempts to mimic the index’s
inverse (-100 percent), while the other
two represent either 200 or -200 percent
of its performance.
Bonds and notes soar
For coverage of gold’s current run, see
Interest-rate futures continued to climb
“Gold express may lose steam above
as stocks continued to fall. The March
$1,000” on p. 49.
10-year T-note contract (TYH08)
Disclaimer: Some Active Trader staff
topped 120 on March 10 before revers-
members had long positions in gold when
ing the next day as stocks rallied. The
this was written in mid-March.
contract broke out of a week-long con-
solidation and easily surpassed the 119-
05/32 January high. Source: TradeStation

Euro tops $1.5000
for the first time Futures volume sets
The U.S. dollar’s respite from the 2007 new records
meltdown that culminated in late
November proved to be short lived. If last year was any indication, 2008
The euro/U.S. dollar pair should be another record year for futures
(EUR/USD) catapulted above 1.500 on trading volume.
Feb. 27, pushing above 1.5400 by Spurred by increasing demand for
March 7. The same day, the U.S. dollar many commodities and record prices in
index (DXY) broke down to a new all- many markets, 2008 has gotten off to a
time low of 72.46. better start than 2007. And according to
For more currency analysis, includ- data released by the Futures Industry
ing statistics on what the euro has Association (FIA), 2007 global futures
done when it has made similar moves volume was up 28 percent over 2006,
in the past, see the free March issue of with more than 15 billion contracts trad-
Currency Trader magazine ed.
(www.currencytradermag.com). The FIA’s numbers are based on volun-
Source for both charts: TradeStation
tary submissions from 63 exchanges in
more than 30 countries.
Oil $100: The new $30?
After a weak January, energy prices regained
momentum mid-February to trade at record highs Gas ETF hits the road
— fueled in part by the U.S. dollar’s decline.
Oil first traded above $100 on Jan. 3 before The U.S. gasoline fund (UGA) was
falling to $85.42 a barrel within three weeks. launched by Victoria Bay Asset
April crude oil futures (CLJ08) broke above $100 Management and the American Stock
again on Feb. 19, but another week passed before Exchange on Feb. 27. Unlike other ETFs,
the contract closed above the $100 mark. Crude which track the moves of selected com-
then cracked its inflation-adjusted high of panies within the energy sector, UGA is
$103.76 on March 3, closed above $105 three based on the price of near-month gaso-
days later, and jumped above $110 on March 13. line futures (RB) traded on the New York
Following oil’s lead, gasoline and heating oil Mercantile Exchange (NYMEX).
futures also climbed to all-time highs. April gaso- Other energy-related ETFs that follow
line futures (RBJ08) climbed to a historic $2.7556 Source: eSignal NYMEX futures include the U.S. oil fund
per gallon on Feb. 20, and April heating oil (USO) and the U.S. natural gas fund
futures (HOJ08) jumped to $2.9863 a gallon. (UNG), which also follow near-month
contracts. Alternately, the U.S. 12-month
oil fund (USC) tracks the 12 monthly
Tit for tat crude oil futures contracts.
News that New York Governor Eliot Spitzer had been allegedly taped arranging a tryst with
a call girl was met with cheers from the floor of the New York Stock Exchange. Spitzer had
aggressively prosecuted corruption on Wall Street in his previous job as New York attorney
general.

Opening Trades continued
Volatility hits grains

Grain prices became more volatile in February as wheat, corn, and soybean futures
soared. May wheat (WK08) gained 14.9 percent in February, hitting an intraday high
of $13.494 per bushel on Feb. 27. After several limit-down moves, the contract fell
21.7 percent to $10.56 on March 4.
May soybeans (SK08) climbed 17.6 percent in February before dropping 14.4 per-
cent from its $15.864 March 3 high.
May corn futures (CK08) followed a similar pattern, sliding 4.2 percent from its
$5.472 high set on the same day. Corn futures had rallied 34.7 percent over the previ-
ous three months.
And don’t forget the forgotten grain — rice. Although it’s the staple food of billions
of people, rice futures are a fairly low profile market in the U.S. Nonetheless, the May
contract (RRK08) rallied from 14.250 to 18.550 from January to March 11 — a 3-per-
Source: eSignal
cent gain, and a new all-time high.
An aftertaste in coffee, sugar, and cocoa?

Like most commodities, coffee and sugar prices continued to rally in late February. In
early March, however, both markets declined roughly 15 percent from their recent
multi-year highs.
In January, prices of Arabica and Robusta coffee were at their highest levels in more
than a decade as January exports fell 9.4 percent compared to last year. But May coffee
futures (KCK08) dropped to $1.5145 per pound on March 7. (See “Java jolt:
Something’s brewing in coffee” on p. 46 for analysis of the coffee market.)
Sugar futures gained 20 percent in February as the May contact (SBK08) reached a
high of $0.1507 per pound on March 3 before slipping 15.3 percent within a week.
The cocoa market was hot in January and February as May cocoa futures (CCK08)
climbed 36.5 percent. After topping $2,845 per metric ton on March 5, the May con-
tract slipped 5 percent by March 10. Political turmoil, harsh weather, and disease have Source: eSignal
weakened West Africa’s cocoa output as of late, driving prices to record levels.
King cotton Exercise those options

May cotton futures (CTK08) climbed Retail options traders gave up profits by failing to exercise certain call options just
13.4 percent in the first three days of before a stock pays dividends, according to a new study published in the Journal of
March to reach a record high of $0.9286 Financial Markets.
per pound. But those heights didn’t last The article, written by professors at Vanderbilt and Indiana University, estimates
long as the May contract plunged 17.6 individual options traders ignored $491 million in unrealized profits from January
percent by March 11. Cotton’s early 1996 to April 2006, most of which was captured by market makers through dividend
March spike followed a bullish February arbitrage, a strategy that profits when call option holders don’t exercise deep in-the-
in which it rose 20.76 percent - the money calls just before a dividend is issued.
largest monthly gain since last summer Although transaction costs are one reason retail traders forego exercise, they don’t
and the fourth biggest monthly increase completely explain why all these profits were left on the table.
in 12 years. For more options news, strategies, and analysis, go to
www.futuresandoptionstrader.com.

Trading STRATEGIES
Night and day in stock index futures

Forget about whether the futures are up or down before the morning bell.
Analyzing the entire range of the night session and putting this information
in the context of the previous day’s price action sheds more light on
what will happen in the upcoming day session.
BY ACTIVE TRADER STAFF
A
lthough the E-Mini S&P 500 (ES) futures trade New York Stock Exchange and Nasdaq; and the night session,
nearly 24 hours a day, most traders divide the which is when the three aforementioned markets are closed.
market into two sessions: the day session, which Financial news stations typically report whether the stock
coincides with pit trading in the full-sized S&P index futures are up or down before the open of the day session,
500 contract (SP) as well as the regular trading hours of the with the implication that strength or weakness in the futures has
some predictive value. Traders know, however, the relation-
ship between the pre-market futures and the regular day
FIGURE 1: UP DAY AND NIGHT
session is foggy, at best: Strength or weakness implied by
the futures may play out in the opening minutes (or sec-
onds) of the regular session, or not at all.
Are there any useful patterns between the overnight ses-
sion and the day session? Rather than simply observing
whether the futures are up or down immediately before the
day session, let’s analyze how the night session responds to
exceptional strength in the preceding day session, and
whether the night session’s subsequent behavior has any
predictive value for the following day session.
To get started, let’s define the overnight and regular trad-
ing sessions.
Night and day

The E-Mini S&P 500 trading session begins at 3:30 p.m.
CT for one hour, at which point the Globex electronic mar-
ket closes for its daily 30-minute maintenance period. At
5:00 p.m. trading resumes and the market officially closes
the next day at 3:15 p.m.
Strong day and night sessions tend to precede further bullish
price action. For the purposes of this analysis (and in keeping with
Source: CQG Integrated Client common trader practice), the day session open is 8:30 a.m.
CT, which matches the beginning of the regular trading day

FIGURE 2: NIGHT REVERSAL EXAMPLE
for stocks as well as pit-traded futures. The day session’s

close is 3:15 p.m., 15 minutes after the close of the
NYSE and the Nasdaq. Accordingly, the “night” session
encompasses all trading between 3:30 p.m. CT and 8:29
a.m. the next day. The study compares the day and
night sessions from Feb. 1, 2007 to Jan. 31, 2008.
Strength and weakness patterns

Now we need to classify the behavior in the different
trading sessions as strong or weak. Our goal is to charac-
terize the market’s behavior in the day session and in the
night session, and determine if the relationships between
these two sessions indicate anything about the next day
session’s performance. Here are the rules for day sessions:
1. Large day sessions: If the day session’s range

exceeds the average range of the most recent five
day-sessions’ ranges, the range is considered large. Large up-closing day sessions followed by down-closing night
sessions were often followed by selling the next day.
2. Up close vs. down close: If the large session’s close Source: CQG Integrated Client
is in the upper third of its range, the session is

considered an up session. If the close is in the
bottom third of the large session’s range, the Notice this is not a comparison of how the night session
session is considered to be a down session. closed relative to the previous day session, but a measure of
where the night session closed (at 8:29 a.m.) within its own
Next, we’ll check whether the night session closes strongly range.
or weakly: The large day session and strong- or weak-closing day session
definitions were chosen because these moves usually occur in
1. If the night session’s close is in the reaction to news. The research then sought to determine when
upper third of its range, it is the subsequent night session perpetuated or reversed the
considered an up session. momentum of these sessions. For example, after a large up-clos-
ing day session, did the night session follow suit by closing in
2. If the night session’s close is in the the upper third of its range, or did it switch gears and close in
lower third of its range, it is the bottom third of its range?
considered a down session. First, the study measured the result after large up-closing day
sessions were followed by up-closing night sessions: the net
3. If the night session’s close is in the (close-to-close) change for the next day session was calculated
middle third of the range, the (i.e., the change from the previous day’s 3:15 p.m. close to the
session is considered neutral. current day’s 3:15 p.m. close).
continued on p. 1 1

Trading Strategies continued
TABLE 1: DAY AND NIGHT SESSION CLOSE IN SAME DIRECTION E-Mini S&P traded after these different
6/8 Large up-closing day + up-closing night scenarios.
Average Median Max. Min.
8.44 7.125 25.50 -2.00 Test results
The first column in each half of Table 1
3/6 Large down-closing day + down-closing night contains a ratio. The denominator is the
Average Median Max. Min. number of times the condition occurred,
-1.71 -3.375 29.00 27.50 while the numerator is the number of
times the subsequent day session closed
While rare, instances of both the day and the night sessions’ closing boded well
in the same direction as the previous day
for the next day’s trading. However, a weak day session followed by a weak
night session resulted in ambivalent (but slightly negative) price action. session. For example, the top half of Table
1 shows there were eight large up-closing
day sessions that were followed by up-
TABLE 3: NIGHT SESSION REVERSALS closing night sessions, and the next day
5/17 Large up-closing day + down-closing night session closed up six times after these
Average Median Max. Min. events (Figure 1). The average and medi-
-4.5 -3.5 32.25 -39.25 an close-to-close gains were 8.44 and
7.125 points, respectively, with a maxi-
2/14 Large down-closing day + up-closing night mum gain of 25.50 points a worst loss of
Average Median Max. Min. -2.00 points.
8.69 8.625 27.25 -14 Even rarer were combinations of large
down-closing day sessions followed by
The largest and most reliable moves followed night sessions that reversed the
down-closing night sessions (bottom half
momentum of the preceding day sessions — especially when a large down-
closing day was reversed by an up-closing night. of Table 1). This occurred just six times,
and the subsequent day sessions were
split 50-50 between gains and losses. The
TABLE 2: NEUTRAL NIGHT SESSION CLOSES average and the median close-to-close
7/14 Large up-closing day + neutral-closing night changes of -1.71 and -3.75 points, how-
Average Median Max. Min. ever, indicate a slight negative bias.
0.0536 0.5 24.75 -19.25 Table 2 shows what the E-Mini S&P
did after large up- and down-closing day
5/13 Large down-closing day + neutral-closing night sessions were followed by neutral night-
Average Median Max. Min. session closes (those that closed in the
3.8654 9.5 24.75 -36.25 middle third of the night session’s range).
There were more examples for these
Neutral night sessions after strong up-closing day sessions did not exhibit much
of a connection to the next day session’s trading, but a down-closing day conditions than those in Table 1. When
followed by a neutral night session tended to be followed by bullish behavior. large up-closing day sessions were fol-
lowed by neutral night sessions (top half
The next portion of the analysis studied the opposite scenario: of table), the next day session was essentially neutral as well:
what happened after large down-closing day sessions that were gains and losses were split 50-50 and the average and median
followed by down-closing night sessions. Table 1 details how the moves were both less than one E-Mini S&P point — incremen-

tal gains of 0.0536 and 0.50, respectively.
After the 13 combinations of large
Related reading
down-closing day sessions and neutral “ What’s the time?””
Active Trader, August 2003.
night sessions, the next day session closed
Do markets have intraday price characteristics short-term traders can use to
lower only five times — an indication that
improve their strategies? We crunch some numbers to find out when the market
a neutral night session in these circum- is moving and when it’s snoozing.
stances means the selling pressure might
have come to an end. The average and Note: This article is also contained in the “Thom Hartle Trading Strategy and
median close-to-close moves were 3.87 Analysis collection, Vol. 1: 2001-2004,” a discounted set of articles packaged in a
single PDF file.
and 9.5 points, which indicates a degree
of bullishness. “ Stock index futures: Numbers you should know””
The final part of the analysis measured Active Trader, March 2007.
what happened after a large up-closing or Before you design a trading system or place a trade, you need to understand
down-closing day session was reversed by how the market you’re trading behaves. Arm yourself with stats you can build
on.
a night session that closed in the opposite
direction (Table 3). These patterns had “ Deciphering intraday price action””
more total examples than the previous Active Trader, June 2007.
scenarios and also had more interesting Reanalyzing the E-Mini S&P 500 with recent price data finds subtle shifts in short-
results. term behavior.
Large up-closing day sessions followed
“ Following through in the S&Ps””
by down-closing night sessions occurred Active Trader, December 2003.
17 times, and the next day session closed Strong closes and large ranges are often interpreted as signs of potential follow-
higher only five times — meaning the through, but this study unveils another way to find out what today’s market
market reversed and closed lower 12 of action says about tomorrow’s. (Note: This article is also contained in the collec-
17 times (70 percent). The average and tion below.)
median close-to-close changes were
“ Stock Index Futures Trading Collection””
-4.5 and -3.5 points, respectively. Stock index futures traders: Futures on the S&P 500, Nasdaq 100, Russell 2000,
The combination of large down-closing Dow Industrials, and other benchmark stock indices are among the most actively
day sessions reversed by up-closing night traded contracts in the world. This collection of 16 Active Trader articles covers a
sessions exhibited the strongest tendency variety of techniques for analyzing and trading these instruments.
of all the scenarios in the analysis (Figure
You can purchase and download past articles at
2). The E-Mini S&P closed lower the next
www.activetradermag.com/purchase_articles.htm
day session only two of 14 times, which
means the market reversed the sell-off and
closed higher 86 percent of the time. The average and median sider results statistically valid. Analyzing more data and confirm-
close-to-close moves were gains of 8.69 and 8.625 points, ing the results of this study would help validate its conclusions.
respectively. Nonetheless, having these tables available and tracking the
day session and night session comparisons are helpful for any
Watch for night reversals intraday stock index futures trader. Overall, it appears night ses-
The one caveat of this study is the low number of occurrences of sions that reverse a previous strong or weak day session are the
each setup. Generally, 30 or more examples are needed to con- most promising signals.

Trading STRATEGIES
System death:
When good systems go bad
A look at two troubled strategies shows how to spot problems
in a trading system before losses really pile up.
BY CHRISTIAN SMART, Ph.D.
N ot every trade can be a

winner, and most traders
endure losing streaks at
some point. But if your
trading system is losing money, how do
you know if it is suffering just a brief
drawdown or if the system is on its last
conditions, popularity, and other factors.
When popular systems suffer an extended
period of losses, traders abandon them;
but those shunned systems eventually
begin working again.
Handling drawdowns is difficult, but
on p. 62.)
Trade rules for

simple breakout system
The idea behind breakout systems is
price will continue to move in the same
paying close attention to a system’s per- direction after it exceeds the highest high
leg? formance offers clues about whether you or lowest low of the previous N days (or
When a trading approach or system weeks, or minutes, etc.). If, for example,
becomes too popular, it often stops work- price climbs to a new 60-day high, it may
ing. If, for instance, too many traders use When a trading trend even higher, and if price drops to a
a trend-following approach, which buys new 60-day low, it could drop further.
(sells) the market after it reaches new approach or system The breakout system used here is a
highs (lows), the technique will eventual- simplified version of one traded by the
ly fail — at least temporarily. Increased “turtles” — Curtis Faith and other stu-
slippage will occur as more traders rush
becomes too popular, dents of Richard Dennis and William
into the market at obvious breakout Eckhardt in the early 1980s. To catch
points, and countertrend traders will it often stops working. bigger trends, the strategy enters the mar-
begin to exploit trend followers’ pre- ket on a longer-term breakout signal (55
dictable behavior by taking the other side days) and exits on a shorter-term signal
of the trade, and trends will then fade (21 days):
shortly after they develop. should continue trading or abandon the 1. Enter long on a stop when today’s
But trend-following systems aren’t technique before you lose too much. high exceeds the highest high
dead. In his book The Way of the Turtle Dissecting the performance of two sim- of the previous 55 days.
(McGraw-Hill, 2007), Curtis Faith ple trend-following strategies uncovers
describes the “system death” phenome- some early warning signs of system 2. Exit long on a stop when today’s
non as cyclical, meaning systems live, die, death. (For more details about the follow- low is less than the lowest low of
and are reborn depending on market ing systems, see “Key concepts” the previous 21 days.

FIGURE 1: UPSIDE BREAKOUT IN THE EURO
3. Enter short on a stop when today’s
low drops below the lowest low of
the previous 55 days.
4. Exit short on a stop when today’s

low is higher than the highest high
of the previous 21 days.
Money management: The system uses

fixed-fractional position sizing, risking
0.5 percent of recent volatility as defined
by the 15-day exponential moving aver-
age (EMA) of a market’s average true
range (ATR) on each trade.
To calculate position size, use the
following formula: The breakout system bought the euro after it rose to a new 55-day high on
Nov. 21, 2006 and exited with a small loss six weeks later.
Position size = (CE*%V) /
(MV*PV)
where, and the system went long the next day. had grown in popularity, and their effec-
Six weeks later later the euro fell to a 21- tiveness began to wane. Figure 2 (p. 16)
CE = current account equity day low on Jan. 5, 2007 and the system shows the breakout strategy’s equity and
%V = percent volatility exited with a slight loss. drawdown curves. In 2004 it lost 26 per-
(percentage of current account The system was tested from Jan. 1, cent and reached a new maximum draw-
equity to risk per trade) 1986 to Dec. 31, 2007 on a diversified down of 37 percent, exceeding its previ-
MV = market volatility (15-day portfolio of 12 futures markets: British ous maximum drawdown of nearly 40
EMA of ATR) pound (BP), cotton (CT), gold (GC), percent in 2000.
PV = point value copper (HG), Japanese yen (JY), natural Let’s assume a system dies when it
gas (NG), Nikkei 225 (NK), gasoline reaches a new yearly maximum draw-
Suppose the Nikkei 225 index futures (RB), sugar (SB), soybeans (S), 10-year down twice as large as any previous year.
(NK) 15-day ATR is 250 and the account T-notes (TY), and 30-year T-bonds (US). By any definition, however, the system
size is $1,500,000: Each trade deducted $75 for slippage suffered a quick death in 2004 with this
and commissions. 12-contract portfolio. But remember:
Current account equity (CE) Performance tends to be cyclical, and sys-
= $1,500,000 System death: tems can be resurrected after profitability
Percent volatility (%V) = 0.5% Quick or slow and painful? improves.
Market volatility (MV) = 250 Table 1 lists the 55-21 breakout system’s
Position size (number of contracts) back-test results from 1986 to 2007. Like Warning signs
= (1,500,000 * 0.005) / (250 * 5) most trend-following systems, it has a There were warning signs prior to the
= 6 contracts. low win/loss ratio of 26 percent that is breakout system’s swift, yet temporary,
offset by a large ratio of average winners demise in 2004. Figure 3 (p. 17) plots
Figure 1 shows a long trade to losers (2.99). the strategy’s annual returns, which
example in eurocurrency futures (EC) in The system gained an average 10 per- trended downward and fell below zero in
November 2006. Price broke above the cent per year from 1986 to 2004. By that 2002 — a red flag.
previous 55-day high on Nov. 21, 2006 point, however, trend-following systems continued on p. 15

TABLE 1: BREAKOUT SYSTEM PERFORMANCE

Profitability Trade statistics
Initial balance: $1,500,000 No. trades: 4,165
Net profit: $4,170,514 Number of wins: 1,087
Return on investment (ROI): 278.03% Number of losses: 3,078
Compound annual ROI: 6.22% Win/loss: 26.1%
Max drawdown: 58.72% Long wins: 583
Longest drawdown (in years): 6.28 Long losses: 1,543
MAR ratio: 0.11 Short wins: 504
Sharpe ratio: 0.23 Short losses: 1,535
Return retracement ratio: 0.20 Avg. $ win to avg. $ loss: 2.99
Sterling ratio: 0.34 Max. consecutive wins: 6
Std. dev. of daily percentage returns: 1.42% Max. consecutive losses: 31
Value at risk: 3.51% Days winning: 2,802
Expectation: 7.78% Days losing: 1,767
Kelly: 0.01 Avg. days in winning trade: 29
Sum of up % / sum of down %: 1.07 Avg. days in losing trade: 5
Percent new highs: 2.66%
Although the system made money overall since 1986, it suffered a maximum drawdown of 59 percent in 2005, which
no one would tolerate.
Source: Mechanica (www.mechanicasoftware.com)
Legend: Kelly: Percent of trading capital that should be risked on each trade to
Net profit: Profit at end of test period, less commission. maximize total returns with a fixed-fractional money management strategy.
Return on investment (ROI): Net profit divided by initial capital. Sum of up % / sum of down %: The percentage return of all winning days
Compound annual ROI: Compounded annual growth rate. divided by the total percentage return of all losing days.
Max drawndown: Largest percentage decline in equity. Percent new highs: Percentage of days on which a new equity high is made.
Longest drawdown (in years): Longest period the system is between two No. trades: Number of trades generated by the system.
equity highs. Number of wins: Number of winning trades.
MAR ratio: Annual return divided by largest drawdown. Number of losses: Number of losing trades.
Sharpe ratio: Average return divided by standard deviation of returns Win/loss: The percentage of trades that were profitable.
(annualized). Long wins: Number of profitable long trades.
Return retracement ratio: Compounded annual growth rate divided by Long losses: Number of unprofitable long trades.
an average maximum daily retracement from a prior equity peak or Short wins: Number of profitable short trades.
subsequent low. Short losses: Number of unprofitable short trades.
Sterling ratio: Compounded annual growth rate divided by the average Avg. $ win to avg. $ loss: Average winner divided by average loser.
maximum drawdown, less 10 percent. Max. consecutive wins: The maximum number of consecutive winning trades.
Std. dev. of daily percentage returns: Standard deviation of system’s Max. consecutive losses: The maximum number of consecutive losing trades.
percentage gain or loss on each day. Days winning: Number of days in which ROI is positive.
Value at risk: A measure of estimated losses over a specific time period. Days losing: Number of days in which ROI is negative.
Expectation: Winning percentage multiplied by average winner minus losing Avg. days in winning trade: The average holding time for winning trades.
percentage multiplied by average loser. Avg. days in losing trade: The average holding time for losing trades.
Studying the system’s monthly per- months — March 2005 to February of 37 percent in 2004 and 55 percent in
formance is even more illuminating (as 2005 — and could have acted as an 2005.
shown in Figure 4). In March 2003, the early warning signal to avoid the system, Finally, contrarians may have noticed
system lost 20 percent, dropping almost at least temporarily. how popular trend-following had become
twice as much as in any previous month. Had you spotted this weak perform- in 2004 — Michael Covel’s book Trend
This plunge preceded a string of 12 losing ance, you might have avoided drawdowns Following was published amid a great deal

