What happens after an extraordinary big fall in SPY? Volatility trading strategies can be very profitable – both long and short.
Let’s find out and test by using some simple variables. To measure a big fall we use the average difference between the high and the low over the last 25 days.
We made the following trading rules:
- Calculate the average H-L range over the last 25 days (in percent).
- If the ETF falls more than 2 times this average, enter at the close.
- Exit at tomorrow’s open, tomorrow’s close, or after 3 or 5 days.
- Test period from 2005 until July 2013.
The best exit is simply to exit tomorrow’s close. That has the best win ratio and is the least erratic. The other exits seem pretty unstable. Here is the equity curve for SPY from close to open:
48 trades and 31 winners make 0.21% on average. That is pretty good if you ask me.
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From this backtest, it seems it might offer a good risk/reward to buy the close of a big fall and hold for one day. This is why we like to work with numbers. Overall, backtesting works.
– How is an extraordinary big fall defined and measured?
An extraordinarily big fall is measured by calculating the average difference between the high and the low of SPY over the last 25 days, expressed as a percentage. If SPY falls more than 2 times this average, it triggers a trading signal.
– What are the entry and exit criteria for the volatility trading strategy?
The entry criteria involve SPY falling more than 2 times the calculated average H-L range. The strategy can exit positions at tomorrow’s open, tomorrow’s close, or after 3 or 5 days.
– What are the key statistics and results of this volatility trading strategy for SPY?
The strategy involves 48 trades, with 31 of them being winners, resulting in an average profit of 0.21%. These results suggest that buying at the close after an extraordinarily big fall and holding for one day may offer a favorable risk/reward ratio.