Saturday, March 11, 2006

Will Very Short-Term Momentum Trading of the S&P Work?

As we've seen from the recent Trading Markets article and yesterday's blog posting, the S&P 500 Index has been losing its trending properties across multiple timeframes, from daily through intraday. Anecdotal evidence suggests that scalpers are suffering in this market, as well. Let's see how the market is trending on their time frame. Please note that when I talk about scalpers, I am referring to liquidity providers in the electronic marketplace. These are participants who are in the market most of the time, working bids and offers and attempting to extract small, frequent profits from very short-term movement.

I went back to January, 2004 and looked at all five-minute periods in the ES contract (N = 44,110). As before, I calculated all instances in which the market was either up following a five-minute rise or down following a five-minute decline. What we see is that only 14,362 of the periods displayed such two-period trends. This proportion is *much* worse than what we saw in the daily or even the hourly data. In essence, it's saying that the odds of the market rising five minutes after a five minute rise (or declining after a five-minute decline) are worse than one in three.

The reason for this is that a number of five-minute periods close unchanged. The low volatility conspires to restrain very short-term trending behavior. This makes momentum trading near impossible. Either one must extend one's holding period well beyond five minutes--in which case you're really no longer a scalper--or one be willing to fade any movement whatsoever, risking those one in three occasions when the market can run you over.

Is there any hope for momentum and trend traders in different instruments? This will be the upcoming focus.


John Wheatcroft said...

OK - I'm buying the fact that the trend doesn't follow on a "period to period" basis - but what if you skip a period. I.E. Instead of looking at period 1 to 2 look instead at period 1 to 3? Rather than 2 to 3 look at 2 to 4. I recognized a while ago that the only possible profit in this particular environment would come from swing trading. I've also been looking at 4 day windows which seem to be just about right for my risk appetite.

Brett Steenbarger, Ph.D. said...


It's a good question. I'll take a look shortly at the issue of trending beyond a day-to-day basis. Thanks--


MS said...

Wouldn't that environment be ideal for scalpers? Most scapers I know are counter-trend, not trend followers...

Brett Steenbarger, Ph.D. said...

Yes, the countertrend style would be good for scalpers if it weren't for the absence of volatility. It's not that very short-term moves are being followed by short-term countermoves; it's that short-term moves are just as likely to be followed by *no* movement. About a third of the time countertrend scalpers have the market go their way, a third of the time the market goes against them, and a third of the time it doesn't move. This is why scalping has become such a game for the automated traders, as they try to improve those odds by getting to the market quickly when the bid/offer situation is favorable.