Mechanica Software code
55-21 breakout system 'Exit Code
IF LONG > 0 AND DAYSINTRADE = 1 THEN MEMORY[1] =
SYSTEM = 1 COL2[1] - 4 * COL7[1]
COL1 = HIGH[55] IF LONG > 0 AND DAYSINTRADE > 1 THEN SELLSTOP =
COL2 = LOW[21] MEMORY[1]
COL3 = LOW[55]
IF LONG > 0 AND COL2[1] < COL3[1] THEN SELLOPEN
COL4 = HIGH[21]
COL5 = CLOSE
COL6 = ATR[1] (SYSTEM = 1: long code)
COL7 = EMA[COL6,15]
SIZING[1] = POINTVALUE * COL7 SYSTEM = 1
COL1 = CLOSE
'Entry Code COL2 = EMA[COL1,20]
IF CLOSE[1] > COL1[1] THEN BUYOPEN COL3 = EMA[COL1,80]
IF CLOSE[1] < COL3[1] THEN SELLOPEN COL6 = ATR[1]
COL7 = EMA[COL6,15]
'Exit Code SIZING[1] = POINTVALUE * COL7
IF LONG > 0 THEN SELLSTOP = COL2[1]
IF SHORT > 0 THEN BUYSTOP = COL4[1]
'Entry Code
80-20 MA crossover system IF COL2[1] < COL3[1] THEN SELLOPEN
(SYSTEM = 2: short code)
'Exit Code
SYSTEM = 2 IF SHORT > 0 AND DAYSINTRADE = 1 THEN MEMORY[1] =
COL1 = CLOSE COL2[1] + 4 * COL7[1]
COL2 = EMA[COL1,20] IF SHORT > 0 AND DAYSINTRADE > 1 THEN BUYSTOP =
COL3 = EMA[COL1,80] MEMORY[1]
COL6 = ATR[1] IF SHORT > 0 AND COL2[1] > COL3[1] THEN BUYOPEN
COL7 = EMA[COL6,15]
SIZING[1] = POINTVALUE * COL7
Money management code (both systems)
'Entry Code
IF COL2[1] > COL3[1] THEN BUYOPEN STARTDATE = 19860101
STARTUPCASH = 1500000
NEWCONTRACTS = (.005 * TOTALEQUITY) / SIZING[1]
You can copy this code at www.activetradermag.com/code.htm
FIGURE 2: BREAKOUT SYSTEM — EQUITY AND DRAWDOWN CURVES
of press coverage. When any particular

method becomes popular enough to be
the subject of an entire book, it is proba-
bly wise to avoid that technique for a
while.
In late 2005, performance improved;
the strategy gained 3.5 percent in both
2005 and 2006 and climbed another 12
percent in 2007. While not spectacular,
these modest returns may signal the
renewed effectiveness of breakout tech-
niques. Although drawdowns were still In 2004 this breakout system lost 26 percent, reaching a new maximum
relatively large compared to previous drawdown of 37 percent. The strategy’s decline exceeded its previous maxi-
mum drawdown of nearly 40 percent in 2000.
periods, they were decreasing, another
good sign. Source: Mechanica (www.mechanicasoftware.com)
continued on p. 17

FIGURE 3: ANNUAL RETURNS

market. Conversely, the system sells short
when the short-term MA crosses below
the longer-term one, because price is
falling. In this example, a 20-day SMA
represents the short-term moving average,
and an 80-day SMA represents the
long-term one.
Trade rules:
1. Enter long and exit short at the

next day’s open when the 20-day
moving average of closing prices
rises above its 80-day moving
The breakout system’s annual performance fell below the zero line in
2002 — a red flag. average.
2. Exit long and enter short at the next

day’s open when the 20-day
FIGURE 4: MONTHLY RETURNS moving average of closing prices
drops below its 80-day moving
average.
This stop-and-reverse (SAR) system is

always in the market as it goes long after
closing short trades and sells short after
exiting long trades. Table 2 (p. 18) shows
the crossover system’s performance from
1986 to 2007, using the same futures
portfolio used in the simple breakout sys-
tem. This system has compounded annual
gains of 13.96 percent, meaning it was
more than twice as profitable as the
breakout system. But the MA crossover
system is always in the market, so it is
exposed to more risk than the breakout
approach. Figure 5 shows the MA
In March 2003, the system lost 20 percent, dropping almost twice as much crossover system’s equity and drawdown
as in any previous month — a warning signal to avoid the system, at least
curves.
temporarily.
For years, the strategy performed well
until it had two consecutive losing years
In 2007, for example, the maximum that tracks two simple moving averages in 2003 and 2004, falling 15 and 18 per-
drawdown was less than 20 percent, about (SMA) with different lengths. A shorter- cent, respectively. That drawdown grew to
half of its maximum drawdown in 2004. term moving average responds faster to 60 percent in 2005. It’s clear the system
price changes than a longer-term MA. began to fail in 2003, and it bottomed out
Moving average crossover system When a short-term moving average in 2005.
Another trend-following example is a crosses above its longer-term equivalent, This MA crossover system died for the
moving average (MA) crossover system price is rising, so the system buys the same reason the breakout system did:

Both strategies are trend followers.
Again, however, warning signs emerged FIGURE 5: CROSSOVER SYSTEM — EQUITY AND DRAWDOWN CURVES
before performance took a nose dive in
2003.
Had you examined the crossover sys-
tem’s quarterly returns, you would have
found a striking anomaly (see Figure 6).
Prior to 2001, the strategy posted eight
quarterly losses of more than 10 percent
from 1986 to 2000. But in each case,
a large quarterly loss was followed by
either a gain or a smaller loss in the next
quarter.
In Q4 2001, the MA crossover system
lost 11 percent, followed by a 16.5-per-
cent loss in the next quarter — an
unprecedented drop at the time. And The MA crossover strategy performed well until it had two consecutive losing
this volatility spike preceded even larger years in 2003 and 2004, falling 15 and 18 percent, respectively. But it recov-
losses. Although the strategy recovered to ered to hit new equity highs in 2006 and gained nearly 60 percent that year.
reach new equity highs in early 2003, it
continued on p. 19
TABLE 2: DUAL MA CROSSOVER SYSTEM PERFORMANCE

Profitability Trade statistics
Initial balance: $1,500,000 No. trades: 922
Net profit: $26,801,140 Number of wins: 272
Return on investment (ROI): 1,686.74% Number of losses: 650
Compound annual ROI: 13.96% Win/loss: 29.50%
Max drawdown: 59.76% Long wins: 153
Longest drawdown (in years): 3.19 Long losses: 309
MAR ratio: 0.23 Short wins: 119
Sharpe ratio: 0.50 Short losses: 341
Return retracement ratio: 0.64 Avg. $ win to avg. $ loss: 3
Sterling ratio: 1.09 Max. consecutive wins: 10
Std. dev. of daily percentage returns: 1.62% Max. consecutive losses: 20
Value at risk: 4.22% Days winning: 2,921
Expectation: 19.38% Days losing: 2,648
Kelly: 0.06 Avg. days in winning trade: 157
Sum of up % / sum of down %: 1.11 Avg. days in losing trade: 30
Percent new highs: 4.49%
The crossover strategy beat the breakout approach (Table 1) with a 13.96-percent compound annual ROI. But it also
had a crippling 60-percent drawdown in 2005.

lost 33 percent in Q2 2004.

FIGURE 6: QUARTERLY RETURNS
This equity decline could have acted as
a signal to avoid the system. Figure 5’s
equity curve shows the crossover system
rebounded to reach new equity highs in
2006 and gained nearly 60 percent that
year.
Life after death?

It pays to study a system’s equity curve,
because strategies tend to die after sud-
den and unprecedented drops in equity. If
your strategy’s performance drops quickly
and sharply, you should probably stop
trading it, especially if those losses are The MA crossover system lost 11 percent in Q4 2001, followed by a 16.5-per-
unusually large. Also, pay attention to cent loss in the next quarter. This equity decline could have acted as a signal
to stop trading the system.
what strategies people are trading by
monitoring blogs and message boards.
The more popular a system is, the greater unprofitable and lose popularity. Both system to start winning again before trad-
the odds it will fail. systems discussed here started to work ing it.
The good news: Dead systems often again recently. But don’t try to time this
show new signs of life after they become cycle too closely. Instead, wait for a For information on the author see p. 4.
Related reading
By Christian Smart: “ Moving average crossover””
Active Trader, July 2002.
This system goes long when a short-term and long-term
“ Controlling risk in a breakout system””
moving average intersect.
Active Trader, March 2008.
Back testing trade strategies without sizing your positions
“ Building a better trend indicator””
correctly can
Active Trader, May 2001.
produce misleading results. This study of two related break-
How accurately are you defining the trend for your short-
out systems tells the tale.
term trading? Here’s an alternative to traditional moving
average techniques that will let you know when the market
“ Filtering Bollinger Band breakouts””
is in buy mode or sell mode.
Active Trader, December 2007.
Does volatility make or break your strategy? Avoiding chop-
Breakout trading technique article collections (basic
py market conditions strengthens this system.
and advanced):
Other articles: The Basic breakout trading technique collection features 12
articles that explain and illustrate basic breakout concepts,
“ Trend strength indicator””
including breakout trading strategies based on chart analy-
Active Trader, August 2005.
sis and simple breakout-channel calculations. The tech-
This system expands and modifies basic moving average
niques cover time frames from intraday to multi-week.
concepts that a market is in an uptrend when price is above
The Advanced collection includes 10 articles that explain
a moving average (the magnitude of the trend being
different trading systems, strategies, and concepts based on
dependent on the length of the moving average), and the
breakout trading. Also, there are special Trading System
farther price is above the average, the stronger the momen-
Labs that illustrate trailing stop and walk-forward
tum.
testing techniques for breakout systems.
“ Short-term WMA crossover system””
Active Trader, May 2004.
These buy and sell signals are based on crossovers of two
weighted moving averages (WMA), which react more quick-
ly to price moves than a simple moving average (SMA).

Advanced STRATEGIES
TIPS, treasuries, and insurance

Traders and investors who buy TIPS thinking
they’re getting protection against inflation may
be disappointed by a comparison to regular treasuries.
BY HOWARD L. SIMONS
T raders are bettors at heart, so

let’s make a collective bet
right now: Very few traders
see themselves as being in the
insurance business. This is no doubt a
matter of self-perception as the insurance
industry is seen as dull and bureaucratic,
Protected Securities (TIPS) involves insur-
ance against unexpected increases in
inflation. The principal on TIPS increases
(after a lag) along with the all-urban con-
sumer price index, not seasonally adjust-
ed (CPI-U). Certain economists and
many investors have become enamored
with TIPS for two separate and disparate
reasons. Economists like to think the dif-
ference in yield between conventional
while many traders view Animal House as FIGURE 1: TIPS BREAKEVEN RATES IGNORE REPORTED INFLATION
the highest achievement of American cin-
ema.
The sentiment is reciprocated as well.
Insurance mogul Warren Buffett takes
potshots at derivatives wherever and
whenever he can, even though his busi-
nesses are nothing but a giant derivative
trade.
But many of the concepts of trading —
options trading, especially — are
explained best in insurance terms. You
pay a premium to insure against an event
and you either forfeit that premium or
collect if the event occurs. The concept
extends to futures markets, too. A hedger
who sells forward in a backwardated
market or who buys forward in a carry
market is exchanging a known loss
against the risk of an even greater loss if
he remains unhedged. Comparing TIPS breakeven rates and the year-over-year change in the CPI-U
(lagged two months) reveals the TIPS market has no predictive relationship to
TIPS and inflation insurance reported inflation.
The market for Treasury Inflation-

FIGURE 2: TIPS UNDERPERFORMED AS BREAKEVEN RATES FELL
treasuries and TIPS – the so-called

“breakeven rate of inflation” – is rich
with information on the course of infla-
tion. Investors like to think TIPS will
protect them from the ravages of infla-
tion. Both are wrong.
Let’s take a look at the relationship
between TIPS breakevens and the year-
over-year change in the CPI-U, lagged
two months; this is the best statistical fit
between the two series. Stare at Figure 1
and search for how well the TIPS market
predicts reported inflation. The proper
conclusion is it does not.
What about protecting investors
against inflation? Let’s assume, for the
sake of argument, whoever is selling
TIPS to you is not a complete fool. Their
expectations of inflation are going to be The total return of a TIPS-based mutual fund and the Merrill Lynch index of
the same as the market’s, plus or minus a 10- to 15-year treasuries tracked each other closely until the Federal Reserve
margin of error. How could they be oth- abandoned its rate-hike campaign in August 2006, implying investors
began overpaying for inflation protection at that point.
erwise, unless we assume TIPS sellers are
endowed with superhuman forecasting
abilities that the rest of us are denied? FIGURE 3: TIPS AND NOMINAL TREASURY RETURNS AS A FUNCTION OF U.S. EQUITY RETURNS
This implies TIPS should be priced
against future inflation in an actuarially
fair manner, similar to how other insur-
ance rates are set. If this is the case, TIPS
can provide protection only against
unexpected inflation — i.e., that quanti-
ty in excess of the market’s expectations
at the time. This implies properly priced
TIPS should return no more than treas-
uries over time unless TIPS sellers
underpriced the risk of future inflation.
Figure 2 compares the total return of
a Vanguard TIPS-based mutual fund to
the Merrill Lynch index of 10- to 15-year
treasuries, both re-indexed to June 2000.
The two series matched each other close-
ly until the Federal Reserve abandoned
its rate-hike campaign in August 2006
(green vertical line). The implication
There is significant evidence treasury yields fall faster than TIPS yields, with no
here is investors began overpaying for change in inflation expectations.
inflation protection at that point.
continued on p. 22

Advanced Strategies continued
FIGURE 4: COMPARING REAL AND NOMINAL 10-YEAR HISTORIC VOLATILITY

Treasuries and crisis insurance
However, what if TIPS breakevens were
not solely the result of inflation expecta-
tions, but were distorted by swings in
treasury yields? We are all familiar with
the flight-to-quality phenomenon — the
rush into T-bonds for safety whenever
the stock market does a face-plant on the
pavement. If investors flee into conven-
tional treasuries and do not flee at an
equal pace into TIPS (why should they?),
then treasury yields would fall faster
than TIPS yields and the breakeven rate
would fall — with no change in inflation
expectations required.
There is substantial evidence this
occurs (Figure 3). Mapping the daily
percentage changes of TIPS and treasury
yields going back to February 1997
Before February 2003, TIPS volatility was often less than treasury volatility. against the daily return on the broad-
Once the Fed abandoned its inflation-fighting campaign and began flooding
based Russell 3000 index shows the
the markets with liquidity, the volatility situation reversed and TIPS volatility
regression beta for treasuries is signifi-
moved above treasury volatility after September 2007.
cantly lower than it is for TIPS (-0.0912
as opposed to -0.0507). Moreover, while
the variance of treasury returns relative
to TIPS returns is much larger when
FIGURE 5: THE EMBEDDED CALL OPTION IN NOMINAL TREASURIES stocks rally, it is even larger when stocks
falter.
The flight-to-quality observed for
treasuries does not exist in TIPS even
though the two securities both bear the
full faith and credit of the U.S. Treasury.
There are three reasons for this. First,
when stocks decline, inflation expecta-
tions can diminish. Second, the “short
call option” on government honesty
embedded in TIPS — you are at the
mercy of the government telling you
what their increased obligation to pay
more as the result of higher inflation is
— can increase and diminish the
prospective return on TIPS. Third,
because TIPS are taxed on their inflation-
The distribution of large positive returns for T-notes dwarfs that of TIPS. The accrued principal much in the same way
price jumps that tend to occur on days with bad economic news or stock zero-coupon bonds are taxed on “phan-
market declines have no counterpart in TIPS prices. tom” income, the embedded short call
continued on p. 23

Advanced Strategies continued
option on that element of TIPS’ payoff Deceiver on two grounds. The first is they Will any of this change TIPS’ populari-
function can increase and diminish the let down economists who thought the ty with either group? Not a chance.
prospective return on TIPS. derived breakeven rate gave them a free Those who sell the promise of a free
If we view T-bonds as insurance against lunch – a perfect and frictionless window lunch can stay in business for years.
a financial disaster such as the 2007 cred- into inflation expectations. The second is Maybe we should talk about Social
it crunch, the comparison starts to come they let down investors who thought the Security and company-paid medical
clearly into view. The impulse to buy principal accrual gave them a free lunch – insurance next.
insurance against an immediate loss of protection against inflation with no con-
current investments is more powerful comitant reduction in return. For information on the author see p. 4.
than the impulse to buy insurance against
the CPI-U over a forward 10-year averag-
ing period, is it not?
Insurance and volatility Related reading

We can compare these relative impulses
by comparing the realized volatility of Other Howard Simons articles:
TIPS and treasuries. Prior to February “Gold: Sound and fury, signifying nothing”
2003, TIPS volatility often was less than
Active Trader, April 2008.
treasury volatility (Figure 4). The two
Gold has burst to new highs as the U.S. stock market and
measures converged but the deviations
dollar have tanked, but don’t believe the easy explanations
often were for TIPS volatility to be less
than treasury volatility, especially during about the yellow metal’s role as an inflation barometer or hedge.
stock market downturns. The February
2003-July 2007 period was characterized “Had enough of the dollar and stuff?”
by generally declining breakevens. Active Trader, March 2008.
Once the Federal Reserve abandoned Analysis shows the relationship between the dollar
its inflation-fighting campaign in favor of and commodity prices isn’t what most people think.
flooding the markets with liquidity in
response to the credit crunch, the volatili- “Oil prices and global petroleum inventories”
ty situation reversed. Demand for infla- Active Trader, February 2008.
tion protection surged, and TIPS volatility
Is an oil shock — and even higher prices — a real possibility?
moved above treasury volatility after
September 2007.
A second way of looking at the relative “Bonds and the first rule of trading”
insurance demands of TIPS and treasuries Active Trader, January 2008.
is to map the distribution of their returns Where do we stand after a 25-year bond bull market?
(Figure 5). The distribution of large posi- Get ready to adjust your T-bond and T-note strategies.
tive returns for T-notes is much higher
than expected and dwarfs that of TIPS.
These price jumps tend to occur on days “Howard Simons: Advanced Currency Concepts, Vol. 1”
with bad economic news or stock market A discounted collection that includes many of the articles listed here.
declines; there are no corresponding
surges in TIPS prices. You can purchase and download past articles at
A tip on TIPS
So there we have it: TIPS are the Great

TRADING System Lab
The 4-percent model
FIGURE 1: SAMPLE TRADE
BY VOLKER KNAPP
Market: Stocks.
System concept: The 4-percent

model is a mechanical trend-follow-
ing approach developed by Ned
Davis and popularized in Martin
Zweig’s book Winning on Wall Street.
It is based on weekly percent
changes in the Value Line
Composite index, also known as the
Value Line Geometric index (VLG).
The model goes long when the mar-
The system typically has long holding periods. In this case, a long trade that opened
ket makes a 4-percent up move (on in January 2005 was still open more than a year later.
the assumption this indicates an
Source: Wealth-Lab Pro 5.0
uptrend and price will continue to
rally) and gets out (or sells short) during downtrends. 4 percent from the previous week’s value, and does the opposite
The system tested uses the Value Line Arithmetic index (VLA) when the index drops 4 percent.
which, like the VLG, equally weights every stock in the Value This method is comparable to the Donchian four-week break-
Line Investment Survey — 1,700 stocks across a broad spec- out rule, which goes long when price exceeds the highest high
trum of capitalizations and industries. of the past four weeks and goes short when price drops below
The VLA is constructed by calculating the ratio of each stock’s the lowest low of the past four weeks. The essential goal of both
closing price to its previous close — e.g., if today’s price is models is to avoid trading insignificant market swings while
52.64 and yesterday’s price was 51.22, the ratio would be 1.03 staying on the right side of the dominant market trend.
(52.64/51.22). All the ratios are summed and then divided by This system takes long trades and stays out of the market
the total number of stocks in the index. (For more during downtrends. Figure 1 shows a typical trade.
information about the VLG and VLA go to
www.valueline.com/news/vlv070406ut.html.) Strategy rules:
The most notable aspect of this technique is its simplicity;
there is nothing to calculate except the weekly close of the VLA. 1. When the VLA rises 4 percent or more from the previous
The system generates a buy signal when the index rises at least week’s close, go long at the market

FIGURE 2: EQUITY CURVE
on the next bar.

