.12 –177,808 156 74 726.251523,507 –26,419 14 33843,196 0.14 0.48 –301,772 133 65 522.28WMT/HD1225,475 –28,710 15 371,176,590XOM/BP0.26 0.68 –245,756 143 71 691.751225,990 –34,894 15 361,066,086 0.48 0.74 –249,644 135 69 1403.40RD/SC621,723 –22,387 16 35517,295 0.30 0.45 –185,845 142 63 1106.89UN/UL316,743 –19,030 15 32970,459 0.28 0.52 –251,713 148 66 542.11Commodity XAU/GC1225,546 –30,612 13 34666,767 0.24 0.34 –439,655 149 67 675.61vs. StockXOI/CL822,639 –30,340 13 33Average164,093 0.10 0.14 –657,479 137 65 676.633124,146 –40,569 14 368,000,0006,000,000Equity
4,000,0002,000,0000
Net Profit :Drawdown :K-ratio :
Portfolio Statistics4,922,788Sharpe ratio :–2,579,686Correlation to breakout :0.21Correlation to 10-40 MA :
0.40–0.69–0.61
© 2002 Lars Kestner - All Rights Reserved
FIGURE
9.22a
Stochastic Strategy Applied to Relative Value Markets. This countertrend strategy shows some promise.
278
Dec-01
Jan-01
Jan-00
Jan-99
Jan-98
Jan-97
Jan-96
Jan-95
Jan-94
Jan-93
Jan-92
Jan-91
–4,000,000
Jan-90
–2,000,000
279
Year199019911992199319941995
9.22b
1990199119921993
1994
1995
Year
1997
Sharpe Ratio1.501.631.190.66–0.25–0.91
1996
Net Profit K-ratio1,786,7310.50864,9500.682,002,3890.34866,0620.36–283,086 –0.08–814,727 –0.24Net Profit by Year
Stochastic Strategy Applied to Relative Value Markets. This countertrend strategy shows some promise.
FIGURE
2,500,0002,000,0001,500,0001,000,000500,0000–500,000–1,000,000–1,500,000–2,000,000–2,500,000
Performance Breakdown by YearNet ProfitK-ratio Sharpe RatioYear1996–2,173,105–0.47–1.55413,2250.2419970.561998726,2010.281.031,917,1030.4919992.392000–1,152,919–0.19–1.262001771,7590.541.59
1998
2000
2001
PercentProfitable57.64%62.68%66.91%67.67%69.29%79.34%
© 2002 Lars Kestner - All Rights Reserved
1999
Num. ofNumber of ProfitableLengthWindows Windows144831 Month142893 Months936 Months1391339012 Months1278818 Months1219624 Months
Average Avg. Bars Avg. BarsLossWinLoss–41,89214351438–67,410–18,4721433–44,5661439–65,9461444–35,0061435–30,4761333Profitability Windows
Breakdown Statistics (Relative Value)
14 day Slow %K stochastics14 days in stochastic calculationEnter long when %K falls below 20, enter short when %K rises above 801/1/1990-12/31/2001Breakdown by Market Sector
AverageAverage Average Avg. Profit AverageAverageAverage AverageMarketWinK-ratio Sharpe RatioMax DD Num Trades % Win Per ContractNet ProfitSectorRates–597,242–102,7101360.0364–0.05023,642Credit–1,243,128 –0.1213564–0.41–13924,396–1,692,838Volatility–196,7001,630,49023,6081510.35701.041,137Commodity–774,685–11,0851310.07620.01–326,887Stock Index –1,209,332 –0.15–1,386,12925,60911961–0.58–7Stock Pairs–479,377467,6781400.15660.31423,364Stock/Comm. 818,613–345,6841490.26670.431024,092
System Name :Parameters :Description :Run Dates :
Net Profit
PART 2 Harnessing the Power of Quantitative Techniques to Create a Trading Program
280
FIGURE
9.23
RSI Strategy Applied to Two’s-10’s Yield Difference. Our RSI Strategy appears to identify tops and bottoms in the yield difference between two-year and ten-year notes.
