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Developing a Bond Trading Strategy

How do you develop a bond trading strategy using ZoneTraderPro?  One of the major advantages of ZoneTraderPro is its ability to back test and develop a trading plan and strategy for the market that you are interested in trading.  This is the first in a series of posts which look at how you develop a profitable bond trading strategy using ZoneTraderPro.

This post is going to look at 15 days of trading a strategy on the 10 year bonds, the ZN futures contract.  The trades took place between January 26, 2015 and February 13, 2015.  The first trades were taken after any 830 EST news event and positions were closed at 1615 hours for the day.  The ZoneTraderPro Forex currency tool  was removed from the pictures to give a clearer picture.

This strategy looked at trading just a single pattern in the bond market and there was 148 documented trades in the three-week period.  Since a win or a loss is based on decisions you will make in real-time, I did not include total wins and losses on the worksheet.  The worksheet contains the date and time, whether the trade was long or short, maximum favorable excursion (MFE), maximum adverse excursion (MAE) and four other columns used to determine and fine-tune a strategy.

 Maximum Favorable Excursion

When we look at favorable and unfavorable excursion is very important understand what ZoneTraderPro has consistently used to develop any statistic.  If the trade was a long trade the numbers were developed from the top of the zone and if the trade was a short trade the numbers were developed from the bottom of the zone.  Additionally in this worksheet you will see a -1 in the MAE column.  This means that the market came within one tick of the blue countertrend zone and did not touch it.  A zero in the column means that the market touched the blue countertrend zone and there was no adverse excursion. 53 of the winning trades had NO adverse excursion and 75 had 1 tick or less.

 Counter Trend Trading Pattern

What is the trading pattern that we are looking at in this post?  In the eSignal version of the software there is a countertrend trade pattern.  This pattern was not included in the NinjaTrader version due to the risk reward in trading the S&P futures contract.  The trading pattern says this.  When the market trades to a blue countertrend zone we have defined a trend in that direction.  The market should retrace to the intermediate trend zone and the trend should resume.  In looking at the above table of maximum favorable excursion there is a reason that 5 to 6 ticks appears to be the sweet spot for taking profit.  The reason is found in the definition of the countertrend trade pattern.  There is generally about 5 to 6 ticks between the blue countertrend zone and the intermediate zone where the trend should continue.  What this study does not look at are the trend trades that follow the pattern we are looking at today.

So why are we looking at the countertrend bond trade and not a countertrend S&P trade?  Is my opinion that there is less adverse excursion in the bond market then there is in the S&P futures contract.  This is not to say the countertrend trade is not profitable on the S&P.  Tick divergence trading pattern is the countertrend trade pattern that has an exceptional risk to reward ratio.  This is because of the tick divergence.  The emphasis is upon quality risk to reward trades rather than quantity.

 Maximum Adverse Excursion

So do we have a winning strategy?  If we look at taking 5 ticks of profit from every trade, placing a stop at 7 ticks, and factoring in the commission cost of $352, we have a profit not including any slippage of $5240 for a single contract over a three-week period.

So if we take a 5 tick profit every time and a 7 tick loss every time, do we have a trading system?  Answer is no.  If you’ve read this blog, approximately one year ago I created a three-part series on how you created trading plan.  This trading plan addresses the entry into a trade, the exit out of a trade, and what you do when you are in a trade.  This is not been addressed yet.  When you realize that wins and losses account for only 110 of the 148 trades, the real strategy involves the 38 trades that are neither wins nor losses. (Note: 38 is going to change because of strategy)

The first thing to address is what you do when it trade is favorable by three or four ticks.  There are 30 trades that went 3-4 ticks in your favor.   Of these 30, seven of these trades went on to be a full loss after favorable excursion.  What is very interesting is that all of these losses went in your favor before they became losses.  Six of the 30 went 4 to 5 ticks against you but allowed you to exit at breakeven or better.  Probably the most interesting statistic of these 30 trades is that if they went against the trade initially after touching the zone, 15 out of 15 return for a small profit at the minor or intermediate zone.  These have been highlighted in light blue on the Excel Worksheet.

