Entering text into the input field will update the search result below

Update On Modified GMR: A Robust Trading System Over A Wide Range Of Parameters

Feb. 10, 2014 9:34 PM ETSSO, MDY, SPY, TLT, EDV, SHY, EEM, EPP, ILF, FEZ17 Comments
Please Note: Blog posts are not selected, edited or screened by Seeking Alpha editors.

I have finally resolved my modified version of Grossman's GMR trading system. The results are improved and appear quite robust under various input conditions.

By way of recap, the system trades 6 ETFs: SSO, FEZ, EEM, ILF, EPP and EDV. It goes to SHY when the stop condition is satisfied. It is backtested to 12/31/2003. (Prior to EDV's inception in 2008, I used TLT data. Prior to SSO's inception in 2006, I used MDY data.)

The system relies only on monthly data and can be implemented simply in an Excel spreadsheet. This makes it a very practical system for ordinary people with limited time to update stock data and without costly trading software.

The system relies on two parameters -- performance and volatility. Performance is the logarithm of monthly performance over 3 months. Volatility is the standard deviation of 6 months of monthly performance.

The performance of the 6 ETFs is then standardized according to their mean and standard deviation. The same is done for the volatilities.

These standardized values are added together using weights of 0.75 for performance and 0.25 for volatility. These weights gave the best overall returns, but the total returns are not terribly dependent on these weighs. Returns are still quite with weights from 0.6/0.4 to 0.9/0.1.

The ETF with the highest final rank is purchased and held for one month. The cycle repeats month to month.

Here are the results of the system as a function of the weighing factors (with the optimal cash stop in place):

0 (performance) / 1 (volatility)

Total

3.64

CAGR

13.79%

Stdev

27.51%

Drawdown

67.02%

Sharpe v SPY

0.23

Sharpe v SHY

0.42

0.1/0.9

Total

3.54

CAGR

13.47%

Stdev

27.53%

Drawdown

67.57%

Sharpe v SPY

0.22

Sharpe v SHY

0.41

0.2/0.8

Total

4.94

CAGR

17.32%

Stdev

28.39%

Drawdown

70.87%

Sharpe v SPY

0.35

Sharpe v SHY

0.53

0.3/0.7

Total

4.69

CAGR

16.71%

Stdev

28.55%

Drawdown

68.01%

Sharpe v SPY

0.33

Sharpe v SHY

0.51

0.4/0.6

Total

8.26

CAGR

23.51%

Stdev

29.07%

Drawdown

69.86%

Sharpe v SPY

0.56

Sharpe v SHY

0.73

0.5/0.5

Total

9.59

CAGR

25.36%

Stdev

28.82%

Drawdown

69.00%

Sharpe v SPY

0.63

Sharpe v SHY

0.80

0.6/0.4:

Total

39.40

CAGR

44.39%

Stdev

24.54%

Drawdown

26.94%

Sharpe v SPY

1.51

Sharpe v SHY

1.72

0.7/0.3

Total

40.22

CAGR

44.69%

Stdev

23.94%

Drawdown

16.11%

Sharpe v SPY

1.56

Sharpe v SHY

1.77

0.8/0.2

Total

40.16

CAGR

44.67%

Stdev

23.57%

Drawdown

22.28%

Sharpe v SPY

1.58

Sharpe v SHY

1.80

0.9/0.1

Total

36.68

CAGR

43.37%

Stdev

23.74%

Drawdown

19.72%

Sharpe v SPY

1.52

Sharpe v SHY

1.73

1.0/0.0

Total

34.03

CAGR

42.30%

Stdev

23.56%

Drawdown

19.72%

Sharpe v SPY

1.48

Sharpe v SHY

1.70

I prefer 0.75/0.25 because it was in the middle of the peak values shown above:

0.75/0.25

Total

43.16

CAGR

45.72%

Stdev

23.89%

Drawdown

16.11%

Sharpe v SPY

1.61

Sharpe v SHY

1.82

With these values and the cash-stop, returns year-over-year were:

Last day of…

SYSTEM

SPY

Dec-04

35.89%

10.70%

Dec-05

50.61%

4.83%

Dec-06

18.88%

15.84%

Dec-07

29.22%

5.15%

Dec-08

51.49%

-36.80%

Dec-09

100.21%

26.35%

Dec-10

32.69%

15.06%

Dec-11

74.43%

1.90%

Dec-12

28.93%

15.99%

Dec-13

48.95%

32.31%

This is without commissions and slippage. If you add in 0.25% commissions and slippage, which is terrible, you still get fine results:

Total

38.60

CAGR

44.10%

Stdev

23.89%

Drawdown

16.11%

Sharpe v SPY

1.54

Sharpe v SHY

1.75

With commissions and slippage of 1% (!!), it's still acceptable:

Total

27.57

CAGR

39.33%

Stdev

23.93%

Drawdown

16.11%

Sharpe v SPY

1.34

Sharpe v SHY

1.55

The system does not rotate into cash. Instead, there is a cash stop when the correlation between SSO and EDV is above a threshold. The system will go to cash regardless of which of the 6 ETFs is being signaled. This only happens at the month's end, so we do need to stomach some inter-month changes.

Here are the scenarios with the weights at 0.75/0.25 and various cash-stop thresholds (with commissions and slippage = 0):

Threshold = 0 (months stopped = 33):

Total

11.32

CAGR

27.46%

Stdev

19.77%

Drawdown

18.94%

Sharpe v SPY

1.02

Sharpe v SHY

1.27

Threshold = 0.25 (months stopped = 24)

Total

16.91

CAGR

32.68%

Stdev

20.67%

Drawdown

16.11%

Sharpe v SPY

1.23

Sharpe v SHY

1.47

Threshold = 0.5 (months stopped = 13)

Total

37.55

CAGR

43.70%

Stdev

23.12%

Drawdown

16.11%

Sharpe v SPY

1.57

Sharpe v SHY

1.79

Threshold = 0.75 (months stopped = 8)

Total

43.16

CAGR

45.72%

Stdev

23.89%

Drawdown

16.11%

Sharpe v SPY

1.61

Sharpe v SHY

1.82

Threshold = 1 (months stopped = 0)

Total

28.89

CAGR

39.98%

Stdev

25.66%

Drawdown

22.56%

Sharpe v SPY

1.27

Sharpe v SHY

1.47

I am using 0.75 as the stop threshold.

I want to reiterate the importance of using monthly data. Every time I have tried to implement this system using some version of daily data (e.g. a 70-day performance lookback, etc.) the results are not as good. Also, the monthly data makes things really easy to do and ignoring everything during the month can take some anxiety out of the trading process.

** If you've read this far you'll be delighted to know I plan to post updates and signals here as the months stroll by because (i) it's fun to discuss these things (ii) we can all play along and (iii) it is proof (or disproof) of the system in real time. In light of last week's good performance for equities, the system says to stay in SSO if things stay flat from here to month's end. In the middle of last week, the signal would have been to EDV. It is interesting to see how the signals evolve over the month as conditions change.

As for the 3-day swing trading system, I attempted to mingle this with the rotation strategy to no avail. The idea was to trade between the signaled ETF and SHY according to the 3-day system. The results were terrible and I do not expect to write more on the matter.

Disclosure: I am long SSO.

Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

Recommended For You