2. When the VLA falls 4 percent or
more from the previous week’s
close, exit tomorrow at market.
Money management: Allocate 10

percent of equity per position. Because it
would be impossible to take a 10-percent
position in all 17 stocks in the portfolio
whenever a buy signal is generated,
trades are prioritized by lowest price (i.e.,
positions are established in lower-priced The system outperformed buy-and-hold for the majority of the test period.
stocks first) to capture as many opportu- Source: Wealth-Lab Pro 5.0
nities as possible.
FIGURE 3: DRAWDOWNS
Starting equity: $100,000. Deduct
$8 commission and 0.10 percent slip-
page per trade.
Test data: The system was tested on

the Active Trader Standard Stock
Portfolio, which contains the following
17 stocks: Apple Inc. (AAPL), Boeing
(BA), Citigroup (C), Caterpillar (CAT),
Cisco Systems (CSCO), Disney (DIS),
General Motors (GM), Hewlett Packard
(HPQ), International Business
Machines (IBM), Intel (INTC),
International Paper (IP), J.P. Morgan
Chase (JPM), Coca Cola company
(KO), Microsoft (MSFT), Starbucks
(SBUX), AT&T (T), and Wal-Mart
(WMT). Data source: Fidelity
(www.fidelity.com). The biggest drawdown occurred in 2002 in the depths of the post-2000 bear
market. None of the other drawdowns exceeded 30 percent (top). Aside from
a nearly two-year stretch that ended in 2001, the time between new equity
Test period: February 1998 to highs was not excessive for a trend-following system (bottom).
January 2008.
Source: Wealth-Lab Pro 5.0
continued on p. 26

Trading System Lab continued
STRATEGY SUMMARY
Test results: Despite its simplicity, the Profitability Trade statistics
4-percent model is a surprisingly robust Net profit: $240,916.71 No. trades: 98
trend-following strategy. The system out- Net profit: 240.92% Win/loss: 64.29%
Profit factor: 4.44 Avg. profit/loss: 15.34%
performed buy-and-hold by a small mar-
Payoff ratio: 2.74 Avg. holding time (bars): 168.54
gin, producing a slightly higher net profit
Recovery factor: 4.83 Avg. profit (winners): 29.91%
(240.9 percent vs. 233.9 percent), with
Exposure: 65.97% Avg. hold time (winners): 192.89
annualized gains coming nip and tuck as Total commission: $1,568.00
well (13.1 percent vs. 12.8 percent).
However, a look at the equity curve Drawdown Avg. loss (losers): -10.90%
(Figure 2) reveals the prolonged depth of Max. DD: -24.45% Avg. hold time (losers): 124.71
the buy-and-hold drawdown in the after- Longest flat period: 544 bars Max consec. win/loss: 10/4
math of the 2000 market collapse, which
took the market almost six years to overcome. The 4-percent The system made only a handful of trades (98), but the aver-
system, though, continuously set new equity highs after 2001. age trade returned a whopping 15.3 percent. A high payoff ratio
Although the system’s equity line is quite jagged, its risk is (the absolute average profit divided by the absolute average loss)
considerably lower than buy-and-hold’s, with the typical draw- of 2.7 and a high profit factor (4.4) are results you would expect
down lasting only six months to a year. The maximum draw- from a trend-following system, but a 64.3-percent win rate was
down (which occurred more than five years ago) was less than quite a surprise.
25 percent (Figure 3), compared to buy-and-hold’s devastating The system’s most significant drawback is its excessive expo-
61 percent drawdown. sure; it spent nearly 66 percent of the time in the market. The
PERIODIC RETURNS
% profitable Max consec. Max consec.
Avg. return Sharpe ratio Best return Worst return periods profitable unprofitable
Monthly 1.14% 0.53 15.50% -11.15% 42.50 5 4
Quarterly 3.41% 0.48 28.14% -14.55% 46.34 5 3
Annually 13.02% 0.48 43.61% -8.60% 54.55 2 1
LEGEND
Net profit — Profit at end of test period, less commission. Profit factor for winning trades. Avg. loss — The average loss for losing trades.
— Gross profit divided by gross loss. Payoff ratio — Average profit of Avg. hold time (losers) — The average holding time for losing trades.
winning trades divided by average loss of losing trades. Recovery fac- Max consec. win/loss — The maximum number of consecutive win-
tor — Net profit divided by maximum drawdown. Exposure — The ning and losing trades.
area of the equity curve exposed to long or short positions, as opposed Avg. return — The average percentage for the period. Sharpe ratio
to cash. Max. DD — Largest percentage decline in equity. Longest flat — Average return divided by standard deviation of returns (annualized).
period — Longest period, in days, the system is between two equity Best return — Best return for the period. Worst return — Worst
highs. No. trades — Number of trades generated by the system. return for the period. Percentage profitable periods — The percent-
Win/loss — The percentage of trades that were profitable. Avg. profit age of periods that were profitable. Max consec. profitable — The
— The average profit for all trades. Avg. hold time — The average largest number of consecutive profitable periods. Max consec. unprof-
holding period for all trades. Avg. win — The average profit for win- itable — The largest number of consecutive unprofitable periods.
ning trades. Avg. hold time (winners) — The average holding time

FIGURE 4: ANNUAL RETURNS
average holding time was around 170
days, equivalent to buying around
Christmas and selling just before
Labor Day. This sluggishness is most
likely a result of the system’s rudimen-
tary exit strategy.
Equity growth came in stages, and
up years alternated with down years
(Figure 4). There were six winning
years and four losing years and the
average annual profit was 13 percent. There were four losing years, but none were consecutive and all were smaller
However, the losses were noticeably than the smallest winning year.
smaller. Source: Wealth-Lab Pro 5.0
Bottom line: Despite its simplicity, the system’s performance hard times set in, as was the case before the declines of Sept. 11,
was clearly better than the overall market’s (represented by the 2001, late 2002, and 2005. But sometimes the system’s logic
buy-and-hold approach) in terms of both return and risk. The fails, as it did in late 1999 and last year. Despite an advancing
system’s primary drawbacks were its relatively high exposure market in 2007, notice how the system sat on its hands through-
and occasional tendency to miss some big moves. out 2007; not a single trade was triggered. (On the other hand,
Generally, a pullback in the index will save the system before the system did not get caught in the January 2008 meltdown.)
One possible way to make the system more responsive
would be to base the signals on recent troughs or peaks in the
FIGURE 5: PROFIT DISTRIBUTION
index. For example, a buy signal could occur when the VLA
rises 4 percent or more from its most recent trough.
For information on the author see p. 4.
Trading System Lab strategies are tested on a portfolio basis (unless otherwise
noted) using Wealth-Lab Inc.’s testing platform. If you have a system you’d
like to see tested, please send the trading and money-management rules to
editorial@activetradermag.com.
Disclaimer: The Trading System Lab is intended for educational purposes

only to provide a perspective on different market concepts. It is not
meant to recommend or promote any trading system or approach.
Traders are advised to do their own research and testing to determine
the validity of a trading idea. Past performance does not guarantee
future results; historical testing may not reflect a system’s behavior in real-
Four stocks — AAPL, CSCO, HPQ, and SBUX —
accounted for the majority of the system’s profits. time trading.
Source: Reports-Lab

Active Trader INTERVIEW
Vitaliy Katsenelson:
Market skeptic
Are stocks stuck in neutral? This professional investor
and author claims the market has fizzled out.
BY DAVID BUKEY
V
italiy Katsenelson is a port- Despite his gloomy outlook, “I was using Bloomberg and taking
folio manager, author, and Katsenelson is an optimist who believes Finance 101, and it just clicked,” he says.
teacher who isn’t shy about investors have many opportunities to After graduating with a bachelor’s
discussing the problems he make money even if the stock market degree in finance, Katsenelson earned an
sees with stocks today. Price-to-earnings remains volatile. MBA and became a Chartered Financial
(PE) ratios and profit margins (earnings / As a professional value investor, Analyst (CFA).
sales) are at historically high levels and Katsenelson searches for undervalued Katsenelson’s recent book Active Value
will likely drop in the near future, which stocks with earnings and dividend growth Investing: Making Money in Range-bound
means stocks could trade in a range- — an approach well-suited for range- Markets (John Wiley and Sons, 2007) digs
bound market for years. bound markets as stocks bounce around, deep into historical fundamental data to
The trouble began when the last long- but ultimately go nowhere. show how high PEs drag down stocks,
term bull market ended in 2000 as the Katsenelson, 34, grew up in the while low PEs often give them a boost.
S&P 500 index traded at 33 times earn- Russian city of Murmansk, above the All of his claims come from analyzing up
ings — more than twice its 100-year Artic Circle, and emigrated to the U.S. to 200 years of price and earnings values.
average of 15.2 (on a one-year trailing with his family in 1991 after the Cold Although he has a long-term market
basis). Although PE ratios have dropped War ended. His family settled in Denver outlook, Katsenelson’s timing couldn’t
somewhat over the last seven years, where he attended the University of have been better. He finished Active Value
Katsenelson thinks they will fall further Colorado. Investing months before the housing bub-
because stocks are still expensive by his- In college, Katsenelson took a part- ble popped and the credit market seized
torical standards. And when PE ratios time job at Investment Management up, but its premise has been surprisingly
slide, stock returns suffer because that Associates, building a database for the accurate as the S&P 500 has declined 17
decline cancels out any positive effect of firm. He then began executing trade percent from its Oct. 11 high (as of
earnings growth. orders and became fascinated with stocks. March 6).

FIGURE 1: A FALLING PE RATIO KILLS GROWTH
The book’s first section explains how including TheStreet.com,

stocks’ current dilemma resembles the MarketWatch.com, and
beginnings of the three previous secular, Minyanville.com.
or long-term, range-bound markets of the In mid-February, Katsenelson
past century, each of which lasted 13 to spoke with us about what’s in store
18 years. The remaining chapters define for U.S. stocks and the themes of his
the tenets of value investing, describe book.
how to customize it for range-bound
markets, and illustrate how valuation
tools such as discount cash flow (DCF) AT: Why do you think the U.S.
analysis can help you buy and sell stocks stock market is in a range-bound
profitably. market right now?
In the hands of a less-talented writer,
these topics might seem dry or tedious, VK: First, I’m referring to long-term,
but Katsenelson’s enthusiasm is infec- secular markets — more than five
tious, and his discussions are filled with years. The long-term cycle has many
colorful anecdotes and self-depreciating cyclical periods in it. The last one
humor. lasted 16 years (1966-1982) and
included five cyclical bull markets,
“ In previous five bear markets, and one range-
bound market.
Wal-Mart’s price hasn’t changed much
In my book, I distinguish between
range-bound since 1999 because two factors are
bear and range-bound markets, which working against each other — earn-
is a huge difference. Both start at high ings climbed 300 percent, but its PE
markets, high-PE valuations, but during long-term bear ratio declined from 44 to 16.
Source: http://contrarianedge.com
markets, economic growth remains
stocks significantly negative. It’s a good bet the U.S econ-
omy is resilient, and the market will AT: So PE ratios are too high?
underperformed recover from this cyclical decline. But if
you don’t think that’s true, then it’s a bear VK: Yes. The return from a stock is
low-PE stocks.” market. derived from two sources — price appre-
If I had to assign probabilities to the ciation and dividends. In the long run,
These days, Katsenelson works as a type of market we have ahead of us, I’d however, price appreciation can be
vice president and partner for the same say 2 percent (bull), 20 percent (bear), explained by earnings growth and PE
money-management firm where he start- and 78 percent (range-bound). contraction or expansion.
ed nearly 12 years ago. He also teaches For a secular bull market to develop, When the stock market moves, that
classes on practical equity analysis and you need average — not great — eco- movement can be explained by three fac-
portfolio management at the University of nomic growth, which is a misconception. tors — earnings, PE changes, or a combi-
Colorado at Denver’s Graduate School of Stocks’ PE ratios also need to expand, but nation of the two. At the end of bull mar-
Business. In addition, Katsenelson occa- PEs must expand from a low base. kets, stocks’ PE ratios are very high. If
sionally writes articles for the Financial you assume economic growth remains
Times, Barron’s, and several Web sites continued on p. 30

Active Trader Interview continued
constant, then investors are willing to pay AT: Is that what you meant when faster too.
more for the same growth. you wrote in Active Value Investing You can’t really compromise on
In 1999, for example, Wal-Mart that range-bound markets are brutally that one.
(WMT) traded at 44 times earnings. In toxic to high-PE stocks? Next, the balance sheet is extremely
the past eight or nine years, WMT hasn’t important, because you want a financially
gone anywhere, while earnings have strong company. The economy is either in
tripled at the same time. Two factors are
working against each other — earnings
“ Looking at numbers recession or on the brink, so in today’s
environment, accessing capital markets,
climbed 300 percent, but the PE ratio financing your debt, and borrowing
declined from 44 to 16. without thinking money becomes a privilege.
Wal-Mart didn’t go anywhere because
its PE contracted. Both forces worked is dangerous.”
against each other to create a range- AT: Has that really changed in the
bound market (see Figure 1, p. 29). past six months?
VK: Exactly. But if Microsoft (MSFT) was VK: Yes. During an economic expansion,
AT: Because earnings were rising founded in 1966, it still would have done companies consider access to capital mar-
and the PE ratio was dropping, price well, because it had an incredible growth kets as a birthright. If a company needs
didn’t go anywhere? rate that was sustained for 30 years. It money, they’ll get it. But during economic
wouldn’t have performed as well as it did, contractions, banks are more stringent
VK: Exactly. If you think Wal-Mart’s though. If you think you’ve found anoth- about lending.
earnings will grow at an average rate, er company like Microsoft, then buy it. These days, the ability to borrow
then you need to subtract PE contraction But realize that for every Microsoft, there money becomes an important competitive
from what WMT earns. Therefore, its are a lot of Ataris — companies that advantage in itself. If a company can’t
stock returns won’t be high. failed. borrow money, its value drops. And if you
In the book, I examined the 1966-82 can borrow money, you can probably buy
range-bound market and measured how that company for 20 cents on the dollar.
stocks with different PEs performed. I AT: In your book, you mention three
divided S&P 500 stocks into five quin- main criteria for a good stock in a
tiles, according to PE. Then I tracked per- range-bound market — quality, valua- AT: Am I correct in assuming the
formance of those stocks many times — tion, and growth. In this environ- problems in the short-term credit mar-
1966-82, 1968-82, and so on. ment, it’s tough to find stocks that kets — commercial paper — in
What happened if you bought high-PE meet all three components perfectly. August 2007 were a big deal? Short-
stocks and held them for different periods When should you compromise, and term debt really is essential to a com-
— 16 years, 14 years, 12 years, etc.? how can you find stocks that meet at pany’s survival, right?
High-PE stocks significantly underper- least two of your guidelines?
formed low-PE stocks. Even if a company VK: Absolutely. Companies that have
grew earnings at an above-average rate, its VK: The first element of a quality stock debt have to make an interest payment
PE ratio dropped at a much faster rate, is a sustainable competitive advantage, every month. But at some point, the debt
which killed the benefits from higher which acts as an electric fence around a matures, and they must refinance it.
growth. company’s cash flows. And if the compa- [Commercial paper] matures every 30
ny is growing at an above average rate, it days. In good times, refinancing was an
also guarantees those cash flows will grow automatic process, but not now.

When picking stocks, make sure the
company has a strong balance sheet and
“ I love to buy stocks (profits/sales) were above average and will
likely drop, reverting to their long-term
high free cash flow, so they can borrow average. Yesterday, I calculated which sec-
money in any environment. Or even bet-
that analysts hate.” tors have those vulnerable higher profit
ter — select stocks of companies without margins — energy, materials, industrials,
debt. I love companies with no debt and a promises. Make sure management isn’t technology, and financials. Therefore, if
lot of cash, because it’s tough to go bank- focusing only on short-term performance you own stocks in those sectors, try to
rupt. and making compromises to please Wall normalize their earnings.
Free cash flow is the cash remaining Street.
after a company has paid for its ongoing Management should have enough self-
expenses and future growth. Companies confidence to be honest and acknowledge AT: How do you normalize earnings?
can do great things with free cash flow — when they make mistakes. If you don’t
buy back stock, pay dividends, and buy admit mistakes, then you will probably VK: For example, I analyzed American
their competitors for pennies on the dol- ignore problems, which will only get Express (AXP) a couple of weeks ago,
lar, if the opportunity arises. However, worse. Warren Buffet is honest and admits which reported 2007 earnings per share
Microsoft spent billions of dollars invest- when he makes mistakes, which is why (EPS) of $3.38, adjusted for one-time
ing in companies in different industries people respect him so much. items. To normalize earnings, I noticed
such AT&T (T) in the 1980s and 1990s, a Look at how much stock management credit-card defaults were at an all-time
stupid move. owns. If they own a great deal of stock, low of 3.3 percent. Going forward,
Also, a company that generates a high their interests are aligned with yours. But defaults will increase as they revert
return on capital (ROC) has a couple of if they own a small portion of the compa- toward the mean. Instead of 3.3 percent, I
advantages. First, if it has had a high ROC ny, they could run it into the ground and used 5 percent, and earnings dropped to
for years, and you can project into the move on. $2.60 instead of $3.38.
future, then it probably has a sustainable Then, I used earnings of $2.60 to cal-
competitive advantage, which is great. culate AXP’s value. The point is to adjust
And a high return on capital means earn- AT: It seems there aren’t any short- those earnings for potentially lower profit
ings growth is cheaper, because the com- cuts. For instance, you shouldn’t pick margins.
pany isn’t capital intensive. Finally, it indi- stocks based on just one or two vari-
cates the company has high free cash ables, simply by screening for stocks
flow. All those numbers are interrelated. with low PE or price-to-book-value AT: In your book, you say investing is
ratios, right? often an ambiguous exercise. Will
you elaborate on that statement?
AT: Regarding the three dimensions VK: Yes. Looking at numbers without
of a good stock, quality seems to be thinking is dangerous. Some stocks trade VK: Let’s discuss discounted cash flow
the most important, but also the most at low PE ratios for the right reasons. If, analysis, which tries to estimate what a
subjective aspect, right? for example, you scanned for low PE company will earn in the future. Then,
stocks last year, a lot of home-building you choose a discount interest rate to
VK: Yes. It’s difficult to quantify every- and financial stocks would have convert future cash flows into today’s
thing. Especially management, which is appeared. But when home builders trade money. By definition, that’s what a com-
probably the most subjective component, at low PEs, they are expensive, because pany is worth — the core of all funda-
but it makes a huge difference. Listen to their earnings are at a cyclical high. mental analysis.
conference calls and be a skeptic. When I recently wrote an article for Barron’s But you make a lot of assumptions.
management speaks, they make certain arguing that companies’ profit margins continued on p. 32

Active Trader Interview continued
Let’s say I crunched the numbers FIGURE 2: A CONTRARIAN VIEW OF NOKIA prescription drugs. And their
for a result of $10.70, and that stocks declined over a two-month
stock trades at $10 today. The period.
problem is most analysts would If you examined the news, it
claim the company is $0.70 sounded horrible. And if you rely
undervalued, but I made so many on headlines to invest, that would
assumptions to derive that num- have forced you to sell either
ber, you can’t be that specific. stock.
Instead, the company is fairly val- However, you need to quantify
ued, because if I change the the impact of bad news. Most
assumptions slightly, I’ll get a dif- investors didn’t realize 95 percent
ferent value. of transactions at Walgreen’s were
A lot of fundamental-analysis paid by insurance companies.
tools act like a shotgun, not a Therefore, WMT’s plan didn’t
sniper rifle. When I value compa- affect CVS or WAG much, because
nies, I look for a general value, it only influenced customers who
and I have no delusions about a paid for drugs directly — five per-
company’s exact worth. Many cent. If you used common sense,
analysts try to calculate exact you would have realized investors
numbers, but that’s nearly impos- overreacted when they sold CVS
sible. Precise numbers can give and Walgreen’s.
investors a false sense of security. In 2004, Nokia looked cheap to Katsenelson Another example is Nokia
Try to understand what’s driv- who thought its loss of U.S. market share was (NOK). In 2003 and 2004, its
overblown. Its price tripled within three years.
ing the value in each company. stock was beaten down because it
Source: eSignal
You can calculate discounted cash was losing market share in the
flows in about five minutes. You U.S., which had been 15 percent
just need to find operating cash AT: Earlier, you mentioned the impor- of their sales. By 2004, the U.S.
flows, take out capital expenditures, and tance of being a skeptic when invest- dropped to just 7 or 8 percent of their
determine the right forecasting period. ing. How can that mindset help sales.
investors find good stocks? The key is to use your own assump-
tions to determine a company’s value with
AT: You don’t want to look too far VK: First, you need to distinguish discounted cash flow analysis. This tool is
out, right? between a good company and a good handy, because you can plug in lower
stock. A good company meets the quality assumptions for growth. Even if you
VK: You can with some companies. For and growth dimensions, while a good assumed Nokia would grow at a slower
example, American Express has such a stock appears when you can buy it at a rate, it was still worth more than its stock
strong brand name, which creates a perfect margin of safety (a certain percent- price of $12 in 2004.
strong competitive advantage. I feel com- age below its fair value, determined by DCF If you asked “what would happen to
fortable looking 10 years in the future — analysis). NOK’s sales if it lost U.S. market share
AXP will still be in business, making Investors often focus more on the com- completely — from 8 percent to zero?”
more money. But with companies such pany than its stock, which creates oppor- The answer was it had little impact on
as Blockbuster (BBI) or NetFlix (NFLX), tunities. Two years ago, CVS Caremark NOK’s value, because 92 percent of sales
who knows? (CVS) and Walgreen Co. (WAG) were came from the rest of the world.
beaten down because Wal-Mart And since 2004, Nokia has tripled
announced its plan to introduce generic (see Figure 2).

Suppose you know a company is worth stocks from which to choose.
AT: How should value investors $1 in the long run, and it trades at $0.70 Although I’m not predicting the mar-
adapt their approach for range- today. Many fund managers will dump ket, there is a very high probability the
bound markets — by buying stocks the stock, because they could lose their market’s long-term slope will flatten
below their fair values to increase jobs before the stock rose to $1. But if because of high PEs and profit margins.
their margin of safety? you can afford to hold the stock for a And if I’m wrong, the opportunity cost is
couple of years, you can often make low. If a full-blown bull market develops,
VK: Yes. They should also look for high money. my strategy should still perform as well as
dividend yields and stick to high-quality In the past, I ignored stock analysts’ — or better than — the overall market.
stocks. They also need to be more proac- reports, but I don’t now because I’m look- If a range-bound market appears, my
tive sellers. ing for those time-arbitrage opportunities. strategy should beat other ones, and if a
These reports have a short-term focus as bear market emerges, you still own high-
analysts try to predict what EPS numbers quality companies that grow earnings and
AT: When you calculate a stock’s fair may be reported next quarter. If an ana- pay dividends. And you bought them
value with discounted cash flow lyst doesn’t like a stock in the short run, with a high margin of safety. Therefore,
analysis, is that value your sell target? that’s great, because I have a longer time that strategy should still outperform the
horizon. I love to buy stocks that analysts market.
VK: That’s right. Over time, a stock’s fair hate.
value changes, depending on earnings
growth. For example, we bought AT: Your book mentions a couple of
Microsoft when it traded at $22 in June AT: You also mention your approach Web sites where investors can find
2006, and it went up to $28. And we isn’t about timing the market, but tim- ideas such as Joel Greenblat’s strategy
bought more shares recently, because ing individual stocks. What’s the dif- of ranking stocks by low PE ratios
even though price rose, earnings grew ference? and high return on shareholder equi-
more, so now Microsoft is cheaper than ty taken from his book The Little Book
when we bought it. VK: It’s very difficult to systematize the that Beats the Markets (magicformu-
market-timing process. When you time lainvesting.com). That seems like a
the market, you must identify the event quick way to find good stocks. Do
AT: One of the themes of Active as well as its timing. Also, you must you have any other suggestions?
Value Investing is that Wall Street has know the market will react to it.
a short-term outlook. Instead of blam- Let’s assume you predicted the sub- VK: Stockticker.com and gurufocus.com
ing mutual fund managers, you sug- prime mortgage crisis and its timing — are a good source of ideas. These Web
gest it’s just human nature to want the summer of 2007. That’s brilliant, but sites may point you in the right direction,
instant gratification. the market didn’t care [because the Dow but they’re no substitute for your own
still jumped 8.5 percent from mid-August research.
VK: It’s a cultural issue. Over the years, to mid-October 2007.] Timing the market For instance, many investors buy
marketing departments have taken over is so difficult because of human emotions. stocks that Warren Buffett has bought. If
the mutual fund business — it changed And there are so many factors that influ- you followed Warren Buffett blindly, you
from [value] investing to tracking the ence markets. would have done fine, except there’s a
hottest fund. However, you can create a system to delay in that information. So, Buffett
When mutual fund managers buy a time stocks. First, calculate a company’s might have sold [a stock] already, and you
stock, they need it to climb in the short- worth and the required margin of safety. think he still likes it.
term, because they have short-term incen- If you analyze enough stocks, it’s just a Also, when stocks drop, you really
tives. This situation creates opportunities matter of time until stocks hit your buy- must know why you own it to maintain a
that I call time arbitrage. ing price. And you have hundreds of rational state of mind.

