System building from the ground up

October 31, 2010 07:00 PM

It’s possible our cap addition renders the three successive lower lows irrelevant. Suppose we tilted cups/caps 180 degrees? Rather than not taking a trade when they contradict, let’s initiate only when they confirm. "Cap confirmation" (below), shows the September, October and combined totals.


If a cap top has been completely formed by the third trading day of either September or October (with no cup bottoms throughout the sequence) then sell on the day four opening. Exit on or just after the 27th of the month.

Separate research has shown that it isn’t a good idea to be short at the end of any month, so we moved the exit date forward. An optimization study between the 18th and the 28th identifies the 27th as the best date.

The top two rows reveal a still-lopsided, although consistent, profitability. There’s not a stat in the bottom totals that isn’t impressive: from the 68% profitable trades to the 1,031% increase in the account. Even the drawdown is an endurable $9,750.

Remember that you also can trade mini contracts worth one-fifth the value (and risk) of the full-sized ones. You could have made $20,000 while at no time over the 28 years drawing down more than $2,000, if the E-minis had existed over the life of the S&P 500 futures (E-minis were introduced in 1996, 14 years after the big S&P).

The major sticking point continues to be the small number of trials. Separate tests can demonstrate the validity of selling in September and October as well as the persistence of cups and caps. Smaller pools are more reliable when they’ve been distilled from larger ones that each held up under individual testing. Besides, the system performs well in related markets as we’ll see shortly. At the moment, let’s ponder a corresponding buy-side possibility.

As dramatic as the historic fall crashes are, there also are good times to be long: The Santa Claus rally and spring tax refunds to name two. Let’s optimize the 12 months and, for the sake of symmetry, settle on the best possible adjacent two-month combination.


"Bullish bias" (above) reveals two standout areas — March/April and November/December. It would be best to choose one, unless you can find another corresponding two month shorting period. March/April makes the tidiest fit as it is exactly half a year away from the bear months, however, the stats — particularly the ROA — are clearly superior for the November/December period. Besides, four adjacent months surrounding one conspicuous turnaround could be argued to be something beyond the merely arbitrary. "Going both ways" (below) shows results for the three holding periods of November-December, both long only and long/short-side combined.


You shouldn’t trust barn-burning results in one index that breakdown in a market of the same sector. "Broad appeal" (above) shows the results of the full four-month cup-cap system in the five major U.S. mini equity indexes Far and away, minis have been more active than their full-sized counterparts. The minis were introduced years after the originals so we have less history, 15 years on the S&P and at least eight on everything else.

The S&P and Dow thrived and there were no blow-ups with the rest. The concept is sound. As usual, though, it serves as a prelude to uncountable "what-if" questions. What if we moved the inception to later in the month? What if we reversed when we’re wrong? What if we re-configured to incorporate all the months? What if we measured relative strength-weakness among the five markets and initiated only in the strongest/weakest? What if we added stops or profit targets?

On and on it goes. That’s the beauty of market research — the chase never ends.

See the last page for formulas...

Art Collins is the author of "Beating the Financial Futures Market: Combining Small Biases Into Powerful Money Making Strategies." You can reach him at:

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