A License To Print Money

October 24, 2016 5:00 am2 commentsViews: 4461

When it comes to legends in the trading world, the name Larry Williams comes up often. Larry is the creator of the ultimate oscillator and the Williams %R Indicator. Furthermore he has written many popular books. His claim to fame is taking a $10,000 account to $1,100,000 during the 12-month competition known as the World Cup Championship of Futures. Interestingly his daughter, Michelle Williams won the same contest at age 17. I bet a little help from Dad went a long way with that one! While Larry’s impressive story is well known to many there is another trader who has done equally as well when it comes to taking a small account to large sums. That trader is Sheldon Knight.

In 1986 Sheldon took a $75,000 trading account and grew it to more than $1 million in a year. He would later double his account in 1989. Sheldon was actually a seminar student of Larry in 1985. Back in those days personal computer power and trading platforms were not what we have today. Sheldon was working in the aerospace industry when developing his trading ideas. He would use his work computers to test his trading concepts and models. Sheldon was a systematic trader who uses a computer program to quantify his trading methods performance. Clearly he was way ahead of most people in the field of quantifiable trading.

So why do I bring up these amazing stories? It’s not simply for inspiration. Instead these stories are an introduction to highlight the trading style both Larry and Sheldon used. Both traders used a similar style to take a small seed account into something much bigger in a very short period of time. In my opinion there are two important aspects to these stories which can have an impact to your own trading today. The first is their trading method. We’ll be going over this throughout the article. The second aspect is the position sizing algorithms they used. I won’t be going over position sizing in this article, but it was critical to their success. For now, let’s see how they did it by looking at the trading method both Larry and Sheldon used.

How They Did It

Clearly to take an account from $10,000 to over one million there is some luck involved. More importantly, you have to take on a lot of risk. You have to be willing to endure large drawdowns. Perhaps as much as 50% or 60% at times. That’s really psychologically difficult to do. You must be completely detached from your money and willing to lose most of it. In fact, you have to be willing to lose it all! Such a game is not mentally within the reach of everyone. Blowing $10,000 would not be OK for most people. But can we take any information from Larry and Sheldon to use in our more restrained or conservative approach to trading? Of course.

So what did Larry and Sheldon use as the basis for their trading system? Was it a complicated trading system with many rules and filters? Or was it a clever trading system that analyzed market order flow and made predictions into the future with a neural net? Maybe a complex  shorter term scalping system that allowed them to take many trades throughout the day? Well, no. It was none of these. In fact, the trading concept they used is rather simple and well known. So what was Larry’s and Knight’s big secret? The heart of their trading method was Opening range/Volatility Breakouts.

There are many variations on this type of method. In essence all the concepts attempt to buy at a level above the market open and sell-short at a given level below the market open. This predetermined level is known as the “breakout level”, the “stretch”, or “offset”. For example, maybe at the market’s open we place a buy stop at yesterday’s high and place a stop sell-short order at yesterday’s low. Then we simply wait for our order to get filled and manage the trade. As you can imagine, there are many formulas for determining a breakout level.

Another famous trader we did not talk about yet who was less aggressive but became a legend in his own right was Toby Crabel. Toby became a money manager and managed billions of dollars using this method. He also wrote a series of articles in the late 1980’s on opening range breakout and then a book, “Day Trading With Short Term Price Patterns and Opening Range Breakout”. This book is such a cult classic that even though it has been out of print for almost 20 years copies which show up on Amazon are often sold for as much as $1,000.00! Sheldon, Larry, and Toby have their own way of calculating this offset.  Let’s now look into each of these methods. The main concept of each of these methods is to calculate a noise level and leave the breakout level just outside of that.

The Crabel Stretch offset is calculated as follows:

BreakoutLevel = Average( minlist( Open of data2 – Low of data2, High of data2 – Open of data2), 10 )

It’s basically the minimum of how far on average the market moves off of the open on a given day. In the TradeStation formula above let’s assume that Data 2 is daily data.

Next, Sheldon Knights offset was a bit different because he used the differences between the Highest High and Lowest Low over a given number of days.

BreakoutLevel = Highest( High data2, 10 ) – Lowest( Low data2, 10 );

Finally Larry’s method was simply using a percentage of the daily average range or true range.

RangMult*Average(TrueRange of Data2,Period)

The period normally used is 3 days.

These systems were developed as patterns with setups triggered using opening range breakouts. They often had target profits, stops, and filters. They also used different breakout levels depending if you were in a bull or bear market.

A License To Print Money – The Good Old Days!

During the years our famous traders were generating massive returns with their opening range breakout trading systems on the commodity futures markets, the commodity pits ruled. Looking back during this time some would say that opening range breakout systems were a license to print money. Naturally within the wider trading community there was a surge of many trading systems which utilized some type of opening range breakout method. But nothing lasts forever. More people had access to computing power which allowed them to perform their own market analysis. This allowed more backtesting to be performed on different ideas including opening range breakouts. This in turn resulted in more people able to test and implement opening range breakout trading methods. On top of these developments a radical change began to happen with the markets. That is, the advent of the electronic market.

The Electronic Market Killed Open Range Breakouts

With the dawn of electronic markets and the death of the pits, the traditional market open has lost its meaning. Remember each of the futures markets opened at slightly different times, from 7:30 a.m. to 10:30 a.m. all of the commodity markets opened so there was not just one time that made sense so once the pit closed there was no opening time. The stock indexes and stocks still had the 9:30 New York open to key one so they did not totally break down like the commodities did. In the commodity world we know we had 24-hour markets which remained close for 45 minutes to a few hours. This destroyed the power of this trading method.

Another likely factor in the reduced performance of this trading model is how well known this strategy is. This trading technique is not unique or unknown. In fact, it’s widely known and understood. To help demonstrate the fading edge of this strategy you can use the published information found at Crabel Capital Management. There you will find monthly and annual returns going back to 1998.

I created a simple graph which displays the annual returns going back to 1998. I then applied a linear trend line through the data (red line). The trend is clear.


click to enlarge


Can We Fix The Opening Range Breakouts To Work Again?

Can we apply a twist to the opening range breakout to improve the results? Or, is the opening range breakout simply going to fade into oblivion? In next week’s article I’m going to point out a clever piece of code that brings the opening range breakout concept into the modern age of electronic trading. This technique uses a proprietary method to calculate a dynamic market open instead of relying on a fixed market open based upon a static time. It can do wonders in resurrecting these opening range breakout systems. Keep an eye out for next week’s article!

Jeff is the founder of System Trader Success – an inBox magazine dedicated to sharing great ideas and concepts from the world of automated trading systems. Read More Google

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  • Thanks Jeff – Really great summation of ORB strategies.

    Very interested to hear how you put the edge back on a strategy where the market has ground it down. No concerns about having your own edge ground? But of course please don’t let me put you off sharing it with me!

    • Actually, the improvement is not my own. It’s from someone else who has a lot more experience in this area. In any event, I’m sure you’ll find it interesting!

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