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Alpha Trading: Profitable Strategies That Remove Directional Risk

ISBN: 978-1-118-00122-6
368 pages
February 2011
Alpha Trading: Profitable Strategies That Remove Directional Risk (1118001222) cover image

Description

From a leading trading systems developer, how to make profitable trades when there are no obvious trends

How does a trader find alpha when markets make no sense, when price shocks cause diversification to fail, and when it seems impossible to hedge? What strategies should traders, long conditioned to trend trading, deploy? In Alpha Trading: Profitable Strategies That Remove Directional Risk, author Perry Kaufman presents strategies and systems for profitably trading in directionless markets and in those experiencing constant price shocks. The book

  • Details how to exploit new highs and lows
  • Describes how to hedge primary risk components, find robustness, and craft a diversification program
  • Other titles by Kaufman: New Trading Systems and Methods, 4th Edition and A Short Course in Technical Trading, both by Wiley

Given Kaufman's 30 years of experience trading in almost every kind of market, his Alpha Trading will be a welcome addition to the trading literature of professional and serious individual traders for years to come.

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Table of Contents

Preface ix

CHAPTER 1 Uncertainty 1

Impact on Trading 2

The Inevitable Price Shocks 3

Why So Much about Price Shocks? 9

Complexity and Contagion Risk 10

The Ugly Side 11

Taking Defensive Action 11

Accepting Performance for What It Is 13

CHAPTER 2 The Importance of Price Noise 15

Noise Explained 15

Different Markets 19

A Closer Look at Equity Index Markets 21

Importance of Noise 22

Determining the Strategy 25

Capitalizing on the Trend of Noise 29

CHAPTER 3 Pairs Trading: Understanding the Process 31

The Process 32

The Basics 32

Target Volatility 54

Home Builders 65

Using ETFs 78

Portfolio of Home Builder Pairs 84

Execution and the Part-Time Trader 89

Stop-Losses 89

Trading Intraday 90

Key Points to Remember 90

CHAPTER 4 Pairs Trading Using Futures 93

Futures 94

Mechanics of a Pairs Trade in Futures 97

Inflation Scares 100

Trading Energy Pairs 102

Revisiting Momentum with Energy Markets 105

A Miniportfolio of Natural Gas Pairs 112

The Inflation Pairs: Crude, the EURUSD, and Gold 119

Equity Index Pairs 128

Leveraging with Futures 138

London Metals Exchange Pairs 141

Volatility Filters 153

Interest Rate Futures 154

Summary 154

CHAPTER 5 Risk-Adjusted Spreads 155

Dell and Hewlett-Packard 155

Trading Both Long-Term (Hedged) Trends and Short-Term Mean Reversion 159

Gold, Platinum, and Silver 161

The Platinum/Gold Ratio 163

Implied Yield 170

The Yield Curve 174

Trend Trading of London Metal Exchange Pairs 179

Summary 184

CHAPTER 6 Cross-Market Trading and the Stress Indicator 187

The Crossover Trade 188

The Stress Indicator 189

Gold, Copper, and Platinum 195

Mining Companies 198

Agribusiness Pairs 206

The Major Energy Producers 208

Portfolio of Cross-Market Energy Pairs 220

Other Opportunities 226

Some Final Notes 228

CHAPTER 7 Revisiting Pairs Using the Stress Indicator 229

Futures Markets and the Stress Indicator 229

Equity Index Futures 230

Interest Rate Futures 238

The Portfolio Spreadsheet 245

Summary of Pairs Trading 248

CHAPTER 8 Traditional Market-Neutral Trading 249

Home Builders 250

Trend or Mean Reversion? 250

Basic Market-Neutral Concept 251

Volatility-Adjusting the Position Size 264

Arbing the Dow: A Large-Scale Program 267

Thoughts about Market-Neutral Trend Following 274

Market Neutral Using Futures 274

Market-Neutral Comments 277

CHAPTER 9 Other Stat-Arb Methods 281

Trade-Offs 282

System Briefs 282

New Highs and New Lows 290

Merger Arb 290

Creating Your Own Index Arbitrage 292

Arbing the Dow 301

Arbing the S&P 500—Index Arbitrage 302

About the Companion Web Site 305

About the Author 306

Index 307

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Author Information

PERRY KAUFMAN has more than thirty years of experience in financial engineering and hedge funds, and is well-known for his role in algorithmic trading. Since 1971, he has specialized in the development of fully systematic trading programs in derivatives and equities as well as risk management and leverage overlays. He is the author of New Trading Systems and Methods, Fourth Edition, A Short Course in Technical Trading, both from Wiley, and other books and articles that have gained worldwide acclaim.
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Reviews

“Whenever Perry Kaufman writes a new book . . .system traders take note. What separates Kaufman’s work from that of many other writers on trading strategies is that he goes into the nuts and bolts of designing and testing system candidates. . . The website that accompanies the book has spreadsheets that make the calculations necessary for setting up trades ever so much easier. . .  What Kaufman offers is different — essentially a do-it-yourself manual for the trader who wants to develop strategies that remove directional risk and unearth opportunities for creating alpha.” (Seeking Alpha)
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