December 16th, 2016

I will start with the conclusion since it is intended to raise eyebrows, and it can be given in one screenshot. The chart below comes from modifications to a program found in the Quantopian Lectures. To achieve such results, I modified the parts of the code that dealt with n, u, and PT since they are the only portfolio metrics of significance. For more explanations on the portfolio payoff: n*u*PT, please refer to recent articles.

   #1   Example Momentum - WOW

Chart #1 

(click to enlarge)

Note that the above chart is just an exploration of possibilities. As is, it would require a lot of guts to put it into operation. For those afraid of the max drawdown, that can easily be solved by adding $ 9 million to the initial capital and not using it.

To increase performance, I increased n considerably since it is the easiest to do, and it will have a major impact on the payoff: (1+a) * n * u * PT. Then, I added some leverage since it can have an impact: (1+lev) * (1+a) * n * u * PT. When using leverage, what you want is to generate a higher rate of return than the cost of the leveraging, which, in this case, is more than covered. Also, increased the trading opportunities available by rebalancing 3 times a month instead of only once. This has an impact on reducing the trading interval and also detecting more trade candidates. The trading strategy itself, its logic, was not changed. Mostly just changed numbers here and there.

The original version of the program (see Quantopian link above (Note. Quantopian shut down in 2020)) produced the following chart:

   #2   Example Momentum - Original Version

Chart #2

(click to enlarge)

There are what I consider flaws in this design. I used a bulldozer to massacre the code. But maybe most importantly, I changed what the trading strategy should do by giving it a longer-term vision than just rebalancing from one period to the next.

I wanted to answer one question: how far can it go? Based on chart #1, it is pretty far, and it is still not the limit. Mind you, I would not trade like this either. I would repair what I consider as design flaws first, and would also add procedures to reduce its volatility. Nonetheless, it is a good indication that one can put the pedal to the metal, so to speak.

For the less adventurous, maybe a more mundane set of modifications might be suitable. Chart #3 is the result of slightly broadening the selection process, pushing leverage to 1.5, and adding a mid-month rebalancing to increase trading opportunities.

   #3   Example Momentum - Partial Modifications 

Chart #3

(click to enlarge)

When designing a trading strategy, one should have a long-term vision of what that trading strategy can or might do. Going from period to period à la Markowitz, or à la Sharpe ratio rebalancing, might not be enough when one could do so much more.

Ah yes, the total return on chart #1 translates to $ 22 billion. One should consider putting $10 million instead of only one while still only using one. It would reduce volatility.

Maybe what chart #1 says is: find the limits of your trading strategy. It is a lot easier to reduce your trading strategy to your comfort zone than to raise it.

Created... December 16th, 2016,    © Guy R. Fleury. All rights reserved