This post is about how to use the previously (link) discussed and build market environment filter for switching between two indicators and decide when to trade long or short. While we will come up with a decent strategy my main focus is to guide you through the thought process of how to build a trading system.
Strategy objectives and background
- Trade the SPY (ETF of the S+P500 index) long / short.
- Outperform the SPY (buy and hold)
- Annual growth rate twice as high as max draw down (intraday).
- Strategy testing ~ 11 years (2000 – today)
- SPY not adjusted for cash dividend.
- 100% equity per trade (compound returns)
I’m going to use DVO and DVI as my only tools for timing the SPY. Both indicators are from David Varadi. DVO is a short-term mean reversion indicator. DVI is an intermediate term indicator signaling overbougth / oversold conditions. While both indicators are a great tool for the savvy trader, their real power comes into play when combining them (and this is what this post is about). Now the fun stuff begins. We will analyze how the indicators do within the various market environments.
Long – Trades
The table has four columns for each of the Market environment filters
- High Trend: TSI > 1.7, High Volatility ATRrank > 50 (HTHV)
- Low Trend: TSI < 1.7, High Volatility ATRrank > 50 (LTHV)
- High Trend: TSI > 1.7, Low Volatility ATRrank < 50 (HTLV)
- Low Trend: TSI < 1.7, Low Volatility ATRrank < 50 (LTLV)
and a fifth column showing the performance without any filter. The explanation of the KPIs used can be obtained here (link).
Short – Trades
- DVO is generally performing better in volatile market
- long: LTHV or HTHV or HTLV
- short: LTHV
- DVI does better in trending markets (intermediate trend cycle is more dominant than short-term cycle).
- long: HTLV or HTHV
- short: LTLV or HTHV
In the next post we will look at how the combined long/short strategy performed.