NatStewart

Here is a bit of additional information for anyone interested using data from 8/1998 to 9/2012. Please note what we are doing here is looking at a market tendency, not a complete trading system or strategy. I have constructed a table that looks at the the close-to-close (day session) return in the ES contract, and then compares it to results after a +10, +15, and +20 point volatility breakout. I then compare it to a +10 volatility breakout that occurs after a +10 point gap up. What emerges is a reasonably consistent pattern. Returns improve for the remainder of the day as price moves away from the open. The last column displays results for a +10 breakout combined with a +10 gap. This last pattern actually demonstrates a very high average return for an intra-day strategy, and a very high level of statistical significance. Note, a price gap was number two on my list of factors that influence volatility breakout returns in the article above. But you don't really have to take my word for it. Here is a very nice academic study that includes backtested results on a specific volatility breakout strategy applied to stock indexes. Intraday Share Price Volatility and Leveraged ETF Rebalancing by Arthur Rodier, Edgar Haryanto, Pauline Shum, Walid Hejazi :: SSRN In the paper they use a 2% breakout threshold, and look to enter at times between 2:15 and 2:45pm. They even have an interesting rationale for why it works (Leveraged ETF re-balancing). Regardless, their rationale is in my opinion not needed. The basic strategy is a refined volatility breakout approach, and such approaches worked before leveraged ETF's became popular. Now, it is a bit ironic that this first article here is on volatility breakouts in stock index futures. Most of my index trading does indeed use mean reversion principles. In fact, I have an article on a mean reversion approach to trading stock index ETF's coming out in the December issue of Active Trader Magazine. If you are interested, pick up a copy. Also, that second article I linked to in the article documents mean reversion principles in stock index ETFs. Now as I suggested above, I'm not all into treating people like trash just because we are not looking each other in the eye. I am always looking for new ideas and productive approaches, and worthwhile discussion - but lets be professional and keep it civil.

I have been conducting empirical analysis on stock index futures for about 12 years on time frames ranging from intra-day to multi-month. My data and experience suggests you are wrong over a day-hold time horizon. Regardless, your tone and lack of common civility do not speak well of you and indeed verges on libel. From this point forward I will only engage those who address me with common courtesy. Thanks.

What is the volatility breakout trading strategy? My original introductory article on volatility breakouts can be found here. Make sure to read it if you are not familiar with this short-term trading concept, as it will get you up to speed for this current article. As I suggested in the original article, recent market conditions will have a large impact on the strategy’s profitability. In fact, if the correct market conditions are not present, volatility breakout trading strategies will not be very profitable. Many people are introduced to the concept of volatility breakout trading through the work of Toby Crabel, who called the concept, “the opening range breakout” in his book that was published 20+ years ago. Crabel Identified two patterns that became quite popular: The “NR7” pattern and the “Inside day NR4” pattern. Crabel’s NR7 strategy is simply to take an opening range or volatility breakout signal after a day where the trading range (highest price today - lowest price today) is less than the range of each of the past six days. The Inside-day NR4 pattern is to take a breakout signal after an inside day (Today’s high is less than yesterday’s high, and today’s low is greater than yesterday’s low) that is also the smallest range day of the past three days. While these patterns were very innovative for their time, my research indicates that in stock index futures, the basis for this pattern (The notion that volatility cycles up and down in a semi-predictable way) is more difficult to use and less effective than it once was. I do not see any real edge in either the NR7 pattern or the Inside-day NR4 pattern over the past 10 years in the emini (ES) futures or the SPDR S&P 500 ETF (SPY). I am also not a huge fan of patterns that use a ton of “If - then” type logical statements. I know some traders who are effective with this method, however I have found that it is too easy to over-optimize these complex patterns. My approach is to distill a trading idea down into its simplest, most conceptual form, because this is what I have found works best in real time trading. What setups are currently significant when trading volatility breakouts in stock index futures? Here are three factors that I believe are very important: The overall volatility level of the market. Volatility breakouts work best in markets that are frothy with speculation and fear, and work poorly during periods when volatility is compressed and declining. You might be surprised to learn that “typical bull market conditions” are not the best time to take long-side volatility breakouts. This is because bull markets often see volatility and daily trading ranges compress, which is bad for this strategy. My approach is set a threshold level for recent volatility and ignore setups when volatility is below this level. The opening price relative to yesterday’s close (known as a price gap). Many people believe that because markets now trade almost continuously, price gaps (When measured by day-session hours) are not relevant to stock index trading. This is false. Where the market opens relative to yesterday’s close has been and continues to be particularly relevant when trading volatility breakout strategies. My general observation is that volatility breakouts work best when the opening gap is in the direction of the breakout signal. For example, a large gap up is good for a long-side volatility breakout. Where the current price is relative to the recent trading range. This can be measured in a number of different ways. One of my favorite methods is to look at where the price closed today as a percentage of the recent “X” day’s trading range. I cover this concept using a one trading day range in this article, however the idea can be extended to cover longer periods of time. My general observation here is that Volatility breakouts work best when they are “contradicting” the recent price behavior of the market. In other words, an upside volatility breakout works best when price is coming off of a relatively low close, as can be seen in the chart examples I selected. Volatility breakout strategies have not only been effective in terms of total profits, they have also offered solid diversification benefits. It would surprise many to learn that this trading strategy really cleaned up in 2008, a year when the S&P 500 was down around 40%. If there is a catch to this strategy, it is that volatility breakouts are best, “left on the shelf” until the correct market conditions are present. However, if you learn to utilize the three factors I have mentioned above (market volatility, the morning price gap, and the swing position of the market), it might become one of your favorite trading strategies - just as it is for me. Good Trading