The ACD Method
- Thread starter sbrowne126
- Start date
Well in terms of risk assets, they all have some correlation. I'm not referring to spreading Corn against Oil. But Corn is a more pure product. In other words, you don't have the same risk as it being dragged down by say an uptick in bonds. Of course within the grain complex you can spread corn against wheat. But what I'm getting at is the noise pollution you get when one asset class contaminates another.
For example, say you get short the SPY outright. And the Euro catches a bid or AAPL, they can contaminate the price action of the SPY and pull it higher. You need to be aware of this. The only way you can isolate yourself from this is make sure you are short the weakest product that will put up the biggest fight against that pull. And vice versa if you get long a risk asset.
Just as before when I talked about looking for clean breakouts and clean moves and using ACD to find those, you want to identify instruments that will have clean price action. Why would I short AAPL for example if it's the strongest stock today knowing that if the NQ upticks, it's going to grab AAPL by the hair and pull it up faster? Now any noise that pollutes the index market will interfere with my AAPL short.
A better short might be BAC which despite the market rally, can't uptick to save it's life. So that stock on this given day is going to be affected the least by outside noise.
I think I understand what you're saying ... the markets should be mutually exclusive to the greatest extent possible (beyond the systemic risk asset correlation that impacts everything). This distinction makes your approach different from common spread/pair/relative strength approaches which generally seek markets that are related in some way (fundamentals, index components, etc).
Yeah I'm trying to show all the different ways one can use ACD as well as a primer on understanding price action.
I want to get these thoughts down on paper before I forget to mention. One of the biggest aha moments I had in my trading life was when I started reading about these large macro hedge fund traders when they would put on a trade and swap the denominating currency to spike the return. In other words, say you wanted to get long AAPL. But instead of buying AAPL in dollars you could buy AAPL in Yen and add 10% to your annual return. Something as simple as swapping the denominating currency can dramatically change the trade. That was such a big revelation to me as it got me to think about trades differently.
You'll often hear someone like Dennis Gartman say he is long Gold in Euros, not dollars. Or buying a bond in another country and not only earning the interest and principal return on that bond but also the currency appreciation. The great Brazilian Bond trades of the 1980's come to mind where traders made 50% plus returns being long government bonds on foreign countries from the currency appreciation.
You'll often hear someone like Dennis Gartman say he is long Gold in Euros, not dollars. Or buying a bond in another country and not only earning the interest and principal return on that bond but also the currency appreciation. The great Brazilian Bond trades of the 1980's come to mind where traders made 50% plus returns being long government bonds on foreign countries from the currency appreciation.
Here is a chart of January WTI Crude vs. December ES. I multiplied CL by 20 to normalize the tick values (CL is expressed in ES terms now.) However, the the chart represents a 1/1 spread.
Note the recent strength of CL. Note also how crude tanked much worse than ES in early August.
By the way, barchart.com has great (free) charting tools for spreaders.
Note the recent strength of CL. Note also how crude tanked much worse than ES in early August.
By the way, barchart.com has great (free) charting tools for spreaders.
I use more of a qualitative approach. So It's not just how much time price traded below there but also price action. If I see a lot of wicks below the A down I tend to discount it. Yesterday the market felt pretty weak and we stayed near the lows long enough to say it was a confirmed A down.