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April 2009 Stocks and Commodities Traders Tips


Profit With High Relative Strength Mutual Funds

Original article by Gerald Gardner
AIQ Code by Richard Denning
Traders Studio Code by Richard Denning

AIQ Version:

The AIQ code for the unilateral pairs trading system in the article, “Profit with High Relative Strength Mutual Funds” by Gerald Gardner, is shown below.

In the article the author uses a pair of mutual funds that are highly correlated using the less volatile one (FHTYX) only for purposes of generating trading signals for the more volatile one (HOTFX). I was not convinced by the back test using this pair since there are very few trades with long holding periods. To test the idea on stocks, I used the Russell 1000 list of stocks and AIQ’s MatchMaker module which uses Spearman statistical technique to correlate stocks on daily or weekly price change basis. I ran the entire list of Russell 1000 stocks against itself to find the highly correlated stock pairs. Two that were highly correlated are Chevron (CVX) and Exxon-Mobile (XOM). A second pair was also tested Lennar (LEN) and Toll Brothers (TOL). I created symmetrical rules to go short (as this was not provided by the author) and tested these two pairs both long and short on a unilateral basis. I used the pyramiding feature of the Portfolio Manager and entered positions in 25% sized positions, one position per day, four maximum positions for each stock. The pyramiding will enter up to 100% of capital if there are four signals in the same direction before an exit signal is generated. Iif only one entry signal is generated before an exit signal then only 25% of capital will be traded. This approach helped to reduce the draw downs somewhat. The long side of the two pairs made a small return but had rather large draw downs relative to the return generated. Neither was able to beat the SPX buy and hold over the time period tested (7/1/86 to 2/10/09). The short side on both pairs lost money over the test period and also had large draw downs. I then consolidated all the tests into a single equity curve and the results are displayed in Figure 1. By consolidating, the final result did barely beat the SPX buy and hold but the draw downs are still rather large relative to the return. I think by using a larger number of pairs and change the exit so that trades are held for a shorter period of time might improve the system and smooth out the equity curve.

Figure 1: Consolidated equity curve for unilateral pair trading of CVX (against XOM) and LEN (against TOL) as compared to the buy and hold equity curve for the SPX.

AIQ EDS Code for Profit With High Relative Strength Mutual Funds:
Profit HRS MF .EDS



Traders Studio Version:

The TradersStudio code for the unilateral pairs trading system in the article, “Profit with High Relative Strength Mutual Funds” by Gerald Gardner, is shown below.

In the article, the author uses a pair of mutual funds that are highly correlated using the less volatile one (FHTYX) only for purposes of generating trading signals for the more volatile one (HOTFX). I wanted to test the concept of unilateral pairs trading where a volatile futures contract is pared with an index of its related sector. I also want to have a trading system that would trade both long and short. I added the reverse logic to create the short sale entry rule and the related short exit rule. Pinnacle data provides cash indexes for some of the futures sectors. The Euro (FN) contract is one of the more volatile of the currency sector futures contracts which I pared with the CRB Currency Index. In addition, I pared Heating Oil (HO) with the CRB Energy Index, the Treasury Bond (US) with the S&P500 Index, the Pork Bellies (PB) with the CRB Meats Index, Soy Beans (S) with the CRB Grains Index, the emini Russell 2000 (ER) with the S&P500 Index, and Gold (ZG) with the CRB Metals Index. The two moving average lengths were quickly optimized to see what parameter sets might work. I did not optimize the number of standard deviations that are used to determine entries and exits but stayed with the author’s value of two. Only the Gold with the CRB Metals Index showed almost all parameter sets to be losers. After eliminating Gold from the portfolio of pairs, I ran a percent margin trade plan on the rest. The code for the percent margin trade plan is included with the TradersStudio product and is not shown below. The results of the test using 25% of available margin on each trade gave the results shown in Figure 1. The test was run from 9/23/1971 to 2/10/2009 on the six market pairs resulting in 1121 trades, a compound annual return of 15.74% with a maximum draw down of 46.08%. Although the tests show that the idea behind the system has merit as applied to futures, I would not trade this system without making more adjustments to try to reduce the draw down.

Figure 1: Log equity curve and related key metrics for the paired portfolio of six futures using Pinnacle data for the futures (FN, HO, US, PB, S, ER) and the paired cash indexes for the period 9/23/1971 to 2/10/2009.

Traders Studio Code for Profit With High Relative Strength Mutual Funds:
Profit_HRS_MF.zip

 

 

 

 

 

 

 

 

 

 

 

 

 

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