Good regime for trend-following and mean-reverting strategies?

[SnakeEYE]

Quote from bone:

..you will find most experienced traders will fade highly volatile multi-sigma single day or event-driven moves and trend-trade the subtle grinding markets.

that`s i was thinking about just recently..

 

[SnakeEYE]

Quote from Mike805:

No I don't think that the OP is going to make money reading about the H word, and I don't really care about that... however, I do know the OP has a history of asking questions and expecting the answers to be laid out for him.

I'm sure that if Mizhael starts thinking and does some research about conditional variance, he might stumble across GARCH and Engle. Then he might actually read a paper or two that outline how to do some silly (and useless) volatilty forecasts. From there, he can come up with some different (and possibly practical)models that can produce decent conditional variances...

I'll leave how this applies to systemic trading alone as I think most here do not have systems that can actually benefit from this type of approach.

You should expect volatility to increase by the 20th of each month.How about this for starter?

 

[Rodney King]

Quote from Mike805:

I do know the OP has a history of asking questions and expecting the answers to be laid out for him.

Very true. I've posted about this tendency in other threads.

Quote from bone:

"Modeling Financial Time Series with S-Plus" by Zivot and Wang.

That's a good rec. Eric Zivot is smart, creative, organized, and a good communicator. BTW he offers an online course on computational finance using R, via U of Washington - http://bit.ly/kqEfKL

 

[Soon2Bgreat]

Quote from bone:

Surf the Wilmott forum threads, because quite frankly you are going to get lots of misleading and ill-informed discussion on financial modeling on this website.

Fair, though there's plenty of crap there too so be careful with that also

 

[bone]

Quote from Mike805:

however, I do know the OP has a history of asking questions and expecting the answers to be laid out for him.

No offense, Mizhael, because I like your questions and your proactive approach in terms of what knowledge might be important to building a viable strategy - but this is a valid point.

X3

 

[Rodney King]

It's not that he asks questions of others -- that's fine -- it's that he doesn't do any legwork himself, or share any of his own findings or insights. He takes but never gives.

 

[sle]

Quote from bone:

Regarding the OP's original question: I discourage generalizations. However, generally speaking, you will find most experienced traders will fade highly volatile multi-sigma single day or event-driven moves and trend-trade the subtle grinding markets.

Well, a simple value on value scatter plot of auto-correlation against volatility (same rolling frame) would give you a general answer. What you are probably going to see is that at low values of volatility autocorrelation can be positive (trending) or negative (meanreverting), while at higher vol levels it is in general negative. Even better is to plot weekly change standard deviations against daily change standard deviations - the weekly volatility will gently flatten as daily volatility increases

 

[bone]

Quote from sle:

Well, a simple value on value scatter plot

Yeah, I know all about the beta scatter plot functionality on the Bloomberg. Got access to EuroMTS ? Pretty please ?

 

[mizhael]

Quote from trend7rader:

Trend following relies on directional moves, volatility can be high or low, you can still make money from a directional move... if volatility is low it will just take more time. Big moves are often preceded by contraction followed by expansion in volatility, this works across all time frames.

Mean reversion depend on prices reverting back to the mean: you are buying low, selling high relative to your reference point.

I've generally found mean reversion works better in low volatility environment and trend following works better in an expanding volatility environment but it depends what kind of systems and parameters you are using.

There are a few things that I really don't understand:

A typical low-vol price series is a straight-line. It has 0 vol.

It should be the perfect setting for trend-following system but worst for mean-reverting.

Maybe we should define "trend-following" and "mean-reverting" system first, precisely.

What's a typical "trend-following" and "mean-reverting" system, in your mind?

 

[mizhael]

Quote from MGJ:

Adding volatility filters to improve the performance of trend following mechanical trading systems, is an old and time-honored practice. One system seller says

• I've come up with a trading filter that indicates when a commodity is becoming abnormally volatile. When the filter determines that activity is within a normal range, trading can take place with any suitable strategy. But when abnormal volatility is detected, on-going trades are exited and new trades are not entered in that commodity. I've tested this on a dozen or so strategies I monitor, and without exception the filter significantly reduces draw-down, and increases the ratio of profit to draw-down.

Notice that they don't say whether "abnormal" volatility is volatility that is (A) too low; (B) too high; or (C) either too low or too high. So that's something for you to test.

I'm sure you can think of two or three ways to quantify "volatility" and four or five ways to define "too high" and/or "too low". Program them up, attach to some of your favorite trend following mechanical trading systems, and try them out. You may get results similar to the claims quoted above. Or you may not. The only way to find out is to perform the tests and study the results.

Assuming you do find one or more volatility filters which improve the performance of trend following systems, you certainly could use the filter to define "regimes". When the filter says "OK to trend trade", call that the "Trend Following Regime". When the filter says "not OK to trend trade", call that the "Mean Reversion Regime". Voila.

You could do the same thing with your favorite mean reversion mechanical trading systems. Attach some volatility filters, run some tests, and identify the filter(s) that give the greatest performance boost. Call this your regime indicator. Voila number two.

If you are absolutely dying to know the author of the quote above, operate the googles. They won't let you down.

I just don't understand why people universally think of using volatility here... as I pointed in my other post, a straight-line with constant slope has a vol = 0 ... but it's perfect for trend-following...

I am afraid that vol is only a secondary factor there, there is a more significant factor that that's more relevant...

Any more thoughts?