Q& A
Ari Kiev
on trading stress
and leadership
Trading coach Ari Kiev’s two most recent books
target trading stress and the challenge of
building a successful hedge fund.
BY MARK ETZKORN
Y ou can’t accuse Dr. Ari Kiev

of resting on his laurels.
Having barely had time to
enjoy the release of his 2007 book,
Mastering Trading Stress: Strategies for
Maximizing Performance (Wiley Trading,
correlation with the mental challenge of
the markets.
“It seemed to me that people experi-
encing stress in the markets were experi-
encing some of the same symptoms as
people who had post-traumatic stress dis-
dealing with failure or striking out.
Also, when you’re right, you’re only
making money on a very small percent-
age of your trades — that is, the bulk of
your profitability comes from only 3 to 5
percent of your trades — so there’s stress
2007), the psychotherapist, former order,” he says. “This tended to impact in not being as successful as you might
Olympic advisor, and trading coach has the way they were trading: Their deci- like and in managing expectations.
just seen his sixth trading book, Hedge sions were less thoughtful, more impul- There’s stress in terms of dealing in a
Fund Leadership: How To Inspire Peak sive, and more fearful, and they were world of uncertainty, because you’re mak-
Performance from Traders and Money often paralyzed. ing predictions, taking bets, and handi-
Managers (Wiley Trading, 2008), hit “[This comparison was] a useful para- capping with insufficient information.
bookstore shelves. digm to explain what traders go through, You’re dealing with a situation in which
In a recent conversation, Kiev, who and to help them understand this and you’re not completely in control and you
was once a consultant to Steve Cohen’s find a way to work more objectively, have to learn to handle that.
SAC Capital Management, discussed the rather than overreacting to their own
impetus for writing Mastering Trading exaggerated interpretations of what was AT: In the book you talk about person-
Stress. going on in the market.” ality types. One that jumped out as
“I’ve always dealt a little bit with stress potentially being problematic in trading
in the various books I’ve written over the AT: In trading, doesn’t everything ulti- was the perfectionist personality.
years,” he says. “I decided I had enough mately revolve around stress and how AK: I think if you’re a perfectionist, [you
material about it, including particular to deal with it? Are there other stresses may be well suited] to being a good ana-
case examples showing how people dealt aside from the stress of potentially los- lyst: You’re never satisfied with the data
with it and how it impinged upon their ing money? you have, so you keep digging to get a
trading, that it would be worthwhile to AK: There is a range of stresses. Even more complete picture and as much
put together a complete book.” under ordinary circumstances there’s the understanding as you possibly can.
Kiev, who has dealt with stress man- fact that if you’re a really good trader But that desire to have all the informa-
agement and post-traumatic stress disor- you’re probably right only 55 to 60 per- tion is something you have to let go of if
der in other areas of his work, sees direct cent of the time, so there’s the stress of you’re going to be a portfolio manager,

“Successful traders have
learned to master their intense and competitive situation. They or you’ve made mistakes; you have to be
use it to improve their concentration, able to say, “This was the bet, and it did-
anxieties and use the tenacity, and intensity; they don’t let it n’t work, let’s cut the position and move
interfere too much. on and put our capital and effort into
They have a goal, a target: They know higher-conviction ideas where we’ve done
adrenaline response that what they need to do to produce certain more work and have a little bit more con-
results and they’re willing to do the nec- fidence in the outcome.”
occurs when in a highly essary work, but they’re not hung up on The natural inclination is to hold on to
what the result is. a loser and rationalize the loss — “Well, if
I like it at $20, I like it even more at $15,
intense situation to AT: But you also say there’s no “best” and even more at $10.”
personality for trading. You have to keep evaluating the quality
improve their focus and AK: I’ve been involved in selecting peo- of a trade idea and whether the reason
ple as portfolio managers and have done you got into the position is still valid and
tenacity; they don’t let it all kinds of psychological evaluations to justifies holding it even when it’s going
try to understand the range of personality against you.
characteristics that might make up the
interfere too much. ideal performer. AT: How do you draw the line
Successful traders have a range of per- between confidence and arrogance in
They know what they sonalities. The critical thing is they must trading?
be risk takers who are comfortable with AK: A confident person is someone who
uncertainty and have a certain degree of has knowledge about his strengths and
need to do to produce abstract reasoning ability. They have to weaknesses, has a replicable process that
enjoy trying to piece together the mosaic allows him to analyze and invest in a
certain results and of information needed to make a good profitable way, and is able to adjust as the
investment, and they need some degree data changes.
they’re willing to do the of caution, thoroughness, and coachabili- When he’s going through a drawdown,
ty. he’s comfortable paring down [his posi-
But not everyone has all these things tions], rather than starting to think cata-
necessary work, but and not everyone has the same mix of strophically — that things are desperate
them. You can learn to manage your and he has to swing for the fences. He
they’re not hung up on strengths and weaknesses, and you don’t recognizes there will be fluctuations and
necessarily need to have all the ingredi- “black-swan” events throughout the year,
ents to begin with. but he’s confident he’s survived them in
what the result is.” Some people who are very cautious the past and he’ll survive them again. As
become successful portfolio managers, a result, he doesn’t flail about when
which is a job in which you have to oper- and you also find big risk takers who things aren’t working. He prepares, he
ate with insufficient information. You learn how to balance their risk-taking does more work, he deploys less capital,
have to rely a little bit more on your intu- propensities with risk-management prin- and he waits for the markets to become
ition and ability to see patterns, trends, ciples that are consistent with good port- more rational before going back in with
and how things are [evolving]. folio management. larger positions.
That’s a stressful thing — it’s not like An arrogant person believes his press
being an accountant who’s adding up AT: Ultimately your conclusion is that clippings and is not humble enough to
numbers and having the luxury of you can’t completely eliminate stress, recognize the market is bigger than he is,
reviewing them over and over. correct? You can only learn to manage that it’s a sign of strength to admit when
The most successful traders and port- it? you’re wrong — to take your lumps and
folio managers have learned to master AK: You can’t eliminate it. You really get ready for recovery when conditions
their anxiety, and they utilize the adrena- want to learn how to ride with it, not to are better.
line response that occurs when they’re cover it up. You have to be able to admit Arrogance is sort of a protective over-
focused and concentrating in a highly you’re having difficulty, you’re uncertain, continued on p. 36

Q&A continued
confidence designed to cover up feelings some other kind of exercise, or by staying decisions and challenge points of view.
of vulnerability and inadequacy, whereas away from alcohol and late nights during These things take a certain amount of
confidence is a quiet understanding that the week in order to keep themselves work — it doesn’t happen automatically.
you’re ultimately going to prevail if you physically fit and mentally prepared to Good portfolio managers and traders who
follow your plan. deal with the high stress and intensity of start hedge funds often have very little
trading. experience managing other people. It
AT: What are some tactics traders can takes a certain amount of coaching, self-
use to defuse especially tense or stress- AT: Sounds like a “healthy body, awareness, and willingness to interact
ful situations? healthy mind” kind of thing. with people in a more meaningful way
AK: First, traders need to recognize AK: Absolutely. than you might have considered neces-
there are going to be stressful periods sary than when you were just running a
when they lose focus and trade from an AT: Can you talk a little bit about the portfolio.
emotional perspective rather than objec- topic in your other book on leadership
tively. qualities in traders? AT: Is there an analogy to the very suc-
The best thing to do is develop a regu- AK: In the course of teaching people cessful hitting coach in baseball who
lar routine — say, on a daily basis — of about managing stress, I came face to face wasn’t actually a great hitter himself?
meditation, relaxation, visualization, and with what the best hedge-fund and port- Are there people who aren’t necessarily
related techniques that help you become folio managers do that differentiates them the greatest individual traders but who
more centered. from those who aren’t so successful. have the ability to assemble the right
Yoga is a good example. I worked with Besides stress management techniques team and teach the right skills?
one guy who spent 45 minutes every and a “trading-to-win” philosophy, they AK: That’s an interesting question.
morning doing yoga and, in the course of have a goal and reverse engineer their The way it seems to work in most hedge
being in this relaxed meditative state, strategy to determine what kind of posi- funds is that the guy who sets it up has
visualized various scenarios and how he tions they need to take in terms of the already been successful at managing a
would handle trades depending on what deployment of capital, they have good portfolio, but if you interview a variety of
the circumstances were, what data came risk-management statistics so they’re able hedge-fund leaders, as I did for this
out, and what moves took place in the to evaluate how they’re doing based on book, you’ll find they come from diverse
market. their stats and can make adjustments backgrounds: portfolio managers, ana-
This allows him to review what he’s (whether they’re holding losers too long, lysts, bankers, asset gatherers.
going do in advance; he has a few scenar- getting out of winners too soon, or mak- Some people are better at managing
ios embedded in his thinking and he has ing money in the short-term, intermedi- people, others are better at creating an
developed the ability to get centered and ate term, or long-term), they identify the organization, and others are better at
relaxed in the face of stress. most successful patterns in their trading defining the process. There’s no one way
You don’t develop the ability to do this and begin to trade in a more success-ori- it has to be done. The commonality is
when you’re stressed, you need to learn to ented way. an awareness of the need to empower
do it [through regular practice] — you It’s a very labor-intensive process to be people.
develop the habit, so that during the successful, but the more you do these But people do this in varying degrees.
course of the day as you become tense, things, the [easier it is] to handle trading In some places the head guy is very colle-
flustered, or frustrated, you’re able to stress because you’ve taken out some of gial and makes partners out of people; in
chill out and take a few minutes to get the mystery from a game that has a lot of others it’s a more authoritarian situation.
back into that meditative state in which mystery to it. I think the one generalization would
time slows, your heart rate and breathing Now, leadership comes into selecting be that, just as I discovered traders trade
slow, you’re calmer and able to see the people to be on your team, guiding them, very differently, to be successful [as a
data more clearly, and you’re less likely to sharing your vision and getting people to hedge fund manager] you have to figure
overreact impulsively, which often gets buy into it, and aligning incentives so out what process works for you, develop
you into trouble. people stay with you more than a couple a methodology and strategy around
Preparation and experience in getting of years. [The team] really becomes your strengths, and then recognize when
relaxed are very useful. Now, some peo- invested because they feel appreciated, you need additional assets or qualities
ple get to this state of mind by jogging or and empowered, and they’re able to make from other people, who you then

Related reading
Previous Ari Kiev articles and interviews:
“ Entering the trading zone: Q&A with Ari Kiev””
Active Trader, June 2000.
Given his past career as a consultant to Olympic athletes, it’s not surprising that
psychiatrist and trading coach Dr. Ari Kiev draws frequent parallels between
bring into the team.
success on the athletic field and success in the market.
Self-awareness is critical. You have
to be able recognize what’s needed to
“ Q&A: Psyching out risk with Ari Kiev””
win, but not be so arrogant to think
Active Trader, January 2003.
you’re the only one who can do it. You
In challenging market environments, even seasoned traders can find them-
have to be willing to admit when other selves breaking rules and taking unnecessary risks. Dr. Ari Kiev discusses how
people can do certain things better than to make the best of bad times.
you, and empower them to take on those
functions. “ Managing losses,,” by Ari Kiev
Now, that’s just managing a portfolio. Active Trader, March 2001.
Managing a hedge fund adds other dimen- How a trader manages losses is a key to trading success.
sions: It’s managing more people, more
money, investors, a back office — it’s man- “ Mind over money management,,” by Ari Kiev
aging a company, and you have to make a Active Trader, June 2001.
decision whether to trade and also man- The risk door swings both ways: Taking too much risk or not taking enough
age, or get someone else to manage. can sabotage your trading. Learn how to improve your understanding of risk
Different people have different models. and trade according to the prevailing market conditions.
You have to be willing to face your
strengths and weaknesses, be open, and “ Psychological roadblocks to successful risk management,,” by Ari Kiev
trust and empower people to get the Active Trader, April 2001.
most out of them. You have to recognize How you handle risk goes a long way in determining whether you’ll be a prof-
the subtleties regarding what makes for itable trader. Overcoming stress and emotions and having a specific plan are
top-notch performance and what moti- crucial to trading success.
vates people.
“ The psychology of handling risk,,” by Ari Kiev
Everybody has something to con-
Active Trader, January-February 2001.
tribute. The key is to figure out what
Effective trading requires the ability to separate emotions from actions.
someone can contribute naturally. What
Learning how to analyze your reactions to your trades can help you better
is it they do instinctively and can be
respond to the realities of a situation instead of responding to your
helped to improve upon, rather than try- interpretations.
ing to get them to change, which only
leads to frustration? Note: These articles (except “Q&A: Psyching out risk with Ari Kiev”) are also part of the
There are really a lot of parallels with “Trading Psychology Collection,” a discounted set of articles in a single PDF file.
the work I’ve done for years in psy-
chotherapy in trying to help people get a Ari Kiev books:
better handle on themselves to make a • Hedge Fund Leadership: How To Inspire Peak Performance from Traders
difference in their own lives — to have a and Money Managers (Wiley Trading, 2008).
goal, a step-by-step plan, to be able to • Mastering Trading Stress: Strategies for Maximizing Performance
tap into their own inner potential so they (Wiley Trading, 2007).
are self actualized in a greater way than • Hedge Fund Masters: How Top Hedge Fund Traders Set Goals,
they might be otherwise be. Overcome Barriers, and Achieve Peak Performance (Wiley Trading, 2005).
I think all of this is what you find in • The Psychology of Risk: Mastering Market Uncertainty
what you might call “transformative” by Ari Kiev and Ken Grant (John Wiley, 2002).
leadership, or “authentic” leadership, • Trading in the Zone: Maximizing Performance with Focus and Discipline
where the leader is functioning in terms (John Wiley, 2001).
of what works best for him while recog- • Trading to Win: The Psychology of Mastering the Markets
nizing that other people aren’t necessarily (John Wiley, 1998).
going to be like him. They’re going to
bring something else to the table, and
that’s the beauty of it all.

Trading setup
The Face of TRADING
Hardware: PC with dual 2.0-GHZ
processors and 3.25 GB RAM; 22-
inch flat-panel monitor.
Brushing up profits Software: TradeStation.
BY ACTIVE TRADER STAFF Internet connection: Cable.
Brokerage: On-line direct access,

Ameritrade, TradeStation.
Name: Steve Reeves

Age: 56 through charts and putting orders in,” he monitors daily charts to make trading
Lives and works in: says. decisions and notes that some pullbacks
Seattle, Wash. One of the biggest drawbacks is the tend to last three to five days, while others
time trading consumes each day. last seven to 10 days. Reeves tries to buy
“It soaks up too much time,” he says. “I the first pullback after a lower low, after it
can spend a whole day watching, but it is looks like a bottom has been made. In
I
n 1980 a childhood friend gave Steve better not to make decisions during the addition to the price pullback, he may act
Reeves a copy of Joe Granville’s day.” on a signal from the Bollinger Band — for
Granville Market Letter. Reeves remembers the early days when example, when price hits the bottom band.
he created charts by hand and had to wait With Raschke’s 3-10-16 oscillator method,
“I became interested in his on-balance for the newspaper to get stock prices. Reeves says a buy trigger occurs in an
volume (OBV) work and started following “You had to wait till the next morning uptrend when the slow line is moving up
his stuff,” Reeves says. to find out how things were doing,” he and the fast line is moving down.
Reeves was starting his dentistry career, says. “I’m looking to buy if it’s a shallow pull-
but he began trading stock options on the But in some ways, Reeves prefers the back,” he says.
side. He charted stock prices by hand, old days. Reeves will place a stop at the last swing
including tools such as the “Real-time feeds have made it hard,” he low on the daily chart.. On the upside,
advance/decline line, and found he really says. “It’s really emotional; it gets you Reeves doesn’t use set objectives, but
enjoyed the analysis. Trading has been a because you can see all the squiggles.” prefers to monitor positions as they devel-
good accompaniment to dentistry for him. “I guess I’m a little addicted to it,” he op.
“They are really separate brain func- adds. “I try to go on vacation and not do “I try to take off half my position when
tions,” Reeves says. “One is pretty mechan- anything. But it’s hard. You can even get I have a decent gain, after three or four up
ical, while the other is all thinking and information on your phone.” days,” he says. “I’ll take half off and move
much more emotional.” my stop up to a two-bar daily close.”
Through the years, Reeves has contin- Outside of trading: Reeves has been
ued to pursue trading on the side, trying a practicing dentist for nearly 30 years. Most important lesson learned:
different methodologies and strategies. “You have to follow your own parameters
“It has been very humbling,” he says. Trading methodology: Reeves has and your own risk levels. Everyone is dif-
He attended workshops by trader Linda settled on a swing trading method, incor- ferent. You have to make your own deci-
Bradford Raschke during the 1990s, which porating elements he learned from sions.”
he found to be helpful. He has also tried Raschke’s trading seminars. He puts on
mechanical system trading. about 10 stock trades per week, focusing Best thing about trading: “Being
“System trading is not really for me,” on a small group he has followed for years, right [and the satisfaction of knowing] I
Reeves says. “Over time [a system might] plus some exchange-traded funds (ETFs). followed my rules and my discipline.”
test out, but I just don’t like taking big He usually holds positions for about four
drawdowns. I think some systems are to six days. He is a 100-percent technical When not trading: Reeves works at
good, but you have to sit through the bad trader and monitors several indicators, his dental practice and enjoys photogra-
times, and it is hard for me to sit and including Linda Raschke’s 3-10-16 oscilla- phy, hiking, skiing, and golfing.
watch a stock go down. I have a low risk tor, volume, Bollinger bands, and the two-
tolerance for large losses — I like to sleep day rate-of-change. Best trading books/Web sites:
at night.” His trading philosophy is to trade with Street Smarts by Linda Raschke and Larry
Ultimately, Reeves found a method the trend, buying on pullbacks. He places Connors and Dow Theory Letters published
within his comfort zone. He may check orders at night and tends to focus on long by Richard Russell.
the markets in between patients, but he trades; if he wants to put on a short trade,
tries not to make decisions during the day. he typically uses ETFs, such as the For definitions of the indicators referenced in
“I try to spend an hour after work going Ultrashort S&P 500 Proshares. Reeves this article, see “Key concepts” on p. 62.

ETF Snapshot
Date: March 6
The following table summarizes the trading activity in the most actively traded exchange-traded funds. The information does NOT constitute trade
signals. It is intended only to provide a brief synopsis of each market’s liquidity, direction, and levels of momentum and volatility. See the legend for
explanations of the different fields.
1-year RS 10-day 20-day 60-day Volatility
Market Symbol Sector Volume rank move/rank move/rank move/rank ratio/rank
Positive one-year performance
UltraShort Financials*** SKF Leveraged inverse index 6.55 M 81.14% 20.10% / 93% 24.43% / 84% 50.01% / 95% .78 / 97%
Brazil EWZ Regional 16.31 M 76.78% -0.77% / 100% 12.41% / 56% -3.74% / 26% .44 / 60%
United States Oil Fund USO Energy 4.08 M 67.41% 8.48% / 72% 21.54% / 100% 20.83% / 67% .46 / 87%
Gold GLD Metals 10.83 M 50.65% 3.80% / 36% 8.81% / 67% 23.14% / 94% .26 / 53%
Gold GDX Metals 4.83 M 44.04% 7.86% / 42% 16.80% / 94% 18.06% / 73% .53 / 57%
FTSE/Xinhua China 25 Index FXI Index 7.51 M 38.93% -4.92% / 73% -1.55% / 11% -27.93% / 85% .22 / 52%
Energy XLE Energy 23.44 M 32.72% 2.42% / 33% 12.35% / 91% -0.43% / 0% .36 / 12%
Oil Services OIH Energy 7.91 M 31.62% 3.00% / 13% 13.50% / 97% -2.99% / 29% .29 / 0%
UltraShort Russell 2000*** TWM Leveraged inverse index 8.82 M 30.42% 9.85% / 100% 8.88% / 34% 35.25% / 92% .49 / 45%
Emerging Markets EEM Emerging Markets 23.13 M 20.36% -3.10% / 100% 3.60% / 32% -15.47% / 83% .40 / 78%
Malaysia EWM Regional 4.57 M 18.61% -6.77% / 82% -7.35% / 100% -7.70% / 95% .72 / 92%
Taiwan EWT Regional 11.78 M 16.08% 7.04% / 41% 18.78% / 94% -1.92% / 19% .21 / 15%
Hong Kong EWH Regional 8.14 M 12.50% -3.15% / 41% -4.04% / 28% -21.60% / 95% .26 / 43%
UltraShort S&P 500*** SDS Leveraged inverse index 25.19 M 11.96% 5.98% / 91% 3.31% / 19% 29.68% / 97% .44 / 43%
Materials XLB Materials 13.94 M 10.75% 0.95% / 11% 6.36% / 56% -3.95% / 55% .42 / 23%
Mexico EWW Regional 4.36 M 9.46% -2.97% / 67% 1.92% / 26% -10.11% / 73% .48 / 55%
Consumer Staples XLP Consumer 3.27 M 5.06% -0.37% / 0% 1.42% / 26% -7.67% / 100% .32 / 28%
Industrial XLI Industrial 6.80 M 3.70% -1.77% / 67% -0.82% / 16% -10.35% / 83% .30 / 30%
UltraShort Dow 30*** DXD Leveraged inverse index 5.64 M 0.17% 4.37% / 92% 2.22% / 11% 24.38% / 97% .45 / 45%
Negative one-year performance

S&P Home Building Index XHB Index 9.19 M -46.35% -6.95% / 70% -8.63% / 52% -8.94% / 10% .68 / 90%
Financial XLF Financial 122.86 M -32.17% -8.83% / 88% -11.20% / 80% -22.21% / 96% .44 / 90%
Dow Jones U.S. Real Estate IYR Real Estate 9.93 M -30.96% -4.24% / 79% -6.38% / 53% -16.92% / 84% .35 / 53%
Retail XRT Retail 5.59 M -26.54% -6.37% / 100% -4.53% / 43% -15.68% / 84% .43 / 80%
Ultra S&P 500** SSO Leveraged index 7.79 M -22.17% -5.73% / 92% -3.49% / 10% -28.99% / 98% .25 / 38%
Russell 2000 Value Index IWN Index 3.10 M -21.41% -5.33% / 100% -5.14% / 43% -14.23% / 88% .42 / 58%
Consumer Discretionary XLY Consumer 6.47 M -18.32% -3.43% / 100% -2.25% / 17% -12.75% / 83% .40 / 82%
Semiconductor SMH Technology 11.14 M -17.83% -1.28% / 29% 1.94% / 50% -14.90% / 72% .18 / 40%
Japan EWJ Regional 25.97 M -17.02% -1.38% / 27% -0.08% / 0% -14.46% / 99% .32 / 37%
Ultra Nasdaq 100** QLD Leveraged index 11.19 M -17.01% -6.82% / 86% -3.84% / 20% -39.98% / 98% .12 / 23%
Russell 2000 Index IWM Index 89.10 M -15.36% -4.68% / 100% -4.13% / 45% -15.70% / 94% .36 / 45%
Retail RTH Retail 9.01 M -11.96% -3.08% / 60% -2.42% / 36% -11.10% / 92% .59 / 80%
Russell 2000 Growth Index IWO Index 3.45 M -9.30% -4.72% / 100% -3.96% / 35% -16.88% / 99% .31 / 42%
S&P Midcap 400 Index MDY Index 4.68 M -8.02% -3.65% / 100% -2.25% / 38% -13.24% / 93% .41 / 38%
S&P 500 Index SPY Index 224.58 M -6.90% -2.77% / 91% -1.50% / 14% -13.15% / 97% .33 / 38%
EAFE* EFA Index 13.30 M -4.79% -0.34% / 0% 1.66% / 25% -15.58% / 87% .23 / 20%
Technology XLK Technology 3.86 M -4.26% -2.18% / 43% -1.39% / 14% -18.14% / 93% .15 / 20%
Health Care XLV Health Care 3.32 M -3.46% -3.57% / 100% -4.01% / 56% -12.63% / 100% .41 / 53%
Nasdaq 100 QQQQ Index 163.03 M -1.88% -3.10% / 85% -1.49% / 26% -19.42% / 100% .18 / 20%
Dow Jones Industrial Average DIA Index 15.37 M -1.78% -1.95% / 92% -1.19% / 8% -11.43% / 96% .35 / 42%
Russell 1000 Growth Index IWF Index 3.86 M -1.56% -2.04% / 91% -0.11% / 0% -12.99% / 96% .29 / 23%
Singapore EWS Regional 4.54 M -0.67% -3.96% / 56% 1.28% / 29% -19.31% / 86% .30 / 70%
UltraShort Nasdaq 100*** QID Leveraged inverse index 36.31 M -0.41% 7.33% / 92% 2.95% / 17% 49.93% / 100% .25 / 30%
Utilities XLU Utilities 6.13 M -0.29% -2.07% / 40% -4.00% / 39% -14.12% / 100% .39 / 60%
* Europe, Australasia, and the Far East ** Tracks twice the move of this index. *** Tracks twice the inverse, or opposite, of this index.
Legend 60-day move: The percentage price move one-hundred-twenty 60-day moves. A reading
Vol: 30-day average daily volume, in thou- from the close 60 days ago to today’s close. of 100 percent means the current reading is
sands (unless otherwise indicated). The “Rank” fields for each time window (10-day larger than all the past readings, while a reading
OI: Open interest, in thousands (unless oth- moves, 20-day moves, etc.) show the percentile of 0 percent means the current reading is small-
erwise indicated). rank of the most recent move to a certain num- er than all previous readings. These figures pro-
ber of the previous moves of the same size and vide perspective for determining how relatively
1-year RS rank: The percentage price move large or small the most recent price move is com-
in the same direction. For example, the “Rank”
from the close one year ago (250 trading days) pared to past price moves.
to today’s close. for 10-day move shows how the most recent
10-day move compares to the past twenty 10- Volatility ratio/rank: The ratio is the short-
10-day move: The percentage price move day moves; for the 20-day move, the “Rank” term volatility (10-day standard deviation of
from the close 10 days ago to today’s close. field shows how the most recent 20-day move prices) divided by the long-term volatility (100-
20-day move: The percentage price move compares to the past sixty 20-day moves; for the day standard deviation of prices). The rank is
from the close 20 days ago to today’s close. 60-day move, the “Rank” field shows how the the percentile rank of the volatility ratio over
most recent 60-day move compares to the past the past 60 days.

