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Long DV2 in different 30-day volatility regimes

May 14, 2010

by Enn Kuutan

In the last post we looked at trading DV2 at extremes in rising or falling 50dma environments. Our goal was to perform an intermediate-term time frame analysis using the 50 day moving average to represent the trend. Today I thought we would look at capturing something different: trading DV2 extremes within different 30-day volatility regimes using DV Percentile Rank Volatility (DVPV) and multiple holding periods. In terms of settings, we will define low volatility as DVPV<0.5 and high volatility as DVPV>=0.5. This gives us a larger sample size to draw from to make conclusions. First we shall examine the results from long trades (DV2 < 20).

Here we see it definitely pays to invest in those high volatility periods associated with high uncertainty vs. those that are relatively calm. Throughout the entire holding period spectrum the high volatility environment beats low volatility for long trades and only begins to converge at the long 20 day holding period. The high volatility trades exhibit a consistent uptrend in average gains per trade as the holding period increases. The low volatility curve is similar but only increases significantly at holding periods higher than 7 days. Both are consistently profitable but the low volatility trades may not be robust to transaction costs. Thus when volatility is low, it may be best to avoid using the DV2, and focus on a more intermediate-term indicator such as the Super-Smoothed Double Stochastic (DVDS).

Taking a look at the risk adjusted measure, the DVR, we find outperformance of trades in the high volatility environment for holding periods under 10 days by a significant margin. However there is a clear deterioration in the DVR for the high volatility curve as holding periods increase while the low volatility trades show the opposite effect with DVR’s improving with longer holding periods. The deterioration for the high volatility trades is likely due to the fact higher volatility also tends to coincide with the SPY being below the 200ma. In contrast the observation that low volatility trades improve over time is likely due to the fact that this environment also tends to coincide with the SPY being above the 200ma.

Next we shall examine the results from short trades (DV2 > 80).

Here we see very different results in comparison to the long side, with generally much less consistency in edge. Shorts in low volatility environments tend to exhibit consitently low positive returns across the holding period spectrum with no discernible trend in P/L, with the edge peaking out at the 4 and 10 day holding periods with an average trade of 0.32%. In high volatility the average gains are higher for the most part except at the long end where holding periods longer than 15 days show negative returns. As a whole, short trades remain still much less profitable than the long trades we looked at earlier. Lets take a look at the DVR to see what insights we can gain:

Looking at risk, we can see that the low volatility trades exhibit a poor reward/risk throughout the entire spectrum, with the optimal result falling within shorter time periods under 5 days. The high volatility trades start off with a high reward/risk for the 1-2 day hold backtests, but decay in an oscillating fashion as the holding period gets longer until the measure goes negative for holding periods greater than 15 days. It is very interesting to note the divergence in the pattern of risk-adjusted versus absolute returns for the high volatility environment. Effectively it may indicate that since volatility is highly cyclic it is not efficient to harvest it over longer time frames.

One Comment leave one →
  1. Brad permalink
    May 16, 2010 9:57 am

    Enn – Great post, and so true to trade differently depending on volatility regimes. Re: trading with the trend, where is your final post on trading shorts based on a rising or falling 50 day MA? I don’t think I have missed it, but if I have could you provide a link?

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