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