Trading System #1–Initial Assessment (Part 5)

We have been studying the difference between 5-day long trades in SPY with daily entry vs. with entry only when VIX closes at least 5% above its 10-SMA (“overbought”).  Going back to Table 1 from my post http://www.optionfanatic.com/2012/09/19/trading-system-1-initial-assessment-part-1/ (9/19/12), today we will discuss the remaining results.

The overbought VIX strategy gets a slight edge with regard to % profitable:  59.11% to 55.45%.  In a broad sense, systems are usually trend-following or mean-reverting (i.e. sell when the market is strong and buy when the market is weak).  Trend-following systems typically have a lower % of profitable trades whereas mean-reverting systems have a higher % of profitable trades.  Trend-following systems typically have a much better average % win (for winning trades) to average % loss (for losing trades) ratio, however.  This is the tradeoff.  Recall that % profitable trades and average gain/loss are the two components of profit factor (PF) calculation.

The final statistic is the one I highlighted with bold:  average % win/loss.  In looking at Table 1, this statistic seemed to be the coup de grace for the “overbought” VIX strategy.  With both strategies having similar winning percentages, the “overbought” VIX strategy dominated with a 0.36% vs. 0.14% average % win/loss.  This difference is also reflected in the PF although the difference is not as clear (1.43/1.18 << 2).  The difference is reflected in the SR but as previously discussed SR is shroud in more complexity and controversy as a meaningful number.  One needs to have studied many systems before developing an intuitive understanding of how SR differences may reflect system performance.

In my post http://www.optionfanatic.com/2012/09/13/trading-system-1-introduction/ (9/13/12), I mentioned the internet claim that “when VIX closes 5% or more above its 10-SMA, SPX has outperformed the average week better than 2-1 over the next five trading days.”  Based especially on this average % win/loss statistic, I consider that claim to be verified.

This now leaves us to determine SPX (SPY) performance when VIX is “oversold.”  I will address this in the next post.