I read a blog post recently that began “suppose you have a trading system that works well on low-volatility days…” and I thought, hmm. Is that a thing? Is there an edge to low-volatility days vs high volatility days? Let’s turn this blog post into a speculator’s version of Dude, What Would Happen?
• SPY, baby! From 2000 through 02/16/16.
• A low volatility day is defined as a less-than-1% change (up or down) from the previous close to the current close. A high volatility day is greater than 1%. Presumably, days that move exactly 1% to the umpteenth digit are falling through the cracks. Call me lazy.
• Gain/loss is recorded from the current close to the close of the following day. This would be a long-only system. This is unicorn-and-rainbowland so there are no commissions or fees of any sort.
That’s it! Not a trading system. Just a filtering system. Let’s take a look:
Those are the graphs for all low-volatility days as defined above. There’s a positive expectation but only just. Most of the time any system built around this would have been underwater. In fact, this looks suspiciously like a buy-and-hold curve from the same period. No thanks!
Well now that’s interesting. The cumulative equity graph for high-volatility days spends most of its time above zero. That’s ALWAYS a plus in my book (hah, I just made a math pun there…). This curve looks great, except for a couple of times where it looks really awful. But still, better than the low-volatility days.
Right, there we have it. Only trade on days when there’s been a lot of movement in the market, and hope for the best.
What if we divided up these low- or high-volatility days into up or down days? Up is when the close is above yesterday’s close (rocket science!) and down is…ok please don’t make me actually spell it out for you.
Low-volatility up-day trading looks like garbage.
Low-volatility down day trading is less sucky but still sucky. Ok now on to high volatility days:
Wow! Yikes! It would almost be a good short-selling idea, except most of the gains (or losses, in the above graph) happened around 2008-2009.We certainly can’t spend our days wishing for the Crash of 2008 again.
Ooh! Now we’re getting somewhere! (Isn’t it weird how the good results always seem to appear at the end of my blog posts?) Trading on high-volatility down days shows a much more consistent equity curve. Drawdowns are less severe, and the differences between bull and bear markets are much less pronounced compared to the other systems. This system does tend to stall out during bull markets compared to more turbulent times, but it’s still kind of impressive.
guaranteed can’t lose trading systems exploratory ideas don’t all trade with the same frequency. The high-volatility-down-days system trades much less than the all-low-volatility-days system. We should be careful comparing them directly. However, a quick and easy way to compare them is to calculate the average gain/loss per day. That equalizes systems with different trading frequencies. Here’s a graph:
Which I guess just proves that the market is highly mean-reverting in the short term, and highly up-trending in the very long term.