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The Breakout Bulletin

The following article was originally published in the December 2002 issue of The Breakout Bulletin.

Dow vs. E-mini S&P

A number of traders have expressed to me their interest in the Dow futures traded at the Chicago Board of Trade (CBOT). While the E-mini's have at least 10 times the volume of the Dow futures, the familiarity of the DJIA index probably draws some traders to the Dow futures. I decided to examine the correlation between the Dow and the S&P 500 futures and see if it might be worthwhile to trade MiniMax II on the Dow futures.


The first thing I looked at was the correlation between the prices. Take a look at Fig. 1, which shows the percent change in the weekly closing price of the Dow futures (DJ), the E-mini S&P futures (ES), and the E-mini Nasdaq 100 futures (NQ).


Fig. 1. Percent change in weekly closing price of the E-mini S&P 500, Dow, and E-mini Nasdaq 100 futures. 


I used TradeStation 6 as my data source and examined weekly closing prices as given by continuous contract data. The symbols in TS 6 were @ES, @NQ, and @DJ.C. All three data series include the evening session prices. I saved the data to a text file using the data window, then opened the files in Excel to create the plot shown above. Obviously, the ES and DJ are much more similar to each other than either one is to the NQ.


Using the correlation function ("Correl") in Excel, I calculated the correlations between the markets. By definition, a correlation of 1.0 is a perfect positive correlation, and a value of -1.0 is a perfect negative correlation. The correlations I obtained are shown below:

    ES-DJ 0.945931
    ES-NQ: 0.933674
    DJ-NQ: 0.796283


As expected, the highest correlation is between the ES and the DJ. However, the interesting result is that the Nasdaq has a much lower correlation with the Dow than with the S&P. This suggests it might be possible to obtain better diversification trading the NQ with the DJ than with the ES. To find out if this is true, I next looked at the correlation between the equity curves produced by MiniMax II on each market.


Before I could generate an equity curve for trading MiniMax II on the Dow, I had to find a good set of parameter values for the Dow. After a little optimization, I came up with the following set of parameter values, which I include here for the benefit of those who trade MiniMax II: 0.3, 0.8, 0.3, 0.4, 2.5, 0.8, 1.6. The optimization encompassed 173 trades over bull, bear, and trading range markets and produced a very smooth equity curve.


The equity curves produced by MiniMax II on each of the three markets is shown below in Fig. 2. For the ES and NQ, I used the recommended parameter values. The curves are for trading one contract and were produced using the built-in Strategy Equity indicator of TradeStation.



Fig. 2. One contract equity curves for MiniMax II on the E-mini S&P 500, Dow, and E-mini Nasdaq 100 futures. 


As with the weekly price data (Fig. 1), the equity curves for the ES and DJ are fairly similar and are much different than that of the NQ. The correlations between the equity curves are as follows:

   ES-DJ: 0.975453
   ES-NQ: 0.915535
   DJ-NQ: 0.827657

The results here mirror those of the prices. The equity curves from the ES and DJ are tightly correlated, as expected. However, the equity curve from the NQ is less correlated with the equity curve from the DJ than with that of the ES. This supports the notion that trading the NQ with the DJ may provide better diversification than trading the NQ with the ES.

The last step was to see if combining the equity curves with a fixed fractional approach, as I currently recommend for trading MiniMax on the NQ and ES, would produce better results with the NQ and DJ together than for the NQ and ES together. The baseline result is shown below in Fig. 3, which depicts the combined equity curve for trading MiniMax II on the ES and NQ using the recommended parameter values and fixed fractions. The fixed fractions in this case are 3% and 4% for the ES and NQ, respectively. The maximum peak-to-valley drawdown over the test period is 26.6%.


Fig. 3. Fixed fractional equity curve for MiniMax II on the E-mini S&P 500 and E-mini Nasdaq 100 futures. 


The combined equity curve for the NQ and DJ is shown in Fig. 4. I found that fixed fractions of 4% for each market produced the same maximum drawdown (26%) as for the NQ-ES portfolio. However, notice how much higher the ending equity value is.


Fig. 4. Fixed fractional equity curve for MiniMax II on the Dow and E-mini Nasdaq 100 futures. 


