Prediction Wizard

Some notes about the Daily  Regular Market Range.

Whenever  we start designing our market playing strategy,  one of the  input parameters will be  the Daily Regular Market Range or “DR”, especially if  we play the market on an intraday basis, being a day-trader.

So it worth  to take a look and  consider  at least some of the basic properties of the  DR.

What kind  of impact  can the DR have on our strategy?

As you can  see below, it  is  extremely important.

-          It can  play a role in the selection of  Asset Class that we are playing.

-          It might  impact whether we are playing the market during a certain period or not playing it at all, as the risk overweight the potential benefits of the game.

-          It can hugely  impact the yearly profit, that  we would like to achieve during a year.

We define the  Daily Regular Market Range  simply  as the following:

For other analysis we might also use the Daily Open or the Previous Daily Close in the denominator, but  the conclusions will be similar for our trading strategy design.

For the sake of simplicity we will look at the  S&P500  index and the Daily Regular Market Range in the index. For this I created the following chart about the  last  year, till the end of Feb 2013:

We can analyze the chart visually and we  can  make deeper analysis by  computer on the available data.

After the analysis  we can make a few  conclusions:

1.   The  Daily range  of the S&P500   has a cycle or even multiple cycles.  The smallest  cycle that is noticeable after careful analysis is a 4 - 5 days cycle.  Often local peaks present  every 4 - 5 days in the Daily range. Of course not with a Swiss clock precision, sometimes  it takes 8 - 10 days or even more  to form a local high in the daily range.

Some pro talk about   the rhythm of the market.  Yes it does have a rhythm.

2.   The other cycle that is noticeable  roughly  4- 5 weeks. 

3.   After a big range, the daily range of the next day is usually small, very often less than half of the previous day's range or even less than that.  This might be very important to select position  size the next day.  The probability of a small(er) range after a huge range is above 80 [%]

4.   The Average  Daily range was  about  1.46 [%]  for the past  50 years, but only  about 1.04  [%]  for the past 1 year. This is only  about two thirds of the long-term average daily range.  Finding the reasons for the decrease of the daily range might  reveal interesting internal specifics of this market.

5.   Local lows present in the Daily range cycle very often one or two days after a big range day.

6.   The fluctuations of the Daily Range is quite big,  so does its effect on our trading result.

One day  the Trading Range can easily be two three times the size of the Daily Range of the next trading day.

The distribution of the Daily Range in the S&P500 summarized in the following table:

What we can see from that is for example that  only  4.7 [%]   of the days  the Daily Range is greater than 2 [%]

More than 75 [%] of the time the  Daily Range is in the  0.5 – 1.5 [%]  range  and more than  50 [%] of the time the Daily Range is below   1 [%].

If  the potential impact  of the Daily Range is that big, how can we detect  a big or small Daily Range  early in the day?

We know that volume is  highly correlated with the Daily Range, We  also know that the 5- 10 Daiy VIX Average can also help a bit  estimating the  Daily Range that is ahead of us.

Another very important  professional  method is to know, the Average Volume  of our asset class 10, 15, 30, 45, 60, 120 minutes after the regular market open.

Bigger volume reinforces direction, so  in case of bigger volume, we have higher probability  for a trending day, but usually  we see the biggest volume  on major reversal days, when  the market  players go in with full  energy and  both  the Bulls and the Bears  exhaust themselves during the day.

A relatively good trader usually can  get no more than  50 [%]  of the Daily Range out of the market  consistently by playing it.

This means that  by  playing the S&P500  index, the trader can expect  to get  1.04 / 2 = 0.52 [%]  as gross profit  out of the market. For most players, the result  usually below that level.

The cost of the trade  can widely wary by broker  and by asset class.

It can be as small as 0.01 [%]  or even less investing  big amounts like hundreds of thousands of dollar in stocks or  it can be as big as 0.1 – 0.15 [%]  investing in  CFD-s, (Contract For Difference)  when the spread  of the buy and sell price is  automatically set to be 0.1 – 0.15 [%].

When the cost of the total trades  relative to the total net profit  is  bigger than 15 - 20 [%]  of the average gross profit than the  market participant  probably  only feeding the  hungry brokers  without real success or the margin of error is so small that  it causes additional  stress during market participation.

Small Daily Range might  push many intraday traders  toward  the more risky  leveraged  assets.  A really smart strategy helps  to  decrease the  impact of the big swings  in the Daily Range by selecting  position size  wisely.

I will write a bit more about that  later.