ELP PROGRAM: Analysis
Cost analysis E-mail: firstname.lastname@example.org
All results in the Performance section are gross of costs incurred in actual trading and are based on the S&P500 spot index. What factors will affect results in actual trading? What costs are we to factor in?
1) Execution costs. They are, first, brokerage commissions, and second, slippage, or bid-ask spread. With 28 (on average) trades a year and in a liquid market with tight spreads like E-mini futures, these costs are negligible ($50-100/year).
2) Spot-futures difference. Some people argue that differences between spot prices and futures prices are such that make systems developed on the spot basis unreliable. Research shows that this is not the case. Correlation is really very close. Of course, futures do not bring you dividends, which is likely to depress prices a little, but you save on financing (having to pay only the required margin instead of the full prices of the underlying stock), which is likely to lift prices a little. So it all boils down, basically, to traders' expectations as to the interplay of interest rates and dividends, and no-one has ever been able to predict such interplay precisely. A futures contract, when it begins trading on the exchange, tends to trade somewhat higher or somewhat lower than the current spot price, depending on such expectations. By the expiration date, though, spot and futures prices must converge to prevent arbitrage. It usually results in a small gap between the expiring front contract price and the next front contract price. If the next front month (and months further out) are lower than the expiring contract, it is called “normal backwardation”, or simply "backwardation", and if it is the other way around (i.e. the next month is higher than the expiring), it is called “contango”.
How can it affect trading under ELP Program? Primarily, by having to roll over to the next front month when you are holding a position. For example, you have one long position in March E-minis, there is no signal to close the position, and the month is near to expiration. So it is time to roll over to June. The March futures market price is 2930 (say), and the market price of the June futures to which you are rolling over is 2935 (the market is in contango). You have no choice but to sell at 2930 (and maybe incur a slippage) and buy at 2935. Now you have the same (long) position in the next front month futures (June), which is good, minus 5 points off your position value (maybe 6 if you are unlucky with execution), or $250-300 in E-minis, which is bad. How bad? Actually, not so much in the short run and not at all in the long run. Moreover, in a backwardation market, this situation works in your favor (if you hold a long position). We analyzed the year 2010 (the worst year of ELP Program; a backwardation year), and instead of 155 index points that the Program generated in the spot index, we would have earned 180 points in the futures market. Also, it depends on the direction of the contracts (long or short) you have to roll over; on the number of rollovers per year etc. And so it goes, year after year; a year or two in backwardation alternates with a year or two in contango (e.g. 2016: strong backwardation – 6 to -7 points; 2017: strong backwardation at first, then mild in the middle, and mild contango in the end; 2018: mild to strong contango; 2019: mild contango but at present i.e the beginning of November, almost flat and looking to go to backwardation). In the long run, it all averages out. Thus, the verdict is: costs negligible in the long run, but in any individual year there may be either a gain or a loss anywhere from zero to 10% of the theoretical result.
3) Subscription fee. The monthly fee is set at $59/month for individual traders ($19 for new and Micro E-mini traders). You pay only for profitable months, hence for 8-9 months in a year (on average). $500 a year is of course not a negligible sum, but let’s look at it in perspective. A typical hedge fund charges a 20% performance fee and a 2% management fee irrespective of performance. $500 is less than 1% of your minimum trading capital, and there is no performance fee. (And maybe your trading capital is millions… well, again, life is unfair: the rich get to pay a smaller fee in terms of percentage cost). Anyway, I find this cost reasonable.
Special offer for new subscribers and Micro E-mini traders with a trading capital of up to $10,000 (see Subscription).
Drawdowns are a factor with which a trader has to live. It is almost a law of nature that as soon as you open a position, the market starts moving against you. With ELP, drawdowns of $2,000-$3,000 is a common feature, $5,000 is not a reason for concern, but $7,000 to $10,000 happen only a couple of times in a year. The really big drawdowns are rare (listed in the table below). Those ones will probably cause you several sleepless nights in a decade, but no pain no gain!
Date S&P500 movement Drawdown Duration (days from high to low) Recovery (days from low to new high) Margin requirement at the time
07-08.1998 1164-957(207) $24,000 30 110 3520/3200
05-07.2010 1171-1022 (149) $22,000 60 220 4950/4500
07.2011 1305-1120 (185) $23,000 10 90 4400/4000
08.2015 2035-1867 (168) $22,000 3 30 5060/4600
12.2018 2651-2351 (300) $32,000 9 15 6600/6000
As already stated elsewhere, the recommended initial unit of capital is $70,000 (for E-minis). This amount covers the CME margin requirements ($6,600 x 3) plus one and a half largest drawdown ($32,000 x 1.5). It should be enough to feel secure. But as mentioned, with the increase of the S&P500 value, we may expect higher volatililty in terms of absolute numerical value of fluctuations. This means, potentially, both higher profits and higher risk of big drawdowns. Therefore we recommend to keep as your trading capital, beginning from the New Year, a sum of $80,000. That will keep your leverage in line with ELP's historical figures, and ensure safe and sound trading going forward.
ELP employs stop-loss orders, but since they are always to be executed on the close of a trading day, they are given as ordinary signals to buy or sell. The ultimate ELP Program stop signal is a loss (drawdown) of more than a half of the recommended capital ($40,000) as of the end of month.
Risk-return analysis. Ratios
For that purpose, we employed the widely used Sharpe ratio and its variations. We calculated them based on monthly results.
Sharpe ratio = 5.28.
This is extremely good as it is (2 is considered “very good”), but we took it on ourselves to “improve” it a little. With all due respect for the Nobel Laureate, in his ratio he punishes the “good” volatility as well as the bad. That is to say, the farther monthly profits go beyond the mean, the worse the ratio. And ELP posted some quite illustrious gains in the most needy times – in the down years of 2000-2002 and 2008. What we did was to average all profitable months and treat them in calculating the ratio as being all the same. With this adjustment, the ratio becomes as high as 6.6.
The Sortino ratio takes into account only down months.
Sortino = 3.41.
Even if we adjust the ratios for leverage (which is inherent in futures trading), they are impressive. The average leverage throught the 24 years being about 2.5, we get: Sharpe=2.6 and Sortino=1.3.
A reasonable interpretation of the ratios would be that in spite of some volatility (which is equated to risk in the Sharpe ratio), ELP Program generates extraordinary results and can be highly rewarding for the investor.
For those interested, the standard deviation of monthly results is 7.9. Raw monthly results can be downloaded from here.
The real risk as I see it in trading ELP Program is discipline and implementation. Please take all signals, do not try to cherry-pick the ones you "like" best. Do not try to improve or add to it unless you are an experienced trader and know how to do it. (For such experienced traders: indeed, the Program can be enhanced and energized by such methods as scale-trading etc. , but ALWAYS take care to figure out BEFOREHAND how you will be quitting the “extra” trades.)