The focus of today's chat was on creating a market-aware strategy that leverages opportunities based on underlying relationships between composite instruments, such as market indices and the stocks that comprise them, or Equity Tradable Funds (ETFs) and the symbols they consist of.

Without knowing exactly what symbols are contained within the composite symbol, you can use Correlation to find these relationships "by the numbers".  What's really interesting is that you can often find relationships that perhaps you hadn't even thought about, such as the strong relationship between F and XLF (in the past 20 days) that we found in the video.  You can use Prodigio's Back-Testing system as a screener to create Symbol Lists that encapsulate these relationships.

The strategy, therefore, entails trading these "highly related symbols" by using the trend of the composite symbol as a filter in our trading system.  To identify the trend, I discussed using a new strategy that compares the Linear Regression Curve with a Simple Moving Average (used as a baseline for comparison).  The Linear Regression Curve (simply called "Linear Regression" in ChartTraderPro) can be considered a type of moving average that is based on Linear Regression lines.  The curve is formed by plotting the "right-hand endpoints" of the line over time, which creates a new time-series.  The big advantage to this curve is that it uses Variance intrinstically, and Variance is the volatily measure used by Standard Deviation, and therefore Bollinger Bands.  By comparing the Linear Regression Curve with the Simple Moving Average, you are asking "where is the tight-fitting average price at relative to the slow-moving average?".  Bullish trends are identified when the Linear Regression Curve is above the Simple Moving Average, bearish trends are the opposite.

Finally, you can build a system that uses any price trigger.  In this example, we use the "Bullish XLF Trend" described above to rule out bearish triggers, only accepting bullish triggers when the market is bullish (and bearish triggers for bearish markets).  You can use any price trigger; in our example we simply used the LR Curve/SMA system with crossovers.  The important point, however, is that you are only trading/triggering on symbols that had been earlier screened to have a close relationship with the composite symbol (XLF in our case).  This facet of the strategy gives you an edge because you're "trading with the market trend".

Best wishes for a prosperous 2012!
Bryan