STOCKS & FUTURES Snapshot
The following tables summarize the trading activity in the most actively traded stocks and futures contracts. The information does NOT consti-
tute trade signals. It is intended only to provide a brief synopsis of each market’s liquidity, direction, and levels of momentum and volatility.
Volume figures are for the most-active contract month in a particular market and may not reflect total volume for all contract months.
For a more extensive futures snapshot, see Futures & Options Trader magazine (www.futuresandoptionstrader.com).
Note: Average volume and open-interest data includes both pit and side-by-side electronic contracts (where applicable).
Price activity for CME futures is based on pit-traded contracts, while price activity for CBOT futures is based on the highest-volume contract (pit or electronic).
Stocks snapshot as of March 6

1-year 10-day 20-day 60-day Volatility
Positive one-year performance Symbol Volume RS rank move/rank move/rank move/rank ratio/rank
Apple Inc. AAPL 47.21 M 37.47% -0.50% / 12% -0.88% / 0% -37.76% / 100% .12 / 2%
Exxon Mobil XOM 25.57 M 18.83% -2.77% / 89% 3.77% / 27% -7.64% / 87% .44 / 48%
Oracle ORCL 45.01 M 15.63% 1.80% / 100% -2.29% / 6% -9.04% / 89% .22 / 18%
EMC Corp. EMC 42.37 M 15.40% -2.33% / 50% -2.46% / 15% -22.97% / 65% .10 / 28%
Applied Materials Inc. AMAT 27.60 M 9.82% 4.41% / 33% 15.16% / 97% 10.06% / 97% .43 / 82%
Intel Corp. INTC 77.60 M 4.03% -2.12% / 54% -0.25% / 0% -28.34% / 96% .11 / 8%
Negative one-year performance

Washington Mutual WM 38.28 M -72.01% -29.67% / 100% -31.31% / 92% -38.20% / 54% .35 / 100%
Citigroup C 98.36 M -57.94% -15.49% / 100% -21.36% / 96% -38.30% / 90% .25 / 95%
Wachovia Corp. WB 29.20 M -50.65% -17.81% / 100% -20.41% / 91% -36.52% / 100% .52 / 100%
American International Group Inc. AIG 26.24 M -37.92% -9.90% / 60% -17.70% / 91% -30.22% / 100% .54 / 90%
Bank of America BAC 47.20 M -28.32% -13.48% / 100% -13.73% / 94% -19.51% / 82% .70 / 100%
Comcast Corp. CMCSA 24.23 M -24.54% 0.61% / 0% 12.50% / 55% 7.82% / 78% .12 / 18%
JP Morgan Chase JPM 36.64 M -23.45% -13.23% / 100% -14.52% / 89% -18.90% / 100% 1.08 / 92%
Wells Fargo WFC 36.11 M -19.33% -9.47% / 83% -7.48% / 44% -12.24% / 52% .64 / 90%
Pfizer PFE 40.51 M -15.03% -3.62% / 82% -4.43% / 78% -11.52% / 100% .50 / 58%
Dell Inc. DELL 31.35 M -13.37% 0.83% / 27% 1.89% / 71% -22.50% / 63% .13 / 27%
Cisco CSCO 77.87 M -8.21% 3.23% / 50% 3.73% / 71% -12.79% / 34% .12 / 12%
General Electric GE 43.68 M -4.25% -2.46% / 65% -3.92% / 55% -11.74% / 67% .17 / 20%
AT&T Inc. T 34.08 M -4.19% 1.60% / 20% -3.79% / 30% -8.97% / 85% .15 / 0%
Yahoo! YHOO 59.13 M -1.44% 0.99% / 0% 0.46% / 0% 11.98% / 52% .10 / 3%
Futures snapshot as of March 6

Pit 10-day 20-day 60-day Volatility
Market E-symbol symbol Exchange Volume OI move/rank move/rank move/rank ratio/rank
E-Mini S&P 500 ES CME 2.20 M 2.32 M -2.90% / 92% -1.65% / 14% -13.22% / 97% .33 / 38%
10-yr. T-note ZN TY CBOT 1.49 M 2.18 M 0.08% / 11% 0.06% / 11% 3.68% / 55% .34 / 67%
5-yr. T-note ZF FV CBOT 786.7 1.63 M 1.02% / 77% 1.03% / 44% 4.64% / 89% .38 / 83%
30-yr. T-bond ZB US CBOT 516.5 940.8 -0.76% / 20% -0.92% / 28% 1.70% / 6% .51 / 87%
E-Mini Nasdaq 100 NQ CME 440.0 398.5 -3.48% / 86% -1.94% / 20% -19.59% / 100% .17 / 22%
2-yr. T-note ZT TU CBOT 350.2 1.07 M 0.84% / 79% 0.86% / 43% 2.83% / 95% .30 / 82%
Crude oil CL NYMEX 280.2 309.9 7.37% / 67% 19.70% / 97% 20.04% / 74% .50 / 85%
E-Mini Russell 2000 ER CME 258.5 646.2 -5.07% / 100% -6.24% / 61% -16.66% / 98% .36 / 50%
Mini Dow YM CBOT 191.9 92.7 -2.04% / 92% -1.35% / 14% -11.58% / 97% .36 / 45%
Eurocurrency 6E EC CME 165.6 196.5 3.73% / 67% 6.34% / 100% 4.31% / 59% .77 / 92%
Corn ZC C CBOT 129.1 311.4 6.22% / 72% 11.09% / 50% 39.46% / 96% .20 / 42%
Gold 100 oz. GC NYMEX 127.4 284.5 2.94% / 29% 7.37% / 60% 20.11% / 87% .24 / 52%
Soybeans ZS S CBOT 85.1 130.7 2.66% / 0% 9.45% / 53% 28.89% / 78% .24 / 50%
Natural gas NG NYMEX 69.4 122.4 9.57% / 70% 20.24% / 96% 38.54% / 95% .32 / 57%
Wheat ZW W CBOT 45.1 90.2 8.22% / 50% 7.84% / 28% 23.31% / 53% .61 / 80%
E-Mini S&P MidCap 400 ME CME 27.0 107.7 -3.68% / 100% -3.61% / 38% -14.12% / 96% .42 / 43%
This information is for educational purposes only. Active Trader provides this data in good faith, but it cannot guarantee its accuracy or timeliness. Active
Trader assumes no responsibility for the use of this information. Active Trader does not recommend buying or selling any market, nor does it solicit orders
to buy or sell any market. There is a high level of risk in trading, especially for traders who use leverage. The reader assumes all responsibility for his or
her actions in the market.

INSIDE the Market
BY JEFF PONCZAK
In this section…
Privacy amendment proposed 43
DOJ critiques futures

44
Rogue trader shredded
clearing structure
Quick Scalps 44
in wheat market Managed money
Coffee heating up
45
46
Rogue trader costs firm $141.5 M with Debate over investor arbitration 47
unauthorized trades in wheat futures.
SEC proposes new ETF rules 48
BY CHRIS PETERS Stock firms 48
Gold: $1,000 — then what? 49
Global news 51
M
F Global Ltd. (MF), a than 8 percent to 1,214.50 (Figure 1). trades, except that he held positions in
futures and derivatives Representatives for MF global wouldn’t several contract months. Although the
brokerage firm that comment on the exact nature of Dooley’s total number of contracts was excessive,
accounts for a large
FIGURE 1: WILD WHEAT
portion of CME trade volume, lost $141.5
million on Feb. 27 after liquidating more
than 15,000 wheat contracts. MF Global
trader Evan “Brent” Dooley had taken the
positions in overnight trading before the
regular trading session opened on
Wednesday, Feb. 27.
Wheat futures had been experiencing
record volume and price moves prior to
the debacle. Wheat had increased 76.6
percent in 2007 to $8.85 per bushel, and
another 35.5 percent between Jan. 2 and
Feb. 26, 2008. Prices consistently hit
their daily limits for two weeks in early
February, prompting the Commodity
Futures Trading Commission (CFTC) to
approve an increase in daily price limits
from 30 cents to 60 cents and the dou-
bling of speculator margin calls. The day Wheat futures declined in pre-market trading when Dooley was rumored to
before Dooley’s trades would cost MF have shorted thousands of contracts, but the market shot higher in the
Global nearly 6 percent of their total regular session as MF Global extricated itself from the positions.
assets, May wheat (WK08) jumped more Source: TradeStation

FIGURE 2: ROGUED
the number in each contract revenue growth of 29 percent

may not have been large enough year-over-year and futures and
to trigger speculative position options volume growth of 47
limits. percent. After the event, the
MF Global CEO Kevin Davis CME group released a statement:
stated in a conference call the “MF Global has met and contin-
following day that under normal ues to meet its obligations to
conditions the retail trader limit CME Clearing and remains in
controls used by the firm would good standing as a clearing
have prevented such actions by member of the exchange.” The
a single trader, but these con- IntercontinentalExchange
trols were turned off for internal released a similar statement.
trades because of their effect on Despite the reassurance, MF
execution speed. Later state- Global stock (MF) fell 40 per-
ments made by the firm attrib- cent in the two days following
uted the mishap to “system fail- the incident (Figure 2), and on
ure.” In an interview with the Feb. 29 Credit Suisse, UBS, and
Wall Street Journal shortly after Lehman Brothers all downgrad-
MF Global’s stock plummeted almost 30 percent
the incident, Dooley himself ed the stock. On the same day,
after unraveling the trades, the largest single day
said, “the computer system loss in the stock’s history. MF Global announced six of the
failed on a lot of things.” Source: eSignal company’s executive officers and
The evidence suggests Dooley board members purchased $3
shorted wheat, placing orders The evidence suggests million worth of MF Global
from home using MF Global’s retail order stock in a move to reassure shareholders.
entry system before pit trading opened in In a letter to clients on March 2, MF
Dooley shorted wheat,
the hope prices had peaked. The market Global reiterated client funds were unaf-
opened nearly 10 percent lower than the fected by the loss and that the company
previous day’s close, but quickly shot up
placing orders from had made the “necessary adjustments” to
nearly 20 percent in the next few hours. their systems to prevent any further unau-
MF global became aware of the posi- home using MF Global’s thorized trading. Since then, they have
tion, which greatly exceeded Dooley’s hired two consulting firms: FTI
own account balance, and immediately retail order entry system Consulting to review their retail order
began liquidating the positions, incurring entry systems, and Promontory Financial
the $141.5 million loss. Dooley, who before pit trading Group to assess their overall risk environ-
according to the National Futures ment.
Association’s Web site had been registered opened in the hope A federal investigation by the U.S.
with the firm for more than two years, Attorney’s Office in Chicago has since
was immediately fired. prices had peaked. been launched to look into the nature of
MF Global’s fiscal third quarter report Dooley’s trades. At press time, there was
released on Feb. 1 had highlighted net continued on p. 43

Inside the Market continued
Rogues gallery
Losing $141 million isn’t something anyone in any old job can do — it takes a trader.
no indication of legal action against
Nonetheless, a hit of this size is rather unremarkable in the pantheon of rogue trader
Dooley. MF Global has stated they incidents in the modern era. Here’s how Evan Dooley stacks up against some of the
are not the focus of the current fed- other loose cannons of the past two decades.
eral investigation.
According to a CFTC press Year Trader Loss Market Institution
release on Dec. 26, 2007, the CFTC 2008 Evan Dooley $141 mil. Wheat futures MF Global
2008 Jerome Kerviel $7 bil. Stock index futures Société Générale
settled previous actions against MF
2004 Luke Duffy AU$360 mil. FX options National Australia Bank
Global for violations arising out of
2002 John Rusnak £350 mil FX options Allied Irish Banks
“their mishandling of hedge fund 1996 Yasuo Hamanaka $2.6 bil. Copper Sumitomo Corporation
accounts.” The settlement required 1995 Nick Leeson $1.6 bil. Nikkei futures Barings Bank
MF Global and one of their associ- 1995 Toshihide Iguchi £557 mil. U.S. T-bonds Resona Holdings
ates to pay more than $77 million 1992 Anthony Catalfo, $6 mil T-bond futures/ Lee B. Stern,
Donald Zimmerman options Goldenberg Hehmeyer
in fines and restitution. Among
other things, the document stated The list contains only individuals who were taking unauthorized or illegal positions
MF Global “failed to have sufficient — hence the absence of multi-billion-dollar blowups resulting from institutionally
internal controls, policies, and pro- sanctioned trading, such as Amaranth (2006), the venerable Long-Term Capital
cedures concerning external com- Management (1994), and Metallgesellschaft (1994).
munications with third parties and The 1992 entries, Anthony Catalfo and Donald Zimmerman, made the list because
of the audacity of their ploy and the fact that it brought down one of the unfortu-
changes to Internet access of
nate clearing firms (Lee B. Stern) through which they were doing business. With virtu-
account information. MFG also ally no money they essentially bluffed their way onto seats at the Chicago Board of
failed to institute sufficient internal Trade and (almost) executed their one-day-and-go-away plan of triggering a panic in
controls, policies, and procedures to the T-bond market by shorting massive quantities of bond futures and simultaneously
detect and deter possible wrongdo- buying boatloads of bond puts on an employment report day. The market actually
ing.” Dooley could not be reached went their way for a while before the ploy was discovered and their positions were
liquidated.
for further comment.
SEC proposes customer privacy safeguards
W ith identity theft such a high-profile problem in

the online economy — and the trading industry
being such a high-profile part of that economy
— the Securities and Exchange Commission (SEC) has pro-
posed changes to existing industry practices designed to
would continue to protect information while providing an
orderly mechanism for departing representatives to take
limited customer information to their new firms. This
should help give firms flexibility while facilitating the trans-
fer of accounts, promoting investor choice, and providing
protect investor information. firms with legal certainty.”
In March the SEC voted unanimously to propose According to the press release, the proposed amend-
amendments to Regulation S-P, which outlines privacy ments would provide more specific requirements for safe-
obligations for SEC-regulated businesses. guarding information and responding to information secu-
In the SEC’s statement Erik Sirri, Director of the SEC’s rity breaches, and would update Regulation S-P’s safe-
Division of Trading & Markets, said, “Today’s proposal guarding and disposal provisions.
should help guard against growing problems such as The comment period for the proposal will end 60 days
identity theft and intrusions into online brokerage from the date of publication of the proposed rule in the
accounts. It also includes a pragmatic exception that Federal Register.

DOJ takes stand on clearing
BY JIM KHAROUF
A
Department of Justice (DOJ) for multiple exchanges and treat identical CME spirals
comment letter roiled contracts as fungible. Futures exchanges CME Group’s stock plummeted on the
exchange stocks and raised would, in turn, compete in terms of price, news, falling $103.55 or 17.5 percent
industry fervor in February quality of execution systems and the Feb. 6 to $485.25, a day after the stock
when it advocated radical changes to the speed and completeness of information slipped 3.2 percent when the comment
clearing structure for U.S. futures available to market participants.” continued on p. 45
exchanges.
The DOJ called for an end to
“exchange control of financial futures
clearing” and an examination of a single
clearing house for the futures industry,
similar to those found in U.S. securities
Quick Scalps
for stocks and options trades. Meet the Nasdaq OMX Group
The 22-page letter, written in response The Nasdaq Stock Market completed its combination with OMX AB (a former
to the Department of Treasury’s request Nordic financial exchange operator), creating the Nasdaq OMX Group, “the
for comment on the regulatory structure world’s largest exchange company” according to the Feb. 27 announcement.
of U.S. financial markets, pointedly states As part of the transaction, Nasdaq OMX Group also became a 33 1/3-percent
that the current clearing house structures shareholder in DIFX, Dubai’s international financial Exchange (Borse Dubai is a
run by futures exchanges impede compe- 19.9-percent shareholder of Nasdaq OMX Group). OMX Nordic Exchange,
tition and recommended that the U.S. while no longer a legal entity, represents the common offering from Nasdaq
Treasury review the clearing system in OMX exchanges in Helsinki, Copenhagen, Stockholm, Iceland, Tallinn, Riga,
place today. and Vilnius.
The letter, written by the same DOJ
staffers who approved the CME Group’s ICE, OCC cross margin Russell contracts
acquisition of Chicago Board of Trade IntercontinentalExchange (ICE) announced in March it received regulatory
(CBOT) last July, said “the department approval from the Commodity Futures Trading Commission (CFTC) for cross-
believes that the control exercised by margining Russell Index futures and options contracts. The ICE’s most actively
futures exchanges over clearing services traded Russell-based instrument is its Russell 2000 futures contract.
… has made it difficult for exchanges to The approval will allow the ICE’s clearing arm to cross-margin positions with
enter and compete in the trading of finan- the Options Clearing Corporation (OCC), which is the clearing organization for
cial futures contracts.” U.S. exchange-traded equity and equity index options.
DOJ also called for fungible futures Cross-margining reduces the margin requirements for qualifying traders, who
contracts and a clearing structure that would otherwise have to pay the full margin rates for related instruments trad-
more closely resembles those that service ed on the different exchanges. Risk-reducing positions — e.g., a long position
the U.S. stock markets, served by the in one Russell contract complemented by a short Russell position in a contract
Depository Trust Corporation, and the on the other exchange — would receive a reduced margin rate. Specifics of the
U.S. options markets, served by Options cross-margining program can be found at
Clearing Corporation. https://www.theice.com/clearing_cross_margin.jhtml.
DOJ urged the “Treasury to propose a
thorough review of futures clearing and Osaka and ISE want to launch “revitalizing” Japanese options platform
its alternatives, including a careful exami- The Osaka Securities Exchange (OSE) and International Securities Exchange
nation into whether a regime more similar (ISE) have signed a Memorandum of Agreement (MOA) that outlines their plans
to that in the equities or options markets to build a cooperative relationship as “the first step toward the formation of a
is feasible and would lead to significant joint venture and the launch of a new, jointly owned options trading platform.”
consumer benefits.” The venture is designed for the Japanese options market. In the joint press
DOJ’s comment letter also says “if regu- release, OSE President and CEO Michio Yoneda says, “[T]his initiative will help
latory policies that encourage and facili- to revitalize the Japanese equity options market and to establish it as a useful
tate exchange competition were adopted, investment tool for investors.”
futures clearinghouses would likely clear

letter became public. is not clear how much of that revenue ness interests than it does with the public
And New York Mercantile Exchange comes specifically from clearing fees be- benefit.”
(NYMEX) shares fell 17.6 percent or cause CME has always bundled the trans- Donohue also fended off questions
$18.78 Feb. 6 to $87.88, while action and clearing fees into one price. about the DOJ’s apparent contradictory
IntercontinentalExchange’s (ICE) shares CME CEO Craig Donohue did his best stance — first approving its acquisition of
slipped 7 percent or $8.75 to $115.90. to allay concerns that the U.S. govern- CBOT, which effectively granted the com-
CME and NYMEX had announced they ment was aiming to take away the CME bined exchange about 90 percent of the
were in merger and acquisition talks. Both clearinghouse. He told analysts in a spe- U.S. futures execution and clearing busi-
stocks slowly recovered but still were cial conference call that the issue raised ness — and then stating that such a
below the pre-DOJ letter prices. by the DOJ has been debated and dis- structure is anti-competitive.
CME and other exchanges stand to lose cussed for many years within the industry The DOJ’s comments focused on finan-
a major source of revenue if a single in various forms. cial futures contracts, not those of com-
futures industry clearinghouse is created “This is simply a comment letter,” modities such as energy futures, which
as the DOJ suggests. Last year, CME Donohue says. “This is not something are highly competitive between the
reported $1.76 billion in clearing and that’s never been talked about. The tug- NYMEX and ICE.
transaction fees, up from $1.34 billion in of-war between exchanges and intermedi-
2006. Total CME 2007 revenue was aries with respect to controlling the clear- Go slow
$2.12 billion, vs. $1.6 billion for 2006. It inghouse has a lot more to do with busi- Market participants voiced reservations
about the DOJ’s proposed solution and
none believed change is likely anytime
Managed futures performance:
soon. The Treasury, led by Sec. Henry
Barclay Trading Group’s January 2008 rankings Paulson who spearheaded the call for
Top 10 traders ranked by January 2008 return comments on achieving more competitive
managing more than $10 million as of 1/31/08. U.S. financial markets, will be undergoing
Trading advisor January 2007 YTD $ Under a transition in the coming months with a
return (%) return (%) mgmt. new president starting next January.
1. Friedberg Comm. Mgmt. (Divers.) 62.90 62.90 16.9M Sharon Brown-Hruska, vice president
2. Emil van Essen (Spread Trading) 31.00 31.00 19.0M in the securities and finance practice at
3. Kelly Angle Inc. (Genesis) 30.48 30.48 23.0M NERA Economic Consulting, is a wary of
4. Hawksbill Capital Mgmt. (Gl. Divers.) 23.63 23.63 42.5M such a major structural change.
5. Mulvaney Capital Mgmt. (Gl. Markets) 21.65 21.65 98.0M “You want to be fair to the clearing
firms and the exchanges,” Brown-Hruska
6. DUNN Capital Mgmt. (WMA) 19.94 19.94 57.7M
says. “The government should be cau-
7. Claughton Capital 19.87 19.87 30.5M
tious when engaging in micro-structure
8. Keck Capital Management 17.91 17.91 22.6M
management or trying to dictate what the
9. Fort Orange Capital Mgmt (Gl. Strat.) 16.98 16.98 16.4M perfect structure of the industry is or
10. Rochester Capital (Managed Futures) 15.85 15.85 30.0M should be.”
Top 10 traders ranked by January 2008 return Others questioned why the DOJ was
managing less than $10 million as of 1/31/08. coming in with its comment letter now,
1. Somers Brothers Capital (Divers.) 24.60 24.60 3.1M about two months after the deadline for
2. Abundance Fund, LLC 23.61 23.61 1.1M comment letters for the Treasury. CFTC
3. Edge Inv Mgmt (Gl Diversified) 21.25 21.25 2.4M commissioner Bart Chilton said in a state-
4. Barbashop LLC 18.00 18.00 2.0M ment he found several aspects of the DOJ
5. Linn, Hare, Huckabay (Apex) 17.58 17.57 2.0M letter troubling.
6. Visioneering R. & D. Co. (V-100 E) 17.09 17.09 1.1M For one, Chilton said the focus is
clearly outside the parameters of what the
7. Red Rock Capital (Diversified) 16.46 16.46 3.4M
Treasury had requested — which was
8. Montague Financial (Pascal) 15.67 15.67 1.8M
comment on regulatory oversight of U.S.
9. DUNN Capital Mgmt. (Combined) 14.69 14.69 9.4M
financial markets. Many of the prior com-
10. Dreiss Research Corp. 14.57 14.57 1.4M ments dealt with merging the CFTC and
the Securities Exchange Commission.
Based on estimates of the composite of all accounts or the fully funded subset method.
“The business model the DOJ staff is
Does not reflect the performance of any single account.
PAST RESULTS ARE NOT NECESSARILY INDICATIVE OF FUTURE PERFORMANCE.
now condemning received, only a few
Source: Barclay Hedge (www.barclayhedge.com) short months ago, the legal blessing of
the DOJ following its extensive, compre-

hensive, and exhaustive review of the other exchanges, which ultimately forces issued a statement supporting the DOJ’s
CME/CBOT merger,” Chilton says. market users to post margin at two recommendation for a review of
Another industry executive says the exchanges. exchange-controlled clearing. In 2003,
futures industry does not need a single “I’m not in favor of spinning off clear- the FIA also pushed for other clearing
clearing entity, but rather a change in the ing into one entity and I don’t think that changes such as directed clearing, or
way clearing houses interact with one adds value,” the executive says. “But regu- clearing choice.
another. Many FCMs and customers are lators should mandate cooperation among But such debates have raised the dialog
frustrated by exchanges which fail to offer clearing houses.” and then quietly been shelved. This time,
margin offsets on competing products at The Futures Industry Association (FIA) it may be different.
Java jolt: Something’s brewing in coffee

