Thursday, July 05, 2007

Being Long and Short - an example

I received the following comment on my previous post, which I consider so important for understanding the new technique, that I copied it and post it as a new article:

It still comes down to eventually one thing, sooner or later you have to make up your mind, do you want to be long or do you want to be short..the only effective thing you have accomplished is doubling or tripling your commission cost...Peaktrade 

You might be right with the commissions, but I'm actually not convinced (yet). Meaning it might be something I need to learn (aka pay the market for) myself.

As I see it right now, the oil market  (as every market) is going from trending to ranging periods and back.
What distinguishes the oil markets from other markets is that the range periods usually show healthy 30 to 50 tick ranges, which can be traded on the long and short side. With the technique I'm proposing I'm effectively lowering say the entry for a (temporarily) wrong long entry to the or near the bottom of the new range. Let's explain that with an example:

I take a Breakout Long signal CL 71.50, but CL is not going up, instead it's rejecting the highs and trades to the downside.

So I go Short WTI 71.30. I'm now down 20 on the Long. Now any further loss in CL is matched with an equal gain in WTI.

For this example's sake let's assume CL really switches into trend down mode and finds a new bottom around 70. I see 70 holding and cover the WTI short at 70.10.

That makes a profit of 120 on the Short side, while my first Long is down 140. On balance that means I've lowered my Long entry from 71.50 to 70.30.

Now let's say CL makes a double bottom at the round number and I add later at 70.10 on a new long signal. Now my average entry for the 2 contracts is 70.20 instead of 70.80, which it would be had I not taken the WTI short.

Let's look at the example the other way: CL trades down to 71.30 on a fake move and jumps up to test the 72.00 area. Again I'm short WTI 71.30 and Long CL 71.50. Instead of a profit of 50 ticks I'm down on balance 20 ticks, as CL shows me a profit of 50 ticks while WTI is down 70 ticks. I see 72.00 breaking, but prices are not able to go beyond 72.10. So I exit my CL long at 72.00 for a profit of 50 ticks. Now I'm short WTI on balance 71.80 (71.30 +50 ticks = 71.80). 72.00 is really holding and prices make a double top, giving me a new independant short signal at 71.90. Now I'm short WTI 71.85 instead of 71.60 which my average would be had I not stayed in the CL long.

Of course I could have exited the WTI short the moment I saw, that it was a fake, but at my current stage as a trade I'm often not quick enough to decide that. So all I would accomplish would be accumulate losses by multiple Stops ( CL long 71.50 stopped at 71.30 and reversed short, Short stopped at 71.50 and reversed long for already -40 ticks).

As I see it my technique might produce more commissions, but it buys me a lot of time and avoids stops which otherwise I would have to take.