Monday, September 24, 2007

Beginning to Relax

After the first week here we are beginning to be able to relax a little. We saw Parliament House, Floriade (and annual Spring flower festival in Canberra), the National Capital Exhibit (explains history of Canberra), and a stroll in Commonwealth Park along the shores of the lake with views to the Brindabella Mountains (picture of the Brindabellas above), and sat at an outdoor cafe in Garema Place. Canberra is cold in the shade and warm in the sun at this time of year.

I've also been testing a few trading modeling ideas. One result is that the correlation between the returns of the overnight session on the NDX and the intraday session is only 0.03. The overnight session has a correlation with the previous intraday session of -0.03. These are low correlations. Yet both have much higher correlations with my model's direction. Trading both sessions is a good diversification strategy. The overnight session (daytime in Oz) has half the volatility of the intraday session. A strategy that uses my model for market direction and trades twice a big a position overnight as intraday has a higher Sharpe Ratio (return/standard deviation essentially) than a strategy that always has the same size position. It has lower returns, but can be leveraged up more. I haven't yet computed Sharpe Ratios for the separate sessions individually. Probably something I should do. I also experimented with different stops. There is a risk-return tradeoff there too. A 1.25%-1.33% stop has maximum return for the NDX. A 1% stop strategy reduces the beta of the strategy to the index to zero (from about 0.15) but reduces returns (alpha is constant). Going to a 1.5% stop and above reduces alpha. In fact a no stops strategy in the last two years has a higher Sharpe Ratio than 1.5% or 2% stops. The key thing here is a setting a stop at a point where if the index reaches that point it tends to run away to the upside. The market often improves after going 1% in the wrong direction. It has much less of tendency to improve after going 1.25% in the wrong direction.

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