Commodity Traders Club NewsÔ "The Commodity Futures Trading Knowledge Network" Copyright© 1993-2005 by Commodity Traders Club News & Webtrading.com Volume 7 No. 3 - Issue 50 Click here to go to--> Webtrading.com Website Home Page

As The Wall Street Journal leads off in its editorial this morning, "Hardly a week passes these days without some regulator, federal or state, making a grab at controlling the Internet.

So it's good to be able to report that the Commodity Futures Trading Commission's (CFTC) latest attempt to carve out some turf from the cyber-world for itself came to naught yesterday in Washington courtroom of Judge Ricardo Urbina.”

Urbina's ruling: First Amendment free speech rights extend to the Internet and software.

This is great news for Institute For Justice (IJ) clients publishers of online content, websites, software, books, and newsletters designed to assist people in analyzing the commodity and futures markets, and consumers who subscribe to the sites, on-line services, and publications to find information and make their own decisions.

You may recall that our plaintiffs were threatened with five years of jail time, $500,000 in fines, and of course, unending harassment if they didn't cede to the federal government and subject themselves to fingerprinting, random audits and requirements that they share their subscriber lists with the agency -- each a criterion for the license the CFTC demanded.

In his decision, Federal Judge Ricardo Urbina pinpointed what's at stake "There comes a point, however, where government legislation crosses the line between the regulation of a profession and the regulation of speech.” That's unconstitutional and that's exactly what his 27-page opinion outlined.

It's also great news for the burgeoning high-tech industry and evolving media like software and the Internet. Urbina drew no distinctions between 1^st Amendment protections afforded to traditional media like books and newsletters and those afforded to new media like software and the Internet. 1^st Amendment is valid across the board.

This is key: The law on technology is being made right now and our case halted an alarming trend. The government argued that because of the interactive nature of software programs, websites and the Internet, these new media required a scrutiny and regulation to "protect the public." 

You might remember in Texas, a federal judge banned the sale of Quicken Family Lawyer software package to protect "the uninformed and unwary from overly simplistic legal advice."

Other states and federal agencies watched the outcome of that case and could have used it to require the licensing and regulation of software and online content in a wide variety of fields.

Traditional "guilds" like the attorney bar and medical establishment, as well as federal agencies like the Food and Drug Administration, the Securities and Exchange Commission, and others also have a strong interest in using that precedent to expand their regulatory authority to the Internet.

Investor's Business Daily ominously foreshadowed this noting, "Feds Target Financial Software, Can Regulators Outlaw Quicken and TurboTax?” and went on to warn "websites that offer medical information could be targeted next."

Our victory, however, could put a stop to that and starkly remove government as software and the Internet's gatekeeper.

Judge Urbina outlined his reasoning: (Citing Thomas vs. Collins) The very purpose of the First Amendment is to foreclose public authority from assuming a guardianship of the public mind through regulating the press, speech, and religion. In this field every person must be his own watchman for truth, because the forefathers did not trust any government to separate the true from the false for us … Very many are the interests which the state may protect against the practice of an occupation, very few are those it may assume to protect against the practice of propagandizing by speech or by press. These are thereby left great range of freedom."

He went on to note that in our case, "The CFTC is attempting to act as 'the watchman for truth, for the public" - an assertion the First Amendment flatly rejects, whether its form is books, newsletters, software or the Internet.

The CFTC has 30 days to appeal, and there's no word yet on what they will do. We'll keep you posted and in the meantime, thank you so very much for your support.

John K. Keppler, Managing Vice President Institute for Justice - phone: 202-955-1300 - Fax: 202-955-1329 - e-mail: JKeppler@ij.org website : http://www.ij.org

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"Book Review" - The Way To Trade: By John Piper Ashwin Joshi

In the last decade alone, the number of books on trading has multiplied significantly, including numerous technical titles, some focusing on the fundamentals and others purely on psychology. This is why The Way To Trade, published in the early part of this year, is like a breath of fresh air since it focuses on the end result all traders are after how to become a success at trading. The book's author, John Piper, trades full-time and also manages a small fund for clients at Berkeley Futures Ltd.

The most provocative premise of his book is "Yes, there is a holy grail to trading, and it is what you see when you look at the mirror." In this lucidly written 280-page hardback, he sets about teaching you how to discover your successful trading personality. There are many books, which expound on market analysis and technical analysis and even money management, but here you do get a feel that you are in dialog with a man who knows what it is like to be in the heat of trading battle.

The author’s main point is that the trader should feel free to arm himself with a wide array of technical tools and create the most fancy system; but the system is just like Michelangelo’s paintbrushes - essential, yet a relatively minor element of his success. It is developing the winning personality that is the key.

The book provides a framework - Trading Pyramid - to help traders understand the different aspects, which build trading success. It focuses trader’s attention to their own levels of competence at the different levels of the Pyramid. The aspects that contribute to trading success such as Money Management, Methodology, Risk Control, Psychology, etc., are all covered.

More importantly, book shows how readers may develop their strengths further and address their weaknesses. A questionnaire at the end of the book will certainly help traders acknowledge and confront their weaknesses. Indeed, I should point out that he is remarkably accessible (details of phone, Fax and e-mail provided in the book) responding promptly to the questionnaire I filled with useful and constructive comments.

His advice on what constitutes low risk and the importance of assuming a low risk stance is well worth reading. As part of a low risk strategy he says, "Trade at or enter at a price which is only briefly available," I was subconsciously aware of this, but it is nice to see it in print.

I would personally have appreciated a more scientific approach to the book, specifying details about the relationship between methodology, system, system parameters, etc. This perhaps would go against the spirit of the book, however, which is an easy going monologue with the reader. In Chapter 24 the author talks about Trading Systems with some good advice on how to make a fortune trading futures. He refers to nine systems in all, but only eight are explained. As for the ninth, we are simply told that he has sold the system and agreed not reveal the rules. For my money, I would like to have seen this space better occupied with what the author wants to reveal. Like most authors, this author has also succumbed to the temptation to advertise his other wares (e.g., newsletter, consultancy, trading systems, etc.).

The author’s personal journey outlined in 55 steps should bring a smile to the most discerning reader. Any reader whether at kindergarten stage or advanced will be able to relate to items in this list, e.g., "30. We are plagued with fear and have no clear methodology . . . 32. We start to look for a suitable methodology . . . 36. We realize that the key element in trading is our own mentality . . . 50. We begin to make money with consistency."

The message of this book is that there are no right or wrong ways to trade. It is a craft, and just like any craft you have to serve the apprenticeship. The book will assist you through your apprenticeship and help you discover your trading personality. The Way To Trade will prove a beneficial read, both for a hardened city trader or a novice groping to find his niche. Indeed it is a book, which needs to be read more than once as the trader carves his own trading path to success in the derivatives markets.

The Way To Trade by John Piper, 282pp, hardback, published by Financial Times Management. The book is available from the global-investor.com website and Amazon.com

Editor’s Note: CTCN and TradersAuction division is now an Affiliate of amazon.com - We would appreciate you ordering books using our link

http://www.amazon.com/exec/obidos/subst/home/home.html/002-8512896-9813811 or by clicking on the Amazon Banner located on the TradersAuction website  http://www.tradersauction.com/

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Wisdom - Right Under Our Noses and Far too Simple
L. from Wimauma

By George, I believe I've GOT IT! The "key” to Wisdom (i.e., the Truth) is to accept that mankind in its collective egotism and vain presumption has succeeded in making life much more complex than it really is. The answers are "right under our noses and are far too simple for most of us to admit!

Boy, is this true of commodities, health issues (my other passion), and any other aspect of life as well! Re: commodities: draw a horizontal line thru any active chart. Now tell me that you couldn't go "long" above it and “short" below it. Tell me that you couldn't decide to take a profit now and then.  Is that just too simple for us?

Having realized this truism years ago, I certainly count myself in your numbers. My personal“cop-out” was to continually look for the “perfect” PD (Pivot Day) or PR (Pivot Range). Even after I realized that prices had to do one of two patterns in order to reverse direction, I couldn't (or wouldn't) put it to―gether.

Pattern #1 - I call the "Classic:" (for a sell), prices exceed the Hi of Day 1 and close in Lower half of Day 2's Range. Sell Day 3 on Open with a stop just above Day 2's Hi. If Day 2’s low exceeded it becomes a Pivot Day and the Stop order becomes a Stop and Reverse (remember the horizontal line?) It's always neat to wait for a modest Range Day 2 to keep prospective risk low. It's also neater, if you're not reversing, to wait to see Day 3's open, so that if it gaps down your order becomes a Day 2's Lo - 1 Limit order.

Pattern # 2 Larry Williams calls "Scoops.” (For a sell), prices exceed the Hi of Day 1 in half of Day 2's range. Sell Day 3 one tick below Day 2’s Lo making Day 2 the Pivot day. PD means the same Stop - Reverse above its Hi. The same “wait and see" trick as above will work again on new orders, just in case. This is going to be too simple for most readers, so you can "spice” up your trading (and your losses) by continually moving the PD as per these same rules.

And further, here's a filter that's working for me. How often have we tried to predict direction changes with lagging indicators? It's sort of like pushing a cart with a rope. Ask your―self what is the first chart indication of a possible trend change. Voila! Taking out the Lo of a day in an up-trend may be the first alert. Make that day a PD and you "almost can't lose!” Instead of building a strategy on what should happen, build it on what shouldn't happen! Here's that filter: for the “Scoops." I'll sell the only if the Sto 14 SloK line is rising (all vice versa for a buy, of course). I’ll keep the same PD until the Sto is falling because I'm still getting Sell alerts! The “Classic” ignores the Sto.

If you want to get simpler yet try this. With energies, cocoa, sugar, the Canadian Dollar, and just last Friday, probably copper seemingly bottomed and still cheap, I’ll do only Buys as per above and Stop out as above rather than reverse. With the grains also bottoming soon, with very few “misses,” I will be positioned in all of these markets if I’m willing to put my trades "in the drawer” and go to Bermuda. After all, most “misses” will re―covered by the opportunity to buy still cheaper. It doesn’t get any simpler than that!

Space precludes anything more than "bare-bones” of this. But you sharpies out there must adapt these ideas to your own tastes anyhow. Just a word on the trend-friend analogy.

