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Re: Larry Williams' "Volatility Breakout System"



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  ----- Original Message ----- 
  <DIV 
  style="BACKGROUND: #e4e4e4; FONT: 10pt arial; font-color: black">From: 
  <A title=nick.channon@xxxxxxxxxxxxx 
  href="mailto:nick.channon@xxxxxxxxxxxxx";>Nick Channon 
  To: <A title=metastock@xxxxxxxxxxxxx 
  href="mailto:metastock@xxxxxxxxxxxxx";>metastock@xxxxxxxxxxxxx 
  Sent: Friday, September 07, 2001 7:29 
  AM
  Subject: Larry Williams' "Volatility 
  Breakout System"
  
  Hi,
   
  I'm writing to ask for assistance from any of you guru 
  code-writers out there.
   
  I wrote to Equis support to ask if they could provide me 
  with the necessary formulas for Larry Williams' "Volatility Breakout System". 
  I provided them with a description which I found on the web (reproduced 
  below). Equis wrote back with the message below. What I need to know 
  is:
   
  1) Have Equis come up with accurate English-language 
  descriptions? (Any Williams experts out there? I do not have the knowledge to 
  judge the accuracy.)
  2) Can anyone save me $60 and benefit other group members 
  also by taking up the challenge to code relevant explorations, indicators, 
  experts etc.?
   
  There follows the description found on the web, and the 
  reply from Equis.
   
