I’ve blogged recently about the change in market behaviour recently, particularly in relation to short term mean or range reversion.
Quite simply, the market aint behaving like it used to.
In some ways, we had it too easy in recent years, with the clear out performance of range reversion indicators such as the DVB.
Now, despite the choppy conditions, the DVB indicator continues to perform poorly. The typical way to trade the DVB has been to go long with a reading below 0.5 and short with a reading above 0.5. Yet over the last 100 days, doing the exact opposite would have brought in some rich rewards.
I’ve taken to calling this approach DVB’s evil twin.
Here are the results from the last 100 days on the SPY.
Rules:
- Go long above 0.5.
- Go short below 0.5.
Will this continue? I'm not sure, but I do believe the DVB's days of easy pickings are gone.
Intermediate Mean Reversion
While the short term mean/ range reversion has flipped around, the intermediate measures are enjoying a good run of form.
There are numerous intermediate Mean Reversion indicators available within the DV indicators package, but the best known is probably the DVI.
The DVI is actually made up of two indicators with indicator explanations from David Varadi. All these indicators are available in the DV Plugin.
DVIS (Intermediate Stretch):
This is one component of the DVI that isolates the stretch in terms of net days up or down over a series of periods and is re-scaled to create an accurate and consistent measure. The stretch is not like RSI because it does not consider the magnitude of up or down days but rather the net difference. It also looks at the short, intermediate and long time frames with a net weighting on the intermediate. This is a very accurate and useful indicator for identify mean-reversion areas of value rather than actual turning points. It can also be used as a trend measurement in conjunction with the ADX (Average Directional Movement).
DVIM (Intermediate Magnitude):
This is the other component of the DVI that looks at the magnitude of up and down movements and is smoothed to reduce noise and also re-scaled to create an oscillator that appears to move in a “wave” format. The DVIM is a great complement to the DVIS because it measures the net percentage move over a variety of lookbacks weighted primarily on the intermediate time-frame. Like the DVIM, it does not attempt to identify turning points, and is instead a measure of relative value that does not change as frequently as other oscillators. The “wave” movement of the indicator is ideal for “hook” type mean-reversion strategies that buy or sell following a transition from overbought or oversold levels. It can also be lengthened to create an excellent trend or relative strength indicator.
DVI (Intermediate Oscillator):
The DVI is blend of the Intermediate Stretch and Magnitude Oscillators.
Performance of the DVI(s):
Trading the indicators as follows on the SPY:
- Long: Reading below 0.5
- Short: Reading above 0.5
DVI:
We can see that the DVI is enjoying a purple patch after an indifferent period. Still the 2517 day CAGR and 250 day CAGR both look respectable at around 15%.
This isn’t the full story though as the DVIS and DVIM have been running at different speeds of late.
DVIS:
The DVIS has not performed well in the last 250 days and appears to owe the bulk of its past performance to riding the credit crunch madness very well.
Short misery: When you isolate short trades only, we get to the crux of the problem. Here the indicator’s faults are laid bare. It caught the credit crunch short side very well, but has done little else before or since.
DVIM:
By contrast, the DVIM has been off at the races, and is clearly the driver behind the DVI’s recent performance.
When we isolate short trades only, we see that the indicator’s past performance still owes a lot to the credit crunch, but showed signs of life before this and is catching good moves now.
Summary:
The implications of this are that on an intermediate term basis, magnitude offers a better measure of markets over extending than a time stretch measure.
All the indicators researched here are available within the DV Plugin.
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