It's excellent except you don't know exactly when a friend actually becomes a friend nor do you know when he (or she) might stab you in the back. So much for the trend. A PD resolves that question right now!

And as usual, thanks to Dave for letting contributors "thrash” out their ideas in his venue. Good trading!

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e-Signal Difficulties - John Roche

I only recently found your site and wish I had a month ago. I have had problems with Signal. I wasn't sure if it was Signal or my Internet provider. I just assumed it was my provider because I have had problems with them before.

Here is what happened: I was trading the e-mini S&P. I put in an order to buy at the market over my broker’s electronic trading desk (Jack Carl Futures). The price that I was filled at versus what my screen showed was way off. A trade, which should have made me $600, cost me $300.

I complained to Jack Carl Futures, the broker, but they insisted on the price I was filled at. I had the CME Fax the time and sales data for the time in question and sure enough my data was inaccurate. It turns out that the data on my screen was almost 5-minutes old!

I wrote letters to both Signal and my ISP. All Signal was willing to offer me was a credit for the one day’s trading. I pay almost $300/month for a live feed and they were offering me $10! I argued that the service was for (real-time data) live-feed and they failed to deliver, but to no avail.

My question: What can I do? Internet data feed is the most cost effective. What are my other options? Would a cable modem help? If I am having difficulty getting filled and I pay for quotes, what is happening to people that are trading stocks on-line with Ameritrade and E-Trade?

Editor’s Note: I am not sure a Cable Modem would help. It very well could be a delay by Signal in transmitting or a broken telephone connection. Likely, it was not a delay caused by a slower Modem. A delay would likely be very slight, a fraction of a second or a few seconds at most.

At this time, we are using PC Quote’s Omega HyperFeed real-time market data. It has been unbelievably lengthy and difficult to set up and get working properly! I encountered many bugs getting it working reasonably well, took over 3-months since we signed-up in May.

Even now (mid-August), there are still some problems such as if for some reason you go offline, such as a the ISP telephone connection breaking, frequently the only way to get the data feed and TradeStation chart working again is to shut down everything and reboot the computer.

Perhaps you could call Rita Karpel at ZAP Futures in Chicago (800)257-6842 x 1852 and ask her what she recommends. You should also consider trading there.

ZAP Futures offer so-called "instant fills" and CTCN's feedback on them has been very good overall. Be sure to mention you were referred by CTCN to qualify for Special Offers and a discounted commission rate. ZAP Futures is CTCN’s “Recommended Broker.”

By the way, there is lots of free daytrading knowledge located on our Real Success website http://www.traders.org - Check it out! We are working on an updated edition to the tapescurrently offered. Also, a new Trader Training Service will be available soon. Visit our sister website for more details: http://www.traders.org

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Market Symmetry - Rick J. Ratchford

There are several books on the subject of Cycles, Geometry, Formations and so-forth that relate to the markets. All these fall under what is called Market Symmetry.

The markets follow a natural order or law. Nothing in the universe can escape the laws that surround us. Plants, animals, people & geography all play to tunes of the natural sound track.

Since so much has been written on this subject, I'm not going to get into detail as to how each are affected by the laws of nature. What I'm going to deal with in this article is simply the symmetry found in the markets and how they can be useful in determining a trade.

Market geometry flys in the face of random market action. There are some who believe that the movements you see on the price charts are the result of random action. However, enough information is available for the astute reader to come to the realization that the patterns you see on a price chart simply could not happen randomly. The ratios within the patterns are mathematically related to each other to form geometric shapes, which upon discovery can lead you to locating major market turns.

I recommend for those new to this subject to consider the study of Fibonacci. As a beginning trader back in the summer of 1990, just prior to the Desert Storm war, the markets appeared to be a jumbled mess of lines moving up and down without any clues of where it might go next.

Indicators such as Stochastics were brought to my attention, and I soon discovered how easy it was to lose a few thousand to something that lagged market action. It was early 1991 when I learned about Fibonacci, and that jumbled mess didn't look so jumbled to me anymore.

There are many traders who like to look for 50% retracements, or for support and resistance by noting previous support and resistance that formed those market tops and bottoms. The reason this actually works to some degree is because those fall into a geometric pattern.

When you bought your first book on market analysis, what were you quickly introduced to? That's right, triangle patterns, flag patterns, rounded bottoms and tops, channels, etc. What do you think those are? Triangles, squares, circles and rectangles. Right?

You are being taught to recognize the shapes of these geometric patterns without being given a reason why they form, or how you can determine where one will start and another will end. The only clue you are given is to watch for a “break-out.”

In going back to the subject of Fibonacci, there are a few geometric ratios I would like to share with you now. Those would be the following (.382) (.618) (.786) (1.00) (1.272)(1.618)

These are just some of the related ratios of Market Geometry. I'll briefly demonstrate how they are related.

First off, 1.618 is called the Golden Mean. It appears in the growth patterns of plants, the human body, seashells and many other things found in nature. Even the planets follow a pattern based on the Golden Mean. For example, for every time the earth orbits’ the sun, Venus orbits the sun 1.618 times. The relationship between Venus and the Earth is 1.618:1.00.

(.618) is the reciprocal of 1.618
(1.272) is the square root of 1.618
(.786) is the square root of (.618)
(.382) is (.618) squared

If you take a right triangle with a base of 1.00 and a right side of 1.272, the hypotenuse of that right triangle would equal 1.618. Also, if you take a right triangle with a base of (.618) and a right side of (.786), the hypotenuse would equal 1.00.

So now you can see how they are all related.

Now it would be very difficult to go into every ratio, and all the applications there are in using them. I can however encourage you to buy all the books on the subject if you so desire to learn this fascinating field of market study. But for now, let us consider a real life example using the daily June 99 Bonds chart (all values are in decimal to make the math easier.)

On January 11, 1999 a low was formed at 123.53. The next major top was on January 28th at 127.69.   By taking the range of this climb, we can derive expanding support and resistance levels using those ratios shown in this article.

The top refers to January 28, 1999. The bottom refers to January 11, 1999.

(1.00) ratio from the top provided us with the reversal bottom on February 8th (.382) from the bottom provided the support for Feb 12th. (1.00) from the bottom provided the March 4th bottom. (.272) from the bottom provided the top on March 17th. (1.00) from the top provided resistance to form the top of April 9th. (.272) from the bottom provided the resistance that formed the double top on April 21st and April 30th. (.786) from the bottom provided the support to form the April 26th, bottom. (1.382) from the bottom provided the support for the recent May 12th bottom.

Coincidence? Random? You decide. But to this market analyst, this is purely market symmetry.

Now, I'm going to use market geometry to determine the likely bottom in the T-Bond market, which has yet to happen. On May 16, 1999 and the current bottom in the T-Bond market is 116.90 made last Friday.

I'm going to use this time the weekly charts because I'm expecting a weekly bottom to occur during week ending 5/21. This is based on a geometric mathematical algorithm that I use to help determine weekly and daily reversal dates called Wdates and Fdates. The algorithm is not available to the public, although the dates are.

On the weekly charts, note the weekly top made week ending April 9th. The previous major weekly bottom was made week ending March 5th. And most recent weekly bottom was made a week earlier from the top, during week ending April 2nd.

The range from the April 9th top to the March 5th bottom is 4.31.   (.618) of that is 2.66. Expand 2.66 downwards from the March 5th bottom and we arrive at 116.62 or 116:20 in 32nds. (T-Bonds are quoted in 32nds.)

Now, take the range from the April 9th top to the April 2nd bottom and we get 3.908. (.786) of that is 3.07.   Expand down from the April 2nd bottom and we arrive at 116.62 or 116:20 in 32nds.

Do I have your attention now?

But here is something else. If you take those same two ranges and expand them out (.786) and (1.00) respectively, they both intersect around the 115:25 to 116:00 area. And to further this geometric picture, if you take the bottom made week ending November 6, 1998 and draw a trend line from there underneath the March 5, 1999 bottom and into the future, it intersects the 115:25 - 116:00 price area for week ending 5/21. That happens to be the same week we are expecting a weekly bottom to occur based on our date algorithm.

And since we are still on this chart, if you take the top made week ending December 11, 1998 to the November 6th bottom and expand it out by (1.382) from the bottom, we again arrive at the 115:25 - 116:00 support area. And if we take this same range and expand down from the bottom by (.786), we get the support price that formed the March 5th bottom!

Okay, I think you get the picture by now. Nothing random about any of this. Purely a mathematical way of exposing the geometric picture of the markets. We have discovered that major and minor market tops and bottoms are related to each other in some geometric form, which may not be clearly visible to the eye (geometric shapes are actually 3 dimensional, whereas the charts are only 2 dimensions). Try to visualize the market forming a cube on a 2 dimensional chart. Get the picture?  However, by simply exposing the ratio relationship of previous market action, we can determine probable market behavior to a point. As traders, we deal with probability. This is certainly not the Holy Grail by any measure.

Some may ask why would I share such information. Isn't there the chance that it could affect future market behavior?

There are a few reasons why I do not believe this will happen.

This is nothing new. I'm sharing things I've learned from other sources that are available to the public.

You could actually expose the Holy Grail system to every trader and most will not do anything with it.  Some because of a level of skepticism, others because they do not wish to do the work.

These geometric patterns occur due to natural laws. Nothing we do will ever change that.

Take the time and work these out on some of your other price charts. See if you can note the mathematical geometric relationship within the patterns. Some markets will show different types of ratio patterns as opposed to other markets. Get to know your market. As you see, the T-Bond chart is one that I've found to have a nice symmetry to it.

So the next time someone tells you the markets are random, simply hand them some darts and wish them a good day.

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The Secrets of Slippage and Fibonacci Price Analysis for Placing Stops
Barry Rosen

How many times have you placed your stop at a key Fibonacci retracement target and gotten hit by the locals and stopped out? With everyone using Fibonacci numbers, you have to be one step ahead to win the race. Here are some tips.

Fibonacci numbers work because crowds - including crowds of numbers - are dynamic systems that conform to mathematical laws. If you have ever been to Museum of Science & Industry in Chicago, you may have seen the machine there that sorts balls randomly into eight slots and at the end of the run, the balls form a bell curve.

