Sunday, May 31, 2015

Tracking Markets in Event Time

Here is a chart of the ES futures for the past month (blue line).  Each bar is not denominated in time units.  Rather, each bar is drawn after 500 price changes.  (Raw data from e-Signal).  Because there are fewer price changes in the overnight session and during midday hours, there are fewer bars drawn during those periods.  Busier early morning and end of trading day hours account for more bars on average.  Movement, not time, is treated as the market clock.

The red line represents price change over a moving 50-bar window as a short-term overbought/oversold measure.  In general, we've seen negative average returns over the subsequent 50-100 bars when we've been in the most overbought quartile of returns and positive average returns when we've been in the most oversold quartile.  I generally won't execute a longer-term trade unless we're oversold on the price-bar measure.  It's a nice way of buying dips/selling bounces, which saves money when trading rangy markets or choppy trends.

A psychological benefit of denominating markets in units other than time is that the charts slow down as markets slow down and pick up as markets pick up.  This is a helpful way of avoiding overtrading slow markets--and it is a nice heads up on when markets are slowing down and when they're picking up.  I also find the cyclical behavior of markets to be clearer when cycles are measured in movement rather than time.

The main takeaway is that if you look at markets in conventional ways, you'll generate conventional returns.  I consistently find that it's the creative ways of thinking about markets that hold the most promise for superior performance.

Further Reading:  Event Time