It is a very interesting pattern and possibly a tradable exit strategy to deal with positions that go both for and against your entry.  So let’s assume that you use this strategy to deal with adverse and favorable positions while you are in a trade.  This would eliminate 6 losing trades and would allow an exit at breakeven or better for all 30 trades.  This strategy added one extra loss for a trade that went six ticks against you but did not stop out initially, but then resulted in a full loss.  That leaves us with the strategy that has won 94 times, had 10 losses, and was stopped out at breakeven or better for a small profit 30 times.

That leaves 14 trades that had between 0-2 ticks of favorable excursion and 3-6 of adverse excursion.  Again we see a very interesting pattern.  13 of the 14 returned to the minor support or resistance zone for either a breakeven trade or a small profit.  The remaining trade only traded to breakeven.  There is a follow on strategy here.  Why not reverse the trade at minor support or resistance once it has gone against you?

We now have a strategy that can be further back tested and adjusted based on the homework that you can do using NinjaTrader and ZoneTraderPro.  The strategy resulted in a win loss record of 94-10-44.  This is why you could have a smaller profit and a larger loss because the win to loss ratio is 90%.  But a win ratio of 90% is only achievable if the trader properly handles the 44 breakeven trades.

Do you need to buy any other indicators for a system that works this good? No.

With those numbers there was a theoretical profit of $7341 and a loss of $1093.  Factoring in the $352 in commissions, that leaves a net profit for three weeks at $5896, not counting any slippage.

And that is the purpose of a written trading plan; to be able to plan to deal with those 44 trades as they occur in real-time.  By having that written trading plan, the psychology of greed and fear is removed from the trade.

One of the other factors that I placed on the chart and noted on the worksheet was whether or not the ZoneTraderPro currency tool was a factor to be considered.  43 of the 94 winning trades did not agree with the direction of the trade.  To understand the reason why, you need to understand the theory of the countertrend trade.  When a market trades to the countertrend zone, that by definition is a trend in that direction.  It makes sense that the currency market which is following the bond market is not always in agreement because the bond market along with the currency market have both been in an established trend.

One of the other huge advantages of using ZoneTraderPro is its ability to predict buy and sell zones in advance of the market actually trading there.  In these three trades you can see how much slower the bond market moves, especially in the afternoon as compared to the ES futures contract.

Disclaimer

THIS IS NOT A TRADING PLAN.  More work has to be done to fine tune this idea and if you trade it without doing your additional homework, you do so at your own risk.

Hypothetical performance results have many inherent limitations, some of which are described below. No representation is being made that any account will or is likely to achieve profits or losses similar to those shown. In fact, there are frequently sharp differences between hypothetical performance results and the actual results subsequently achieved by any particular trading program.

One of the limitations of hypothetical performance results is that they are generally prepared with the benefit of hindsight. In addition, hypothetical trading does not involve financial risk, and no hypothetical trading record can completely account for the impact of financial risk in actual trading. For example, the ability to withstand losses or to adhere to a particular trading program in spite of trading losses are material points which can also adversely affect actual trading results. There are numerous other factors related to the markets in general or to the implementation of any specific trading program which cannot be fully accounted for in the preparation of hypothetical performance results and all of which can adversely affect actual trading results.

Unlike an actual performance record, simulated results do not represent actual trading. Also, since the trades have not actually been executed, the results may have under-or-over compensated for the impact, if any, of certain market factors, such as lack of liquidity. Simulated trading programs in general are also subject to the fact that they are designed with the benefit of hindsight.

Information herein has been obtained and prepared from sources believed to be reliable; however no guarantee to its accuracy is made. Comments contained in these materials are not intended to be a solicitation to buy or sell any of the commodities mentioned. Past performance is not indicative of future performance results. Opinions expressed herein are the options of the author only and not the opinion of any firm the author may be affiliated or associated with.