Likewise, the Fibonacci numbers of .362, .500, .618, 1.618 and 2.168 etc., create important, predictable price values - even in the wild chaos of 400,000 T-Bond contracts traded daily in the pits.

A bull market is likely to have a minimum retracement of .236 or .382, and if you are looking to get in an entry from the top that will get you filled, then a safe, tight stop may be the only slippage factor below the 38% retracement.

Knowing Elliott Wave principles can also aid in choosing proper stops. We recommend the basic Elliott Wave books to guide you in this area.

On double-tops and double-bottoms, locals will usually pick-off a stop 1 or 2 ticks above or below the market, but a real breakout or breakdown will be occurring if the market has slippage. While each market has its own behavior patterns, the following slippage numbers can keep you out of trouble and prevent the locals from gunning you down.

The following list shows the slippage factor for the most actively traded commodities:
S&P - .65
T-Bonds - 7 ticks
DM -       20 ticks
SF&Yen - 25 ticks
Gold -   $1.10
Silver -   2 cents
Copper - .60
Crude - 09
Beans - 5 cents
Corn - 2 cents
Wheat -  2.5 cents
Live cattle - .35 cents
Hogs -   .35 cents
Bellies - 55
Cocoa - .10
Sugar - .08
Coffee - .55

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Samarai? - l Don't Think So - Eric Lippert

I have been purchasing trading software from many vendors since 1986 and I have never had to question integrity of any of them until I dealt with a trading system vendor last October.

I had originally purchased their method several years ago. I hadn't used it in a while and when I tried to use it again last October , I found the password for the program had expired and I would have to call the company to get a new one.

Mr. W., the owner informed me the program was upgraded and it would cost me $499 to receive a new password and the obligatory upgrade. I balked about the price and Mr. W proceeded to give me a sales pitch that any used car salesman would have been proud of. 

I agreed after he said he would throw in the TradeStation module for free and would give a 30-day money back guarantee if I weren’t satisfied.

After I received the program and installed it, I tried to go through the copy protection procedure, which would provide me with a computer identification number, which then would be forwarded to IPTC, and a password based on the number would be given so I could use the program.

However, before I was able to generate my computer identification, I kept getting an error message and was unable to finish the copy protection procedure. I spent a week with Mr. W on the phone trying to solve the problem and we were unable to. The Omega Tradestation module also did not work. I then over-nighted the program back to him and purchased a competing candlestick program from his ex-partner, which works fine.

I waited three weeks for my refund. When I still hadn't received it, I called Mr. W and asked him when I would be receiving it. He stated that he never received the program and that until he did; it was against company policy to give refund until he received the program back. He then said if I would give him the tracking number, he would check with the Post Office and if they said they delivered it, he would send me my refund. Unfortunately, I had misplaced the Express Mail receipt and was not able to provide it.

Then in April, while cleaning behind my desk, I found the Express Mail receipt and called the Post Office and inquired about the status of the delivery.

They said it had been delivered the next day (October 26) at 2 PM. I called Mr. W and told him that I had found it and would Fax him a copy of it. He said he didn't have a Fax machine and to mail it. I wanted to overnight it so I would have proof of delivery, he would not give me his new residence address (he is using a post office box for mail) and to use his old address. 

I called back several days later and asked him if he received my overnight package and he said he hadn't -- I offered to give him the tracking number and the phone number of the Post Office and their website address so he could check it.

He said to call back when the office was open (this was at 9:30AM Pacific Time) and hung up on me. I have since called back several times and left messages for him to call me back and have not heard from him.

I find very ironic that someone who sells a program called the Samurai lacks honor and courage, which characterized the true Samurai, lacks honor and courage. He is also listed on an All-star Trader Hotline and occasionally gives seminars on trading. I don't think a trader who has to stoop to stealing from customers can be much of trader either and I would strongly recommend readers not to do business with him.

Editor’s Note: We received your article about the Vendor you are unhappy with. Due to the controversial nature of your letter and the fact you said he "steals," are grounds for a libel lawsuit against you and possibly CTCN. Therefore, we hesitate printing his name and need to contact him for his side of the story and ask about the facts involved. There are usually two sides to a story.

Also, CTCN recently moved and we are now using a PO Box ourselves (PO Box 1888, Sedona, AZ 86339). You mentioned in a negative sense that Mr. W uses a PO Box and would not give his home address.   This is actually quite common. Many Vendors use a PO Box or sometimes a street address, which looks like a real address, but frequently, is a place like Pak-Mail or Mail Boxes.   In addition to vendors, many individuals do this, as they don’t want to reveal their home address.

There is nothing wrong with a vendor not giving out his home address to the public. This is a weird business and there are always some angry people who sometimes threaten and do odd things when they are angry. For example, in the past we’ve been threatened by a Commodity Broker on the East Coast who said he was planning to come to Arizona and "kick my ass" (Over his default on paying CTCN fees he owed).

Also, we recently saw an Internet User Group posting about a Trading Product Vendor we know named Kent Calhoun of KCI Seminars.

The News Group Posting actually seemed to threaten Kent's life as the poster said he was going to find out where Kent lived so “he better watch where he is walking or he may get run down by his truck.” Some other members of the User Group also wanted Kent's home phone number so they seemingly could somehow harass him at home.

There was also similar threatening postings about other vendors, one of whom used extreme obscenities and seemed to threaten Larry Williams with harm.

This is a tough business, especially when you consider over 90% of traders lose their money. They are naturally hostile toward vendors who were involved in their losing trading, even if the vendor’s product was "good." They sometimes tend to blame the product vendor, either directly or indirectly

Do you think Presidents or Chairmen of the Boards of large Corporations like Ford or GM or IBM, etc., would reveal their home addresses to buyers of their products, of course not!

Per your suggestion we have also asked other club members for either positive or negative feedback on the vendor you are complaining about.

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The Other Side of the Story - He Earned 10-times the Cost of The Program, After Using it for 5-years! – Gary Wagner, IPTC

Dave, thank you for e-mailing me. Yes Eric Lippert and I have had a misunderstanding. He paid and received the program. After 2-months he asked for a refund without returning the product.

Please ask Eric how many years he used and loved the program. He wishes to slander me because I will not bend to his unrealistic demands of having the program and getting a refund. I asked him to provide documentation showing he sent the program back “he said he did not have it.”

Then 1-year later he said he had the document I asked for a year previously. Please note that we have 4000 happy end users, and we do honor our refund policy for any new purchase. We even honor it for exciting clients upgrading within 30-days.

But in Eric’s case two things raised flags. First he did not provide us with the product, and could not remit paperwork showing he returned it. Then a year later he wanted me to look at what he claims was the lost paperwork.

Second, he stated his return was not due to him being unhappy with the software, rather because he wished to buy it from my ex-partner offering a similar product.

Sir, in the spirit of free enterprise, I welcome him to choose between mine and my ex-partner’s software, and choose whichever program he wishes.  But I felt that he was trying to have his cake and eat it to, by asking for the program and a refund - all I asked was its return, which I never got.

Now he thinks by threatening to slander me, I will bend rather that act with honor and justly. I will not bend. Had he returned the program, he would have received a full refund.

BTW his last phone call was one in which he threatened to strong-arm me by showing up at my office with other friends of his. His actions lack honor and truth, I know I have acted fairly.

Lastly, I am most sorry for his bad feelings, however, I think the motivation is to cheat our firm, a far cry from his letter.

If you print his article, you act justly as the feeling of a very old and dear client, I feel bad that a client who himself told me that he has earned 10 times the cost of the program, after using it for 5-years would act as he had. In closing, to refund the money is no big deal. 

To act to please a client that we fell acts to dishonor his commitment to pay for a product he has used for 5-years, because he thinks that I will wield to a squeaky wheel just because it squeaks, I’ll oil the wheel, but not yield to threats.

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5-Ways to Make Money with Spread Trading vs. Only 2-Ways with Open Position Trading – Bob McGovern

Commodity futures spread trading is fast becoming a lost art among average traders. Most Account Executives (Commission Sales People) seem not able to comprehend or really want to be bothered with spreads, as open position trades normally generate commissions faster. With one eye on the Lexus in the parking lot and another on the alimony payment to ex-wife, the last thing the average salesman wants is a slow trading spread.

However, much can be said for spreads. Let's compare spreading advantages with open position trading.

In a naked long trade, the market has only one way to go to make money, and that is up. In a naked short position, to make money, the market must go down. Any other movement means a loss, even a "wash" trade, because commissions still have to be paid.

In an average spread, with one sidelong and the other side short, the market can produce a profit under the following conditions:

1. One side can move up and the other stay unchanged.

2. One side can move down and the other stay unchanged.

3. Both sides move up, but one side moves up more than the other.

4. Both sides move down, but one side moves down more than the other.

5. One side moves up and the other side moves down at the same time.

Most of the time, the margin requirements for spreads are much less than the margin requirements for outright long or short positions, and sometimes, because of the nature of the spread and the seasonal factors involved, certain spreads are marked-to-the-market, which means that margin is only required to makeup paper losses if they occur in the spread.

Spreads are a blessing when markets go lock-limit up or down in that you are able to exit if you wish. Naked longs cannot escape a lock-limit down market, as there are no bids. Naked shorts cannot exit a lock-limit up market since there are no offers. The relationship between the legs of the spread is the only factor considered by the floor when you're entering and exiting during lock-limit days, so the trade, though not necessarily the best fill in the world, can be done over wailing and gnashing of teeth of those caught in the trap!

When it is difficult to determine whether a particular market is changing trend, comparing the back month's price action with front month price action may be a good indicator of whether the market is a bull or bear market. Chances are if the back months are performing better than the front months, you are in a bear market. The reverse could indicate a bull market environment. Spreading action may be justified in such cases to the trader's benefit. It's amazing how few traders pay attention to this rather obvious and readily activity.

The basic knowledge of seasonal trends can give the spreader immense advantage at times. We know that Wheat is harvested in June and July. Corn is harvested in the Fall. Isn't it possible to determine with the help of charts to go long the last month of old crop Corn and Short the first month of new crop Wheat sometime in the spring to take advantage of this natural process? Of course, other factors may enter the picture, such as planting intentions, supply/demand, etc., but the simple knowledge of this spread possibility should be profitable each year.

