SIERRA HOTEL operates in
TradeStation and SuperCharts. It is easy to use, having only
one parameter. That parameter lets you adjust your trading
style from trend following to position trading to optimizing
for the personality of your favorite contract. Typical
durations of a trade range from one to three months,
depending on the single parameter value. The 24 year
performance was calculated on back-adjusted continuous
contracts. The following table shows the data on a single
contract without compounding. No allowance for slippage and
commission was used. Please note how stable and continuous
the equity growth has been, without serious setbacks and
drawdowns. SIERRA HOTEL is an exceptionally
robust trading system.
Percent Annual Return is calculated as
the average return on a single contract with $10,000 initial
investment without compounding. A $50 per roundturn allowance
is made for slippage and commission.
SIERRA
HOTEL trading records
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SIERRA HOTEL EC TRADESTATION REPORT (500 KB)
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SIERRA HOTEL JY TRADESTATION REPORT (500 KB)
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SIERRA HOTEL SF TRADESTATION REPORT (500 KB)
SIERRA HOTEL is $995
Engineering a Low-Risk Portfolio
by Bob Pelletier, www.csidata.com
There has been a good deal of interest in the Sierra Hotel trading system we introduced to our readers in last month's CSI Technical Journal (CTJ) and also in the risk management techniques we discussed there. I am pleased to announce that in the past few weeks we have implemented several small, but significant changes to the Sierra Hotel program and its network of markets, aimed at better managing risk through diversification and by utilizing correlation data. The Sierra Hotel trading system is now available with these adaptations through CSI's Unfair Advantage platform.
As brief background information, let me explain that Sierra Hotel is an adaptive channel breakout trading system that uses a proprietary algorithm developed by John Ehlers and Mike Barna. It is based upon Maximum Entropy Spectral Analysis or simply, " MESA ." The MESA signal processing technology (where technical applications lie in radar development and analysis) adapts parameters for optimal trading signals. The original version offered by CSI provides signals on four currencies.
Before addressing how we added diversification to Sierra Hotel, there's a misunderstanding that must be cleared up about the program's methodology. As many of you may know, I was interviewed by Jayanthi Gopalakrishnan, the editor of Technical Analysis of Stocks & Commodities Magazine, for an article that was published in their "Bonus Issue" at the end of March 2006. In that interview I questioned systems that use today's price as a predictor of future price. I cautioned that such a posture can result in a principally flawed outcome, as one is trying to gain too much meaning from too little data. I have since been asked if Sierra Hotel is not such a system. The answer is an unequivocal "no." Sierra Hotel's MESA technology does not try to predict futures prices in a price-determines-price formulation because price alone may not necessarily predict price in the future.
A valid exception to my rule against price-determines-price trading tools can be found in the concept of "out of sample" data. A trading system is said to employ "out-of-sample" data when the results are not known to the trading algorithm at the time trading recommendations are generated. Those results can therefore be considered independent and unbiased. With the concurrence of John Ehlers, we employed walk-forward optimization to provide up-to-date parameter settings that were derived only from the past. This assures that no after-the-fact curve-fitting occurs.
I said in the S&C interview and still maintain that intermarket analysis leading to diversification is essential to good trading. I also addressed this subject in the April '06 CSI Technical Journal, emphasizing that it won't do to simply trade multiple markets; you must select markets that are not positively correlated to achieve a balanced portfolio that will minimize coincident risks. You can also trade markets that are negatively correlated, but we'll cover that later. The danger in trading correlated markets is not when the markets move in your desired direction. The danger lies when the markets go against you, serving up double losses.
With the permission of John Ehlers, Steven Davis of CSI tested the Sierra Hotel software on a much larger collection of markets than the four we initially supported. The new candidate markets included grains, indices, metals, petroleum products, financials, other currencies and more. Sierra Hotel is now applied to at least a dozen markets over an extended time period reaching back, in most cases, to the very first day of trading.
We posted the results of the top two dozen performers in this hypothetical* study on our website on the Sierra Hotel "Back Testing" page. This listing details the average trades per year, percentage of profitable trades, profit factor, drawdowns, and more for each market, as shown in Figure 1, below.
