Back Testing Summary
Short Trades Index ETFs
February 14, 2016
It would be so easy if traders could just flip a switch and move between non-inverse and inverse Index ETFs. When the market is moving up simply buy shares of non-inverse ETFs like SPY, QQQ or IWM (or their leveraged counterparts) and then on weakness switch into the inverse versions. At first blush this seems doable and that we would want to add this feature into the Early Warning Alert System in order to trade both ways. The remainder of this brief report highlights the back testing results analyzing how well trading to the downside would have performed for each of the Index ETFs from 2002 through January 2016.
Three of Index ETFs were back tested including SPY, QQQ and IWM representing the S&P, Nasdaq 100 and Russell indexes. Unlike the Early Warning Alert system which was based on time-tested reliable proprietary indicators to provide alerts for entry there were no specific external indicators that provided similar triggers for downside trades. The proprietary indicators used to the upside did not function well in predicting downside opportunities.
In order to provide an objective means of back testing, price action in relation to weekly moving averages was used for the testing. The rules were:
Sell Short Trigger: Price below the 8 week EMA and a cross of the 8 week below the 20 week EMA.
Entry: Sell Shares of the Index ETF at the open of the week after the Short Trigger
Exit: Buy back shares the week price closes above the 8 week EMA
The following table shows the summary results for the back test. The observations from the testing.
- Win/Loss Ratio: Less than 50%
- Low % Gain/Loss over the testing period
- The range of price movement was skewed to the low side
- Trigger profits at 5% would have resulted Win/Loss ratio above 50% for each Index ETF
Follow on action: Due to a more erratic behavior in trading Index ETFs to the downside it is not advisable to add downside trades to the Early Warning Alert System. The EWAS was tested and traded to the upside with exceptional results with a Win/Loss Ratio of about 0.88. Additionally we must remember that some of the largest upside Index moves occurred during Bear Markets. Staying focused on the upside trades with EWAS is critical to improve the probability of taking advantage of these rallies. Adding another focus would add an unnecessary distraction.
While trading to the downside with the Index ETFs does not fit the parameters of the EWAS there is good value in these trades which fits better into the Active Trend Trading System. Trades that take advantage of the downside moves are defined and allowed in the ATTS. For the Indexes ETFs this would include shorting the non-leveraged ETF; buying Put options on the Index ETFs; and buying Inverse Index ETFs (leveraged or non-leveraged). Now that we know how the results of the downside testing, downside trades on the Index ETFs will fit into either ATTS Strategy I or Strategy II. ATTS members will receive text and email alerts of potential downside trades going forward. As a courtesy I will provide the same alerts to EWA members.
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