Wouldn't it be a good idea to also look at the relationship between different months in the same crop to weigh carrying charge premiums? Much profit has been made in spreads that were at full carry by buying the front month and shorting the back month in cases where carry is unusually wide.

The relationship between different currencies, bonds and notes, gold and silver, heating oil and unleaded gas, hogs and cattle, and many other commodity futures contracts is a fascinating study! It's much more interesting and much more profitable in relation to risk at times compared to open position trading.

Once the trader gets involved in spreading and becomes familiar with order placement and fundamental seasonal factors, he should find that perhaps his open position trading improves. He is more aware of the fundamentals and charts have more meaning.

His thought process is now expanded past the simplicity of deciding whether to go long or short. His timing, because of his new knowledge of seasonal spread factors is more precise. His ability to determine trends is enhanced, and best of all; his bottom line performance in terms of net profits in all his trading activities should show marked improvement!

I've covered only a few considerations in the preceding paragraphs. There are many more, such as the consideration of the "personalities" of the various trading pits, delivery points for different commodities and their impact on prices, differences between contract sizes in inter-market spreading, and whether a market is cash settled or subject to delivery. All these factors influence spreading.

Learn as much as you can about spreads. I consider them to be the secret to my longevity as a commodity futures trader! Good trading!

Bob McGovern publishes a nightly spreading letter and biweekly letter on a subscription basis. His latest hardback 247-pg Spreader's Handbook in combination with a one-year subscription to Bob McGovern's Commodity Futures Spreads biweekly letter is available at a special discount for a limited time to subscribers of Dave Green's letter. You may wish to check Bob's website, www.spreading.com or contact Bob via e-mail at: spreads@ix.netcom.com or phone 949-363-6667 for more information on spreading.

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Capturing Intermarket Trading Opportunities – Bob Pelletier - CSI

Trend Following Versus the Multi-Market Approach

A great many traders jump on the long-term trend with plans to hop off before the ride takes a turn in the opposite direction. Although the exact turning point is difficult (if not impossible) to call in advance, the routine of following trends and capitalizing on market movement is worthwhile.

That is, provided sufficient trading capital is available to take and maintain positions in various markets. There is certainly abundant room for profit in following trends, so long as you follow time-proven methods that can balance the inevitable risk of loss with the potential for reward.

Trend-following procedures have wide appeal, but they are not necessarily preferred as a method of capturing profits from trading. Last month we presented material on CSI's new MultiMarket Analyzer (MMA), which was developed by staff Mathematician Steven Davis as part of the Unfair Advantage®(UA) database/analysis system.

MMA's systematic trading procedure is much more than just a typical market study because it delves deeply into mathematical statistics. The MMA is a mechanism economists might employ to uncover the market forces that produce the most favored trading opportunities -- the kind that do not involve excessive risk, Adopting market positions where the odds favor a profitable outcome is much preferred over the routine 50:50 (or worse) prospects one might obtain from less sophisticated trend-―following procedures.

The MMA has been enhanced during the last month through the inclusion of still another indicator called the Davis Elasticity Index. It identifies the effective percentage level that any one market is out of step with all others, making it readily apparent which market is most overpriced and which is simultaneously most under priced, given their respective historical norms. This added indicator simplifies the task of selecting the market pairs that offer the best opportunity for profits in spread trading.

I cannot over-emphasize the potential for market insight one might derive from making full and complete use of the MMA tool. It is highly unlikely that you will find such sophisticated analytical power in the pricey, though uninspired, products offered by our competitors.

Unfair Advantage's newest release-version 1.76.0 contains an altogether new charting/portfolio facility. It permits the display of chart pairs, together with a tabular display of the user's portfolio. Appropriately scaled pricing information on both charts facilitates the study of spread trading opportunities between markets, even when they possess differing conversion factor properties.

The MultiMarket Analyzer supports analysis of the many opportunities one might find in the futures/commodity domain for intermarket spreads. Below is an overview of a few of the market pairs that might present opportunities for intermarket analysis. Some have been expansively exploited by traders and technical writers; others may not be widely known, and many others may be awaiting your discovery before they can be mined for profits.

The Crude Oil Spreads

Crude oil (traded as Light Crude and Brent Crude) has a very prominent influence over the world economy. The abundance or scarcity of energy products has made this commodity a very important contributor to market forces around the world. Intermarket analysis has readily and regularly benefited from the crude oil influence, which has long been an intermarket participant. It has been paired with gold, T. Bonds, the CRB Index, aluminum, the grain complex, electrical energy futures and many other products. Look for numerous opportunities in positively or negatively correlated markets paired with this resource.

Why was aluminum included in the above list? In case you may have forgotten, 95% of the value of aluminum comes from the electrical needed to produce it. (Crude oil and coal are used around the world to fuel electrical power plants.) The residual balance of the price value of aluminum comes from bauxite and transportation, the latter of which depends heavily upon the crude oil needed to move the product market. Spread relationships between crude oil and lumber, orange juice, sugar, cotton, other precious metals and coffee might also be explored.

Treasury Bonds, Bills and Interest Rate Spreads Versus Stocks, etc.

The CRB Index, gold prices and other forms of interest rate products move together or inversely with the cost of money. I would urge all readers to explore the opportunities in these areas when searching for market opportunities. The UA database and the vast data resources available to users of QuickTrieve® offer a depth of market resources.  Prospective traders are likely to find fruitful opportunities for profit among one or more of these spread pairs on a daily or weekly frequency.

Currency Spread Opportunities

Given the slow reaction of governments to the valuation of their respective currencies versus the balance of the world or with any given country, the currency spread or outright naked currency position has regularly been a winner for many traders. When a government finds its currency suffering versus the dollar (or the reverse), it is typically very slow to react to the conditions at hand, thereby awarding the trader with an abundant opportunity to benefit.

Countries are slow to react because of the red tape, the internal legislative delays and their reluctance to admit that their currency is in jeopardy or subject to official devaluation. For all of these reasons, the currency trader has been seen to excel in the markets by using fairly simple trading approaches.

A World of Interrelationships

Just about every major stock, commodity and futures market on earth is widely represented in the UA database. The U.S. Dow Jones Index, the S&P 500 Index, the NASDAQ Index, the FT-30 Index, the Hang Seng Index, the All Ordinaries in Australia, the PSE Technology Index, the DAX MidCap Index, the JSE Industrial Index, the Russian Index, the Czech Index, etc., etc., are all part of the immaculately precise UA database presented for daily review.

They give the trader the opportunity to balance multiple economies within a single portfolio. UA gives the trader the unparalleled ability to effectively analyze this abundance of data with surprisingly little effort. The many and varied interrelationships between the markets become very apparent to the initiated observer using UA's MultiMarket Analyzer or the dual scale charting facility found in the most recent release of Unfair Advantage.

The spread trader must recognize and be prepared to act on the simple fact that raw materials are the building blocks of the world economy. As the cost of raw materials goes up or down, the stock market often reacts inversely. A high cost of raw materials is considered bad for stocks, which often depend upon low priced and readily available raw materials for optimal production. Capturing the effects of price relationships and misalignments in raw materials through MMA analysis can help the trader capitalize on lucrative spread trading opportunities.

We hope this article gives you food for thought on your trading as well as worthwhile information to help you get the most from CSI's products. Feel free to check our website at http://www.csidata.com for past issues of this journal discussing related topics.

Chart Caption: A new facility in Unfair Advantage version 1.76.0 permits the creation of intermarket charts displaying two markets simultaneously, each with its own scale. The above chart illustrates the S&P Index (the right scale) vs. the CRB index (the left scale).

The combined chart exhibits the inverse relationship between these two markets. UA software uses pixel color-coding to distinguish one chart from the other. The volume relationship, not so evident in black and white, is also in color for a clear on-screen view.

See the Unfair Advantage and/or QuickTrieve® User Manuals or contact CSI marketing at (800) 274-4727 for more information on CSI's Perpetual Contract Data.

For a very substantive presentation of intermarket trading opportunities, may I suggest you consult John Murphy's book, "Intermarket Technical Analysis " published by John Wiley & Sons, Inc., copyright 1991.

The charts shown in that book go through early 1990. Use Unfair Advantage to carry the many candidate intermarket relationships forward through 1999 to see how well his predictions have held up.

Editor’s Note: The trading book mentioned above and others can be ordered online via the amazon.com link on our TradersAuction website http://www.tradersauction.com/

By the way, CSI is CTCN’s recommended source for futures and stock market data. We have dealt with CSI since 1982 and have found them to be excellent. The depth and quality of their data is incredibly good. In addition, Bob Pelletier and his staff are very nice and helpful and offer superb service. You may also visit CSI’s website via a link this link http://www.webtrading.com/links/data.htm

You may also order CSI’s Unfair Advantage (UA) by calling CSI Marketing at 1-800-274-4727 or from other countries at 561-392-8663. Please tell them you were referred by CTCN.

Various Opinions on Testimonials

Rick Harle - It seems to me that if one had an actual successful trading method/program and for whatever reasons decided to sell it, that the easiest thing on the planet to produce would be an actual account statement. That statement would look like any successful trader's statement, more profitable trades than unprofitable trades. “Ratboy” (Rick Ratchford) has turned the MIF News Group into his personal advertising group. He has failed to do the simplest of the simple to convince anyone he has a successful and Win big methodology.

John Lothian - I know a second hand story about a vendor, who made up quotes from respected industry sources about his product, including one supposedly from one of his brokers. The statements were totally fabricated and false. The quoted sources never made those statements and never gave permission to be used in a promotional piece.

The vendor would just find new people to "quote" when confronted. This was in the days before the widespread use of the Internet and newsgroups. Yes, testimonials as a replacement for a track record and disclosure document are pretty lame.

Gary Smith - I always tell traders to “never” buy a trading related product based on a testimonial or reference given by the vendor. Uncover your own references such as through newsgroups. Some vendors are masters of the art of testimonial ship.   I’ve known references that were put on the payroll of the vendor to say great things about the product.

Editor’s Comment: As you know, Gary, I have great respect for your overall knowledge and put great value in most of your comments. In addition, for many years your personal trading track record appears to be significantly better than average.

