Thursday, August 13, 2009

Equity Curve Surfing

Here is one last look at the unbounded DV-2 strategy by CSS Analytics to demonstrate the larger concept of Equity Curve Switching. From the last post (here), I took the two best equity curve results, namely those from the Raw DV-2 (blue) and the Opposite-Direction (purple) strategies, and then overlaid a simple switching routine based on the higher short-term rate of change among the two.

The result is the orange equity curve (simple, frictionless returns). Obviously, this type of system-level trading overlay will work best when the alternative curves present persistent offsetting periods of over/under performance.

In that last follow-on DV-2 post, I referenced the importance of "knowing your trading environment." Now imagine a similar system to the one described above that perennially checks and compares the performance of basic trending, break-out and mean-reverting strategies. In this regard, a good recent companion thought piece to this post may be found over at MarketSci on the State of Mean-Reversion Systems.

I've about beat the unbounded DV-2 indicator to death at this point (with respect David)! In the future I will work with the bounded variant.

Note: This post was originally published as an ETF Rewind 'subscriber-first' article delivered over the weekend. This will be my new practice to provide added value to my members.

6 comments:

Woodshedder said...

Jeff, is it possible that you could specify your ROC measure that determined when you switched?

"the higher short-term rate of change among the two."

I love this trading the equity curve series Jeff. Well done.

Jeff Pietsch CFA said...

Thanks Wood -- In this case I used a simple Last Price/ Average(N Periods). The strategy worked across a fairly broad short set of N's. However, the main idea is to think about applying relative strength methods to your equity curves in general rather than specifying a specific formula here.

Shivar said...

Jeff, I have tested your idea with the daily follow through concept. I wanted to switch between mean reversion and trend following so I build the equity curves of "going long if S&P500 daily perf > 0" and "going short if S&P500 daily perf > 0".

Then I defined your short term rate of change and switched to the strategy with the higher rate of change. The weird thing is that it fails pitifully if I am using a short term time window (like 20 days). The combined equity curve is worse than the worst of the initial equity curves.

If I increase the time window, performance increases (almost linearly).

Can you precise your concept to allow short term rebalancing ?

Jeff Pietsch CFA said...

Hi Shivar, I suspect you are headed in the right direction, but may consider reconfiguring your trend-method formulation. Think of trend-systems you would actually trade, and start with that. Best, Jeff

Dennis said...

Jeff,

I was wondering if you tried this approach as well with more more systems. Like 100 or so...

Regards,
Dennis

jgpietsch said...

Hi Dennis, I use it for about a dozen at a time. More on this in future posts. Best, Jeff