Refining crude-oil breakouts

By Kevin J. Davey
Crude oil is a volatile market — prone to violent price swings and large overnight moves — making it especially challenging for system traders. Starting with a combined trend/countertrend trade setup, we’ll use different tools to analyze the system’s results and improve performance.

First, let’s attempt to create a crude oil (CL) trading strategy that performs well on out-of-sample data. The setup occurs when crude oil’s closing price hits its highest high or lowest low over a certain number of bars. When this happens, the system trades in the direction of a trend or against it depending on degree of trend strength or price momentum, as measured by the average directional movement index (ADX). If the indicator is high and/or rising, the market may be trending, which would validate a breakout trade. But if the ADX is low and/or dropping, the market’s trend is likely weak, a sign of a possible false breakout.

The system is stop-and-reverse, meaning buy signals close existing short trades and simultaneously establish new long positions, and vice versa. The strategy is designed to exploit large trends and tends to stall in range-bound markets.

Trend-following rules:

1.    Go long (and exit shorts) at next bar’s open if:
       a.    Current bar’s close = x-bar highest closing price
       b.    11-bar ADX >= 11-bar ADX[Y]

2.    Sell short (and exit longs) at next bar’s open if:
       a.    Current bar’s close = x-bar lowest closing price
       b.    11-bar ADX >= 11-bar ADX[Y]

Counter-trend rules:

3.    Go long (and exit shorts) at next bar’s open if:
       a.    Current bar’s close = x-bar lowest closing price
       b.    11-bar ADX < 11-bar ADX[Y]
       
4.    Sell short (and exit longs) at next bar’s open if:
       a.    Current bar’s close = x-bar highest closing price
       b.    11-bar ADX < 11-bar ADX[Y]

        where:
        x = breakout channel length
        y = look-back periods

TradeStation code for the system can be copied from www.activetradermag.com > Web Only > Strategy Code. The system doesn’t distinguish between the two sets of trade rules. If it takes a long trend-following signal (rule 1), it may exit based on either a short trend-following signal (rule 2) or a short counter-trend signal (rule 4).


For the complete article, see the March 2010 issue of Active Trader magazine. Click here to subscribe.



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