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May 2006 Stocks and Commodities Traders Tips

Cross-Market Evaluations with Normalized Average True Range

Original article by John Forman
AIQ code by Richard Denning

The normalized average true range is a useful function to compare volatility of stocks to each other and to the market in general. It can be an effective filter for a stock trading system to improve the quality of the trading signals. To test this idea, I created a volatility range filter that is adaptive to the market’s volatility using the N-ATR indicator. I then used the stocks from both the NASDAQ 100 and the Standard & Poor’s 500 as a test list and used the following simple dip buying strategy

Enter a long position if:

1) The 5 day RSI is below the oversold benchmark and
2) The stock is trading above its 50 day simple moving average

Exit all long positions after 5 trading days.

To select between signals when there are more than can be taken on a single day, I used the 30-day relative strength based on the AIQ formula and choose the strongest in descending order.

To test the effectiveness of the N-ATR filter, I ran two tests using the AIQ Portfolio Simulator using the combined list over the last three years. I did not attempt to optimize the results. One test was run without the filter and the other was run with the filter. The addition of the volatility filter made a significant improvement as shown in Figure 1, which compares the resulting equity curves of the two tests.

FIGURE 1 (click here to view).

Backtest Screenshots (all possible signals):

EDS backtest results NOT using N-ATR as a trading system filter
EDS backtest results USING N-ATR as a trading system filter

EDS Code for Normalized Average True Range:
N-ATR.EDS

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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