is contributed from trading volatility, stock pairs, and the relative pricing betweencommodities and underlying stocks. Thirteen out of 15 stock pairs generate profits.Credit spreads and the relative performance of stock indices perform very poorly.Difference Between 10- and 40-Day Moving AverageOur second method of determining price exhaustion compares the value of a 10day moving average to the value of a 40-day moving average. When prices movetoo quickly, the 10-day moving average will separate from the 40-day movingaverage. This occurs because the 10-day moving average is more sensitive torecent price changes than the 40-day moving average.10/40 stat = (10-day moving average – 40-day moving average) / 100-day standard deviation of price changesLong entries are established when the 10/40 stat falls below –2 and are exited if the 10/40 stat rises above zero. Short entries are established when the 10/40stat rises above 2 and are exited if the 10/40 stat falls below zero.
Trading Strategy Evaluation (Relative Value)14 day RSI14 days in RSI calculationEnter long when %K falls below 35, enter short when %K rises above 651/1/1990-12/31/2001#Avg.Avg. Avg.Sharpeof%Avg.ProfitAvg.Avg. Bars BarsMarketNet Profit K-ratio Ratio Max DD Trades Win hrs (000) Per Con. WinLossWin Loss–609,085 –0.08 –0.28 –843,09838 68 333.90Yield–43 47,456 –148,254 43 1492's-10's–477,333 –0.02 –0.24 –772,16522 77 466.09360,508 –198,631 69 3132's-5'sCurve–488,435 –0.05 –0.25 –623,41036 64 549.78–23 34,248 –95,138 46 14510's-30's38 79 521.514058,090 –119,783 44 2012-10-30 Fly 634,684 0.12 0.35 –379,50246 52 8.51Credit–829 45,356 –64,240 33 101Swap spreads –316,740 –0.10 –014 –824,000SpreadsHigh yield –1,604,259 –0.15 –0.58 –2,226,217 41 66 156.81 –245 40,340 –190,312 46 1231,281,900 0.27 0.74 –238,59031 94 10.44 4,007 45,661 –13,855 79 350VolatilityVIX–648,977 –0.09 –0.31 –820,50735 57 632.78Commodity–29 42,901 –99,676 63 114C/W77,456 –0.02 0.04 –827,38847 66 1050.48245,854 –83,894 42 105S/BO31,405 0.02 0.02 –419,27042 64 1257.49145,041 –78,663 44 121S/SM7,3490.04 0.00 –474,79635 57 918.92242,601 –52,415 54 131GC/SL37 41 1103.39 –19 64,145 –78,417 35 112StockSPX/NDX –785,311 –0.06 –0.37 –903,50539 56 1777.82Indices–750,396 –94,560 52 109SPX/RUT –577,918 –0.08 –0.26 –861,609786,386 0.21 0.49 –265,18935 74 502.33Stock4546,720 –47,983 60 161BSC/MER–57,232 0.01 –0.03 –533,96530 63 529.84Pairs–441,087 –76,889 78 138CVS/WAL362,124 0.08 0.20 –354,59740 65 679.981342,784 –53,676 61 98DAL/AMR30,069 0.02 0.02 –364,06631 52 618.47248,084 –49,285 73 123DD/DOW31 81 745.694753,597 –40,551 83 97FNM/FRE 1,068,405 0.30 0.67 –233,334–693,392 –0.18 –0.40 –782,53132 47 600.24–33 38,573 –70,821 52 124GM/F760,037 0.06 0.43 –493,59338 76 596.383650,818 –72,948 47 160KO/PEP146,598 0.02 0.09 –473,05234 62 396.971349,556 –66,404 54 135MOT/TXN41 63 434.81–648,153 –90,797 44 120MSFT/INTC –118,065 –0.01 –0.06 –567,639674,809 0.13 0.38 –400,97833 70 631.623452,579 –50,791 66 142PFE/MRK1,329,975 0.34 0.78 –250,47239 82 771.654350,356 –44,684 54 173VZ/SBC44 80 560.875546,967 –31,451 60 100WMT/HD 