Trading strategy persistence and reversion

Deeper into the rabbit hole we go…

I’ve been playing around with automating trading system generation and evaluation.  It’s been crude and slow so far but has been a good learning experience.  One of the things that’s come out of this is my thinking about whether short term strategies exhibit a sort of persistence (good results followed by good results) or mean reversion (poor results followed by good results).

There’s no good reason I can think of that either has to be the case.  Still, it’s something that can be looked at when evaluating a strategy.

Let’s think about a simple mean reversion system – holding SPY when it’s below its 10 day moving average.  The inverse of this, a follow through system, will hold SPY when it is above the 10 day moving average.  Ok, how does the mean reversion strategy perform when it has recently outperformed or underperformed the follow through strategy? Below is a chart with results based on a 20 day look back period.

In this case recent underperformance has been a good predictor of strong future performance (especially since 2008). Recent outperformance has been followed by so-so to poor performance.

SPY10SMA

This makes me wonder what other simple systems show similar trends if we apply the same type of analysis.

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Posted on January 24, 2014, in Other. Bookmark the permalink. 5 Comments.

  1. Similar questions occur to me.

    * Timeframe of entry/exit ?
    * Pain threshhold? Where are the stops? Measured however you like.
    * What is on your side with the “does well after underperformance”? The global concerted will of pretty much everyone with a stake in the market, including sovereigns.

    How do you tell a coherent and _actionable_ story from the above with your system?

    One thing I’ve found about trend-following systems is that they really do seem to have 1:2 or 1:3 win:loss ratios. All about “let the winners run”, which mean-revision systems by definition do not do. Ok, so to create a mean revision system – take a trend following system and reverse the signals. Just did that over the week with the Turtle system. Question is, how do you tune your stops to avoid the nasties? Do you leg in further (i.e. average down) and look like a balsy genius when price reverts, or an idiot when you lose that much more? I’ve managed to do both in the past week.

  2. I think there is an error in backtest. Looking at the chart, the performance seems too good to be real (too much linear growth). The error could be when you compare recent outperformance and underperformance. It’s possible the you look one day in the future. Can you confirm please?

  3. Mike, I just found your blog and think its really good. I’m fairly new to volatility trading and would love to get an opportunity to talk to you about trading. If you are willing to, whats the best way to contact you (ie. phone, skype, etc)?

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