However, I think you and some other News Group Posters are grossly exaggerating the usage of false testimonials by trading system vendors. For sure, there have been some occasional false ones in the past, but why would a typical vendor bother to use fraudulent ones when it's real easy for most all Vendor's to get legitimate ones?

The majority of trading system buyers will write good testimonial letters if asked to do so by the vendor (if requested very soon after purchase), sometimes doing it on their own, with no prodding.

This is because immediately after buying a system, the buyer is usually pumped-up and extremely positive and thinks (at first) the newly acquired trading methodology is great and perhaps may be the Holy Grail.

After all, they just spent lots of money and naturally want to have a real positive mental attitude about it! However, often they will change their mind later, but only after they have already written a positive testimonial for the vendor.

If you want to blame someone, blame the individual traders who write the great testimonials you see advertised. For the most part, they are 100% legitimate. Very few are fraudulent in nature, a minor and fairly insignificant percentage. However, due to its nature, the number of false testimonials is likely higher than average posted via the Newsgroup channel than other media sources.

Sorry, but saying fraudulent testimonials are a big problem (as you and others have said or implied many times in the past) seems to be seriously twisting the facts and probably misleading the Newsgroup Members, and causing unwarranted negative attitudes.

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CFTC Initial Decisions & Press Release
re: Ken Roberts Co., et al

Emad Masadeh v. Sukhmeet Dhillon a/k/a Micky Dhillon, Main Street Trading Company, Newhall Discount Futures & Options, Inc., The Ken Roberts Company, and Alan David Yee. Filed June 9, 1999. After a careful review of the record it was determined that complainant had established that respondents: The Ken Roberts Company, Newhall Discount Futures and Options, and Alan David Yee had violated the CEA Act. Further, respondent Dhillon was found liable as a principal of Newhall under the CEAct. Accordingly, respondents The Ken Roberts Company, Sukhmeet Dhillon, Newhall Discount Futures & Options, Inc., and Alan David Yee were ordered to pay reparations to complainant Masadeh in the amount of $50,483.73, plus a filing fee of $50. Complainant was not able to demonstrate any violations of the CEA Act by Main Street Trading Co. and, therefore, the complaint against Main Street was dismissed. Joel E. Maillie, Judgment Officer. CFTC Docket # 99-R019.

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System Testing: "Black Box" Systems Rarely, if Ever “Work” - Reprinted with permission of Technical Traders Bulletin

Computer testing of mechanical trading systems has been around for over 20-years, but has only become popular in the last several years with the introduction of user-friendly PC based software packages that make the process quick and easy. Anyone with a little money and time can now create a "profitable" trading system that shows fantastic hypothetical results over historical data.

Almost all of the trading systems sold for large sums over the past 20-years or so have been created by this method. Unfortunately, as thousands of disappointed investors can testify, commercial "black box" systems rarely if ever work as expected.

As far as we know, the same can be said of the great majority of trading systems generated by the use of testing software. The reasons for this apparent lack of success don’t lie in the testing software, but in the testing and evaluation methods used by the testers.

We use Omega SystemWriter Plus and Computrac-SNAP, and both are excellent programs, which we can recommend without hesitation. Neither of them shows any bias or lack of flexibility that might tempt a researcher to adopt inadequate testing methods. The problem is, as we pointed out, the testing methodology itself and not the software.

The somewhat misguided objective of most testing projects has been to develop trading strategies that squeeze the greatest possible profit out of the historical data. The assumption is that if it worked in the past, it will work in the future.

To carry that logic one step further: the better it worked in the past, the better it will work in the future. If this were true, everyone who designed a historical model that worked in the past (meaning essentially everyone who has ever used system testing software) would be very wealthy by now. Obviously this hasn't happened to majority of system testers.

Most testing we've seen follows a standard scenario. A trader buys the latest software package and some back data. He puts together a few of his favorite technical studies, adds some chart patterns that seem to have marked market turning points for him in the past, and optimizes to find the values for each parameter that produces the most profit.

Greed takes hold and he starts trading right away. Inevitably, he runs into a series of losses. Two months later he decides that something is wrong with his system and that the best thing to do is optimize again and to get rid of the losing components of his system.

He re-optimizes, and is grateful to see that his work has, in hindsight, eliminated his losing trades. Confident again in spite of previous losses, he resumes trading, only to suffer another series of losses. He repeats the process until his money, his patience, or his wife runs out. Usually, it's his money that gives out, leading him to believe that he would surely succeed if only he could afford to optimize one more time.

A Series of Losses - What Went Wrong?

It is useful to dissect the above process and review what went wrong and why before exploring more correct procedures. First and most obvious, we are wary of optimization in almost any form.

Literally any technical indicator or set of indicators will show tremendous profits when optimized for the best combination of parameters, even over a random data set. The computer is analyzing millions of combinations, so the probabilities are very good that some of these will, at least in hindsight, make money.

Faced with the lure of almost instant riches, as indicated by the optimized results, the temptation to begin trading immediately is overwhelming. The belief in this optimization process is so strong that traders will optimize again and again, even though the status of their trading accounts should be telling them that they are doing something wrong.

This is exactly what has happened to the trader in our previous example. You can hear him saying, "Just one more optimization, and I'll have it made." Unfortunately, one more optimization will never solve the problem.

How to Avoid Curve-Fitting

Some curve-fitting is unavoidable. It would be difficult and undesirable to design a technical study without it. When a trader "eyeballs" a chart and sees that a 9-day RSI seems to fit that particular market better than the standard 14-day RSI, he is curve-fitting. Because that seems so simple and effective, it is only a small step to test every possible RSI parameter. From there it is only a small step to test every possible value of a simple moving average, for example. Once this process begins producing profitable results, the permutations become almost endless.

We'd better add a few more technical studies to make sure we don't miss anything. While we're at it, let's optimize for the correct initial risk and best trailing stops so our system is as complete as we can make it.

The ultimate product is a system contrived with all the best intentions that has been curve-fitted to the N-th degree. As good as it looks on paper, the odds against it working in the future have become astronomical. In fact, the better it looks and the more complete and complex the system is, the less likely it is to succeed at all.

Robert Pelletier, of CSI (the data vendor), has provided the most rigorous explanation of why optimization and curve-fitting can go wrong. Frankly, it's such a simple and easily described concept that we can't believe that more traders aren't paying more attention to it.

Any statistician knows about the notion of freedom loss. In layman's terms, it means that each parameter that is added to a trading system represents a degree of control lost over the final outcome of the testing procedure. The more technical studies or trading rules or variations of trading rules that you introduce, the less robust and reliable the results.

Bob Pelletier recommends a low number of variables, two to five at the most. The fewer variables, the more reliable the results. An interesting corollary of this is that it allows you to look at your own past work and that of others and quickly decide if any of it is curve fitted.

The likelihood of the system being curve fitted varies directly with the number of variables used to test the system. The greater the number of technical studies and rules (especially exceptions to rules) the more curve-fitted the model is.

Another way to avoid curve-fitting is to avoid creating systems that are custom tailored to specific markets. This is an easy trap to fall into, but it is the ultimate in curve-fitting.

A good trading system does not have to work historically in all markets to be successful, but should work in most markets with few if any changes from market to market. If you have to change the system to make it adapt to each market-something is wrong with basic system.

Testing Period

Another critical area that is often overlooked is the test data itself At the barest minimum, the test period should be long enough to generate at least thirty trades in each market. Having less than thirty trades violates one of the basic rules of sampling theory, which dictates that at least 30 data points must exist for a data set to indicate a normal distribution. Note that this doesn't refer to days, weeks, or months of data, but actual trades. Anything less than thirty will generate statistically unreliable results.

Just as importantly, the market periods you are testing must contain as many occurrences of each possible market condition as possible. Up, down, and sideways are the simplest (albeit subjective) definitions of possible market conditions; your study period should contain as many of each as possible.

The intent is to simulate potential future conditions by including as much of the past as possible. Measuring this only in years can create problems. For example, the stock market has not had a serious down period since stock index futures were introduced. The full life of the market doesn't really contain enough data to reflect potential future market conditions.

The petroleum complex, on the other hand, has shown us a great deal more variability and might be expected to produce a more robust trading system as a result.

To explain it another way, the results of a short time period of testing in the crude oil market might give truer results than a longer period of testing in the stock indexes because the stock index data contains an obvious upward bias so far. A buy only system in the stock index market would have been likely to produce much better results than a sell only system.

An interesting corollary of this is that, as tempting as it might seem at times, a system should never be biased towards one side of the market. Obviously, with a few notable exceptions, most of the profits in the stock indexes will have been on the long side. This doesn't mean that a trading system should favor that side of the market.

The system should have no opinion or bias toward one side or the other. If this seems obvious, recall that in the 1970's most of the profits made in the commodity markets were on the long side.

Many of the trading systems devised became essentially bull market systems. The easiest way to improve your system was to restrict or eliminate short sales. We recall that this bullish bias was a principal reason for the poor performance of many commodity advisors in the early 1980's.

Our conclusion is that there is no static definition of how much data a test should include. If we assume that the average trend-following system trades about once a month per market, at least three years would seem to be a minimum, at least for an initial test which will produce the 30 trade minimum mentioned earlier. Then add two or more years for forward testing (we'll explain this later) and you have five years; which, only by coincidence, is the generally accepted minimum.

Add more time if the market has been only one or two-dimensional during the period studied. You will want to include as many different market conditions as possible in your study.

What to Test For

The most obvious testing goal is profitability. How much money did my model make? A better way to calculate this might be percent return, which is the annualized return based on the amount of money needed to trade the account. The percent return should be looked at over the entire testing period and then broken down into small segments so that negative periods can be isolated.

Keep in mind that percent return is a function of the amount of capital used. You can double the percent return by starting with only half as much capital but you have not improved the system. You may actually improve a system by starting with more capital, but percent return will suffer accordingly.

Frivolous and meaningless trading contests are always won by making big returns with small amounts of capital. This seldom results in a viable or sustainable track record, as evidenced by the dismal performance of the commodity funds managed by some well-known contest winners.

