50% More Gains with Half the Risk

As committed to in our July 4 and August 15 email blogs, we are following up with a defined trading system to take advantage of the next spike in volatility.  As we shared before, we believed that there was a way to construct a trading system by exiting a long market position when volatility spikes and then re-enter the position as volatility declines and there is some measure of confidence that the violating peak (market bottom) event had occurred.   We’ve proven this now as a sound theory and that serves well for a mechanical system structure that provides strong results as stated in the headline – 50% more gains with half the risk.

The trading system closely follows our prior analysis by exiting a long market Dow Jones 30 (using the DIA index tracking ETF) position when volatility (defined as the a simple standard deviation calculation of the last 10 days Open-High-Low-Close prices divided by today’s close price) spikes 1.75 times greater than the long-term average (9.4 years in this study) and then re-enters the position when the volatility falls by 50% compared to the maximum value of the prior 50 trading days.

The graph below shows the total gains of this trading system versus a buy-and-hold strategy with the performance statistics summarized in the table beneath the graph.

This model was developed using a simple Excel spreadsheet and round parameter settings (10-Day StDev moving, 1.75X peak,  and 0.50x drop) for illustrative purposes.  The results can likely be improved by using the more volatile NASDAQ-100 index, optimizing the parameters with more robust software (like TradeStation), using a leveraged ETF like DDM or UDOW, and, for some with higher risk tolerance, also short the market when volatility spikes above 1.75 times the long-term average.

As of Friday’s market close, the StDev of the last 10 days is 1.69 times greater than the long-term average – so the model is still long in the market now but will likely exist soon with another day or two of high volatility.

Lastly, we hope this helps in some way – at a minimum, to equip you with hard facts for your next cocktail hour conversation when a boorish market expert tries to convince you that it is impossible to beat the market with a mechanical method or timing.   Here’s one simple example to do that by at least 50% and with half the risk.   The graph even shows that it beat the market within 90 days and then held and extended the gains for the following 9 years.

Forte Strategy Update

We executed 9 trades last week for a net loss of 1.0% compared to a loss of 2.5% by the S&P 500. Our YTD net results equal a 2.9% gain compared to a 3.4% YTD gain for the S&P 500. Our YTD max drawdown is 9.5% versus 33.9% for the general market. 

More details about our trading activity can be found by registering on the Collective2 website and searching for Forte Strategy. A running list of these email blogs and general information about Maestro Capital Research can be found at maestrocapitalresearch.com.

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