BY ACTIVE TRADER STAFF FIGURE 1: ICE COFFEE
Y
our morning cup of joe may
get more expensive over the
next several months to a year.
Nearby ICE Futures US coffee futures

surged to multiple-year highs in February
and analysts say there could be more to
go on the upside.
After the May 1997 top at 280.00, cof-
fee declined into 2001 before creeping
higher, forming the large base evident on
the monthly coffee chart (Figure 1). Most
analysts agree the coffee market has
etched a major long-term bottom on the
charts, and the recent price action por-
tends even higher prices to come.
“We have a big base going back to the
late 1990s,” says Paul Hare, executive vice
Coffee futures have been percolating higher since the 2001 bottom. Despite
president at the Linn Group. “[The mar- the early March correction, industry watchers expect coffee to push higher.
ket has] established a bottom, there is no
Source: TradeStation
question about it.”
This year’s rally through the 140.00-a-
pound level (topping the May 2005 high managing director at Hencorp Futures in lies. Nonetheless, Ganes adds, even
of 139.50) was a significant upside break- Miami. “when you take that out of the equation
out. Citing historically low inventory levels and go back to the underlying fundamen-
“When you come out of a formation and rising consumption levels (1 to 2 per- tals they are pretty solid.”
like this over the past 20 years you’ve had cent per year), de la Roche says the bal- May coffee futures corrected in early
big moves out of your base,” Hare says. ance between supply and demand will be March (Figure 2), but overall analysts
Fundamentally, the case for higher cof- tighter every year. weren’t fazed by the retreat. Analysts are
fee is there. Producer stocks have been “This is the first time both Arabica and pointing to the 200.00 mark as a clear
falling recently. Judy Ganes Chase, presi- Robusta (the two primary coffee grades) upside target for the market.
dent of JGanes Consulting, has forecast a have rallied together not as a direct result Beyond that, Hare says the 2.1200
138-million-bag figure for world produc- of frost or drought in Brazil,” Ganes says. zone is a key Fibonacci retracement target
tion in 2008-2009 vs. a consumption esti- Brazil is the world’s largest coffee pro- (61.8 percent of the May 1997-December
mate of 133 million bags. ducer and exporter. 2001 sell-off) as a possible objective into
“Through 2009-2010 we will see limit- In recent months, coffee futures have the summer months. Given the way coffee
ed supply,” she says. been driven higher in part by “pervasive has trended on a historical basis, he even
“Consumption is getting close to pro- fund buying” as trend and momentum sees the potential for a spike to 250.00 or
duction,” agrees Hernando de la Roche, players jump on commodity market ral- 260.00.

Groups exchange barbs regarding investor arbitration
A
recent survey conducted by Thirty-five percent of unqualified to comment on the process.
professors at Pace University However, a SICA spokesman says a par-
and the University of customers would not ticipant doesn’t need to see the arbitration
Cincinnati College of Law was to the end to determine if there is bias
not very friendly to the arbitration involved.
choose arbitration in the More than 55 percent of arbitration
process used by Wall Street to resolve dis-
putes with investors. cases were settled in 2007, up from 36
More than 3,000 investors, lawyers,
future because they percent in 2003. However, while 42 per-
and security employees who had been cent of investors won their cases in 2006,
involved in arbitration between January believe it is unfair; that number dropped to 37 percent in
2002 and December 2006 were surveyed, 2007.
and only 28 percent thought the process 44 percent did not think Still, SIFMA believes an increase in set-
was fair. Furthermore, only a quarter of tlements shows investors are happy with
investors surveyed thought the process arbitration was conducted the process, saying nobody would agree
was fair. to settle unless they believed the settle-
The survey was commissioned by the “without bias.” ment was fair and adding that many on
Securities Industry Conference on the brokerage side also believe the process
Arbitration (SICA), and the results did is unfair, balancing out the results.
not please the folks at the Securities hearing concluded. “The Thinking Person’s Guide…”
Industry and Financial Markets However, a lawyer for SICA called states, “Customers, on the one hand, felt
Association (SIFMA). SIFMA published a SIFMA’s response “out of touch,” and Jill they were not fully compensated for their
response entitled “The Thinking Person’s Gross, co-author of the study, says SIFMA losses. Securities firms, on the other
Guide to Interpreting the Latest Survey was “denigrating the observations and hand, felt that customer awards were
on Subjective Perceptions of Fairness of views of an entire class of arbitration par- overly generous. The fact that both sides
Securities Arbitration” in which it ques- ticipants.” were somewhat dissatisfied with the out-
tioned the process used in conducting the According to the survey, almost 35 per- come does not reflect that the process is
survey and downplayed the results. cent of customers would not opt for arbi- biased. Rather, it is a good indication that
“The survey focuses solely on subjective tration in the future because they believe the system is taking a balanced approach
perceptions by arbitration participants the process is unfair, and 44 percent did and producing results that are within an
and does not address objective standards not think arbitration was conducted acceptable range of fairness.”
of substantive or procedural fairness,” the “without bias.” However, state regulators have sided
response says. “The survey, for example, Unfortunately, arbitration is the only with investors, claiming the survey points
attempts to analyze fairness, in part, by route aggrieved investors have if they out the need for removing industry mem-
participants’ views about the alleged time believe they have been wronged. Before bers from arbitration panels.
and cost inefficiency of arbitration, and opening an account, brokerages require Bryan Lantagne, chairman of the arbi-
about the alleged bias of arbitrators. investors to sign an agreement that they tration working group sponsored by the
Yet, individuals’ perceptions about these will seek arbitration and not opt to go to North American Securities Administrators
particular factors can be proven to be court if there is a dispute. Association (NASAA), says “We’re trying
inaccurate because these factors have Of those in the survey who had been to see whether the investors believe [the
already been measured objectively and lawyers, plaintiffs, or defendants in a arbitration system is] fair. Now we have a
empirically.” court case over the past five years, 63 per- report that shows that they don’t, and
For starters, SIFMA points out the cent say arbitration was “very unfair” everyone’s trying desperately to put a spin
survey consisted of 40 multiple-choice compared to court. on this. These numbers really speak vol-
questions and was sent to about 30,000 A lawyer for SIFMA claimed the umes to what the investors believe. That’s
people. However, only 10 percent of that investors who responded to the survey crucial to the forum. If they feel they’re
group responded and, of that total, but did not go through the entire process, forced to go into a forum that’s biased, it
almost 60 percent settled before the opting instead for an early settlement, are perverts the program.”

SEC wants to streamline the ETF pipeline
E
xchange-traded funds (ETFs) “individual exemptive orders” from the Investment Management, in the SEC’s
have been the golden child of Commission — a process that adds time press release. “Permitting most ETFs to
the equities industry for several and costs to bringing new ETFs to mar- come directly to market without the cost
years, and the SEC has pro- ket. and delay of obtaining an exemptive
posed new rules to make it easier for “The proposed rules would increase order would also allow staff to focus on
ETFs to operate. investor choice by eliminating a barrier to more novel and difficult requests.”
In early March the SEC proposed two entry for new participants in this fast- The comment period for the proposal
new rules under the Investment Company growing market, while preserving investor will end 60 days from the date of publica-
Act to permit exchange-traded funds protections,” said Andrew J. Donohue, tion of the proposed rule in the Federal
(ETFs) to operate without obtaining Director of the SEC’s Division of Register.
STOCK PRICES OF TRADING-RELATED FIRMS

Company Symbol Exchange Closing 1-month % 52- 52- Avg. Market
price change change week week daily cap
3/6 high low vol.* ($)
Brokerages
Track Data TRAC NASD 1.74 0.07 4.19% 3.86 1.45 8,062 $14.6 M
Terra Nova Financial Group TNFG OTC BB 1.41 0.02 1.44% 2.5 1.1 23,892 $38.2 M
TD Ameritrade AMTD NASD 17.2 -0.41 -2.33% 21.31 13.82 5.59 M $10.2 B
Charles Schwab SCHW NASD 18.96 -1.22 -6.05% 25.72 17.41 12.5 M $21.9 B
OptionsXpress OXPS NASD 21.9 -2.5 -10.25% 34.95 20.78 1.23 M $1.38 B
TradeStation TRAD NASD 9.37 -1.1 -10.51% 14.87 9.28 537,739 $414 M
AB Watley ABWG Pink Sheets 0.07 -0.01 -12.50% 0.45 0.009 82,605 $2.04 M
Siebert Financial SIEB NASD 3.03 -0.53 -14.89% 5.76 3 3,056 $67.3 M
E*Trade ETFC NASD 3.77 -0.83 -18.04% 25.79 2.08 39.9 M $1.74 B
AlphaTrade APTD OTC BB 0.195 -0.045 -18.75% 0.33 0.1035 82,491 $9.05 M
Man Financial Global MF NYSE 18.39 -9.9 -34.99% 32.2 14 1.95 M $2.21 B
Exchanges/Trading firms
IntercontinentalExchange ICE NYSE 132.44 16.54 14.27% 194.92 114.62 2.22 M $9.29 B
New York Mercantile Exchange NMX NYSE 99.38 11.5 13.09% 148 86.61 2.21 M $9.23 B
Nyfix NYFX Pink Sheets 4.1 0.25 6.49% 7.5 3.6 54,860 $150 M
CME Group CME NYSE 505.45 20.2 4.16% 714.48 475.17 1.00 M $26.9 B
Nasdaq Stock Market NDAQ NASD 38.79 -1.37 -3.41% 50.47 26.57 2.54 M $4.44 B
Interactive Brokers IBKR NASD 29.71 -2.89 -8.87% 35.93 21.00 981,843 $1.19 B
NYSE Euronext NYX NYSE 61.6 -7.43 -10.76% 101 62.05 4.20 M $16.3 B
Penson Worldwide PNSN NASD 9.35 -2.32 -19.88% 34.91 9.245 270,056 $237 M
Market makers/Specialists
Knight Capital Group NITE NASD 15.92 -0.66 -3.98% 18.49 11.5 2.30 M $1.55 B
LaBranche LAB NYSE 4.34 -1.07 -19.78% 9.3 4.03 675,448 $267 M
Miscellaneous
Value Line VALU NASD 40.25 0.34 0.85% 56 31.1 4,661 $402 M
Interactive Data Corporation IDC NYSE 27.77 -0.76 -2.66% 33.68 22.92 268,142 $2.62 B
eSpeed ESPD NASD 11.38 -0.62 -5.17% 12.97 7.02 235,523 $356 M
MarketAxess MKTX NASD 8.83 -0.65 -6.86% 19.87 9 224,839 $272 M
*over last three months

Gold express may lose steam above $1,000

BY ACTIVE TRADER STAFF
FIGURE 1: PARABOLIC RALLY
Y
ou don’t have to look far these
days to find a commodity
market scoring new all-time
highs. However, in the days
leading up to spring, one particularly
“sexy” market — gold — finally climbed
above the psychologically significant and
historic $1,000-an-ounce mark.
Gold has been moving higher since
2001, although the lion’s share of the cur-
rent rally has occurred since April 2003
and the months since June 2007 have
been especially explosive (Figure 1).
However, starting in 2001, the U.S.
Federal Reserve embarked upon a histori-
cal monetary policy easing cycle that ulti-
mately took the fed funds rate down to 1
percent. The U.S. dollar entered a major
bear market around that time and com-
modity markets boomed across the board. This monthly chart of continuous gold futures highlights the huge gains the
market has made in recent months.
Gold bugs woke up after more than a
decade of hibernation. Source: TradeStation
For several years, the rally in the gold
market was a quiet upward march, with anything that can logically be squeezed lower and real estate markets collapsing
the price of the yellow metal climbing to out of the fundamentals. across the U.S., investment money has
$456.50 in December 2004. By mid-2006 flowed into the commodity arena.
gold had vaulted to around $725, fol- Self-fulfilling prophecy? “Commodities have been the success
lowed by nearly a year of consolidation. A bevy of factors have fed the new gold story,” he says. “There are tremendous
In August 2007 the Fed launched a new mania, which has intensified in recent amounts of capital being thrown at this
easing cycle after a year of holding rates months. Flight-to-safety concerns regard- market as traders and funds look for
steady. ing the U.S. sub-prime debacle supported assets that are performing well.”
“Gold was trading sideways after the gold in late 2007 and beyond, and con-
May 2006 peak until the Fed started cut- cerns that global inflation would pick up It’s not just gold
ting rates,” says Dan Vaught, futures ana- amid the strong world-wide demand for Gold may be the marquee market, but
lyst at Wachovia Securities. The dollar commodities also underpinned the yellow virtually all metals have been rallying
continued to fall, which continued to bol- metal. Historically, gold has been seen as across the board, with double-digit gains
ster commodity prices. both an inflation hedge and a flight-to- in both the precious and industrial sec-
“Gold and all internationally traded safety vehicle. Plenty of purely speculative tors.
commodities that are priced in dollars see money has been chasing the gold market. Terence Gabriel, senior technical strate-
a negative correlation between the dollar “The continued capital influx has tend- gist at Ideaglobal in New York, points out
and the price of the commodity,” he says. ed to exaggerate this move,” Vaught says. that gold futures gained 45 percent from
But what’s happening now goes beyond With the U.S. stock market pushing the end of February 2007 to the end of

FIGURE 2: FLIRTING WITH $1,000
February 2008. During that same period,

silver rallied 40 percent, copper soared
41 percent, and platinum skyrocketed 74
percent. Gabriel noted that platinum and
palladium have both “gone ballistic” in
part due to recent South African mine
shutdowns.
The market catalysts for industrial and
precious metals are not necessarily the
same, though. According to Gabriel,
industrial metals have the benefit of
strong emerging market demand for the
actual use of the materials, while precious
metals benefit from dollar weakness and
instability, which may be leading into for-
ward-inflation expectations.
The energy connection

With crude oil topping $100, the pass-
through costs of higher energy prices After consolidating between roughly $960 and $995, on March 13 gold
have the potential to ripple through virtu- finally cleared the $1,000 psychological hurdle.
ally every aspect of the global economy.
“The big inflation concern really goes
back to energy,” Vaught says. “Gold tradi-
tionally has been closely associated with This is only about money chasing “Looking at reward/risk at over $1,000,
the energy sector. As long as crude oil money.” the next move favors a correction,”
prices remain strong, gold will remain When asked if he thought gold was Gabriel says. “It is a crowded trade to
strong. Ultimately, when and if crude overvalued, Vaught says unlike most chase gold at $1,000.”
turns downward, I think gold bulls other commodities, “Gold value is such a However, Gabriel expects a late-spring,
would be hard pressed to sustain this nebulous concept.” early-summer sell-off to present another
rally.” buying opportunity in the continuing
The $1,000 barrier long-term uptrend in gold.
Bubbles and fair value Just as this story went to press, gold Expectations remain high the U.S.
Leonard Kaplan, president of Prospector pierced the $1,000 mark, another notch Federal Reserve will continue its easing
Asset Management and long-time gold on its historical-significance belt (Figure stance in an effort to stave off recession
watcher, says the financial world over the 2). Most market watchers agree the level into mid-year (the next scheduled inter-
last eight years has been all bubbles, cit- has acted as a “magnet,” as round num- est-rate meeting is on March 18). Lower
ing the Nasdaq top in 1999, the real bers so often do. What happens next, interest rates weigh on the U.S. dollar,
estate bubble, and now commodities. though, is very much open to debate. which in turn could continue to support
“Is any of it real?” he asks. “Of course “The parabolic structure of the rally gold and other commodity prices.
not. [The recent upward spiral in gold would tend to suggest that we are close to Again, the big question is, how far and
prices] is total mania. There are 10,000 the end of the move,” Gabriel says. “It is a for how long? There are huge risks to
hedge funds with hundreds of billions of dangerous market once it gets over overheated markets.
dollars throwing money at gold. Will it $1,000.” “As long as the Fed continues to be the
end very badly? Yes. But will it end a He is forecasting a near-term thrust slut of Wall Street, I think metals go high-
week from now, a month from now, or above $1,000 — perhaps a top at $1,025 er,” Kaplan says. “It is very difficult to
three years from now? No one knows. or even $1,100. From there, however, he know what can prick a bubble.”
“Gold is worth about half of where it is believes the market is vulnerable to a His advice for those interested in trad-
right now. If you can produce gold at hefty correction, possibly to the $750 to ing gold: “Go to Las Vegas. The odds are
$350/400 ounce, why is it worth $950? $800 level. better.”

Inside the Market continued Interest-rate monitor

Global News
The Bank of Canada lowered its overnight target rate 0.50 percent
to 3.5 percent.
The Bank of England lowered its bank rate 0.25 percent to 5.25
percent in February and held steady in March.
EUROPE
The Reserve Bank of Australia raised its overnight lending rate
0.25 percent to 7.25 percent.
The European Central Bank (ECB) The Bank of Japan (BOJ) raised its overnight rate 0.25 percent to
0.50 percent.
held overnight interest rates steady at 4
percent at its March 6 meeting. Reserve Bank of New Zealand held rates steady at 8.25 percent.
France’s Q4 GDP increased 0.7 per- European Central Bank (ECB) held rates steady at 4.0 percent.
cent, a 4.2-percent gain from a year
ago. Decreases in household and gov- Bank of Japan (BOJ) held rates steady at 0.5 percent.
ernment expenditure, industrial produc-
tion, and exports contributed to the
slowest quarterly economic growth in in biomedical manufacturing rather
more than a year. The Swedish Riksbank raised its than the impact of the slowing U.S.
repo rate 0.25 percent in February to economy,” according to a government
Germany’s unemployment rate fell 4.25 percent, the eleventh increase in press release. GDP has increased 10.8
in December for the sixth consecutive two years. percent over the past year.
month to 7.8 percent — 1.2 percent Singapore’s Q4 unemployment fell
less than a year ago. Unemployment The National Bank of Romania to 1.6 percent, down from 1.7 percent
has fallen steadily in Germany since raised its monetary policy rate 1.0 in Q3 and down 1.0 percent from the
January 2006 when it hit 10.4 percent. percent in February to 9.0 percent, a same period last year. Growth in the
Germany’s GDP grew 0.3 percent in 2.0-percent increase since June of last construction sector doubled in 2007
Q4, due in part to an increase in year. compared to the previous year, con-
exports. This brings the growth since tributing to the decade-low unemploy-
Q4 2006 to 3.7 percent. ment estimate.
ASIA &
UK unemployment fell 0.2 percent AUSTRALIA The Central Bank of Philippines
to 5.2 percent in the October- lowered its overnight borrowing
December period, down 0.3 percent Japan’s Q4 GDP grew 0.3 percent rate 0.25 percent to 5.0 percent in
from the same period last year. This compared to the previous quarter, a January, marking four consecutive
coincides with a 74.7-percent employ- 1.2-percent increase from year ago. months of 0.25-percent decreases.
ment rate, the highest level since com- Japan’s unemployment rate was
parable employment recording began 3.8 percent in December, the same as
in 1971. In February, the Bank of in November. This level is 0.2 percent AMERICAS
England lowered its overnight lend- less than the rate reported in
ing rate 0.25 percent to 5.25 percent, December 2007.
the same rate as a year ago. It held Canada’s unemployment rate fell
rates steady at its subsequent meeting The Reserve Bank of Australia 0.2 percent in January to 5.8 percent,
on March 6. raised its cash rate 0.25 percent to equal to the 33-year low recorded in
7.0 percent in February. This rate has October 2007. Employment has contin-
Czech Republic incumbent increased steadily since early 2005 ued to climb in many sectors, bringing
President Vaclav Klaus was reelect- when it was 5.25 percent. The the employment rate up to a record
ed for a five-year term, defeating Australian unemployment rate fell high of 63.8 percent. The Bank of
University of Michigan economics pro- 0.2 percent to 4.1 percent in January, Canada lowered its overnight fund-
fessor Jan Svejnar in a heated race 0.6 percent less than a year ago. Over ing rate 0.25 percent to 4.00 percent,
requiring three separate rounds of vot- the past decade, the unemployment the lowest rate since April 2006.
ing. The Czech National Bank rate has fallen 3.8 percent.
raised its two-week repo rate 0.25
percent to 3.75 in February. This rate Hong Kong’s November-January
has increased steadily from 1.75 per- unemployment rate held steady at AFRICA
cent in April 2005. 3.4 percent from the previous three-
month period. This is the lowest figure
The National Bank of Poland in 10 years. Employment surged to over South Africa’s Q4 GDP rose 5.3 per-
raised its 28-day intervention rate 3.55 million, another record high. cent from the previous quarter and 4.6
from 5.0 percent to 5.25 percent in percent from a year ago. Expansion in
January. This marks the fifth increase in Singapore’s GDP rose 2.42 percent in the manufacturing and construction
the last 10 months after hitting a Q4 — a slowdown from the previous industries played a significant part in
recent 4.0-percent low in 2006. quarter due mostly to a “sharp decline this growth.

