In the first post, I established that a very basic method for determining whether a market was following-through or mean reverting was to track daily follow through.
Now we want to look at the performance of a daily follow-through strategy against a daily mean-reverting strategy. It is important to know which method is working as it tells us whether it is better to follow the market or trade against it. Finally, a basic quantification will be identified (the secret ingredient) which we will use to determine when to switch between trading daily follow-through vs. daily mean-reversion.
Daily Follow Through- All SPY History
Daily Follow Through strategy:
Buy Signal: If the today’s close is higher than yesterday’s close, then buy the close.
Sell Signal: If today’s close is lower than yesterday’s close, then sell short the close.
This strategy will stay long (or short) as long as the closes continue to be higher (or lower) than the previous closes.
No commissions or slippage was used in the testing.
Results:
I know, that is a ton of statistics for a very simple (and losing) strategy. Some of the key metrics to note are the Net Profit %, Annual Return, Avg. Profit/Loss %, Avg. Bars Held, and Percentage of Winners. You might also want to notice the differences between the long and short trades.
They say a picture is worth a thousand statistics, so now lets see the equity curve.
Daily Follow Through Strategy Equity Curve:
The equity curve clearly shows when daily follow-through quit working…and consequently, when daily mean-reversion became the play du jour.
The simplest interpretation of this equity curve is that it has not worked to trade in the same direction as the market, since 2001. The last decade has truly been the contrarian’s market.
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In Part 3, we’ll look at the results of the Daily Mean-Reversion strategy. Once we’ve examined both, I’ll introduce the secret ingredient. The fun part is when we attempt to combine both strategies, using the secret ingredient to tell us when to switch between one or the other.
Feel free to leave a comment or ask a question, especially if I have been unclear about anything up to this point.
Great Wood!
So far I’m right with you.
This is great and is essentially what I was trying to figure out when I joined the PPT. Although, at the time, I phrased it as trying to fine a way to combine trend following with and an oscillator strategy.
Can’t wait!