1,359,504 0.32 0.81 –167,166–348,082 –0.03 –0.20 –874,05126 54 702.07–19 53,295 –91,764 43 194XOM/BP1,108,010 0.37 0.92 –148,29525 84 1506.772960,528 –42,301 114 146RD/SC528,807 0.13 0.55 –94,95214 71 1215.803262,957 –23,158 232 164UN/UL754,181 0.17 0.45 –270,36842 76 554.42Commodity XAU/GC3339,826 –50,083 53 116123,347 –0.01 0.07 –474,92031 68 681.47vs. Stock851,918 –91,572 58 175XOI/CLAverage 144,674 0.06 0.13 –565,44135 67 683.91106 48,680 –77,100 63 148
Net Profit :Drawdown :K-ratio
Portfolio Statistics4,340,217Sharpe ratio :–2,599,481Correlation to breakout :0.16Correlation to 10-40 MA :
Dec-01
Jan-01
Jan-00
Jan-99
Jan-98
Jan-97
Jan-96
Jan-95
Jan-94
Jan-93
Jan-92
Jan-91
5,000,0004,000,0003,000,0002,000,0001,000,0000–1,000,000–2,000,000–3,000,000Jan-90
Equity
Strategy Name :Parameters :Description :Run Dates :
0.34–0.75–0.69
© 2002 Lars Kestner - All Rights Reserved
FIGURE
9.24a
RSI Strategy Applied to Relative Value Markets. Similar to the Stochastic Strategy, the RSI Strategy also showssome promise when applied to relative value markets.281
–500,000
0
500,000
1,000,000
1,500,000
2,000,000
2,500,000
9.24b
1991
K-ratio–0.39–0.270.290.26–0.160.82
1992
Sharpe Ratio–0.96–1.110.910.95–0.922.20
1993
Year199619971998199920002001K-ratio0.55–0.010.090.60–0.020.14
1994
1995
Year
1996
Avg. BarsWin50407951437556
2000
7882859191102
144142139133127121
1999
Num. ofProfitableWindowsNumber ofWindows
Profitability Windows
AverageLoss–140,452–127,276–13,855–78,662–86,489–56,900–70,828
© 2002 Lars Kestner - All Rights Reserved
1998
Length1 Month3 Months6 Months12 Months18 Months24 Months
AverageWin50,07642,84845,66144,09957,27049,73745,872
1997
Sharpe Ratio1.60–0.200.7230.28–0.300.82
Avg. ProfitPer Contract–6–5374,007–6–131921
Net Profit by Year
Net Profit1,840,108–147,7221,302,1151,047,145–274,147795,685
AverageAverageNum Trades % Win3472445931944061384833683772
Performance Breakdown by Year
AverageMax DD–654,544–1,525,109–238,590–635,490–882,557–400,259–372,644
2001
54.17%57.75%61.15%68.42%71.65%84.30%
PercentProfitable
Avg. BarsLoss202112350118110138145
RSI Strategy Applied to Relative Value Markets. Similar to the Stochastic Strategy, the RSI Strategy also shows some promise when applied to relative valuemarkets.
FIGURE
–2,000,000
–1,500,000
1990
Net Profit–1,475,248–813,850757,832763,636–912,3511,455,162
–1,000,000
Year199019911992199319941995
Breakdown Statistics (Relative Value)
14 day RSI14 days in RSI calculationEnter long when %K falls below 35, enter short when %K rises above 651/1/1990-12/31/2001Breakdown by Market Sector
AverageMarketAverage AverageNet Profit K-ratio Sharpe RatioSectorRates–235,0420.00–0.11Credit–960,500–0.13–0.36Volitility1,281,9000.270.74Commodity –133,192–0.01–0.06Stock Index –681,615–0.07–0.32Stock Pairs462,5300.120.31Stock/Comm. 438,7640.080.26
System Name :Parameters :Description :Run Dates :
Net Profit
282
CHAPTER 9 New Ideas of Markets
FIGURE
283
9.25
Difference from 100-day Moving Average Strategy Applied to the VIX. This oscillator strategy appears tocorrectly identify tops and bottoms in the VIX.
