mindmoneymarkets

Combo templates - When two is better than one

In a past post I blogged about the advantages of combining a short term mean reversion indicator with an intermediate term indicator of the same bent. Click here to view the post. 

As a recap, the DVI/B combo method helped smooth the ride with the longer term DVI modulating the shorter term and more erratic DVB. These indicators are available from DV Indicators.

This year the DVI will have had its work cut out in modulating the shorter term indicators like the DVB which came unstuck in August (though have enjoyed a good month or so recently). 

To help assess this better I've created two templates for the DV Indis Research package. The general rule is that you only trade if both indicators are signalling in the same direction. You stay flat otherwise. 

Template 1 Combines a short term and intermediate term indicator. 

Template 2 Combines a short term indicator with a longer term unrelated trend type indicator. 

Combo 1 - Short term and intermediate term indicators. 

I've used the template to test out various combination options. The first idea presented a few months ago was the DVB/ DVI combination. This helped soften the blow of the DVB's poor performance, but did not avoid it entirely. Following my recent post analysing the components of the DVI, I have been focusing my trading on the DVIM component and stripping out the DVIS. This combo option improves results further. 

Finally, using the DVO instead of the DVB has been another way to lift results. 

Combo 2 - Short term and longer term trend or skew indicators.

Logically combining separate indicators should offer better diversification and this indeed seems to be the case. The longer term trend filter, the DLTI has been a great companion for shorter term MR indicators helping to reduce drawdown and keep a good level of upside. 

Short term mean reversion isn't quite dead yet, especially when its used in conjuction with a wiser, slower moving companion. 

Templates available soon. 

Close to Close or Open to Open?

Much of my trading and system research is based on entering the trade at the close and exiting at the next day's close. 

There's one practical problem with this - Trading from the UK this means checking/ acting on trades in the evening. This is fine most of the time, but a) It can be hard to switch off for the evening if you know you've got to trigger a trade b) when you are out and about, its a pain to have to dash out and check a signal, especially if you're in the middle of a meal or an martial arts class! 

The more practical alternative for European traders is to trade based around the open, but will performance still hold up?

DVIM Performance (Intermediate term indicator)

I've been researching various indicators and have generally come to the same conclusion. The DVIM has performed well this year on a close to close basis (CtC) but has Open to Open (OtO) been much different?

This is based on the basic rules of going long below 0.5 and short above 0.5.

In turns out, there has been very little difference in 2011. I think this is primarily a function of the holding period being a lot longer for the DVIM than other shorter term indicators like the DVB. 

Speaking of which...

DVB Performance (short term indicator)

Speaking of which...

Trading the DVB OtO this year has actually been better than close to close. This is certainly against the long term trend for the CtC to out perform. 

I'm sure those pesky Europeans are playing their part in this year's performance differential. 

The Rolling Sortinos

In a recent post I previewed a neat service coming soon from my colleague Jeff Pietsch that ranks various indicators by their rolling 252 period Sortino ratio.

I raised the possibility of being able use these rolling Sortinos to switch between systems or manage position size.

It’s taken a while to get the models built but they are showing some initial promise.

The Rolling Sortinos

Despite sounding like a travelling circus act, this metric does appear to have some use as a filtering tool.

DVB’s Evil Twin & The DVI.

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. 

What's working right now?

There's no doubt markets are behaving in a different than they have in recent history. Some short term indicators like the DVB have fallen out of sync with markets. While there are some ways to filter and adjust to market conditions to turn off certain inputs, it’s useful to know what is actually working right now.

Luckily I’m privy to a great tool my colleague Jeff Pietsch has in beta right now. A performance matrix displays various indicators across different ETFS via 252 period Sortino ratio. It’s a very neat, visual way to see what is working on which market.

Here’s a sneak preview:

As you might have guessed, the shortest of the short term indicators have not been doing well, but looking a bit further out (DVI, DVIM etc), markets are still mean reverting – It’s just not the sort of mean reversion that the likes of the DVB thrives on though.

The longer term DVI, DVIM and DVIS have fared better on the main markets of late, but the real star has been the Livermore Trend Indicator which has shone while the DVB has faltered. All of these indicators are available within the DV Indicators package, a product I must disclose I am involved in.

The simple solution would therefore be to switch your attention to what is working and step away from what isn’t. But we all know this is incredibly easy to do with the benefit of hindsight, but rather more difficult in reality.

In the next few weeks I’ll be running a test of a 252 period Sortino rank method for indicator switching and will report back when I can on this rather mammoth undertaking.

One solution going forward might be to hedge bets by averaging indicator signals across fast and slow indicators with the addition of a trend indicator (Livermore Trend Indicator) as a final overlay.

Inputs:

• Fast: DVB (DV2 period)
• Fast: DV3 Period
• Slow: DVI (Intermediate)
• Slow: DVIM (Intermediate Magnitude)
• Trend: Livermore trend indicator

Buy on score below 0.5 sell on score above 0.5

Returns:

This still of course comes with a huge dollop of hindsight in the selection of the indicators to throw into the averages. Still it gives you an idea of what is working right at present.

Now where’s that time machine…

Equity curve surfing & other filters

Following my last post on the struggles the DVB indicator is having, a reader reminded me of this excellent post Jeff Pietsch's market rewind blog. 

Worth a read certainly. The main highlights from this post for me are these three suggestions: 

1. Know what environment you are trading in (reverting/ trending).

2. Trading methods themselves revert (addition by David V.).

3. Track your methodology's equity curve like it was a stock.

In the context of the current market, I thought it would be a good idea to put some flesh on these ideas applied to the DVB Indicator. 

When does oversold become a sell signal?

My favourite short term indicator the DVB is not having a happy time of it, doggedly signalling long, but the market has been stubbornly refusing to listen.

Trading the indicator via the basic method of long below 0.5 and short above 0.5 is still up 6.14% for the last 250 days on the SPY, as the equity curve below shows, it has fallen from grace somewhat.

Measuring Indicator volatility instead of market volatility

Question – Can you use volatility In DVB scores to modulate the indicators usage?

Historically, mean reversion type indicators have performed better in volatile conditions compared to trend following conditions (when the price does not pull back). Instead of using the market as a measure of volatility, can you use the indicator values themselves as a volatility proxy?

Normalised Volume

I’ve never been able to get much out of volume analysis, but then again I’ve not really given it too much serious attention. Logically, if the size of up days and down days has some predictive ability, the volume behind such moves must glean some important data?

There are a gazillion ways that volume could be examined, but I have chosen to take a look at the predictive ability of volume when used in combination with my favourite weapon of choice, the DVB. Specifically I wanted to look at returns from normalised volume moves.

DVB Through the crisis

I've been out of action trading wise for the last month. I got married at the start of the month and enjoyed an active yet refreshing honeymoon in Peru for 3 weeks (We're not beach people!). 

Even in the Peruvian Andes I couldn't fail to miss the headlines from Greece and the ensuing market volatility. 

It looked good time for Mean Reversion type strategies which is typical when you’re aware from your screen. So I was keen to find out how a basic DVB strategy would have fared recently.

The basic strategy is to go long on a reading below 0.5 and short on a reading above 0.5.

Here’s how things have panned out recently using this method on the SPY (S&P 500 ETF). 

Not too shabby based on a rather simplistic eyeballing of the charts.