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August 2010 Stocks and Commodities Traders Tips


Normalized Volatility Indicator

Original article by Rajesh Kayakkal
AIQ Code by Richard Denning
Traders Studio Code by Richard Denning

AIQ Version:

The AIQ code for Rajesh Kayakkal’s Normalized Volatility Indicator (NVI) and the NVI trading system from his August 2010 article, “Normalized Volatility Indicator”, is shown below.

I tested the author’s system on the S&P 500 SPDR (SPY) rather than on the S&P 500 Index (SPX) because we can’t trade the SPX and I wanted to apply capital limitations rather than create a hypothetical test. In Figure 1, I show the consolidated (trading both long and short) portfolio equity curve using the author’s parameters for the indicator and with the AIQ pyramiding option turn on in the portfolio manager. I tried different capitalization settings in the range from 0.1% up to 2% and found that the 1% per trade with up to 100 possible positions was the setting to use with a starting balance of $500,000. The Figure 1 graph compares the resulting equity curve to the SPX buy and hold and Figure 2 compares the equity curves for trading long only versus trading short only. The system, especially the long side, outperforms the indexes on a risk adjusted basis which can be seen by comparing the Sharpe Ratios for the system equity curves against the indexes Sharpe Ratios. However on a raw performance basis the system underperforms all the indexes over the test period which ran from 12/31/1993 to 6/11/2010.

Captions:

Figure 1: Consolidated equity curve trading both long and short for the NVI system trading the SPY as compared to the SPX index buy and hold over the test period from 12/31/1993 to 6/11/2010.

Figure 2: NVI system equity curve trading long only compared to the NVI system equity curve trading short only, trading the SPY over the test period from 12/31/1993 to 6/11/2010.

AIQ EDS Code for Normalized Volatility Indicator:
Vola Pct Index.EDS
(RIGHT CLICK AND CHOOSE "SAVE AS." DO NOT LEFT CLICK OR YOUR BROWSER WILL TRY TO OPEN THE FILE.)


Traders Studio Version:

The TradersStudio code for Rajesh Kayakkal’s Normalized Volatility Indicator (NVI) and the trading system including the scaling code from his August 2010 article, “Normalized Volatility Indicator”, is shown below.

In the article the author tests the indicator in a system that buys or shorts one unit of the SPX whenever the indicator is above or below a given level. Since the results he shows do not take into consideration capital limitations and also we can not trade the SPX index as such, I decided to run tests using the Russell 2000 ETF, symbol IWM. The robustness of an indicator can be evaluated by examining the shape and levels of a three dimensional graph of the parameter optimization. In this case we have the two system parameters, the ATR length and the NVI indicator level that determines when to buy and sell. These two are plotted against the resulting net profit (Figures 1 & 2). I used the entire available data for the IWM optimization. To make the optimization realistic, I wanted to take into account capital limitations so the scaling-in stops once a certain level of investment has been reached. This adds a third parameter which does affect the total return of the system. The system (session) code accomplishes this objective.

In Figures 1 & 2, I show the long side and short side parameter optimization trading the IWM market. While most of long side parameter sets, Figure 1, showed net gains, the surface is very peaky and most of the short side parameter sets, Figure 2, showed a net loss for the test period from 1/3/2001 to 6/9/2010. A robust system will have a smooth surface with most of the parameter sets, which are fundamentally valid, showing a net gain over the test period. I would conclude that for the IWM market the system is not robust and the indicator should not be used with a fixed cutoff in a system. There might be an adoptive method using the indicator that would result in more robust results.

Captions:

Figure 1: Three dimensional parameter optimization graph trading on the long side only for the IWM market over the period 1/3/2001 to 6/9/2010.

Figure 2: Three dimensional parameter optimization graph trading on the short side only for the IWM market over the period 1/3/2001 to 6/9/2010.

Traders Studio Code for Normalized Volatility Indicator :
NVI_IND_TSZ.zip
(RIGHT CLICK AND CHOOSE "SAVE AS.")

 

 

 

 

 

 

 

 

 

 

 

 

 

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