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Volatility Adaptive Trend-Following with Mean-Reversion

A trading strategy that combines volatility adaptive  trend-following with mean-reversion shows significant outperformance of SPY total return buy and hold since inception.

The long-only strategy employs a volatility adaptive moving average to identify and follow trends and switches to mean-reversion when there is no trend.

The strategy uses price action volatility to adjust the period of a moving average (AMAV) in a crossover that signals uptrend start and end. As a result, the adaptive moving average speed  changes to better capture directional moves while minimizing losses due to whipsaw.

In addition, when the volatility adaptive moving average signals no trend, mean-reversion based on PSI5 algo is employed to maximize returns. The PSI5 mean-reversion strategy is not data-mined but based on a formula from a text in probability theory and is available for sale to professional traders and hedge funds subject to acceptance of a non-disclosure agreement.

Strategy general description (AMAVMR):

Trend-following mode: AMAV > 200-day simple moving average
Mean-reversion mode: AMAV < 200-day simple moving average

Backtest details for AMAVMR strategy

Time-frame: Daily (adjusted data)
Strategy type: Long-only
Market: SPY
Backtest period: 01/29/1993 – 12/10/2019
Commission per share: $0.01
Position size: Fully invested
Position entry and exit: Open of next bar

Before including the results for AMAVMR strategy, we include below the results for just the trend-following strategy part.

Buy: AMAV > 200-day simple moving average 
Sell: AMAV  < 200-day simple moving average 

It may be seen that the strategy has stayed out of the market during bear markets and major corrections. Still, the strategy outperforms buy and hold on both absolute and risk-adjusted basis. CAGR for the strategy is 10.5% versus 9.6% for total return buy and hold while maximum drawdown is 19% for the strategy versus 55% for buy and hold.

In AMAVMR strategy, mean-reversion is used during periods of tend-following inactivity, mainly bear markets and major corrections. Below is the equity curve of the backtest.

Strategy performance

Parameter Strategy Buy and Hold
CAGR 15% 9.6%
Max. DD -23.7% -55.2%
Sharpe 0.93 0.47
MAR 0.63 0.16
Win rate 66%  –
Trades 225  1
Payoff ratio 2.0  –
Exposure 87% 100%

The strategy has outperformed SPY total return buy and hold on both absolute and risk-adjusted basis by a wide margin. CAGR for the strategy is 15% versus 9.6% for buy and hold. Sharpe for the strategy is 0.93 versus 0.47 for buy and hold.

The strategy backtest shows high returns during 2008 bear market and a potential of providing tail risk hedge assuming no major change in bear market dynamics that will cause the PSI5 algo to not perform as expected.

This AMAV code is offered at a discount with a purchase of PSI5 mean-reversion algo.

Charting and backtesting program: Amibroker

Data provider: Norgate Data

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