A derivative of the percent return is the Sharpe Ratio, which is defined as the annualized return (a profitability measure) divided by the annualized standard deviation of return (a volatility measure). The higher the Sharpe ratio, the higher the return and the lower the volatility.

The industry standard for CTA’s is to calculate the Sharpe ratio based on monthly data. We realize that the Sharpe ratio has limitations (for example, increased upside volatility will result in a lower Sharpe ratio) but it is still the most common index of its type.

We suggest you use it to compare the results of one system versus another and to compare your results with those of professional advisors. The best system for you may not be the one that makes the most money, but the one with the highest Sharpe ratio.

A very important yet commonly overlooked statistic is Percentage (%) equity drawdown, measured peak-to-valley. A trading system which generates an annualized percent return of 100% over five-years will be difficult to follow if it has allowed peak-to-valley drawdowns of 50% several times during the five years.

It would take a strong stomach and deep pockets to trade such a system with confidence. In our experience, a smooth equity curve is much more desirable and harder to obtain than a high annualized return.

Other worthwhile measures of system testing results include % profitable trades vs. % losing trades, average profitable trade (in dollars), average losing trade (also in dollars), ratio of average win to average loss, the largest profit or loss, and the % of long or short trades that were profitable.

This last measure can give you some idea of whether your test period or system is biased towards one side of the market. Both of the testing systems we use will generate these statistics.

We want to stress that a trading system should be designed from the beginning to achieve a predetermined set of performance measures. For example, you may set out to design a trading system that has at least 45% winning trades with average profits that are more than 2.5 times losses.

Volatility and The Probability of Ruin

Calculating two key figures will give you some idea of how reliable your trading system will be in real time.  The first figure to calculate is the standard deviation of your trading results.

The higher the standard deviation the more volatile your trading results will be. The lower the standard deviation the less volatile your results will be. All other things being equal choose the system that has the least volatility (lowest standard deviation) in terms of individual trading results. This should help ensure the highly desirable smooth equity curve.

The second key figure is Probability of Ruin (POR). POR gives the trader the exact probability, expressed as a percentage, that his or her account equity will decline to a specified point before rising to a specified higher point.

Six figures go into the calculation: % winners, average profitable trade in dollars, average loss in dollars, initial account equity, level at which an account can be said to be at ruin, and level at which account can be said to be successful.

The POR is based on the notion that within any trading system, events will routinely occur that may appear abnormal but that are really within the realm of probability. For instance, a coin flipped an infinite number of times will have a heads/tails ratio of 1:1, but approximately every 1,024 coin flips either heads or tails will show up 10 times in a row.

Every trading system therefore lives with the possibility that, independent of changing market conditions, it will to some extent self-destruct. POR is the probability of that self-destruction. The extent to which we can control % winners and the profit/loss ratio dictates the degree of control we have over our trading system. We may not be able to control changing market conditions, but we can at least make sure that our trading system won't self-destruct of its own accord.

The following table shows POR figures for a representative variety of winning percentages and average profit to average loss ratios. Just to keep the numbers simple we've assumed initial account equity of $10,000, a profit target of $15,000, and a loss level (ruin) of $5,000.

Chart in Printed Version

As you can see, the POR changes drastically as the winning percentage and profit/loss ratios change. A small system adjustment that results in a positive change in either ratio can make an enormous difference in our confidence in the system's future capabilities.

POR can be very revealing. For example, the average CTA managing public fund today probably has a winning percentage of from 35% to 45%, with most of them under 40%. A 35% winning percentage demands a high average profit to average loss ratio to be successful, as you can see

This is fine and readily attainable when the markets are trending, but if they get choppy the profit/loss ratio will quickly drop and the POR will increase to frightening levels. Monitoring these two statistics closely and perhaps altering your trading system to take into account non―trending markets may be necessary to ensure survival.

The Mechanics of Testing

Earlier, we mentioned forward testing as a means of weeding out the elements of a trading system that have crept in as a result of curve-fitting. Another term for forward testing is blind simulation. In practice, it means creating and testing a trading system over a data series, for example the back three years of a 5-year data set, and then testing the completed system over the remaining data, in this case two years. Remember you need enough data to create at least 30 trades in each test.

Whether you optimize or not in the first phase of testing is not as important as keeping the number of variables low, as we discussed. The testing will eliminate a very high percentage of "winning" systems.

>We've seen a number of different schemes for optimizing, re-optimizing and forward testing. By far the most important point is that any trading system that is subjected to simple testing or optimization without forward testing and a careful analysis of its volatility and probability of ruin is most likely doomed to failure.

Trading System Creation & Testing

We realize that not everyone has system testing software. It is expensive and complex, with a steep learning curve. It is not necessary to possess it to create a viable trading system.

The elements of any system should be the same whether you have expensive testing software or are doing your own programming, as some of our subscribers do. It’s even possible to test a system without expensive software, simply by sitting in front of a computer screen and objectively trading your system over back-data. In fact, there are certain advantages to doing it this way.

One advantage is that without the extensive optimization capability of the software packages, your system won't be over-optimized. However, the pros of the testing packages far outweigh the cons. We strongly recommend that you obtain some system testing software.

Elements of a Trading System

At the risk of being redundant, we'd like to cover the attributes that a trading system must possess if it is to be successfully tested. Some (or all) of these things may seem obvious, but we have spoken to literally thousands of traders over the past year and a half and we can say with some confidence that many people don't fully understand what a trading system should or should not do.

The first prerequisite of a trading system that is to be seriously tested is that it must be purely mechanical. The only discretionary component should be the decision to trade the system fully or not. All other decisions must be built into system.

We realize many, if not most readers are currently using trading systems that are at least partly discretionary. We're also aware that most truly successful traders consider some degree of discretion a necessary component of their trading. We have no quarrel with this, but it's impossible to test because it's hopelessly subjective. Discretionary elements have no place in a mechanical trading system that is being prepared for testing.

Expect the Worst!

The trading system you design for testing should attempt to anticipate all contingencies. It is very common for us to hear a trader downplay a missing element of a favorite trading system. The typical response to a polite comment is "it's never happened to me, so why plan for it? Why should I use stops if my system always seems to catch tops and bottoms, and there's never been a drawdown that I couldn't handle?"

This is not only naive, but also dangerous. What can happen will happen. A system must always expect the worst, and be prepared to cope with it. You must always use complete risk control. Don't assume that because it hasn't happened in the past it won't happen in the future.

Here is a typical example: Many traders prefer to use close-only stops. The rationale is that intraday price movement is inconsequential and that only the close is significant.

A deeper motive might be that the trader is trying to avoid taking whipsaw type losses. (They probably got stopped-out of a potentially profitable trade once and they're making sure that it won't happen again.) 

It only takes a few of these to convince anyone that it's better to have an ordinary stop and a re-entry strategy. Anticipate the awful; then you won't be quite as surprised and unprepared when it happens.

Note that it is entirely acceptable for your trading system to be profitable in most of the markets you're testing and a loser in a few of them. One successful CTA of our acquaintance trades in all the markets he has tested (winners and losers), and claims that his equity curve is smoother as a result of this diversification.

He deliberately seeks some negative correlation between commodities in the portfolio. He has found that the profitable periods in his "losing" markets usually coincide with losing periods in the "winning" markets.

A trading system will not be profitable in all markets all the time. If you have designed it correctly, the drawdowns will be minimal in the losing markets, and they will eventually have profitable periods. 

Be careful about testing lots of commodities and then constructing a portfolio of only the winning contracts. This is a popular device of system vendor and is pure fantasy. (Though it sure produces a heck of a track record.)

Test for Specific Results

We previously stressed the need to test with specific goals in mind. As we mention and the most important of these are % winners and the ratio of average win to average loss.

These can be used to calculate Probability of Ruin, giving you some idea of the robustness of your system. The testing software gives other useful data also. Here is a list, with comments.

Net Profit: A very overrated measure of success for several reasons. First, check to make sure that a few large trades haven't skewed your results. You don't want to use a system whose success depends on nonrecurring events (Like the Hunt's comer of the silver market or sugar futures going back to 63 cents).

Next, don't assume that, in real time, your system will reproduce anything like the net profits from your tests. Future results depend on the markets performing as they did in the past and we know that they won't.

You cannot predict what the markets will do in the future. You can only try your best to make sure your system is prepared to deal with most of the foreseeable future market conditions.

Number of Trades in the Test Sample: The total must be over 30 to be sure of statistically significant results. Even if you tested 25 years of data, if you didn't have at least 30 trades, the results would be highly suspect. We once heard a lecture about the validity of a stock market indicator that averaged one trade every 40-years. We would have wanted to see 1200 years of results to be impressed.

Largest Winning and Largest Losing Trade:Largest winner is important if it has skewed Net Profit unreasonably. Many conservative system testers will throw out the largest winner in each commodity and reevaluate the results. The largest loser can be especially important if it exceeds your normal risk control measures.

Perhaps there is some problem or contingency you've overlooked. Be careful of measures to eliminate the biggest losers; this is where most traders stumble into curve fitting. Don't make special rules that skip the big losers, just review your stop and risk control procedures.

Maximum Consecutive Winners and Losers: Maximum consecutive losers could be useful. It gives you an idea of how much emotional pain you might have to endure while trading your system. A forecast of this number could help prevent panic.

Peak-to-valley Drawdown: This is very important as a measure of how practical your trading system will be with real money on the line. Most often, the systems that give the largest net profits have the largest drawdown. Combine a large drawdown with a string of losses and you have the reasons most people prematurely abandon a potentially good trading system.

You've heard us stress before that a system must be designed within the personal stress tolerance of each individual trader. Much like the anticipation of consecutive losses, anticipation of the potential drawdown that we must endure can generate a vital element of confidence, which will allow us to trust the system and survive inevitable losing periods.

For professional money-managers there is another reason for calculating Maximum Drawdown. CTA’s and the people who market CTA’s tell us that the public is getting smarter (about time) and is more interested in those rare CTA’s whose record shows steady growth and small drawdowns rather than in the high-fliers who show big short-term gains with large peak-to-valley drawdowns.

Those of you who are interested in becoming CTA’s and managing public money would do well to create a system whose largest portfolio drawdown is in the 20-25% area, measured month-end to month―end. This really requires a combination of good money management (including proper capitalization) and a sound, risk-controlled trading system.