Global MARKETPLACE
FOREX (VS. U.S. DOLLAR)
Current
price vs. 1-month 3-month 6-month 52-week 52-week Previous
Rank* Country Currency U.S. dollar gain/loss gain/loss gain/loss high low rank
1 Swiss franc 0.96312 5.43% 7.84% 16.49% 0.9699 0.8005 2
2 Swedish krona 0.16266 4.89% 4.58% 11.81% 0.1635 0.14 8
3 Brazilian real 0.59898 4.87% 7.67% 17.08% 0.6001 0.453 14
4 Taiwanese dollar 0.03244 3.71% 4.81% 7.20% 0.03255 0.02983 6
5 Japanese yen 0.009655 3.25% 6.47% 11.79% 0.00970 0.00805 1
6 Euro 1.52127 3.14% 3.33% 11.74% 1.5302 1.3072 7
7 Australian dollar 0.92718 2.51% 6.49% 12.58% 0.9497 0.7672 5
8 Russian ruble 0.04167 2.43% 1.86% 6.96% 0.04178 0.03799 10
9 Singapore dollar 0.71971 1.90% 4.09% 9.86% 0.7204 0.6468 3
10 Chinese yuan 0.14087 1.08% 3.99% 6.23% 0.1406 0.1285 4
11 New Zealand dollar 0.79807 1.00% 4.48% 15.17% 0.8213 0.6642 12
12 British pound 1.98464 0.74% -2.99% -1.46% 2.1161 1.918 13
13 Canadian dollar 1.00772 0.61% 2.21% 5.96% 1.1038 0.8455 15
14 Hong Kong dollar 0.12843 0.17% 0.09% 0.09% 0.129 0.1277 11
15 Thai baht 0.03192 -1.66% -3.59% 2.24% 0.03396 0.02782 16
16 Indian rupee 0.02481 -1.86% -2.05% 1.51% 0.02549 0.02237 9
17 South African rand 0.12747 -4.49% -13.36% -7.82% 0.1555 0.1242 17
As of March 6 *based on one-month gain/loss

ACCOUNT BALANCE
+
Rank Country 2007 Ratio* 2006 2008+ Rank Country 2007 Ratio* 2006 2008
1 Singapore 41.395 27 36.288 42.208 13 Mexico -6.368 -0.7 -2.425 -10.588
2 Switzerland 65.534 15.8 58.708 64.106 14 France -39.363 -1.6 -27.712 -48.885
3 China 379.162 11.7 249.866 453.146 15 India -23.131 -2.1 -9.503 -32.301
4 Hong Kong 22.796 11.2 20.586 20.456 16 UK -96.687 -3.5 -77.236 -105.144
5 Netherlands 55.891 7.4 8.6 6.7 17 Australia 50.816 -5.7 -41.49 -52.988
18 U.S. -784.341 -5.7 -811.483 -788.293
6 Taiwan 25.402 6.8 24.661 28.365
19 South Africa -18.495 -6.7 -16.608 -19.237
7 Sweden 25.903 6 27.707 25.584 20 Spain -138.916 -9.8 -106.399 -154.849
8 Russia 72.543 5.9 95.322 49.181
9 Germany 175.371 5.4 147.134 174.137 Totals in billions of U.S. dollars
10 Japan 195.904 4.5 170.437 195.145 *Account balance in percent of GDP +Estimate
11 Canada 25.603 1.8 20.792 17.909 Source: International Monetary Fund, World Economic Outlook
12 Brazil 10.253 0.8 13.276 4.299 Database, October 2007

NON-U.S. DOLLAR FOREX CROSS RATES
Currency 1-month 3-month 6-month 52-week 52-week
Rank pair Symbol March 6 gain/loss gain/loss gain/loss high low Previous
1 Franc / Canada $ CHF/CAD 0.95606 4.79% 5.50% 9.93% 0.9751 0.8044 1
2 Franc / Pound CHF/GBP 0.48535 4.66% 11.16% 18.22% 0.4889 0.4005 2
3 Real / Canada $ BRL/CAD 0.59459 4.23% 5.33% 10.49% 0.5946 0.5213 5
4 Real / Pound BRL/GBP 0.30186 4.10% 10.99% 18.82% 0.3019 0.2431 8
5 Real / Aussie $ BRL/AUD 0.64617 2.30% 1.10% 4.00% 0.6544 0.5883 11
6 Franc / Euro CHF/EUR 0.6331 2.22% 4.37% 4.25% 0.6369 0.5942 4
7 Franc / Yen CHF/JPY 99.76636 2.10% 1.29% 4.21% 101.852 92.152 13
8 Aussie $ / Canada $ AUD/CAD 0.92038 1.89% 4.18% 71.03% 0.9493 0.8439 3
9 Aussie $ / Pound AUD/GBP 0.46725 1.76% 9.77% 14.25% 0.4753 0.3975 6
10 Real / Euro BRL/EUR 0.39376 1.67% 4.20% 4.78% 0.3995 0.3569 10
11 Real / Yen BRL/JPY 62.04962 1.56% 1.13% 4.74% 66.2821 54.3068 19
12 Euro / Yen EUR/JPY 157.582 -0.11% -2.95% -0.04% 168.96 149.227 17
13 Canada $ / Pound CAD/GBP 0.50784 -0.13% 5.36% 7.53% 0.5219 0.4373 12
14 Aussie $ / Euro AUD/EUR 0.60955 -0.61% 3.06% 0.76% 0.646 0.5727 7
15 Aussie $ / Yen AUD/JPY 96.04732 -0.72% 0.02% 0.75% 107.831 85.975 16
16 Pound / Euro GBP/EUR 1.30461 -2.33% -6.11% -11.82% 1.4968 1.3001 9
17 Pound / Yen GBP/JPY 205.585 -2.44% -8.88% -11.85% 251.095 203.462 18
18 Canada $ / Euro CAD/EUR 0.66246 -2.45% -1.08% -5.17% 0.7476 0.639 15
19 Canada $ / Yen CAD/JPY 104.392 -2.56% -4.00% -5.20% 124.527 98.32 20
20 Aussie $ / Franc AUD/CHF 0.96295 -2.76% -1.25% -3.35% 1.0755 0.9452 14
GLOBAL STOCK INDICES
1-month 3-month 6-month 52-week 52-week
Rank Country Index March 6 gain/loss gain/loss gain/loss high low Previous
1 South Africa FTSE/JSE All Share 31,079.15 11.47% 7.73% 2.27% 31,728.18 24,005.35 9
2 Brazil Bovespa 62,975.00 6.79% -4.28% 15.40% 66,529.00 42,051.00 3
3 Canada S&P/TSX composite 13,360.44 3.83% -3.53% -3.15% 14,646.80 12,011.68 2
4 Mexico IPC 28,717.04 2.82% -8.13% -6.81% 32,851.10 25,282.30 1
5 Japan Nikkei 225 13,215.42 0.89% -16.75% -18.71% 18,297.00 12,572.70 13
6 Singapore Straits Times 2,917.92 -0.48% -17.86% -15.81% 3,906.16 2,859.08 12
7 Hong Kong Hang Seng 23,342.73 -0.54% -21.03% -2.94% 31,958.40 18,738.50 11
8 U.S. S&P 500 1,304.34 -1.67% -13.47% -11.78% 1,576.09 1,270.05 4
9 UK FTSE 100 5,766.40 -1.86% -11.09% -8.66% 6,754.10 5,338.70 5
10 Italy MIBTel 25,148.00 -2.55% -16.01% -18.43% 34,369.00 24,545.00 10
11 Australia All ordinaries 5,531.90 -2.57% -16.94% -11.71% 6,873.20 5,253.50 7
12 France CAC 40 4,678.05 -2.87% -17.55% -16.11% 6,168.15 4,505.14 14
13 Germany Xetra Dax 6,591.31 -3.74% -16.99% -13.52% 8,151.57 6,384.40 15
14 Switzerland Swiss Market 7,269.90 -3.91% -16.84% -17.67% 9,548.10 6,950.90 6
15 India BSE 30 16,542.08 -8.81% -16.44% 5.93% 21,206.80 12,316.10 8
GLOBAL SHORT-TERM INTEREST RATES
Country Interest rate Rate Last change Sept. 07 March 07
U.S. Fed Funds Rate 3 0.5 (Jan. 08) 4.75 5.25
Japan Overnight call rate 0.5 0.25 (Feb. 07) 0.5 0.5
Eurozone Refi rate 4 0.25 (June 07) 4 3.75
UK Repo rate 5.25 0.25 (Feb. 08) 5.75 5.25
Canada Overnight funding rate 3.5 0.5 (March 08) 4.5 4.25
Switzerland 3-month Swiss Libor 2.75 0.25 (Sept. 07) 2.75 2.25
Australia Cash rate 7.25 0.25 (March 08) 6.5 6.25
New Zealand Cash rate 8.25 0.25 (July 07) 8.25 7.5
Brazil Selic rate 11.25 0.5 (Sept. 07) 11.25 12.75
Korea Overnight call rate 5 0.25 (Aug. 07) 5 4.5
Taiwan Discount rate 3.375 0.125 (Dec. 07) 3.25 2.875
India Reverse repo rate 6 0.5 (Dec. 07) 6 6
South Africa Repurchase rate 11 0.5 (Dec. 07) 10 9
GLOBAL BOND RATES
Rank Country Rate March 6 1-month 3-month 6-month High Low Previous
1 Japan Government Bond 138.97 0.82% 2.04% 2.41% 139.45 130.96 3
2 Germany BUND 117.24 0.28% 1.77% 3.07% 118.08 109.92 2
3 Australia 10-year bonds 93.73 -0.19% -0.28% -0.38% 94.355 93.46 4
4 UK Short sterling 94.28 -0.28% 0.86% 0.78% 94.92 93.6 5
5 U.S. 10-year T-note 116.245 -0.73% 2.76% 6.49% 119.03 103.21 1
All data as of March 6

THE Economy
FIGURE 1: QUARTERLY GDP PERFORMANCE
U.S. economic briefing
FED MINUTES REVEAL CONCERN ABOUT

ECONOMY AND INFLATION Fourth-quarter GDP growth remained at 0.6 percent, according to a
preliminary (second) estimate. In 2007, average quarterly GDP growth was
2.5 percent, its lowest performance since 2002.
Date and time: Feb. 20 at 2:15 p.m. ET
Source: Bureau of Economic Analysis
Summary: The Federal Open Market
Seasonally adjusted *advanced **preliminary
Committee (FOMC) acknowledged economic
conditions had “decelerated sharply in recent
months,” according to minutes from its meet- FIGURE 2: PAYROLLS VS. UNEMPLOYMENT RATE
ing on Jan. 29 and 30.
The Fed cited several sources of the eco-
nomic troubles: sluggish home sales, slowed
consumer spending, reduced industrial pro-
duction, weakened labor market, and rising
inflation.
The following tables compare the S&P 500’s
daily and weekly reactions to economic releas-
es as well as historical behavior since 1997 (or
earlier). The S&P 500 climbed at least 0.69
percent on CPI and PPI report days in late
February, while it fell 0.84 percent following a
dismal jobs report on March 7.
Rate Historical moves

changes since 1994
Report day 0.31% February payrolls fell by 63,000 in February, the largest decline since
Five days later -0.06% March 2003. In addition, the unemployment rate’s three-month average
hit a two-year high.
Unchanged Historical moves Source: Bureau of Labor Statistics Seasonally adjusted
rates since 1994
Report day 0.21% FIGURE 3: OVERALL VS. CORE INFLATION
Five days later 0.38%
FOURTH-QUARTER GDP REMAINS WEAK

Report: Gross domestic product for Q4 2007
(preliminary estimate)
Date and time: Feb. 28 at 8:30 a.m.
Actual: 0.6 percent
Previous: 0.6 percent
Consensus: 0.8 percent
S&P 500 Historical moves The PPI’s annual gain jumped to a new high in January, while the CPI and
GDP reaction since 1994 core readings rose slightly.
Report day -0.89% 0.00% Source: Bureau of Labor Statistics Not seasonally adjusted
Five days later -3.36% 0.43%

FIGURE 4: ISM MANUFACTURING INDEX
PPI LEADS INFLATIONARY PRESSURES

Report: Consumer Price Index (CPI)
Actual: 0.4 percent (core 0.3 percent)
Previous: 0.4 percent (core 0.2 percent)
Consensus: 0.3 percent (core 0.2 percent)
S&P 500 Historical moves

CPI reaction since 1980
Report day 0.83% 0.06%
Five days later 2.41% 0.15%
In February, the ISM manufacturing index dropped 2.4 points to 48.3, its
lowest value since April 2003.
Source: Institute of Supply Management Seasonally adjusted
Report: Producer Price Index (PPI)
Actual: 1.0 percent (core 0.4 percent)
Previous: -0.3 percent (core 0.2 percent)
Consensus: 0.4 percent (core 0.2 percent)
S&P 500 Historical moves FIGURE 5: S&P

PERFORMANCE
PPI reaction since 1994
Report day 0.69% 0.11% The S&P 500 fell
Five days later -2.95% 0.41% 3.27 percent in
February amid
recession worries,
following a 6.12-
MANUFACTURING INDEX FALLS percent loss in
TO FIVE-YEAR LOW January. The
Report: ISM manufacturing index market dropped
another 2.8
Date and time: March 3 at 10 a.m. percent in the first
Actual: 48.3 week of March.
Previous: 50.7 Source: eSignal
Consensus: 47.5
ISM S&P 500 Historical moves FIGURE 6: S&P 500 REACTION TO NEWS
manufacturing reaction since 1997
Report day 0.05% 0.28%
Five days later -2.81% 0.53%
DROP IN PAYROLLS POINTS TO RECESSION

Report: Employment
Date and time: March 7 at 8:30 a.m.
Non-farm payrolls
Actual: -63 K
Previous: -22 K
Consensus: 25 K
Unemployment rate
Actual: 4.8 percent
Previous: 4.9 percent
Consensus: 5.0 percent
The S&P 500 gained or lost roughly 0.8 percent on report days in February
S&P 500 Historical moves and early March. However, the market managed to bounce off intraday
Employment reaction since 1994 lows and close up 0.1 percent when the ISM manufacturing index hit the
Report day -0.84% 0.12% Street on March 3.

Trading BASICS
The maxiworld of mini futures

After only a decade, mini futures contracts are some of the most actively traded futures
in the world. Get the facts on the growing list of U.S.-traded mini futures.
BY STEVE GRAUBART
T he launch of the E-Mini S&P 500 futures contract in

1997 offered an alternative vehicle to trade the S&P
500 stock index. Over time, its smaller size attracted
large numbers of traders who could not afford the margin
(upwards of $20,000 per contract) and risk profile of the full-
and the U.S. branch of the Intercontinental Exchange (ICE).
Many of these contracts, including several mini stock-index
contracts, are among the most actively traded U.S. futures (see
“Stocks and Futures Snapshot,” p. 40).
sized, pit-traded S&P 500 futures contract. Trading in bytes

Although in retrospect its advantages might seem obvious — One common characteristic of all the mini contracts is that they
a smaller contract that offers more precise trade sizing and the are traded electronically, regardless of exchange. Before electron-
ease of instantaneous electronic trading — the success of the E- ic trading assumed the primary position in the U.S. futures mar-
Mini S&P was hardly assured. And to the surprise of many long- ket, exchanges’ electronic trading systems (such as the CME’s
time floor traders, by 2003 the E-Mini S&P futures had passed Globex) were outlets to try out new contracts with relatively low
the once-dominant pit-traded contract in volume. overhead. Today, however, electronic volume outstrips pit vol-
It hasn’t looked back since. ume, and new contracts are almost always launched electronical-
Since then, futures exchanges have launched many other ly even if they also have pit trading.
mini-sized trading products. Along with many new stock index Electronic trading hours are usually different from pit trading
products have come offerings in grains, energy, currencies, and hours. For example, the E-Mini S&P trades virtually 24 hours a
metals. Table 1 lists the product specifications for actively traded day (except for Sundays): 5 p.m. to 3:15 p.m. (CT) the next day,
mini futures contracts traded at the Chicago Mercantile with a 15-minute break until 3:30, followed by trading until
Exchange (CME), New York Mercantile Exchange (NYMEX), 4:30 p.m. and a 30-minute break until 5 p.m. By contrast, the
pit-traded S&P contract trades 8:30 a.m. to 3:15 p.m. This
means the price data for the two contracts is actually different
Related reading — e.g., the intraday highs and lows are likely to be different for
“The futures advantage” the E-Mini and standard S&P contracts. This, of course, will
Active Trader, October 2002. impact your analysis.
Part I of our two-part guide showing the unique characteris- Mini contract sizes vary from 20 percent (stock indices) to
tics of futures. The Article explains basic principles, highlights
50 percent (crude oil and some metals) of full contract size,
key trading concepts and helps minimize the risks of trading
in this arena. with margin proportionally smaller. For example, one full point
(1.00) of the E-Mini S&P 500 contract represents $50, com-
“Market mechanics”
pared to $250 for the full-sized S&P 500 futures contract, and
Active Trader, November 2002.
Article highlights the unique properties of futures and the the E-Mini’s $4,500 per contract margin is one-fifth the full
mechanics of futures contracts that will allow you to focus contract’s $22,000 margin.
on strategy instead of things like rollover and price limits.
“Futures contracts and rollover” Trends in minis
Futures & Options Trader, April 2007. Interest in mini futures contracts doesn’t appear to be waning.
From a strategic perspective, there’s really no difference Three-quarters of the contracts in Table 1 increased their average
between stock and futures. Generally, the same approach daily volume from January 2007 to January 2008, although the
used to exploit trading opportunities in stocks can be most popular markets continue to be the stock indices.
applied to futures, and vice versa. However, futures do have
characteristics that make trading them slightly different from They’re not that mini
trading stocks.
Finally, despite their smaller contract sizes, trading mini
Note: Some of these articles are also part of the “Futures futures on minimum margin is still risky: The leverage you
Basics Collection,” a discounted article set packaged in a are employing when trading mini contracts is still very high
single PDF file.
compared to stock trading, for example. Make sure you fully
You can purchase and download past articles at understand the instrument you want to trade before putting
www.activetradermag.com/purchase_articles.htm money at risk.

TABLE 1: U.S.-TRADED MINI FUTURES CONTRACTS
Average daily volume
Contract Contract % of full Sample Tick size/ January January Initial Launch
Symbol Exchange size contract price value 2008 2007 Change margin* date
Stock indices:
E-Mini $50* 0.25/ Sept.
S&P 500 ES CME index 20% 1,355.75 $12.50 2,631,279 1,030,104 155% $4,500 1997
E-Mini $20* 0.25/ June
NASDAQ 100 NQ CME index 20% 1,781.00 $5.00 552,590 339,124 63% $3,250 1999
E-Mini $100* 0.10/ Oct.
Russell 2000 ER2 CME index 20% 694.90 $10.00 318,766 167,592 90% $5,250 2001
E-Mini $50* 0.10/ March
MSCI EAFE EFE CME index 2,043.60 $5.00 892 132 576% $6,250 2006
E-Mini MSCI $50* 0.10/ Oct.
Emerging Markets EMI CME index 1,159.20 $5.00 324 N/A N/A $4,688 2007
E-Mini S&P $100* 0.10/ Jan.
MidCap 400 EMD CME index 20% 801.30 $10.00 34,654 18,792 84% $4,000 2002
E-Mini S&P $100* 0.10/ July
SmallCap 600 SMC CME index 20% 368.50 $10.00 397 N/A N/A $2,250 2007
Mini-sized $5* 1/ April
Dow YM CME index 20% 12,395 $5.00 224,229 107,702 108% $3,125 2002
NYBOT Russell $100* .05/ May
1000 Index Mini RF ICE index 739.00 $5.00 610 N/A N/A $2,600 2007
NYBOT Russell $100* .10/ Aug.
2000 Index Mini TF ICE index 694.90 $10.00 324 N/A N/A $3,000 2007
Currencies:
E-Mini 62,500 0.0001/ Oct.
Euro FX E7 CME Euros 50% 1.4805 $6.25 1,597 1,696 -6% $1,418 1999
E-Mini 6,250,000 0.000001/ Oct.
Japanese yen J7 CME yen 50% 9,294 $6.25 112 25 348% $1,350 1999
Eurodollar 5-Year 0.0025/ Oct.
E-Mini Bundle E5B CME $100,000 10% 96.0838 $12.50 4 11 -64% $1,485 2006
Energy:
miNY Light 500 2.5¢/ June
Sweet crude oil QM NYMEX barrels 50% 98.230 $12.50 17,496 39,743 -56% $3,544 2002
miNY 2,500 million .005/ June
natural gas QG NYMEX mmBtu 25% 8.891 $12.50 4,577 12,061 -62% $1,688 2002
miNY gasoline 21,000 1¢/ Jan.
RBOB QU NYMEX gallons 50% 2.5220 $21.00 5 1 400% $4,050 2006
miNY 21,000 1¢/ Jan.
heating oil QH NYMEX gallons 50% 2.7381 $21.00 6 293 -98% $3,375 2006
Metals:
Mini-sized 33.2 10¢/ Oct.
gold YG CME troy oz. 33% 937.5 $3.32 9,218 5,959 55% $1,121 2001
Mini-sized 1,000 $.001/ Oct.
silver YI CME troy oz 20% 18.077 $1.00 2,507 1,558 61% $812 2001
miNY 50 $0.25/ Dec.
gold QO NYMEX troy oz. 50% 944.50 $12.50 58 38 53% $2,363 2006
miNY 2,500 $0.0125/ Dec.
silver QI NYMEX troy oz. 50% 18.035 $31.25 35 14 150% $3,038 2006
miNY 12,500 $0.0020/ Dec.
copper QC NYMEX lbs. 50% 3.7980 $25.00 30 20 50% $3,882 2006
Grains:
Mini-sized 1,000 1/8¢/ April
corn YC CME bushels 20% $5.22.2 $1.25 675 768 -12% $270 2003
Mini-sized 1,000 1/8¢/ April
soybean YK CME bushels 20% $14.20 $1.25 2,309 2,158 7% $594 2003
Mini-sized 1,000 1/¢/ April
wheat YW CME bushels 20% $10.49.4 $1.25 343 220 56% $810 2003
*As of Feb. 25, 2008

