SQN Report for August 13, 2012

I’ve been following Dr. Van Tharp for a several years now. I first found out about him on a CD interview included with the Cashflow game and as I was interested in trading at the time, I bought his book “Trade Your Way To Financial Freedom” and signed up for his Newsletter which I have always found interesting and informative.

One thing presented by Dr. Tharp in his book “Definitive Guide to Position Sizing” is his idea of a System Quality Number (SQN) as a way to evaluate your trading system. However after he had written this book, he got the idea of using SQN as a way to monitor market moves by applying the technique to the daily percent change of the market from close to close over a period of time (He monitors the 25, 50, 100, and 200 day SQN numbers, but uses the 100 day to define the current market type). He also uses ATR%(20), or ATR(20) divided by the close which normalizes the value regardless of the price of the instrument, to determine the current market volatility. He combines these 2 indicators to create a market type which helps you determine which trading system you should be using. You can read more about this classification here.

He considers the SQN calculation to be proprietary, and thus does not discuss it’s calculation openly and it can only be found in the “Definitive Guide to Position Sizing” book. The book is pricey and while the content is very good and very important if you are serious about trading, it reads very much like a textbook and has a lot of Math and Statistical exercises and data in it. Thus it’s probably not worth buying the book if you are just interested in the SQN calculation. I’m not exactly sure why Dr. Tharp doesn’t release the calculation as the book’s value stands on it’s own even if you didn’t need the SQN calculation, but that’s just my opinion!

Still, I find the value interesting and as I would like to test some of my hypotheses against multiple market types (Such as Harmonic Rotations) and so I created a strategy in NinjaTrader to pull this data into a spreadsheet or SQL Server Database so I can test my hypotheses. I’ll likely post this strategy in my NinjaTrader section later on so others can benefit from it, but I’ll likely have to protect it and not provide the source code so that I comply with Dr. Tharp’s wishes for the calculation to remain closed.

Using this strategy, I have compiled some spreadsheets and charts to show the SQN and ATR%(20) values of the ES. Let’s take a look:

First up is the SQN(25), SQN(50), SQN(100), and SQN(200) charts:

I can see myself using the SQN(25) and SQN(100) charts the most, as my trading time frame is generally limited to day trading or a couple of days. Thus the SQN(25) is shorter-term and would be more conducive to my trading style. However the SQN(100) value would also help me classify the longer term trend as well.

On the SQN(25) chart we see that we moved into the Strong Bull category on the 7th and the general direction has been up for the last couple of months. Looking back, we see a lot of peaks around the 2.5 to 3 area, so a strong push up may be a sign to take some short term profits and potentially look for a short-term retracement down.

On the SQN(100), we see we are in solid Neutral territory. However the trend for the SQN(100) has also be to the upside since June, so that bodes well for an upside breakout.

Next up, the ATR%(20) chart:

Here we can see that volatility has definitely been low and decreasing. Low volatility is a sign of a bull market, as most bear markets are either volatile or very volatile. This also bodes well for an upside breakout over the next few months or so.