This strategy is applied to five-year swap spreads in Figure 9.27. We enterlong in early August as the 10/40 stat falls below –2. Longs are exited as the 10/40stat rises above zero in mid-September. A short position is established in lateSeptember as the 10/40 stat rises above 2. This short position is covered only a fewdays later as the 10/40 stat falls below zero.Trading based on the difference between the 10-day and 40-day movingaverage does not produce strong results on relative value markets (Figures9.28a and 9.28b). Among the strongest sectors are volatility and stock pairs.Trading in 11 of the 15 stock pairs is profitable. Most interesting is the factthat performance appears to be improving dramatically over time. After performing poorly in 1990 and 1991, the 10-day/40-day average strategy has produced profits in eight of the past ten years. In fact, the most profitable yearwas 2001. These results suggest that despite its overall mediocre performance,the 10-day/40-day average exhaustion strategy may perform superbly in thefuture.
NEW MARKETS, NEW OPPORTUNITIESThe strategies in this chapter mostly confirm our theory that the relative valuemarkets introduced and studied are not prone to trends. Trend-following strategieswere largely unsuccessful, especially when applied to stock pairs and volatility
Trading Strategy Evalution (Relative Value)Strategy Name :Parameters :Description :Run Dates :
Difference from 100 day moving average100 day averageEnter long when stat falls below –2.5, short when stat rises above 2.5, flat on crosses of zero1/1/1990-12/31/2001
Net Profit :Drawdown :K-ratio :
Portfolio Statistics5,732,381Sharpe ratio :–2,620,449Correlation to breakout :0.24Correlation to 10-40 MA :
Dec-01
Jan-01
Jan-00
Jan-99
Jan-98
Jan-97
Jan-96
Jan-95
Jan-94
Jan-93
Jan-92
Jan-91
7,000,0006,000,0005,000,0004,000,0003,000,0002,000,0001,000,0000–1,000,000–2,000,000–3,000,000Jan-90
Equity
#Avg.Avg. Avg.Sharpeof%Avg.ProfitAvgAvg Bars BarsMarketNet Profit K-ratio Ratio Max DD Trades Win hrs (000) Per Con. WinLoss Win LossYield2's-10's–1,134,921 –0.11 –0.59 –1,204,453 42 64 344.28–65 28,033 –113,011 20 116Curve2's-5's–594,4570.00 –0.33 –753,424 52 77 473.11529,564 –87,367 14 11710's-30's–349,637–0.03 –0.18 –510,610 51 69 553.25–13 25,735 –78,490 21 942-10-30 Fly 246,0820.12 0.14 –298,542 55 71 563.9613 34,932 –60,409 21 87Credit–0.14 –0.19 –935,543 47 64 8.88Swap spreads –402,790–990 28,092 –73,855 24 98SpreadsHigh yield –1,284,717 –0.15 –0.42 –2,031,543 47 70 161.90 –167 32,905 –168,167 27 121VolatilityVIX1,714,9900.50 1.35 –181,930 75 89 10.33 2,226 28,171 –20,388 20 39CommodityC/W–613,350–0.07 –0.30 –1,128,894 53 72 659.04–17 27,501 –110,259 24 99S/BO–75,430–0.04 –0.04 –651,336 54 67 1074.36–1 32,078 –67,646 21 94S/SM303,9670.05 0.20 –339,716 49 69 1328.22434,305 –58,340 27 102GC/SL155,0610.05 0.09 –489,064 55 71 925.57425,151 –49,903 29 69StockSPX/NDX –855,891–0.13 –0.44 –964,684 45 62 1046.11 –18 24,901 –91,741 28 101IndicesSPX/RUT –1,001,906 –0.22 –0.46 –1,356,563 44 61 1759.93 –12 29,509 –100,600 27 110StockBSC/MER519,4320.21 0.40 –254,041 59 75 474.8819 24,346 –36,786 21 90PairsCVS/WAG208,0540.07 0.14 –406,696 55 69 517.4513 27,883 –41,296 27 70DAL/AMR 1,440,8480.36 0.87 –211,296 64 83 717.5231 34,060 –35,737 25 87DD/DOW571,2620.21 0.42 –282,302 62 71 607.7916 27,185 –33,992 20 78FNM/FRE 1,129,8840.44 0.80 –233,334 65 78 792.2622 29,087 –25,255 18 77GM/F–393,804–0.13 –0.24 –496,060 47 55 604.50–11 25,639 –47,256 21 86KO/PEP896,