visit for more: http://trott.tv Your Source For Knowledge P1: JYS FM JWBK304-Katsanos November 22, 2008 14:21 Printer: Yet to come To my wife Erifili v P1: JYS FM JWBK304-Katsanos November 22, 2008 14:21 Printer: Yet to come Intermarket Trading Strategies i P1: JYS FM JWBK304-Katsanos November 22, 2008 14:21 Printer: Yet to come For other titles in the Wiley Trading Series please see www.wiley.com/finance ii P1: JYS FM JWBK304-Katsanos November 22, 2008 14:21 Printer: Yet to come INTERMARKET TRADING STRATEGIES Markos Katsanos A John Wiley and Sons, Ltd., Publication iii P1: JYS FM JWBK304-Katsanos November 22, 2008 14:21 Printer: Yet to come Copyright C 2008 Markos Katsanos Published by John Wiley & Sons Ltd, The Atrium, Southern Gate, Chichester, West Sussex PO19 8SQ, England Telephone (+44) 1243 779777 Email (for orders and customer service enquiries): [email protected] Visit our Home Page on www.wiley.com All Rights Reserved. No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning or otherwise, except under the terms of the Copyright, Designs and Patents Act 1988 or under the terms of a licence issued by the Copyright Licensing Agency Ltd, Saffron House, 6–10 Kirby Street, London, ECIN 8TS, UK, without the permission in writing of the Publisher. Requests to the Publisher should be addressed to the Permissions Department, John Wiley & Sons Ltd, The Atrium, Southern Gate, Chichester, West Sussex PO19 8SQ, England, or emailed to [email protected], or faxed to (+44) 1243 770620. Designations used by companies to distinguish their products are often claimed as trademarks. All brand names and product names used in this book are trade names, service marks, trademarks or registered trademarks of their respective owners. The Publisher is not associated with any product or vendor mentioned in this book. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is sold on the understanding that the Publisher is not engaged in rendering professional services. If professional advice or other expert assistance is required, the services of a competent professional should be sought. Other Wiley Editorial Offices John Wiley & Sons Inc., 111 River Street, Hoboken, NJ 07030, USA Jossey-Bass, 989 Market Street, San Francisco, CA 94103-1741, USA Wiley-VCH Verlag GmbH, Boschstr. 12, D-69469 Weinheim, Germany John Wiley & Sons Australia Ltd, 42 McDougall Street, Milton, Queensland 4064, Australia John Wiley & Sons (Asia) Pte Ltd, 2 Clementi Loop #02-01, Jin Xing Distripark, Singapore 129809 John Wiley & Sons Canada Ltd, 6045 Freemont Blvd, Mississauga, ONT, L5R 4J3, Canada Wiley also publishes its books in a variety of electronic formats. Some content that appears in print may not be available in electronic books. Library of Congress Cataloging-in-Publication Data Katsanos, Markos. Intermarket trading strategies / Markos Katsanos. p. cm. Includes bibliographical references and index. ISBN 978-0-470-75810-6 1. Investment analysis. 2. Portfolio management. I. Title. HG4529.K376 2008 332.64—dc22 2008040290 British Library Cataloguing in Publication Data A catalogue record for this book is available from the British Library ISBN 978-0-470-75810-6 (HB) Typeset in 10/12pt Times by Aptara Inc., New Delhi, India Printed and bound in Great Britain by TJ International Ltd, Padstow, Cornwall, UK iv P1: JYS FM JWBK304-Katsanos November 22, 2008 14:21 Printer: Yet to come vi P1: JYS FM JWBK304-Katsanos November 22, 2008 14:21 Printer: Yet to come Contents Acknowledgments ix Introduction xi PART I 1 1 Intermarket Analysis 3 2 Correlation 17 3 Regression 33 4 International Indices and Commodities 41 5 The S&P 500 69 6 European Indices 85 7Gold 93 8 Intraday Correlations 111 9 Intermarket Indicators 121 PART II 145 10 Trading System Design 147 11 A Comparison of Fourteen Technical Systems for Trading Gold 175 vii P1: JYS FM JWBK304-Katsanos November 22, 2008 14:21 Printer: Yet to come viii Contents 12 Trading the S&P 500 ETF and the e-mini 189 13 Trading DAX Futures 201 14 A Comparison of a Neural Network and a Conventional System for Trading FTSE Futures 215 15 The Use of Intermarket Systems in Trading Stocks 235 16 A Relative Strength Asset Allocation Trading System 247 17 Forex Trading Using Intermarket Analysis 261 18 Conclusion 293 Appendix A MetaStock Code and Test Specifications 297 Appendix B Neural Network Systems 357 Appendix C Rectangles 367 Glossary 371 Bibliography 385 Index 391 P1: JYS FM JWBK304-Katsanos November 22, 2008 14:21 Printer: Yet to come Acknowledgments I am particularly indebted to Dr Evangelos Falaris, Professor of Economics at the University of Delaware, who took the time to review selected chapters and offered both technical and expositional comments. Many thanks also to Murray Ruggiero, one of the world’s leading experts in intermarket analysis, who