Don't throw away your testing results. They provide an early warning system to alert you if your system is beginning to self-destruct in real trading. Any results approaching the maximum drawdown, or maximum consecutive losers, should be viewed with caution, as should any downtrend in winning percentage or win/loss ratio.

Testing - What to Look For

We like to use lots of data, and to test over varying time periods. Unless you've done this, you can never fully appreciate how elusive a profitable trading system can be, and how time-dependent the testing results are. We are very wary of systems that have not been tested through time periods that reflect as many different market conditions as possible.

Notice how in the following table the results are affected by changing the time frame, especially with regard to drawdowns. The return is similar, which brings up an interesting point. Just about all of the optimization/testing procedures we've seen focus on total return as the sole criterion for choosing the most optimal parameters to use in subsequent tests or in real-time trading. In our simple example above, the returns seem to be in line with one another.

Table in Printed Version

The drawdowns, however, are vastly different. How many traders would be willing to ride out a drawdown while trading a contract with an average margin of only about $2,500?   That's asking a great deal.

The example above illustrates one of the seldom-―mentioned perils of testing in general and optimization in particular. When you test for only one result (usually total return) you are probably ignoring other, more important data.

We recommend that you test for the above matrix of attributes, rather than just for one. We realize that this complicates the procedure, and may in many ways make it subjective, but testing only for total return is misleading and can be harmful to your financial health.

Here are some guidelines that will help focus your testing goals:

Percentage (%) Winners: Try for at least 40% to 45% winners. However, be suspicious if a winning percentage is much over 50%. It is probably not sustainable, and most likely represents inadvertent curve-fitting or a very low profit per trade as a result of large losses and small profits. It can also mean that your risk-control stops are too far away.

Ratio of Average Win to Average Loss: This should be well over 1:1 (break-even). Obviously, a ratio of 3:1 or 4: 1 is nice but, given a decent percentage of winners, even 2:1 will make you more money than you can spend.

Total Return and Maximum Drawdown:These are both contract-specific measurements expressed in dollars. For example, the total return on   S&P contracts should only be compared with the maximum drawdown on S&P contracts. Total return and maximum drawdown are the ultimate expression of risk/reward.

Of the two, drawdown is more important. It is possible to express both as a % of margin, but margin is a moving target related to contract months and can change frequently and abruptly so it doesn't always give a precise measurement.

Test Data

As far as we know, there is no existing testing software that incorporates the ability to roll a trade from one contract month to another without causing a break in the values of any technical study it is calculating at the time. The break invalidates the study and therefore the test.

It is possible to feed the computer a series of contract months for a given commodity, test each month separately, and then consolidate the results, but we can't imagine a more tedious and error-prone procedure.

The solution is to arrange your data into a continuous stream that has no breaks and therefore allows continuous testing. We won't go into detail about the calculations to ensure a smooth transition from one contract to the next, but we are satisfied that, given that any testing is hypothetical, the results are reasonably accurate.

We have data from 3-sources: FutureSource, Technical Tools and Omega Research. The latter arrives as continuous contracts. The Technical Tools data comes with software to create your own continuous (or other) contracts.

If you have a number of different analytical software packages (as we do), Quote Butler, from Technical Tools, is an excellent way to switch data from one to another without having to buy data for each specific application. We have no recent experience with any other data vendors.

Slippage and Commissions

Don't trust any testing results that don't include a liberal allowance for slippage and commissions. They make an incredible difference in your results.

There are a lot of trading systems that make small steady profits when tested without allowing for slippage and commissions, and turn into steady losers when transaction costs are factored in. This is especially true of short-term or daytrading systems. The more trades a system has, the more critical transaction costs become.

There was a particularly glaring example in a recent national publication. The article explained an indicator that purported to call intra-day turns in stock index futures. Although the volume of trades was high, there was no allowance for transaction costs. We calculated that, given very discounted commissions and only occasional slippage, the system was at best a break-even method, at worst a steady loser.

Everyone has their favorite numbers for transaction costs. We allow $75 for slippage and $50 for commission per round turn, for a total of $125 per trade. This number may seem high, but we prefer to err on the conservative side.

To Optimize or Not To Optimize

Anyone who believes that full optimization works as well as touted by some system vendors would do well to read "The Usefulness of Historical Data in Selecting Parameters for Technical Trading Systems" by Louis B. Lukac and B. Wade Brorsen, in The Journal of Futures Markets, Vol. 9 (1989), No. 1, pp. 55-65.

Their work is systematic and complete. They tested two trend-following systems, Channel Breakout & Wilder's Directional Movement System, using 20-years of data. The only variable that was optimized was the number of days used in each calculation. That parameter was stepped through a time period of 5 to 60-days, in 5-day increments.

They compared three different optimization schemes with a random test, which used parameter values randomly chosen from the 5 to 60-day set. The most significant finding was that the re-optimization strategies did nothing to increase system performance. Each optimization method produced results not significantly different from the random test.

With or without optimization, profits were on the order of 50 to 65% for the Channel Breakout System, and 30 to 54% for Wilder's Directional Movement System. They stated, "The results of all tests suggest the forecasting ability of optimization is limited. Optimization was not able to forecast parameter sets which would produce portfolio profits better than a random selection strategy.”

Let us stress that this was a rigorously formal test done with great attention to detail. Anyone who claims that full optimization works better than a simple blind simulation will have to produce contrary results that are just as rigorously attained.

Testing Protocols

We'll explain a few of the most common optimization and testing schemes.

Simple Optimization: This is as easy as it sounds. You create a trading system, then optimize it over a comprehensive set of parameter values until you find the ones that yield the best return. In our testing opinion this is the least productive system method. It is curve-fitting of the worst kind.

Cumulative Forward Testing: This requires that you optimize a system over a period at the beginning of your data, and then test the results over a relatively short subsequent period. You then re―-optimize over a period that includes both data sets, and continue the cycle. For example, if you have 10-years of T-Bond data, you might optimize over the first 3-years, then test over the next one. If the results are still good, you then optimize over the full four years, then test the fifth year, and so on.

Simple Forward Testing: This is also called blind simulation. You optimize for the beginning of your data (say for the first five years of a 10-year data set), and then test the results of your optimization over the more recent time period, with no modification. If it doesn't work, it's back to the drawing board.

Forward testing is the most elegant solution to the system-testing muddle. It offers some of the advantages of optimization with none of the disadvantages. If your system doesn't prove profitable with this forward testing procedure, throw it out. It will probably be only sporadically effective in real-time.

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Review of Don Fishback's Products - Jerry Woolston

The following comments represent my opinions and/or experiences.

"Options Wizardry From A To Z” - This system is priced at $195. It consists of 4 video tapes (approximately 5-hours of instruction), a manual and a few other tidbits.

This system does a very good job of explaining various option trading strategies. Don does a good job of explaining each type of strategy and when they should be implemented. Approximately 3.5 to 4-hours of the video instruction covers:

• What options are and how they work
• Puts - Calls
• Debit Spreads
• Credit Spreads
• Straddles and Strangles
• Back-spreads
• Put Selling
• Calendar Spreads

The remainder of the video instruction covers Don's strategy of implementing trades that are he says will be successful 90% of the time. This involves an understanding of standard deviations and a few other statistical principles.

Overall, I enjoyed the course. I think the material would be beneficial particularly to someone who has very little knowledge of options and is looking for a system to teach them the principles of option investing. The price may be a little steep at $195 but, if it works, it may be worth the price.

Paper-trading results were done in February 1999. Here's the strategy I'm using to paper-trade the system:

1. Each Monday morning, I pick up a copy of Investors Business Daily.
2. I use options on the OEX (which is the SP-100) for all my trades.
3. I perform the Don Fishback analysis to find my 90% trade. Note: depending upon where the option strike prices fall, some trades may have less than a 90% chance of winning, i.e., 85%, but all should be in the range of 85-90%.
4. If the OEX options have less than a week to expiration, I use the next month’s options.
5. I will perform this analysis for 3-months to evaluate the system.

TRADE #1 - 2/1/1999:

• Sell the Feb 595 OEX Put for a credit of 3.125 or $312.50
• Buy the Feb 590 OEX Put for a debit of 2.75 or $275.00
• This creates a net credit in my account of $37.50 for each spread trade.
• As long as the OEX stays above 595 until the 3rd Friday in February, I will get to keep the $37.50 for each spread trade. Probability of this happening is 88.7%
• Max Loss potential is $462.50 per spread (calculated by subtracting the credit amount received from the difference between the 2 strike. prices, i.e., 500 minus 37.5). Probability of Max Loss Occurring 11.3%
• How Did The Trade Work Out? This trade worked out! I would have made $37.50 per spread.

TRADE #2 - 2/8/1999:

• Sell the Feb 575 OEX Put for a credit of 2.5 or $250.00
• Buy the Feb 570 OEX Put for a debit of 2.00 or $200.00
• This creates a net credit in my account of $50.00 for each spread trade
• As long as the OEX stays above 575 until the 3rd Friday in February, I will get to keep the $50.00 for each spread trade. Probability of this happening is 90.2%.
• Max loss potential is $450.00 per spread (calculated by subtracting credit amount received from the difference between the 2 strike prices, i.e., 500 minus 50.0). Probability of Max Loss Occurring 9.8%
• How Did The Trade Work Out? This trade worked out! I would have made $50.50 per spread.

TRADE #3 - 2/16/1999

• Sell the March 550 OEX Put for a credit of 4.5 or $450.00
• Buy the March 540 OEX Put for a debit of 3.625 or $362.50
• This creates a net credit in my account of $87.50 for each spread trade
• OEX stays above 550 until the 3rd Friday in March, I will get to keep the $87.50 for each spread trade. Probability of this happening is 88.9%
• Max loss potential is $912.50 per spread (calculated by subtracting the credit amount received from the difference between the 2 strike prices, i.e., 1000 minus 87.50). Probability of Max Loss Occurring 11.1%
• How Did The Trade Work Out? This trade worked out! I would have made $87.50 per spread.

