- Ben Warwick,
Event Trading -- Profiting from Economic Reports and Short-Term Market Inefficiencies
, Irwin Professional Publishing, 1996 (Hardcover, $50.00)
You know that author
possesses a goodly amount of market wisdom when he cites the old poker adage, "If you can't spot the sucker in the first half hour at the table, it's you." Warwick is a professional futures fund manager, currently at the Denver-based
, and is a co-editor of several books, including
The Handbook of Managed Futures
The Futures Game
is studded with frank and sensible observations about why trading is hard, including the limitations of his own approach. Event trading, which Warwick uses as a strategy in managing his own portfolio, is a third approach to markets, different from fundamental analysis and technical analysis. Just as "earnings surprises" can generate exceptional returns when the actual release differs substantially from expectations, so too economic data can surprise and offer profit opportunities. The question is whether one can create a consistently profitable trading system in futures contracts using economic data releases, instead of trading individual stocks based on their earnings releases. If so, are the results satisfactory on a risk-adjusted basis, and are the gains larger than transaction costs? Warwick's answer is a resounding yes.
The intended audience for
is futures traders, although the ideas Warwick presents are equally applicable in other contexts.
He has read and understood the trading classics and incorporates essential principles without effort or flinches. This is quite an achievement, given that much of trading wisdom comes only from understanding statistics -- something most traders are unwilling to undertake.
In this regard, Warwick is fearless. He uses statistics in such a clear and straightforward manner as to render the analysis painless for the reader. In fact, a second and probably unintended benefit of
is a new appreciation of the correct use of statistical techniques, such as the dreaded Sharpe ratio.
To make his case, Warwick constructs four case studies utilizing the
S&P 500 Index
Treasury Bond Index
. Warwick tests nine economic indicators (Producer Price Index, Consumer Price Index, Gross Domestic Product, Industrial Production Index, Durable Goods orders, Retail Sales, Trade Balance, the National Association of Purchasing Managers index, and the Employment data) to see if any of them moves these markets to such an extent as to create a profitable trading opportunity. All are calculated on a monthly basis, and all except the NAPM index are released by government agencies on a scheduled basis.
To carry out his study, Warwick constructs a hypothetical trading model, which buys or sells the futures contract if its price "breaks out" to the upper or lower 20% of its average true range after the release, and maintains the change for a "holding period" anywhere from one to five days.
The time period he uses is 1989-94, a time of considerable volatility in economic measures. He analyzes upside and downside breakouts separately, and finds some interesting results. It turns out that durable goods orders moves the U.S. Treasury Bond in the first two days, with a confidence level (a statistical measure of probability) of 97%. The same indicator moves the S&P in the first four days with a confidence level of over 99%.
Retail sales are good for generating a breakout in bonds and the S&P, but GDP and employment are indicators with a low confidence measure, and therefore are not promising for trading. Of course, he found that the power of these indicators to move markets waxed and waned over that time. In this period, the trade balance was never a good indicator; it was correlated with the Japanese yen, but failed to generate breakout trades in the Dollar Index.
But it must be realized that event trading, unlike technical analysis, doesn't offer up many opportunities to trade. To see why, understand that there were 540 individual economic data releases over the five-year testing period. But when Warwick applied his criteria, it turns out that only 38 of these events provided a sufficiently large subsequent price move to qualify them as opportunities for "event trading."
The section of the book that describes how to limit losses is alone worth the price of admission. Warwick's approach is simple: "All risk-reduction techniques limit losses at the cost of smaller profits." The good news is that you can figure out the optimum stop-loss level. It's the one that produces both significant results and the highest risk-adjusted return.
Warwick expands his discussion to plot charts of trade efficiency (the ratio of winners to losers) and the percentage of winning trades for every stop level in his universe. In the end, stop-loss levels were not related to trading performance in real time, but Warwick's stop-loss exercise is still a lesson most traders need to learn.
Can a trader take Warwick's analysis of past data and use it to pursue profitable trades today? Warwick applied the event trading rules he developed from the 1989-94 study to price data in the four futures contracts over the first three quarters of 1995. This is what is known in statistics as an out-of-sample walk-forward test.
Despite the fact that this subsequent experiment covered only nine months, Warwick found that the trading rules generated gains in three of the futures markets (the Eurodollar being the exception), producing better than 50% winning trades, high efficiencies and low risk-reward ratios.
What's most interesting for equity traders is that the S&P turned out to offer the most opportunities for the event-trading approach. And to translate Warwick's work into the world of the technician, he shows that the crossover of two moving averages can constitute an "event."
Finally, Warwick discusses how to create an optimum portfolio and recommends margin-weighting rather than risk-weighting, an outcome not intuitively obvious. The recommendation implies that futures traders -- who typically use a lot of leverage -- would be better off limiting the amount of personal capital at risk in any single trade than determining the amount of capital they are willing to place at risk by the historical riskiness of the event itself.
By extension, traders in individual stocks should figure out in advance how much they are willing to lose on any single trade rather than guess how much a stock will rise or fall given its past price history.
Warwick's analysis of this approach so impressed trading encyclopedia author Perry Kaufman that Kaufman included this summary and several of the charts in his
Trading Systems and Methods (3rd Edition).
enriches our knowledge base, not least by demonstrating to all types of traders how to test a trading hypothesis. Equity traders who buy and sell on "stories" can learn from Warwick that trading discipline is a viable alternative and that we can predict some, if not all, market responses to known events.
Barbara Rockefeller is the principal behind Rockefeller Treasury Services, a Stamford, Conn.-based independent research firm specializing in foreign exchange forecasting and best-practices currency management. A former currency risk manager for Citibank, European American Bank and Brown Brothers Harriman, Rockefeller has advised major multinational corporations and global fund managers since she founded RTS in 1991. At time of publication she held no positions in the currencies or instruments mentioned in this column, although holdings can change at any time. She can be reached at her investing
Web site, or via email at
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