Finding Balance in Strategies
One challenge system developers face is finding the magic set of rules that will perform reasonably well in a range of market conditions. It can be easy to fixate on optimistic report statistics while losing track of trends in the overall market that may have contributed to the numbers. As the markets are fluid and dynamic, with uptrends and downtrends, our trading systems should be able to handle all that the markets can throw at them.
The overall downtrend in the markets over the past couple of years can create a short-side bias for trading systems - especially trend-following systems. Imagine if your system only went short - you would have probably done pretty well! However, chances are your system would not have done very well if it had been designed to just go long. It is important to find a balance that allows a system to perform well under both bear and bull market phases.
When we design systems, we have the advantage of being able to apply logic to the past x number of years and see how the system would have done: wow, hindsight looks great!
But, even with the past data, it is important to weight the immediate and futures markets as well, even if it's just a guess. We can't assume the markets will continue to go down, just like we can't assume the markets would go up forever. We can assume the markets will move, so having a balanced system deserves some thought.
Take a simple stop-and-reverse 17-day breakout system: if the current day closes higher than the previous 17 days, the system goes long; if the current day closes lower than the previous 17 days, the system reverses and goes short. Figure 1 shows the trades this system took with a definite bias towards the short positions. Look at the performance report in Figure 2. Had we tried this as a long-only system we would have closed up shop. But the shorts kept us afloat. But can we sit back and relax? Probably not. Our short trades are winning much more frequently than our long trades, so I would be worried about how the system would be affected by a change in the market trend.
This is just a thought...
Consider trying to achieve a balance in your trend-following systems so that they can reap the rewards in both bear and bull markets.
Comments