  Cheers
  Nick
   
  **************************
  DESCRIPTION FOUND ON WEB
  As far as we are aware, the early groundwork for volatility-based 
  tradingsystems was laid by Larry Williams in the early 1970's. He sold at 
  leastthree systems based on the same technique, each at successively 
  higherprices (one of them was called the Million Dollar System). Welles 
  Wilder, inhis 1978 book New Concepts in Technical Trading Systems, 
  reiterated theessential principles, as did Perry Kaufman in Commodity 
  Trading Systems andMethods.After Williams a number of vendors sold 
  systems based on the method, thebest known of which is probably the 
  Volatility Breakout System offered byDoug Bry of Lakewood, Colorado. 
  Anyone who is interested in reproducingand/or testing any of these 
  volatility based systems should be aware of avery reasonably priced 
  software package, Steve Notis' Trader&#8217;s Powerkit,that incorporates most, 
  if not all, of the trading logic of the systems thatsold for many 
  thousands of dollars.The Basics - Measuring VolatilityThe 
  volatility-based trading systems all use the concept of range to definethe 
  extent of recent market movement. The simplest definition of range isthe 
  distance from high to low of any given time period. This is usually aday, 
  but it could be a week or a month or even an intraday period measuredin 
  minutes.This simple definition of range works fine most of the time, 
  but it doesn'ttake into account days of extreme price movement. Limit 
  days, for example,may have a very narrow range, but the market is 
  obviously very volatile andvolatility is increasing. Similarly, a day when 
  there is a gap opening andthe day's trading takes place outside the prior 
  day's range is an example ofincreasing volatility, even if the actual 
  range of the day is lessthan that of the prior day.Wilder 
  recognized this problem and defined the True Range (TR) as thegreatest of 
  the following:        
  1.   The distance from today's high to today's 
  low.        2.   The distance 
  from yesterday's close to today's 
  high.        3.   The 
  distance from yesterday's close to today's low.By itself, the True 
  Range is still just an isolated number. To make itmeaningful, we must take 
  a number of past days and find the mean, giving usan Average True Range 
  (ATR). This is a direct measurement of marketvolatility. If the ATR is 
  increasing, the market is becoming more volatile.If the ATR is decreasing, 
  the market is becoming less volatile.How many days to use to produce the 
  "best" ATR is a matter of conjecture.Wilder's original volatility formula 
  (to be explained later) uses 14 days,but most of the modern system sellers 
  have optimized this variable and foundthat anywhere from 2 to 9 days was 
  better. The most profitable (as measuredby Futures Truth) of these 
  systems, the Volatility Breakout System, normallyuses only two 
  days.How the Volatility Systems WorkAll of the popular 
  volatility-based trading systems work on the principlethat a breakout or 
  price spike outside of the recent Range or Average TrueRange is 
  significant and should be used as a point at which to enter themarket. For 
  example, let us say that the ATR for the last five days in theNYSE 
  Composite futures is 1.00 points. We would be interested in a pricemove 
  that is a percentage, say 150%, of the ATR from the prior day's close.This 
  means that we would be buying or selling if prices moved 150% x 1.00,or 
  1.50 points. If the prior day's close was 190.00, we would buy at 191.50or 
  sell short at 188.50.The two variables of the system 
  are:        1) the number of days 
  used to find the ATR        2) the 
  percent move from the prior day's close that constitutes avalid 
  breakout.Most of the system vendors and the presently available 
  software rely onoptimization to decide which values to be used for each 
  variable.As you may have deduced, the basic volatility breakout system 
  is a reversalsystem that is always in the market. Each day after the 
  close, calculate theATR, and then multiply it by the percent move 
  necessary to trigger a trade.Add the result to the close, and you will get 
  the point at which a buy willbe triggered the next day. Subtract the 
  result from the close, and you willget the point at which a sell will be 
  triggered. Enter both orders the nextday and you are in 
  business.Comments and VariationsOne of the significant 
  strategies of the basic system is that since you areeither long or short, 
  there is no neutral area. The risk on any one trade issimply the 
  difference between the entry point and the reversal point. Ifthey are both 
  triggered on the same day or very close in time to oneanother, a whipsaw 
  is the obvious result.  Perhaps more importantly, the risk on a trade 
  depends entirely onrecent market volatility, which may or may not agree 
  with a trader's walletsize or money management techniques. However, the 
  market does not care aboutconforming to your money management 
  techniques.  If you can not tolerate thehistorical volatility and 
  potential drawdown of a certain stock or futuresmarket, then you should 
  trade smaller lots or mini-contracts.Good trading systems are designed 
  first to make money, and then, onlysecondly, to make the process as 
  comfortable as possible by smoothing outpotential drawdowns. These two 
  goals are always at odds.  Less risk (e.g.tighter stops) always 
  produces less profit.  There is a limit to howcomfortable you can 
  make a system and still show a profit.Another interesting aspect of 
  volatility systems is that the entry point andthe reversal point will move 
  away from each other if short-term volatilityincreases. It is easy to see 
  how this could happen: the market moves, therange increases, and the stops 
  are positioned farther and farther away fromeach other. This might tend to 
  reduce whipsaws, but it can also increase theinitial risk on a trade after 
  the trade has been entered.Volatility breakout systems are trend 
  following systems.  They are notdesigned for short term scalping for 
  limited objective trading.  They aredesigned to get in on the really 
  big moves and stick with them until theend.  As such it is necessary 
  to expand the stops when the market heats up &#8211;even if that means 
  increasing your initial stop.  The alternative is to bethrown out of 
  a strongly developing move and then being faced with thedifficult task of 
  finding a low-risk re-entry point.  The stronger the moveis the 
  harder it will be to get back in, because a pull-back may not occuruntil 
  it&#8217;s too late to catch the bulk of profits.  Therefore the best 
  policyis to let the market determine the optimal placement of 
  stops.Professionals trade many markets concurrently to achieve a smoother 
  overallequity and reduce drawdown.Suggestions on Making It 
  Work - FiltersThere is no question that they should always be in the 
  right direction whena market is trending with enough volatility to be 
  worth trading at all. Thereal difficulty, common to most trend-following 
  approaches, is whipsaws whenthe markets have no trend and low 
  volatility.Over a long period, markets will be alternately stagnant 
  and dynamic withmost of the time spent in the stagnant mode. Similar to 
  moving averagesystems, a volatility system set up for a trending market 
  will not work wellin the sideways periods.Obviously, a filter is 
  needed. We can suggest several. First, it is possibleto cut down the 
  considerable initial risk on each trade by creating aneutral zone between 
  long and short entry points.The simplest way to do this is to set a 
  percentage risk stop that is smallerthan the percentage of the ATR that 
  triggers the entry. For instance, in ourearlier example we had an ATR of 
  100 point in the NYSE Composite, and wewould buy on a move upward of 150% 
  of this, or 150 points.A tighter stop could be set by subtracting a 
  smaller percentage of the ATRfrom the entry point. We are afraid that 
  anything less than 100% of the ATRmight be classified as too close and 
  subject to almost random whipsaws, butusing a number like 125% still gives 
  a tighter stop level than our reversalpoint. If the risk stop is 
  triggered, the system is now neutral until thesell reversal at 150% is 
  hit, or until a new buy entry is reached.Another possible improvement 
  might be to avoid trades when a market isacting poorly, especially when 
  the volatility is unusually low. There maywell be 'windows' of optimum 
  profitability for the ATR of each commoditywhere it is within acceptable 
  boundaries, neither too high or too low. It issafe to assume that a 
  stagnant market with a relatively small range willresult in losing trades, 
  while a more volatile market will tend to be moreprofitable. The usual 
  impulse is to re-optimize when the markets becomestagnant, but it might be 
  more profitable in the long run to sit outcompletely during the quiet 
  markets and wait until the ATR becomes more inline with what your system 
  normally needs to be successful.A third possibility is to add an 
  external filter, something that identifiesconditions that must be met 
  before a breakout is taken. There are at leasttwo possibilities for this 
  among readily available technical studies:DMI/ADX and CCI. Our regular 
  readers are aware that we often mention that anupturn in Wilder's ADX 
  signals that a market is trending. Try tradingvolatility breakouts only 
  when the 18-day ADX is rising. (Up-Down Volatilityand Percent V serve a 
  similar function).Similarly, a 20-period CCI based on either monthly 
  or weekly signals willalso tell you to what extent a market is trending 
  over the longer term. Lookfor rapid acceleration of the CCI from its null 
  or zero line; if thiscondition exists, the market is probably moving 
  rapidly enough to makevolatility based trading highly profitable. (CCI and 
  Bollinger Bands aredifferent views of the same study formula.)"
   
  END
   
  ********************
  REPLY FROM EQUIS
   
  "Nick,I have read the article you 
  supplied and have pulled from it the followingconditions.  Please 
  read them and verify they are what you want to usefor your entry and exit 
  conditions.Entry conditions:18-period ADX is risingtoday's 
  high is some percent of the ATR greater than yesterday's high (for buys ) 
  ORtoday's low is some percent of the ATR lower than yesterday's low ( 
  forshorts )Exit conditions:an entry condition in the other 
  directions ( a short signal when long ora buy signal when short ) 
  ORthe price moves a percentage of the ATR against the position you are 
  in.The article did not give set values for several of the factors 
  listedabove.  These are:1) the percentage of the ATR required for 
  the entry signal2) the number of periods used in calculating the ATR3) 
  the percentage of the ATR used for the stopDo you have values you want to 
  be used, or would you rather the systembe written to optimize on these 
  values.  If you want it to optimizebased on these values, I will need 
  you to specify the range you wantthem to cover (ie. check ATR time periods 
  2 through 28).I need you to verify and respond to the above 
  information because we arenot licensed financial consultants.  
  Writing trading systems can beconsidered offering financial advise so we 
  err on the side of caution.After you have responded, I can most likely 
  provide the system to youwithin a day or two.  The fee for this 
  system will be around $60, unlesssome unforeseen technical difficulties 
  arise."
   
  END
  ***************************