In my last newsletter, I alluded to a rotational system I’m in the throws of developing.
In perfect Jane style, I jumped on the diving board, straightened up my approach perfectly. I was just about to leap into the explanation pool with all the “when, what, and wheres” lined up in a row. Then my editor sent me back a note, “The system will identify ?”
I gingerly stepped off the diving board, stood back and thought I should probably slow down a bit and start at the beginning. I should probably scribe a few notes as to what I’m prattling on about when I say a “rotational system.”
Whenever I have to explain a trading or stock market concept I take a back seat to Investopedia and let them do the driving. Here is how Investopedia describes sector rotation, “Sector rotation is an investment strategy involving the movement of money from one industry sector to another in an attempt to beat the market.”
Systems Pairs Trading
I am using the same concept but it’s not “sector” rotation. My methodology will rotate between indexes within one portfolio. Eventually, it will rotate between portfolios.
With that out of the way, I now can get back on my perch and dive into the muddy murky minutia. If you’re not into muddy minutia you may want to skip to the end. Just saying.
I Test and Test and then Test some more
As you know from my previous pontifications I test everything. I need quantifiable data telling me what I’m going to trade is profitable. Since I started QiT I’ve run 1000s of tests with every combination and permutation on the planet.
So it goes without saying I’m doing the same with this new Systems Pairs Trading system because this is a monumental change for QiT.
Of course, like all QiT enhancements, it is all free to current members. Whether you are a member of QiT, QiT+ or Premium, you will have access to this development.
Let’s Set the Stage
I recently made a change to the SP500 portfolios nomenclature to Large Cap. Why? These four portfolios (SP500 Margin, SP500 Retirement, SP500 Leverage and the Blend) are no longer filtering trading candidates from the 500 symbols that make up the S&P 500 Index but from the 100 symbols that are constituents of the NDX100.
It is time now to don your Google specs and enter a world of virtual reality for I’m going march you through the process that landed me at this juncture.
Let’s start with an equity curve of the current SP500 Margin Portfolio that pulled potential trades from S&P 500 Index stocks only.
As you can see it hit an equity high in April and has not done well since. Aren’t you glad I threw the switch on the Circuit Breaker and we are watching its lack-luster performance from the sidelines?
Now, using the exact same code, the same algorithm, keeping everything static except the constituents from which its pulls trading candidates, let’s use NDX 100 Index constituents instead of the S&P 500.
I’m sure you see the difference and, like me, prefer the second chart. The one using the NDX 100.
But how do we know for sure it is better? This is where a computer and software like Amibroker provide the edge essential in trading profitably. Amibroker, and software like it, can gaze at that chart without writing love letters in the sand. It can make rational, unfiltered decisions without the emotional baggage we all carry to each and every trade.
Amibroker will quantify the word “better,” or if it is actually better at all.
I’m going to warn you these charts look daunting at first but like a child learning to navigate the process of walking, I’ll take it one step at a time.
I’m not really obsessed with drawdowns, I just like to give drawdowns the respect they deserve. Thus we’re going to start with the drawdown charts.
The upper panel is the equity curve of each of the two charts above and the lower panel displays its drawdown. Each blue isosceles triangle is a drawdown – drawn out in painful detail.
Here is the SP500 equity chart with its drawdowns
Here is the NDX equity chart with its drawdowns
Now we put these two chars on top of one another so we can compare them but I think this newsletter is getting a tad long in the tooth and will continue this discourse next week.
Next week I will put those two drawdowns charts together then do a Relative Strength analysis on them.
Then as I’m sure you are all waiting with bated breath, I’ll show the metrics of the resulting system
I’ll “Show you the Money.”
We’re the Plan in “Plan your Trade and Trade your Plan” – TraderJanie
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