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TASC 2013-02 | Volatility Switch (McEwan)

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Traders' Tip text

In this month's issue, author Ron McEwan presents a simple, intuitive yet seemingly effective new indicator whose purpose is to act as a filter in a trading strategy, facilitating it to adapt to changing market conditions. A change from a trending mode to a mean reverting one is measured through a ratio dividing the number of bars when the Historical Volatility (HV) of the daily close price change in a given lookback period was lower or equal to today's daily ROC's HV.

To take advantage of Volatility Switch in Wealth-Lab's charts, code- and interactive rule-based strategies, all it takes is to install (or update if you haven't done that already) the TASCIndicators library from the www.wealth-lab.com site to its latest version.

To illustrate the application of the new regime filter, we created a demo system that takes entries and exits depending on the market's volatility switch state: above 0.5 it's considered choppy with a potential for mean reversion, and at or below 0.5 it's more likely to trend.

  • Entry rules

  1. If volatility switch is in trend mode, buy at market next bar when today's close crosses above the 10-day simple moving average of close price
  2. If volatility switch is in mean reversion mode, buy at market next bar when the 7-day RSI crosses above 30

  • Exit rules

  1. If volatility switch is in trend mode, sell at market next bar when today's close crosses below the 10-day simple moving average of close price
  2. If volatility switch is in mean reversion mode, buy at market next bar when the 7-day RSI crosses below 60

Image

Figure 1. Daily chart of SPY illustrating the application of a trend/mean reversion trading system powered by McEwan's Volatility Switch filter.

We ran a backtest with $10,000 per trade on 5 years of SPY's Daily data. With real world position sizing and trading costs rules applied, the simplistic system was able to beat Buy&Hold, returning a 26% net profit figure (vs. -6%), proving that the regime switch filter can become a valuable addition to a trader's arsenal. The system's C# code for Wealth-Lab can be found below:

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Figure 2. Chart of strategy's equity curve vs. Buy&Hold.

WealthScript Code (C#)


using System;
using System.Collections.Generic;
using System.Text;
using System.Drawing;
using WealthLab;
using WealthLab.Indicators;
using TASCIndicators;

namespace WealthLab.Strategies { public class EwanRegimeSwitchStrategy : WealthScript { private StrategyParameter paramPeriod; public EwanRegimeSwitchStrategy() { paramPeriod = CreateParameter("Period", 21, 2, 100, 1); } protected override void Execute() { int period = paramPeriod.ValueInt; VolatilitySwitch voltSwitch = VolatilitySwitch.Series( Close,period );

for(int bar = GetTradingLoopStartBar( period * 3 ); bar < Bars.Count; bar++) { bool regimeSwitchIsTrending = voltSwitch[bar] > 0.5 ? false : true; if (IsLastPositionActive) { Position p = LastPosition; if( regimeSwitchIsTrending ) { if( CrossOver( bar, Close, SMA.Series( Close,10 ) ) ) SellAtMarket( bar+1, p, "Trend exit" ); } else { if( CrossUnder( bar, RSI.Series( Close,7 ), 60 ) ) SellAtMarket( bar+1, p, "MR exit" ); } } else { if( regimeSwitchIsTrending ) { if( CrossOver( bar, Close, SMA.Series( Close,10 ) ) ) BuyAtMarket( bar+1, "Trend" ); } else { if( CrossOver( bar, RSI.Series( Close,7 ), 30 ) ) BuyAtMarket( bar+1, "Mean reversion" ); } } } ChartPane vrsPane = CreatePane( 30,true,true ); PlotSeriesOscillator( vrsPane, voltSwitch, 0.5, 0.499, Color.Coral, Color.DarkGreen, Color.Transparent, LineStyle.Solid, 1 ); HideVolume(); } } }

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Used under license from FMR Corp. Copyright 2008 FMR Corp. All rights reserved.


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