TRADING Resources
NEW PRODUCTS & SERVICES

ATC Analytics, LLC has released NexTrend version 7.0. The all- also doubles the number of technical studies and line tools avail-
inclusive software, available starting at $9.95 per month, pro- able. In addition, many new add-ons are available, including
vides traders of every level with information and tools needed to Option Chains, Market Depth, Premium News as well as
make informed decisions. NexTrend is a full-featured, down- QuoTrek, a mobile product that brings real-time quotes, charts,
loadable multi-tasking program. The software, username, and and news to BlackBerries, smartphones, and other handheld
password can be used anywhere in the world. NexTrend offers devices. Full product information is available at
online stock quotes, scanning, real-time news, alarms, and histo- www.LiveCharts.com.
ry for domestic and international securities. More information
about ATC Analytics and its products can be found at www.nex- DiscoverOptions provides options education and resources to
trend.com. help traders find opportunities in all market conditions, includ-
ing bearish markets. The DiscoverOptions Education Center
The Commodity Futures Trading Commission (CFTC) has (www.DiscoverOptions.com) provides articles, lessons, Web
approved trading in additional Eurex products for the U.S. mar- casts, and other content for all levels of options traders.
ket effective immediately. The approval comprises the futures on DiscoverOptions provides a clearer understanding of how using
the Dow Jones STOXX Large 200 Index and Dow Jones STOXX options can help minimize risk, generate additional income, and
Small 200 Index as well as six Dow Jones STOXX 600 sector allow traders to profit under virtually any market condition. The
indices. These newly available futures enable U.S. customers to DiscoverOptions Personal Mentoring Program’s curriculum is
trade specific segments and sectors of the European stock uni- taught by options professionals who work with students one-on-
verse represented by the DJ STOXX 600 Index. Eurex launched one, showing them how to identify profitable trades in variable
futures on the two DJ STOXX size indices on July 23. These markets using proven back-tested strategies.
futures on the DJ STOXX Large 200 Index and DJ STOXX Small
200 Index supplement the futures available on the DJ STOXX Rosenthal Collins Group (RCG) has introduced a package of
Mid 200 Index, which was approved by the CFTC in 2007. The advanced Java-based interactive charts from Barchart.com on its
DJ STOXX 600 sector index futures cover the insurance, media, RCG Onyx 2 trading platform. The new service represents the
utilities, travel and leisure, personal and household goods, most advanced Java-based charting technology that Barchart has
industrial goods, and services sectors and complement the bank- offered to date. The charting, available on the Internet both
ing sector futures, which are already available to U.S. customers. through the RCG Onyx 2 trading platform and RCG Onyx Web,
More information is available at http://deutsche-boerse.com. the online account management tool, includes real-time and his-
torical price and volume information for the major futures
FXCM’s No Dealing Desk trading platform recently added an exchanges in North America. It provides multiple interactive
additional bank as a price provider, bringing the total to seven charting types, including bar charts, candlestick charts, and
global banks that compete to provide pricing for FXCM’s dozens of technical studies. Users can view charts for multiple
Trading Station. Over the last three months, typical spreads have commodities at a time and can customize them by designating
already tightened. For a complete list of currency pairs and their time periods analyzed and trading styles. RCG and Barchart are
new tighter spreads, go to www.fxcm.com. offering “continuation” charts for futures contracts, enabling
users to capture the “roll” when contracts expire and to select
eSignal has upgraded its LiveCharts product. LiveCharts offers charts based on daily, weekly, or monthly activity. More informa-
users Web 2.0 functionality via eSignal’s social networking site tion can be found at www.rcgdirect.com.
and also links with Quote.com. Running entirely on eSignal’s
data network, LiveCharts is powered by PlusFeed data, a low Saxo Bank (www.saxobank.com) now offers FX options to pri-
latency, consolidated data feed service from Interactive Data vate investors in the U.S. after its success in Europe and Asia.
Real-Time Services. LiveCharts is a java-based application that Saxo Bank was the first forex options trading provider to offer
integrates streaming charts, portfolios, and real-time news on options trading for 31 major forex crosses directly on live
any Web browser. This upgrade includes a new, customizable streaming prices without dealer intervention to private investors.
modular interface, major international stock exchanges, and the Options can be quoted with one-day to one-year expiries, as
popular currency spot market, in addition to data for major U.S. well as zero to 100 deltas.
stocks, options, and futures markets. This LiveCharts upgrade

BOOKSHELF
Mastering Trading Stress: Strategies for Technical Analysis Tools: Creating a
Maximizing Performance Profitable Trading System
By Ari Kiev By Mark Tinghino
Wiley, 2008 Bloomberg Press, 2008
Hardcover, 224 pages Hardcover, 295 pages
$49.95 $39.95
Trading can be emotionally and psycho- Instead of relying on a single indica-

logically taxing. As markets grow increas- tor, most traders use many technical
ingly complex and volatile, so do the analysis instruments. In this book,
stresses involved in trading them. In this Mark Tinghino discusses several technical approaches and
book, psychiatrist Ari Kiev discusses where this stress comes explains how to create a profitable system. He covers the rela-
from, how it affects traders, and how to reduce it. Real-life tionship between fundamental and technical analysis, how to
traders provide examples of how they manage stress, enhance time buying and selling, and how to use spreads to manage risk.
performance, and improve profitability.
The ART of Trading: Combining the Science
Winning with Options: The Smart Way to of Technical Analysis with the Art of
Manage Portfolio Risk and Maximize Profit Reality-Based Trading
By Michael C. Thomsett By Bennett A. McDowell
AMACOM, 2008 Wiley, 2008
Paperback, 248 pages Hardcover w/ DVD, 320 pages
$19.95 $70.00
Geared toward the average trader, this This multimedia package discusses the
book describes options as a smart and Applied Reality Trading (ART) and
practical way to protect and enhance a includes ART trading software. It
portfolio. The book introduces readers to many aspects of option explains how to ignore others’ opinions and suggestions and
trading and offers strategies to help manage risk and turn a prof- develop a system that aligns with your personality. Whether
it through basic concepts and real-life examples. enhancing a fundamental approach or creating a purely technical
one, this book attempts to provide all the tools traders need.
Beating the Market, 3 Months at a Time:
A Proven Investing Plan Everyone Can Use The Rookie’s Guide to Options:
By Gerald Appel & Marvin Appel The Beginner’s Handbook of Trading
FT Press, 2008 Equity Options
Hardcover, 218 pages By Mark D. Wolfinger
$24.99 W&A, 2008
Hardcover, 232 pages
Rather than handing your hard-earned $34.95
cash over to a professional investment
manager, this book claims that by spend- In his book, Mark D. Wolfinger
ing only one hour every three months you can take matters into explains how options work and how
your own hands, using the authors’ recommendations and sim- you can employ them to earn profits and manage risk. Aimed at
ple investment techniques. These father-and-son investment the novice investor, it offers step-by-step instructions on option
advisors offer advice on portfolio construction, increasing invest- systems from basic techniques to more complicated strategies
ment safety, improving rates, and identifying strong market sec- such as iron condors and double diagonals. He explains when
tors. They demonstrate how to quickly evaluate, adjust, and different strategies should be used depending on the situation
optimize performance. and objectives.

TRADING Calendar May 2008
LEGEND
CPI: Consumer price index
1 • March personal income
ECI: Employment cost index • March construction spending
First delivery day (FDD): The first • April ISM business report
day on which delivery of a commodity
in fulfillment of a futures contract can
take place. 2 • April unemployment
First notice day (FND): Also known • March factory orders

as first intent day, this is the first day
on which a clearinghouse can give
notice to a buyer of a futures contract 3
that it intends to deliver a commodity
in fulfillment of a futures contract. The
clearinghouse also informs the seller. 4
FOMC: Federal Open Market
Committee 5 • April ISM non-business report
GDP: Gross domestic product

6
ISM: Institute for Supply Management
Last trading day (LTD): The final 7 • Q2 productivity and costs (prelim)
day trading can take place in a futures
or options contract.
• March consumer credit
PPI: Producer price index

8 • March wholesale inventories
PMI: Purchasing managers index
9 • March trade balance
Quadruple witching Friday: A day
where equity options, equity futures,
index options, and index futures all 10
expire.
11
CBOT: Chicago Board of Trade
CME: Chicago Mercantile Exchange 12 • April federal budget
NYMEX: New York Mercantile

Exchange 13 • March business inventories
• April retail sales
14 • April CPI
S M T W T F S
15 • April production and capacity utilization
28 28 29 30 1 2 3
• May Philadelphia Fed survey
4 5 6 7 8 9 10
• LTD: June crude oil options (NYMEX)
11 12 13 14 15 16 17
18 19 20 21 22 23 24 16 • May University of Michigan consumer sentiment index (prelim)

25 26 27 28 29 30 31 • April housing starts
• LTD: All May equity and index options

Economic Release
release time (ET)
GDP 8:30 a.m.
CPI 8:30 a.m.

17
ECI 8:30 a.m.
18 PPI 8:30 a.m.
Productivity and costs 8:30 a.m.

19 • April leading indicators
Employment 8:30 a.m.
Personal income 8:30 a.m.

20 • April PPI
Business inventories 8:30 a.m.
• April Chicago Fed national activity index
Durable goods 8:30 a.m.
• LTD: June crude oil futures (NYMEX)
Retail sales 8:30 a.m.
21 Trade balance 8:30 a.m.
Housing starts 8:30 a.m.

22 Production
& capacity utilization 9:15 a.m.
23 • April existing home sales
Leading indicators 10 a.m.
• LTD: June T-bond futures (CBOT)
Consumer confidence 10 a.m.
24 Univ. of Michigan
consumer sentiment 10 a.m.
25 Wholesale inventories 10 a.m.
Philadelphia Fed survey 10 a.m.

26 • Markets closed — Memorial Day
Existing home sales 10 a.m.
Construction spending 10 a.m.

27 • May consumer confidence
Chicago PMI report 10 a.m.
• April new home sales
ISM report on business 10 a.m.
• LTD: June gold options (NYMEX)
ISM non-manufacturing report
28 • April durable goods on business 10 a.m.
• LTD: May gold futures (NYMEX) New home sales 10 a.m.
Chicago Fed
29 • Q1 GDP (prelim) national activity index 10 a.m.
Factory orders 10 a.m.

30 • May University of Michigan consumer sentiment index (final)
Federal budget 2 p.m.
• April personal income
Consumer credit 3 p.m.
• May Chicago PMI
The information on this page is subject to
Note: For expiration dates of commodity futures and options, as well as first change. Active Trader is not responsible
notice and first delivery dates, see the calendar in Futures & Options Trader magazine for the accuracy of calendar dates beyond
(www.futuresandoptionstrader.com). press time.

Key CONCEPTS
3-10 oscillator: The difference between a three-day simple mov- The indicator is similar in concept to the moving average enve-
ing average and a 10-day simple moving average, plus a second lope, with an important difference: While moving average
line which is a 16-period simple moving average of the 3-10 envelopes plot lines a fixed percentage above and below the average
line. In “Trader toolbox” (Active Trader, March 2004) trader (typically three percent above and below a 21-day simple moving
Linda Raschke said, “On a chart, I usually just alter the settings average), Bollinger Bands use standard deviation to determine how
for the MACD, changing the moving average type from expo- far above and below the moving average the lines are placed. As a
nential to simple and the moving average lengths to 3, 10 and result, while the upper and lower lines of a moving average enve-
16.” lope move in tandem, Bollinger Bands expand during periods of
rising market volatility and contract during periods of decreasing
Advance-Decline line: A breadth indicator that measures aspects of market volatility.
supply and demand not always reflected directly in price. The Bollinger Bands were created by John Bollinger, CFA, CMT,
indicator is a day-to-day running total of the number of stocks the president and founder of Bollinger Capital Management (see
that have closed higher on the day (advancing) minus the num- Active Trader, April 2003, p. 60). By default, the upper and
ber of stocks that have closed lower on the day (declining). A lower Bollinger Bands are placed two standard deviations above
version using the week-to-week figures can also be used as a and below a 20-period simple moving average.
longer-term indicator.
The most commonly referenced A-D line is the one calculated Upper band = 20-period simple moving average + 2
on New York Stock Exchange (NYSE) stocks, but the indicator standard deviations
can be calculated on any index or exchange. Middle line = 20-period simple moving average of
Calculation closing prices
A-D line = [AS(today) – DS(today)] + AD(prev) Lower band = 20-period simple moving average - 2
standard deviations
where
AS(today) = the number of advancing stocks (those that Bollinger Bands highlight when price has become high or low
closed higher than the previous day’s close) on a relative basis, which is signaled through the touch (or
DS(today) = the number of declining stocks (those that minor penetration) of the upper or lower line.
closed lower than the previous day’s close) However, Bollinger stresses that price touching the lower or
AD(prev) = previous day’s A-D line value upper band does not constitute an automatic buy or sell signal.
For example, a close (or multiple closes) above the upper band
That is, add the difference between the number of advancing or below the lower band reflects stronger upside or downside
stocks and declining stocks today to yesterday’s A-D number, momentum that is more likely to be a breakout (or trend) sig-
which is the running total of all previous days. A nominal value nal, rather than a reversal signal. Accordingly, Bollinger suggests
is often used to begin the A-D calculation. using the bands in conjunction with other trading tools that can
supply context and signal confirmation.
Bollinger Bands: Bollinger Bands are a type of trading “envelope”
consisting of lines plotted above and below a moving average, Donchian breakout (channel breakout, breakout system,
which are designed to capture a market’s typical price fluctua- n-bar breakout): Named after the man who popularized the
tions. continued on p. 63

Key concepts continued
approach, Richard Donchian, this approach refers to buying a days ago) or (Ptoday – Pn days ago)/Pn days ago. Except for
price move above an n-bar (n-day, n-week, or n-minute, etc.) scaling, the resulting momentum and ROC indicators are the
high and selling on a move below a n-bar low. Donchian’s origi- same; momentum simply expresses price change as the differ-
nal “system” was called the “four-week rule” and consisted of ence between two prices, while ROC expresses price change as a
buying and selling moves above and below the four-week high percentage or ratio.
and low, respectively.
Pure breakout systems are often designed in stop-and-reverse Moving average convergence-divergence (MACD): Although it is often
(SAR) fashion: when a buy signal occurs, any existing short grouped with oscillators, the MACD is more of an intermediate-
position is liquidated and a new long position is simultaneously term trend indicator (although it can reflect overbought and
established; when a sell signal occurs, the long position is liqui- oversold conditions).
dated and a new short position is established. Thus, the system The default MACD line (which can also be plotted as a his-
is always in the market. togram, as is the case in the accompanying article) is created by
One basic variation is whether a trade is triggered by a simple subtracting a 26-period exponential moving average (EMA) of
penetration of the n-bar high or low or by a close above an n- closing prices from a 12-period EMA of closing prices; a nine-
bar high or below an n-bar low. period EMA is then applied to the MACD line to create a “signal
line.”
Momentum (or “price momentum”): A generic term used to describe MACD = EMA(C,12)-EMA(C,26)
the rate at which price changes as well the name of a specific Signal line = EMA(MACD,9)
calculation. Rate of change (ROC) is simply an alternate version of
this basic indicator. The implications and interpretations of On balance volume (OBV): A running sum of daily market volume
these two studies are identical. weighted by whether the market closes up or down for the day.
Momentum/ROC are similar to oscillators, such as the relative Joe Granville introduced the indicator in his book New Strategy
strength index (RSI) and stochastics, in that they are generally of Daily Stock Market Timing for Maximum Profits.
intended to highlight shorter-term price momentum extremes To get the current OBV reading, today’s volume is added to or
(overbought or oversold points). subtracted from the previous OBV reading based on whether the
The most common calculation for momentum is simply market closes up, down or unchanged on the day. The formulas
today’s price (typically the closing price) minus the price n days are:
ago:
If today closed higher than yesterday:
(Ptoday – Pn days ago). yesterday’s OBV + today’s volume
The most basic ROC formula is today’s price divided by the If today closed lower than yesterday:
price n days ago: yesterday’s OBV - today’s volume
(Ptoday/Pn days ago). If today closed unchanged from yesterday:

yesterday’s OBV
Alternate calculations for rate of change are 100*(Ptoday /Pn

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TRADE Diary
Reversing a pattern in gold pays dividends.
TRADE
Date: Monday, Feb. 25.
Entry: Long April 2008 mini gold futures

(YGJ08) at $933.90.
Reason(s) for trade/setup: Having topped

$900, robust gold trading has morphed into
something approaching public “gold fever” as
more ordinary investors read about the mar-
ket’s supposed inevitable rise to $1,000 —
and beyond.
Hype aside, what scant historical parallels
exist support the notion that gold is in a self-
Source for all charts: TradeStation
fulfilling prophecy mode that will propel it to the major
round-number price of $1,000. (After that, it’s anyone’s guess.)
“Futures Insight: Gold” (Active Trader, April 2008, p. 40) We got in on the third day of a correction after the Feb. 21
showed that gold has favorable odds of rising for the first two high (just below $960). Although the $933.90 entry price was
months after seven-month, 33-percent rallies, the most recent a little more than five points above the Feb. 25 low, it repre-
of which had concluded in January. The median closing gain in sented a nearly $25 (2.6-percent) correction from the Feb. 21
the first month was 5.75 percent; 7.96 percent for the second high. (Note: The trade was actually entered in the electronic
month. Extending this pattern would roughly forecast a $981 market before the open of the Feb. 26 day session.)
February close (the actual close turned out to be $975) and a
$1,001.87 March close. Initial stop: $922.90, which is $5.70 below the low of the entry
After paying the price for over-eager entries in the volatile day. Although from that perspective the stop is rather tight, it is
gold market (see the Trade Diary on p. 88 of the April issue of nonetheless $17 (1.8 percent) below the entry price.
Active Trader), this trade represented an attempt to get back on
the correct side of the market — i.e., waiting for price to pull Initial target: $984. The target was based on the prior
back and buying at a relative low price rather than going long upswing, from Feb. 13 to Feb. 21, which resulted in a low-to-
on a short-term upside breakout and hoping the move would high gain of nearly 60 points. Adding that amount to the entry
continue. day low created a target around $988.00.
Trade Summary
Initial Initial
Date Stock Entry stop target IRR Exit Date P/L LOP LOL Length
2/25/08 YGJ08 933.90 922.90 984.00 4.55 974.10 2/29/08 40.20 (4.3%) 44.50 -5.30 4 days
Legend — IRR: initial reward/risk ratio (initial target amount/initial stop amount). LOP: largest open profit (maximum available profit during lifetime of
trade). LOL: largest open loss (maximum potential loss during life of trade).

RESULT
Exit: 974.10
Profit/loss: +40.20 (4.3 percent).
Trade executed according to plan? No.
Outcome: Other than the early exit, the trade

was executed according to plan. The entry
timing was definitely better on this trade than
for our other recent gold trades; the market
closed nearly $14 above the entry price on
Feb. 26 and pretty much marched straight
upward for the next three days.
We did get out too early, though. On Feb. 29 the market lost Of course, the next day gold jumped as high as $993 and hit
some momentum intraday after topping above $978. After three $995 two days later. However, it subsequently retreated twice to
days of higher highs, lows, and closes and a nearly $50 gain around $960 (the first time, the day after it first reached $993).
from the Feb. 26 low to the Feb. 29 high, it seemed time to take It can be a challenge taking profits in a market making all-
money off the table and wait for a pullback before considering time highs because there are no existing reference points.
re-entering for another run at $1,000 — rather than risking Conservatively extrapolating from the market’s recent up moves
another one of this market’s dramatic corrections. (We don’t (other up swings had, in fact, been larger than the one we used
trust this market!) to estimate a target) is as viable an approach as any. However,
this trade is another example of the benefits of
taking partial profits. We could have exited part of
our position early and potentially enjoyed $20
more of profit on the remainder of the position.
Final note: As planned, we re-established a long
position around $5.00 below this trade’s exit
price.
For more coverage of the gold rally, see “Gold
express may lose steam above $1,000” on p. 49.
Note: Initial targets for trades are typically based on

things such as the historical performance of a price
pattern or trading system signal. However, individual
trades are a function of immediate market behavior;
initial price targets are flexible and are most often
used as points at which a portion of the trade is liqui-
dated to reduce the position’s open risk. As a result,
the initial (pre-trade) reward-risk ratios are conjec-
tural by nature.

TRADE Diary
Trade plan not followed to the

letter, but close enough.
TRADE
Date: Wednesday, Feb. 27, 2008.
Entry: Short March 2008 mini Dow futures

(YMH08) at 12,721.
Reason(s) for trade/setup: With price

approaching the implied chart resistance of
the Feb. 1 high and the market still in a
downtrend, we will look to go short on an
intraday up move.
The market jumped higher a little after
9:30 a.m. CT, and we went short after it
failed to quickly surpass the new 12,752
intraday high.
that has lasted more than n bars, after an up or down move of x
Initial stop: 12,774, which is 24 points above the session’s high. percent.)
The market eventually resolved itself to the downside and we
Initial target: 12,619, which is 5 points above the session’s low got out at what amounted to the third down thrust, lowering a
— we expect the market to at least test the day’s range. Take stop order along the way. We exited the position early, and in its
profits on partial position and lower stop. entirety, because we decided the initial target was too aggressive:
The market had fallen relatively far relatively fast (almost 100
RESULT points in less than an hour), and was also approaching possible
support around 12,640.
Exit: 12,657. We actually expected to re-enter on the short side after a
bounce, but the market kept rallying strongly enough to dis-
Profit/loss: +64 (0.5 percent). suade us.
Trade executed according to plan? No. Note: Initial targets for trades are typically based on things such as the histor-
ical performance of a price pattern or trading system signal. However, indi-
vidual trades are a function of immediate market behavior; initial price tar-
Outcome: The market moved sideways to slightly higher for gets are flexible and are most often used as points at which a portion of the
more than two hours after the entry. (It might be interesting to trade is liquidated to reduce the position’s open risk. As a result, the initial
test the odds of a move in either direction out of a consolidation (pre-trade) reward-risk ratios are conjectural by nature.
Trade Summary
Initial Initial
Date Stock Entry stop target IRR Exit Date P/L LOP LOL Length
2/27/08 YMH08 12,721 12,774 12,619 1.9 12,657 2/27/08 64 (0.5%) +76 -41 3 hours
Legend — IRR: initial reward/risk ratio (initial target amount/initial stop amount). LOP: largest open profit (maximum available profit during
lifetime of trade). LOL: largest open loss (maximum potential loss during life of trade).

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DRAWDOWN VS. SYSTEM DEATH p.

$4.95 U.S. / CANADA

13 System death: When good systems go bad

Trading System Lab

1 www.activetradermag.com • May 2008 • ACTIVE TRADER

Contact Active Trader:

Inside the Market Trade Diary

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3 www.activetradermag.com • May 2008 • ACTIVE TRADER

For all subscriber services:

The information in Active Trader magazine is intended

4 www.activetradermag.com • May 2008 • ACTIVE TRADER

Diary of a hedge fund manager Oscillator coding

ACTIVE TRADER • May 2008 • www.activetradermag.com 5

Stocks: Status quo Gold fever: 1,000˚

ETF Sym +/-

iShares FTSE/Xinhua China 25 FXI -23.95%

6 www.activetradermag.com • May 2008 • ACTIVE TRADER

ACTIVE TRADER • May 2008 • www.activetradermag.com 7

Volatility hits grains

An aftertaste in coffee, sugar, and cocoa?

King cotton Exercise those options

8 www.activetradermag.com • May 2008 • ACTIVE TRADER

Night and day in stock index futures

BY ACTIVE TRADER STAFF

Night and day

9 www.activetradermag.com • May 2008 • ACTIVE TRADER

for stocks as well as pit-traded futures. The day session’s

Strength and weakness patterns

1. Large day sessions: If the day session’s range

is in the upper third of its range, the session is

ACTIVE TRADER • May 2008 • www.activetradermag.com 10

11 www.activetradermag.com • May 2008 • ACTIVE TRADER

ACTIVE TRADER • May 2008 • www.activetradermag.com 12

BY CHRISTIAN SMART, Ph.D.

N ot every trade can be a

Trade rules for

13 www.activetradermag.com • May 2008 • ACTIVE TRADER

4. Exit short on a stop when today’s

Money management: The system uses

ACTIVE TRADER • May 2008 • www.activetradermag.com 14

TABLE 1: BREAKOUT SYSTEM PERFORMANCE

15 www.activetradermag.com • May 2008 • ACTIVE TRADER

FIGURE 2: BREAKOUT SYSTEM — EQUITY AND DRAWDOWN CURVES

of press coverage. When any particular

ACTIVE TRADER • May 2008 • www.activetradermag.com 16

FIGURE 3: ANNUAL RETURNS

1. Enter long and exit short at the

2. Exit long and enter short at the next

This stop-and-reverse (SAR) system is

17 www.activetradermag.com • May 2008 • ACTIVE TRADER

TABLE 2: DUAL MA CROSSOVER SYSTEM PERFORMANCE

ACTIVE TRADER • May 2008 • www.activetradermag.com 18

lost 33 percent in Q2 2004.

Life after death?

19 www.activetradermag.com • May 2008 • ACTIVE TRADER

TIPS, treasuries, and insurance

they’re getting protection against inflation may

be disappointed by a comparison to regular treasuries.

T raders are bettors at heart, so

20 www.activetradermag.com • May 2008 • ACTIVE TRADER

treasuries and TIPS – the so-called

ACTIVE TRADER • May 2008 • www.activetradermag.com 21