Figure 1. These are hypothetical results of Sierra Hotel trading on an array of markets. The color coding indicates market correlation. Past performance is no guarantee of future results.
Of particular interest in the Backtest results for candidate markets is the computed "Sharpe Ratio," a mathematical figure of merit derived from the hypothetical historical profitability of the Sierra Hotel platform as applied to each market. The greater the Sharpe Ratio, the greater the return and the less the risk for each market taken as an independent portfolio entity. At present, 12 have what we consider to be a good Sharpe Ratio of perhaps 0.5 or higher. To view a current table on the CSI website (www.csidata.com), go to the Sierra Hotel page and then click "Back Testing: Sierra Hotel."
The Backtest page is shaded to show correlation commonality of the color- coded classes. If you read last month's CSI Technical Journal, you'll remember the techniques for considering correlation data in portfolio selection. There I referred to the CSI Correlation Studies and recommended against trading correlated markets. To repeat: Correlation is your enemy! This web page will help users of Sierra Hotel and other products develop broader trading portfolios that avoid positive correlation. The elimination of all correlated markets from a portfolio provides an ultra-safe basket of markets that is highly unlikely to expose you to devastating coincident losses. Avoid correlated products when picking markets to trade by holding no more than one market in each color category.
The Sierra Hotel "Current Orders" page (Figure 2, below) shows the same color coding as the Backtest page, but on the smaller subset of recommended markets. This page displays current trading signals and profit calculations to Sierra Hotel users. It shows current positions and provides a quick look at the trading markets and their relationships to each other. This exhibit is not intended to supply, nor should it be used to derive market orders.
Figure 2. The CSI website's "Current Orders" screen for the Extended Sierra Hotel system. ( Current Orders Page )
For more hands-on correlation analysis, you can view a matrix of correlation coefficients (Figure 3, below). This is a premium CSI product that will help you keep your portfolio balanced. The correlation matrix shows the 14 markets that CSI suggests for Sierra Hotel, and which we found to exhibit viable trading opportunities. We propose to offer these in the extended Sierra Hotel package, but the list of markets might change over time.
Figure 3. MultiMarket Analyzer's Correlation Table for Sierra Hotel's "Recommended markets."
This table was produced by Unfair Advantage's MultiMarket Analyzer. The 14 recommended Sierra Hotel markets were selected for analysis using long-term Perpetual Contract(R) data. When the Factor Analysis screen displayed during the MMA run, I clicked the [Raw Correlation] button to produce this report. As you can see, it displays correlation coefficients like those discussed in the April CTJ and found on the Correlation Studies page of the CSI website.
As discussed last month, a correlation coefficient of 0.0 for a pair of markets suggests there is absolutely no predictable connection between the two. A positive correlation coefficient of around +1.0 suggests that a pair of markets will move up and down together - always in the same direction, but a negative correlation coefficient of -1.0 implies that the markets in the pair consistently move in opposite directions. These diverging markets pose excellent opportunities to sell one against the purchase of another. Armed with information like this, I sometimes favor trading negatively correlated markets. A strategy of this type requires a rather complex series of analyses. In addition to correlation scores, it requires the Z-score values that are accessed through our website's CSI Correlation Studies. The typical scenario would involve selling the market with the Z-score that is statistically higher relative to the norm and buying the market with the Z-score that is statistically lower relative to the norm. In this way one would hope to capitalize on the tendency for the members of the pair to move in opposite directions from each other. Results may be inconsistent with the trading signals of Sierra Hotel or other trading systems.
All this is too much to discuss in a single article, so we will try to delve further into it next month. In the meantime, please consider the wisdom of avoiding correlation in your trading portfolio. Remember that when exploring heavily positively correlated markets, you should choose the one you wish to trade from among the many. Markets correlated near the zero level are recommended. The danger of coincident loss is greatly lessened for these because the near-zero correlation coefficient suggests independence of movement.
Although these correlation tips are relevant to Sierra Hotel, they apply equally well to all system approaches, including the many CSI-compatible trading systems. Choose your markets carefully, visit UA's MMA study to capture the correlation matrix, and attempt to keep your risk under control. Your trading success is likely to depend upon consistently following these rules and recommendations.
Bob Pelletier
