The two-day mean-reversion trade, i.e. RSI-2 or DV-2 has become very popular. Though the performance of this trade has weakened lately (during late 2010-2011). So the twenty thousand dollar question becomes: Is the edge of this trade gone or is it about to resume
With this post I want to share an observation I’ve made by tracking my Trend Strength Indicator (TSI). TSI is a non-directional trend strength indicator. A lower TSI is indicating a tendency to mean-reversion while a higher TSI is indicating follow-through action. Read more about TSI [here].
Let’s start with some “chart porn”.
Above you see a SPY chart from 1998 until today (Nov. 2011). Prior 2009 TSI spent most of it’s time bellow 1.6. Post financial crisis 2008 it raised to the highest value ever of >2.0 and it allays maintained the level of > 1.6. However what you also can notice is the trend strength decrease lately. I can also confirm that by simply looking at the performance of my mean reversion strategy over the last few month.
Here are some facts.
This is a simple strategy: long DV2B 50. Notice the amazing performance in 2008 and the weak period mid 2011. That’s when a lot of people declared the end of this trade.
The same strategy but with a additional filter: TSI
Returns remained about the same while trades have been reduced. Risk adjusted metrics improved as well. These results are without any trading cost. Considering for commission and slippage the difference would be stronger. There are many ways to improve the effectiveness of the 2-day mean reversion trade. Looking at TSI is definitely a good approach to adapt trading style within trading strategies. Let me know your ways of improving mean-reversion trades – send an email to hassler.blog (at) gmail.com
# Frank
