Automated Trading Strategy #48
Strategy 48 made $47K and has a profit factor of 3.11. A variation on the strategy that uses more than one contract made over $200K and has a profit factor of 3.18.
There is no guarantee that these strategies will have the same performance in the future. Some may perform worse and some better. Backtests are based on historical data, not live data. Backtests are used to compare historical strategy performance and are inherently flawed due to the limitations of the simulation. We therefore use backtests as a “first test” to further study and advise you do the same. They should not be traded live unless you are prepared to lose all of your money. Trading futures is extremely risky. If you trade futures live, be prepared to lose your entire account. We recommend using our strategies in simulated trading until you/we find the holy grail of trade strategy.
For a link to all strategies click here.
Click on the table to enlarge.
Strategy 48 is a variation on Strategy 47. Like Strategy 47, Strategy 48 thrives in volatile markets. As you can see from the cumulative net income chart below, Strategy 48 doesn’t really start to make money until September of 2021, which is when the Fed announced its intention to end its $120 billion PER MONTH asset purchase program and volatility began to increase.
As a quick primer, the Federal Reserve employed an asset buying program to decrease volatility and increase liquidity in the market after volatility soared in March 2020 due to COVID. This is an excerpt from the September 2021 FOMC statement:
Last December, the Committee indicated that it would continue to increase its holdings of Treasury securities by at least $80 billion per month and of agency mortgage‑backed securities by at least $40 billion per month until substantial further progress has been made toward its maximum employment and price stability goals. Since then, the economy has made progress toward these goals. If progress continues broadly as expected, the Committee judges that a moderation in the pace of asset purchases may soon be warranted.
It’s the last line that shook the market.
Then we learned that the Fed would start parring off its Treasury bond buys by $10 billion and its mortgage-backed security purchases by $5 billion each month starting in the middle of November 2021, which is when you see the second boost in market volatility and cumulative net income from Strategy 48.
And then on May 1, 2022, just a few weeks ago, we get a press release telling us exactly how the Fed is also going to start reducing their balance sheet on June 1:
Consistent with the Principles for Reducing the Size of the Federal Reserve's Balance Sheet that were issued in January 2022, all Committee participants agreed to the following plans for significantly reducing the Federal Reserve's securities holdings.
The Committee intends to reduce the Federal Reserve's securities holdings over time… Beginning on June 1, principal payments from securities held in the SOMA will be reinvested to the extent that they exceed monthly caps.
For Treasury securities, the cap will initially be set at $30 billion per month and after three months will increase to $60 billion per month…
For agency debt and agency mortgage-backed securities, the cap will initially be set at $17.5 billion per month and after three months will increase to $35 billion per month.
We’ve gone from ending the asset buying program to reducing the balance sheet and we haven’t even addressed interest rates. No wonder the market is so volatile.
And, while Jay Powell, US Fed chair, doesn’t want to link the tapering of asset/bond buying programs with the onset of higher policy rates, we now know them to be overlapping events and we are in the midst of what it does to an economy. The buyback scheme was put in place to address ‘dysfunctional trading conditions’ in the bond market during one of the sharpest contractions in history (March 2020 - Covid), but who’s to say that the market is ready to stand on its own two feet? Again, this is why volatility is approaching near term highs.
Now I know some of you have told me that volatility isn’t really that bad. You use the VIX (CBOE Volatility Index) to support your claim. It’s a good claim. Here’s a chart of the VIX over the last 5 years:
Clearly, the VIX is not where it was in March 2020. The black line is where we are today. As you can see, even the VIX tells us that we are above 2021 volatility levels, but a better indicator of volatility is standard deviation. In particular, the standard deviation of the market you trade.
The chart below is the QQQ over the last 5 years. The black OHLC line is the price, the blue line is the moving standard deviation. It’s telling us that we’re almost back at March 2020 levels - at least for the NASDAQ or NQ futures contract. In fact, it appears as though we’re about to push above the high of 21.20 set in March 2020.
The highest performing day of Strategy 48 was February 24 of this year. In one day, it made $15K on one trade. This coincides with the most volatile day of 2022 for QQQ as well.
My hope here is to connect the dots between market volatility, future Fed action and the performance of Strategy 48. From a larger perspective, however, the primary takeaway is that the Fed doesn’t know what’s coming next. They’ve said as much (I talk about this a bit in a post from my own blog: The Federal Reserve: This Is A "Time of Uncertainty"). What we/they do know is that these are unprecedented times and that the likelihood of volatility going down at this point is very low.
Before we get into how Strategy 48 is formulated, let’s look at the performance results:
Strategy 48 has 409 trades and one of the lowest drawdowns we’ve seen at 1.63%. This is holy grail worthy. It has a return on max drawdown of 1,030%, which means it made 10.3x more than the drawdown. Remember, the drawdown isn’t the worst day the strategy has ever had, it’s the lowest the strategy has ever been from its high. This is why we like to use the max drawdown as a proxy for the balance you need to have in the sim account to trade the strategy. This is also why we use max drawdown as the basis for return.
Strategy 47 has an average trade time less than a minute, which means it has a high backtest risk. Unlike Strategy 47, Strategy 48 has an average time in the market of 34 minutes, which reduces backtest risk. Profit per trade is $117, up from $87, so there’s more room for error. And, while Strategy 48 made $47K in one year, almost 7x more than Strategy 47, daily net income never falls below $1,100.
From an activity perspective, Strategy 48 makes lots of small trades and a few large ones. It’s the large ones that make the strategy profitable. The average losing trade is -$80, the average winning trade is $1,916. Again, this helps to increase backtest accuracy, which is why the backtest score for Strategy 48 is so much lower than Strategy 47. We also looked at Strategy 48 with no ‘exit on session close’. That is, we wanted to see what the results of Strategy 48 would be if we did not close all trades at the end of the session. Results were mostly the same, but profitability was slightly higher with a profit factor of 2.75 up from 2.65.
Strategy 48a, c and d are variations of Strategy 48. Each has slightly different elements which I’ll outline in the strategy description section below. Strategy 48a only makes 224 trades, but has a profit factor of 3.12. Strategy 48c and d have attributes that boost net income from ~$50K to $200K. While max drawdown is higher, it’s relatively the same from a percentage of net income basis.
Strategy 48 Performance Charts
This is the cumulative profit of Strategy 48 over a 1 year period (05/01/2021 to 05/01/2022). There’s very little activity until volatility hits the market in September of 2021.
This is how the strategy breaks down on a day-of-week basis. As you can see, Thursday is the most profitable day.
This is the weekly profile of Strategy 48. You’ll also notice that the performance is increasing with volatility throughout the year. This is also confirmed in the cumulative net income chart above. One thing to note is that while volatility is increasing upside net income, downside net income remains the same.
This is the hourly profile of Strategy 48. It shows that the strategy makes most of its money at session close.
And, here’s a chart of what net income looks like if you don’t close trades at the end of the session. As you can see, 2pm and 8pm are the most profitable hours.
When we don’t close trades at the end of the session, it also changes the distribution of net income by day of week. Instead of Thursday, Tuesday and Friday are the most profitable days.
Now, let’s talk about how to recreate Strategy 48.