The lower correlation of the equity curves allows for a larger fixed fraction and provides a much greater rate of return than trading the NQ with the ES.


Lastly, I combined all three equity curves using fixed fractions of 2%, 3.5%, and 3% for the ES, DJ, and NQ, respectively. As above, these fixed fractions were chosen to obtain a maximum drawdown of about 26% to match that of the ES-NQ equity curve. This three-market portfolio is shown below in Fig. 5.



Fig. 5. Fixed fractional equity curve for MiniMax II on the E-mini S&P, Dow, and E-mini Nasdaq 100 futures. 


With the same drawdown as for the ES-NQ and DJ-NQ combinations, a much higher final equity value is achieved by trading all three markets. Also note that if you add up the fixed fractions, the total is 8.5%. In other words, you would lose at most 8.5% of your account equity at one time if you had a loss in each market at the same time. This compares to a total risk of 8% for the DJ-NQ combination. This means that by adding a third market to the mix, our total position risk increases by only 0.5%.


Before you send me an email asking if you should start trading the Dow or replace the ES with the DJ, let me add a few cautionary points. First, as mentioned above, the Dow futures have nowhere near the liquidity of the E-mini's. Whether this would be a problem for you or not I can't say. I've never traded the Dow futures, and I can't comment on the type of fills you should expect. Secondly, the equity curve I'm showing for the DJ is based on an optimization that includes the period shown in the figures. While I believe the parameter values are valid, there may be a bias in the results for the Dow relative to the results for the E-minis.


The bottom line is that if you trade the Nasdaq and/or S&P futures now, it may be worthwhile to take a look at the Dow. As far as MiniMax is concerned, there appears to be some value in adding the Dow futures to the MiniMax mix. I may consider adding the Dow to my own trading. However, since the fixed fractions are somewhat lower for the three-market portfolio, I will need to determine if I have enough equity to make it work. Also, I wouldn't recommend blindly jumping into a new market if you've never traded it before. I frequently find that it pays to be cautious in futures trading.


Your Question

Q: I got a lot of slippage on a recent exit in the NQ when the market briefly plunged then rebounded past my stop price. Should I be using stop-limit orders instead of stop orders?


A: Good question. When the price of your stop order is reached, the stop order becomes a market order and is filled at the best available price. In a fast moving or thinly traded market, it's possible to get a lot of slippage. Fortunately, the E-mini's are usually very liquid (i.e., heavily traded) during the day session, so most stop orders (at least for relatively small sizes) are filled exactly at the stop price (i.e., without slippage). However, there are occasions where bad slippage occurs. Your recent bad experience was on the Friday after Thanksgiving when the volume was much lighter than usual. Some trader probably put in a big sell order, which under normal circumstances would have been easily absorbed. In a thinly traded market, buyers were scarce, so the market fell sharply before anyone stepped in to bid it back up.


A stop limit order would have solved your problem in this case. With a stop limit order, you not only specify the stop price but the worst price at which you'll accept the fill. For example, you might specify "sell 2 Dec NQ 105000 stop with 104800 limit." If the market drops to 105000, you'll get filled at no worse than 104800. I've been told that stop limit orders have precedent over stop orders, at least in the e-mini's. In other words, if another trader has a stop order at 105000 and you have a stop limit at 105000, your order will get filled first, assuming it can get filled within your limit price.


The drawback of a stop limit order is that it doesn't guarantee that you'll get filled. If the market gaps past your limit price, your order won't get filled, and you could be exposed to a large loss. In the example provided in the question, the market rebounded after spiking lower, but this may not always happen, of course. You do take a risk with a stop limit order. Unfortunately, the risk is often greatest when you need the protection of a stop limit order the most; namely, in thin markets.


I would recommend placing stop limit orders in the evening session for the E-mini's and maybe during pre- and post-holiday sessions where the volume is expected to be low. Your goal when placing a stop limit order should be to avoid getting a bad fill on a spurious market move. Getting a bad fill on a genuine market move -- even when the move is sudden and large -- is an unavoidable part of trading.

That's all for now. Good luck with your trading.


Mike Bryant

Breakout Futures