Program Trading
There is a lot of talk in the news about program trading. But what part about program trading applies to your daily trading with ZoneTraderPro? Program trading is defined as a computerized program to buy or sell a basket of at least 15 stocks. The trading that we will be talking about is not High Frequency Trading (HFT) where algorithms look to make fractions of a penny on thousands of trades. The program trading we are interested in is Index Arbitrage and using the S&P E-Mini Premium.
Index arbitrage
Index arbitrage is buying something cheap and selling something else similar that is more expensive. Futures move faster than the stocks that make up the S&P 500. The futures have a Fair Value which is reset every day. The S&P 500 futures will normally trade between the buy arbitrage and sell arbitrage during a normal day. A small tight range around fair value is a normal liquid market. A number of wide ranging bars reflect an illiquid market and a market reacting to news.
This picture reflects a good liquid market and a “normal” e-mini premium range. There has not been index arbitrage program trading.
Buy and sell arbitrage occurs when the faster moving futures get in front of the physical stock prices usually due to a news event. Price needs to exceed the arbitrage limits in order to pay for the cost of the trade and turn a profit. In a selling arbitrage situation the futures climb very fast and there is more demand than there is supply. Futures are then what is expensive and they are sold and the physical stock is then bought. Typically the futures may fall back 4-5 ticks due to this selling. The NYSE stock which is now inexpensive is bought, pulling up that index. That is program trading that applies to ZoneTraderPro. How?
If you are in a short position when this occurs you are likely stopped out. If you are not, it is a good reason to consider the risks in staying short. When the futures spike outside of the arbitrage range, it is because somebody with a lot of money has just made a huge bet, usually because of breaking news. These are traders that know what the news is. Cable news is usually 15 seconds behind the news if it is a financial number that they expected a release on. It will take minutes if it is a breaking news story, because they have to confirm the story. If you are not already involved in the trade before the news broke, it is likely too late.
That is precisely what occurred today on 8/26/13. At around 1500 hours EST there was extremely tough talk by the Secretary of State about Syria. The financial cable news networks did not start talking about this until about 1530 hours. But somebody at the CME around 1510 hours realized that we are about to (possibly) start warming up the cruise missiles.
After 1515 hours the increase in volatility results in a decrease in the liquidity on the e-mini futures. ZoneTraderPro defines this as illiquidity volatility. This is an extremely important concept. The more illiquid a market is, the fewer number of contracts are required to move price. Logical computerized program trading has now been replaced by floor traders with information the general public does not have.
After the market found the initial bottom at 1526 hours, the ZoneTraderPro zones took over, even with the illiquidity. A detailed examination of the chart will follow in the next post.