contributed to improving the final version of the book by making valuable comments and suggestions on a preliminary manuscript. Murray is Vice President of Research and Development of TradersStudio, contributing editor for Futures Magazine and author of several books on trading systems. Special thanks to my wife, Erifili, for her love and patient support, and for putting up with late nights, despite having no actual interest in the subject. I also want to thank Jayanthi Gopalakrishnan, the editor of Technical Analysis of Stocks & Commodities magazine, for encouraging me to write the articles for the magazine and helping me later with the task of finding the best publisher for the book. Many thanks also to Caitlin Cornish, my editor at John Wiley & Sons, and to her assistant Aimee´ Dibbens, for their guidance and support during the publication process. It is difficult to appreciate the effort and hours that go into researching and writing a book of this nature until you’ve had a chance to work on one yourself. The correlation studies involved a huge amount of historical data and I would like to thank Peter Day for helping out with the VBA to manage the data in Excel and Rubi Cabal, marketing director at CSI data, for allowing me access to CSI’s correlation reports. Finally, I would like to thank the technical support staff at Ward Systems Inc., and also Lynn Dufrenne, Lead Support Representative at Equis Technical Support for their help in solving the unavoidable software problems. ix P1: JYS FM JWBK304-Katsanos November 22, 2008 14:21 Printer: Yet to come x P1: JYS FM JWBK304-Katsanos November 22, 2008 14:21 Printer: Yet to come Introduction With the emergence of the internet and international cross border trading, the world’s futures and equity markets started to converge, making intermarket analysis an essential constituent of technical analysis. Single market technical analysis indicators were designed in the 1980s for na- tional markets, and are no longer sufficient nor can be relied upon for analyzing the constantly changing market dynamics. But how do markets interact and influence each other and how can we use inter- market relationships to construct a viable technical system? Because the answers have been so elusive, they became the motivation for my research. The more I looked into it, the more I became convinced that there is clear and incontrovertible evidence that the markets are linked to each other, and incorporating intermarket correlations into a trading discipline can give a trading advantage. Two years of research later, I finally came up with some rules and mathematical formulae for intermarket trading. It has been more than 15 years since John Murphy, a pioneer on the subject, wrote his first book on intermarket analysis. The material in my book is based on original research not published anywhere else and, unlike Murphy’s intuitive chart-based approach, I am going to use mathematical and statistical principles to develop and design intermarket trading systems appropriate for long- and short-term and even day trading. Although the book makes extensive use of market statistics obtained from hundreds of correlation studies, the data and empirical findings are not its heart. They serve as a background in developing the trading systems presented in the second part of the book, as well as help shape our thinking about the way the financial markets work. The key difference between Intermarket Trading Strategies and other books on trading lies in its philosophy. I believe that knowing how the markets work is, in the end, more important than relying on a “black box” mechanical system that produced profitable trades in the past but not even the creator of the system can fully explain xi P1: JYS FM JWBK304-Katsanos November 22, 2008 14:21 Printer: Yet to come xii Introduction why. The focus of this book is how intermarket analysis can be used to forecast future equity and index price movements by introducing custom indicators and intermarket- based systems. A total of 29 conventional and five neural network trading systems are provided to trade gold, the S&P ETF (SPY), S&P e-mini futures, DAX and FTSE futures, gold and oil stocks, commodities, sector and international ETF, and finally the yen and the euro. Naturally, past results are no guarantee of future performance. Even so, the results of out-of-sample back-testing are compelling enough to merit attention. Some results are more compelling. The multiple regression gold system, presented in Chapter 11, returned an amazing $1.2 million of profits on a $100 000 initial equity. The stock index trading systems also produced impressive profits. The profitability of the Standard & Poor’s e-mini intraday system was neither standard nor poor, producing a 300 % profit during the test duration.