Skip to main content

What Quant Models Can Teach Us About Trading Psychology

Above we can see SPY (blue line) plotted against a six-variable trading model that I developed using ensemble modeling.  When we have a positive score, the model is deemed to be bullish over a next 10-day horizon.  When we have a negative score, the model is deemed to be bearish.  The model is flat as of yesterday's close.  The model includes such variables as market volatility, breadth, buying/selling participation, and market cycle status.  

When the model has been at a score of +2 or higher, the next 10 days in SPY have averaged a gain of +2.08%.  When the model has been at a score of -3 or lower, the next 10 days in SPY have averaged a loss of -.83%.  Between scores of +1 and -2, the next 10 days in SPY have averaged a small loss of -.08%.  

The model has a couple of important implications for trading psychology:

1)  Out of the 573 days of my in-sample and out-of-sample periods, nearly half are scores less than +2 and greater than -3:  in other words, days with essentially no edge 10 days out.  That doesn't mean sources of edge can't be found on different time frames with different models, but this finding is important.  Even with a solidly researched source of edge, there are plenty of occasions when not trading is the best trade.

2)   The model signals have been good, but even with their edge, there is plenty of noise.  Note, for example, that the model was bearish during much of mid-2015, when prices chopped around quite a bit.  We were also bullish during fall, 2015 during a volatile bottoming period.  A trader could have an edge with a model but be unable to survive the noise around signal, especially if sized quite large.  

3)  I suspect the model works because it's exploiting cyclical behavior in markets at a time frame that is too long for active traders and too short for true investors.  A key to trading the model, as we've seen, is not placing trades when there is no clear signal.  There have been no solid signals from the model in the last 14 trading sessions; such periods are not rare.  It's the selectivity of the model that might be its greatest advantage.

4)  Such models don't have to be traded mechanically.  For instance, a short-term trader could use the model to decide when to trade with a directional bias and when to take short-term setups without such bias.  More fundamentally grounded traders could use models such as these to help with the execution of longer-term positions.  Good models provide good information; that information can be useful in discretionary decision making.

The act of developing models itself gives one a feel for markets.  The model inputs are there for a reason: the model simply captures when those reasons line up.  It is interesting that the most rational of analyses can feed the deepest intuitions.

Further Reading:  The Psychology of Quant Analysis
.

Comments

Post a Comment

Popular posts from this blog

Women and children overboard

It's the  Catch-22  of clinical trials: to protect pregnant women and children from the risks of untested drugs....we don't test drugs adequately for them. In the last few decades , we've been more concerned about the harms of research than of inadequately tested treatments for everyone, in fact. But for "vulnerable populations,"  like pregnant women and children, the default was to exclude them. And just in case any women might be, or might become, pregnant, it was often easier just to exclude us all from trials. It got so bad, that by the late 1990s, the FDA realized regulations and more for pregnant women - and women generally - had to change. The NIH (National Institutes of Health) took action too. And so few drugs had enough safety and efficacy information for children that, even in official circles, children were being called "therapeutic orphans."  Action began on that, too. There is still a long way to go. But this month there was a sign that ...
Post a Comment
Read more

Benefits Of Healthy eating Turmeric every day for the body

One teaspoon of turmeric a day to prevent inflammation, accumulation of toxins, pain, and the outbreak of cancer.  Yes, turmeric has been known since 2.5 centuries ago in India, as a plant anti-inflammatory / inflammatory, anti-bacterial, and also have a good detox properties, now proven to prevent Alzheimer's disease and cancer. Turmeric prevents inflammation:  For people who
Post a Comment
Read more

Austerity-A Fancy Word for Destitute.

The reason for this post is not for the folks who have been caught in the first wave of personal economic hard reality, but the next wave. Regardless of the optimism espoused by grinning leaders and sycophant press, we are entering the final stage of global economic collapse. It began in 2008 and was forestalled for five years with fudge putty, but the weight of global indebtedness cannot be propped any longer and the final crunch is imminent. Austerity measures herald the final throes.  Indications of coming austerity.   Austerity measures are the final last ditch effort, futile or not! Back in the day many of us old-timers went through periods of "hard-times". In retrospect I realize there is no comparison to yesteryear hard times and today's version. Back then, expectations were never very high for the working class, there were no sophisticated systems or conveniences anyway. In fact the difference between being "set" or not was about having treats or not. Si...
Post a Comment
Read more