TRADE #4 - 2/22/1999

• Sell the March 560 OEX Put for a credit of 4.125 or $412.50
• Buy the March 550 OEX Put for a debit of 3.125 or $312.50
• This creates a net credit in my account of $100.50 for each spread trade.
• As long as the OEX stays above 560 until the 3rd Friday in March, I will get to keep the $100.00 for each spread trade. Probability of this happening is 89.7%.
• Max loss potential is $900.00 per spread (calculated by subtracting the credit amount received from the difference between the 2 strike prices, i.e., 1000 minus 100.00). Probability of Max Loss Occurring 10.2%
• How Did The Trade Work out? This trade worked out! I would have made $100.50 per spread

Comments:  So far, I'm very under-whelmed at the potential in this system. Don's flyer for this system kept talking about making $1,000 to $2,000 per week! So far, I don't see how that's possible when your only making $30 - $100 per spread trade. Also, the risk/reward ratio seems skewed heavily to the LOSS side! Oh well! We'll keep tracking our progress!

The major problems I see with 90% of the Systems are:

• High probability of success on each trade, but VERY small profit on each trade.
• Even though the risk of loss is 10%, it would only take 1 of those situations to WIPE OUT all the gains you had accumulated with the 90%
• Commissions will eat you alive!

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There’s No Holy Grail - However, your (CTCN’s Real Success Video Course) Work Spells Out a Good Solid Road Map for S&P Daytrading - Buz Cook

I have been living with your Real Success video course over the last 48-hours. I am on my second viewing. Like I mentioned to you on the phone (though we all would like one) there is no holy grail for trading. However your work spells out a good solid road map for day trading the S&P's.

It's funny that over my many years of trading I have seen all the concepts in your tapes. I just have not seen them spelled out with such a clear-cut plan on how to get from A to B to C. Bravo!

Dave, what do you now suggest for a stop loss? With $250.00 vs. $500.00 a point when you taped the course and with the higher levels, is 2 to 2.5 points about right? Also does general profit targets between 2 and 5 points seem about right? Also do you still use mental stops in your trading as opposed to a resting stop loss order?

I have figured out what was wrong with the Keltner formula in your course material (very minor correction) and now have the Keltner bands up and running. Thanks for a great course.

Editor’s Comment: Yes, I think the 2 to 2.5 stops and 2 to 5 profit targets you referred to above are very good.  With the contract size being different and the volatility being much greater, these make sense.

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OPTIONS & SPREADS: The Biggest Difference in the World, or, Profiting off of Cannibalism & Quicksand - Greg Donio

Chamfort wrote, "Bachelors' wives and old maids' children are always perfect." Sure. For sports fishermen, the one that got away is always huge. The book that the would-be author plans to write but never does -- always a literary masterpiece. The architectural blueprint that never left the drawer "would have been" another Taj Mahal.

We arrive at traders' millions, the strongbox that should have come on the noon stagecoach. That stock should have been the new Resorts International. Skyscrapers were supposed to replace the weeds on that real estate tract. Why does cash not cascade in from the chain letter or pyramid scheme? Those "newly-minted collectible" coins have dropped 40% on the resale market.

Stock options. Futures contracts. Futures options. Count―less thousands of traders read yachting magazines hopefully and cry in their lager on dry land afterward. On the sea of dreams, the bachelor's wife and the spinster's child ride the trader's brigantine. Take a lesson from the checkerboard in the sea chest. If you ever tried that old experiment, you did not get far.

You place one penny on the first square of the checkerboard, two cents on the second, four on the third and keep doubling. The surprise is that the figures become astronomical rather quickly. You pass the thousand-dollar mark on the 18th square, the million-dollar mark on the 28th square, the billion-dollar on the 38th, and so on through trillion and quadrillion.

"What has this to do with financial trading?” you ask. Plenty. Becoming wealthy should be the easiest thing in the world when you consider that a thousand dollars has to double only 10 times to be―come a million. No flight to the moon, just 10 squares on the checkerboard. Yet how many have done it?

Dalton's Bookstore near Wall Street has an array of tall bookcases, shelves and shelves allegedly telling you how to increase and re-increase your money. Yet how many venturers who started out with more than a thousand dollars have managed to traverse those 10 simple squares?  Plenty of brilliant minds, ideas, degrees in engineering and physics, micro-chip aids, voluminous charts and mathematics. Yet practically everybody falls into abysses between red and black squares. Private Fort Knox’s remain dusty blueprints.

Since stock options, futures and futures options are zero sum games, Peter perpetually plunders Paul and the reverse. Someone must lose a dollar for every person who gains a dollar; one pocket must be picked for every pocket that bulges. Financial reality must shoot a thousand traders to deliver a profit to another thou―sand. About half the winning thousand face the firing squad next time .

Andrew Tobias told of people he knew who made a bundle buying a batch of options or "playing them long," then lost it all trying to repeat that success. If you have a 50-50 chance of winning and not losing once, you have only one chance in four of doing it twice in a row, and just one in eight of three consecutive wins. Thus the third try is Russian roulette with seven of eight chambers loaded. 10 doublings in a row increase the money a thousand-fold but you have only one chance in a thousand of doing it 10 times in a row.

Think of brokerage commissions as a sad story riding the coat―tails of another sad story. If you keep repeatedly tossing a silver dollar, it will come up heads approximately half the time and tails approximately half. Venture money on it and losses will approximately cancel out wins. Now imagine brokerage commissions chopping a nickel or half-nickel off the silver dollar on each toss. Will the game last long?

Commodities that underlie futures contracts can only go up or down. Stocks and futures that underlie options can only go up or down. Heads or tails. With options, 50-50 odds are too generous an estimate because time-decay eats up their value in bigger and bigger bites as the calendar progresses.  Also, commissions make the zero sum game a minus sum game.

All this helps to explain how "zero sum" and "minus sum" shoot and rob traders, why every barfly is not a millionaire, and how come crying towels far outnumber limousines. The double doors at which all this arrives are what I call The Biggest Difference In The World: The Difference between winning once and winning with anything resembling consistency. Practically every speculative trader and horse―player has done the former. Those who have done the latter are slightly more numerous than blue-coat survivors at Little Big Horn.

I took up option spreads because they contained that consistency. Not risk-free, not instant millions, but repeat profits in the manner of a successful business enterprise. Spreading does require a certain psychology or mind-set. It is too venturesome for financial conservatives such as bond investors or buy-‘em-and-hold-‘em-for-years stock investors. Yet it is too conservative for crap-shoot speculators who pursue what promises vast wealth and delivers a massacre.

That happy medium between those two intransigencies is business, profitable enterprise. I am used to collecting markedly more gains in markedly less time than the coupon-clippers. I am also used to climbing over the corpses of speculative traders to gather my profits. I am also used to the month-after-month returns of a landlord or a kitchen appliances dealer or a gems-in-a-satchel entrepreneur. Business constitutes the middle ground west of the bond coupon and east of the paper dice, and I discovered it with spreads.

In the previous issue of CTCN, I wrote of opening a "horizon―tal calendar" spread position with Wal-Mart put options. "Horizontal" meant that the batch of options bought and the batch sold had the same strike-price. "Calendar" meant that the two batches each had a different expiration month. In this type of spread, one buys far-in-time options and sells near-in-time ones. The near-in-time ones are worth fewer dollars because of less time value.

The price difference between these two batches is a debit or minus-figure, which the trader pays out of his capital. In other words, that difference forms the “spread,” the gap which his money fills in. In this instance, I bought 10 Wal-Mart put options with an expiration date of June and a strike-price of 90, purchased them at a price of 4¼ points -- $425 for each or $4,250 for 10. I sold 10 other Wal-Mart put options with the same strike-price of 90 but a nearer-in-time expiration date of May. My selling price: 3 points or $300 each, 10 for $3,000.

The $3,000 I took in from the sale of the Mays paid for most of the $4,250 cost of the Junes I bought. In the trader's broker―age account, the money received from the sell is automatically credited toward the cost of the buy when both transactions are executed on the same day, as is customary with option spreads. My investment capital paid the difference between or "filled in the gap between" these two figures -- the "spread" of $1,250 -- plus discount brokerage commissions.

Less than seven weeks later, an investment of approximately $1,400 with commissions brought an after-commissions profit of $460. Nearly a 33% gain annualizing to over 230%. A small negative -- it took longer than usual since as a spread strategist I tend to think in terms of three to five weeks. Yet bond investors are satisfied to wait far longer for far less. Many I'm―in-a-hurry futures and options players are too badly shot up to look at clock or calendar.

Icebergs test navigator and helmsman. Three investment specialists have left George Soros' group of managed funds to form their own company due to multiple "disappointing results" plaguing their former boss lately. Mario Gabelli of Gabelli Asset Management was razzed recently according to the Wall Street Journal (May 25, 1999) for "creative accounting" in issuing a quarterly earnings report that camouflaged the bottom line -- a 17.9 million dollar loss. Non-giant though I am, I know I am doing something right when red ink splashes on their boats but not mine.

Can an independent trader surpass the big boys? I have not found it all that difficult. Nor does it require formulae abstracted from physics or engineering or cyber-science.  As with many one-person businesses, the foundational game-plan is not complicated and can be etched on a hard boilerplate: Do a horizontal calendar spread, buying the far-in-time options and selling the near-in-time ones. Secondly, be sure that the near-in-time sold options have a market value of at least 3 points and preferably more. Finally, be sure that the "spread" or gap between the bought and the sold is less than 1½ points -- as much less as possible.

Look to the already-described Wal-Mart put spread as an example. The nearer-in-time Mays were sold for 3 and the farther-in―time Junes were bought for 4¼. What if the Mays traded for 2½ and the Junes for 3¾? The spread between them is still 1¼, less than 1½ and okay. However, the value of the near-in-time options is only 2½, below the minimum of 3.   What if May traded for 3¼ and June for 5¼? The near-in-time now meets the requirement but the spread or gap stands at 2 points, certainly in excess of the mandatory "less than 1½." No deal.

A couple of solid second-tier rules. Look beyond the expiration date immediately ahead for both ends of the spread. At the time of this writing (June 2, 1999) the June options scheduled to expire later this month are scrawny and depressed in value due to advanced time-decay. Almost no, 3-pointers among the out-of-the―money puts & calls. More like ¾of a point or 1¼ point. The months beyon