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PSI5 Mean-Reversion Strategy Update – February 25, 2021

The PSI5 mean-reversion strategy in SPY ETF is up 5.1% year-to-date vs. 2.3% for buying and holding. A performance comparison with another popular mean-reversion strategy is included below.

The PSI5 mean-reversion strategy is not a data-mined but based on a formula from a text in probability theory that models price action.

PSI5 strategy in SPY ETF backtest details

Time-frame: Daily (adjusted data)
Strategy type: Long-only
Market: SPY ETF
Backtest period: 01/04/1993 – 02/25/2021
Commission per share: $0.01
Position size: Fully invested
Position entry and exit: Open of next bar
Current position: Flat as of February 25, 2021

Equity curve with monthly returns

The strategy fully recovered from March 2020 drawdown to gain 19.8% for the year and that was more than the 18.3% buy and hold. The win rate in backtest period is 66.9% with a sample of 1061 trades. Profit factor is 1.65 and annualized return is 10%. Average holding period is 3.9 days. Exposure is 43.6% (percentage of time in market.)

Note that the equity drawdown during March 2020 did not exceed the historical maximum drawdown of about 23%.

Below we compare the performance of the PSI5 strategy in SPY to another popular strategy: RSI2. Backtest period is from 01/02/2020 to 02/25/2021. Commission is $0.01/share. Equity is fully invested.

RSI2: Buy if RSI(2) < 10 – Sell if RSI(2) > 70

PSI5 RSI2
Total Return 26.2% 1.3%
Maximum DD -22.2% -24.7%
Trades (long-only) 34 12
2020 return 20.1% -1.7%
2021 YTD return 5.1% 3.1%

Note that the default parameter values for RSI2 strategy may not be optimum. However, walk-forward analysis showed that optimum values of parameters result in severe trade-offs. With anchored walk-forward testing based on annual periods, 2020 performance increased at the expense of unacceptable drawdown during 2008. Without anchoring but based on 5-year rolling periods, 2008 performance was highly negative but 2020 performance was positive.

The RSI2 strategy was very popular in the past but in the last few years it has lost its robustness possibly due to widespread use.

A few comments about mean-reversion strategies

Mean-reversion strategies can amplify market risks because they usually go against the short-term trend. Stop-loss cannot be used in most applications because it destroys profitability.

Mean-reversion strategies are more suitable for professional traders who know how to manage risk at the strategy and trade level.


Charting and backtesting program: Amibroker

Data provider: Norgate Data

More information about PSI strategy: PSI mean reversion strategy information.

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