VOLPAT Day Trader: Buy and Sell Signals

By: Lee Gettess

The following is an excerpt from Lee Gettess' Trading in the Trenches

VOLPAT system is a volatility-based recognition system for the S&P 500, plus several patterns traded together.  This combination of systems serves to lower the drawdown and thereby enhance profitability.  The trades signaled by VOLPAT are mainly all entered on a stop order after receiving an opening price.  When you get an opening price range instead of opening price, taking the average of the range will suffice.  When the system calls for an open to lower than a certain price the entire range should be lower.  If you have the ability to follow the market during the day you have an advantage.  You can often enter at a much more favorable price than the system calls for.  The market will often trade through VOLPAT’s entry price, then retrace back through it before continuing on.  Of course, there are other days when the market charges through the stop price and never looks back.  Obviously, by waiting for the retracement you can miss a large move day.  Use your own discretion.

In addition to entering at stops, the VOLPAT track record assumes all exits are taken at the close, or with a Market-On-Close (MOC) order.  You may find it more profitable to exit a few minutes before the close.  Also, those of you following the market intraday may see reasons to exit well before the close.  You may indeed outperform the mechanical VOLPAT Day Trader.  However, our track record is generated strictly entering on the stop and exiting on the close.

Let’s get to the volatility-based part of VOLPAT.  These calculations are done everyday, regardless of what the market did.  You will always be using at least one (and possibly both) of the numbers we will calculate, either as your entry point or as a stop-loss order.

We begin by finding the total true range for the last three days.  We define this as being HIGHEST HIGH minus the LOWEST CLOSE for the last three day period.  However, if the highest close minus the lowest low is a greater number than highest high minus lowest close, then that is the total true range.  True range can be calculated many ways, but this method suits our purposes.

Now that you have your three day total true range, multiply it by .7.  If your answer is not exactly a 0 or 5 in the second decimal place (as in 3.37 or 2.41) always round up so that it is.  For example, 3.37 would become 3.40 and 2.41 would become 2.45.  ALWAYS round up!  This new figure will be added and subtracted from yesterdays close to get our initial possible entry points.  The CLOSE minus your figure will be a SELL point, and the CLOSE plus your figure will be a BUY point.

Now we will perform the same function again, only this time we multiply the three day total true range by .75, and we add and subtract it from the current day’s opening price.  Again, the OPEN minus your new figure is a SELL point, and the OPEN plus the figure is a BUY point.

You compare the two BUY points you have, and whichever is LOWER becomes the actual BUY point.  Do the same with the SELL points, only whichever is HIGHER is the actual SELL point.  But, there is one exception to each of these:

1. If the OPEN is HIGHER than the BUY point you calculated from the CLOSE you must use the BUY point calculated from the OPEN.
   
2. If the OPEN is LOWER than the SELL point you calculated from the CLOSE you must use the SELL point calculated from the OPEN.

Here is an example:

Using the first 3 days (#1 – 3) to calculate the entry points for day #4 we see this:

Highest High minus Lowest Close (254.15 – 242.15) = 12.00

Highest Close minus Lowest Low (253.25 – 240.60) = 12.65

We use 12.65 since it is the greater of the two numbers.  We then get our filter factors by multiplying 12.65 by .7 and .75 like this:

We take the lowest BUY at 262.15 and the highest SELL at 244.35.  If the open had been higher than 262.15, we would have had to use the OPEN plus 9.50 as our BUY point.  If the open was lower than 244.25, we would use the OPEN minus 9.50 for our SELL point. 

To summarize the volatility for VOLPAT, calculate 70% of the three day total true range and add and subtract it from the CLOSE to get a BUY and SELL point, respectively.  Calculate 75% of the three day total true range and add and subtract it from the OPEN to get a BUY and a SELL point, respectively.

Your final BUY point is the lower of the two BUY points, unless the OPEN is above the lowest one, in which case the BUY point becomes the highest.  Your final SELL point is the HIGHER of the two SELL points, unless the OPEN is below the highest one, in which case the SELL point becomes the lower.

These BUY and SELL point calculations form the basis for all of our trading decisions.