ATR.pdf

8/14/2019 ATR.pdf

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Average true range is often used as an indication of a security’s volatility. Although the

aw number alone does not imply high or low volatility, plotting the historical average trueange of a security allows you to view where volatility was decreasing, increasing, oreaching a peak or a trough. In this paper, I will introduce an indicator and strategy thatry to take advantage of the increased trading opportunities that occur during times ofigher- or lower-than-average volatility for a stock when compared to the overall market.

This is accomplished by comparing the relative strength index (RSI) of the average trueange (ATR) of a specific stock to the relative strength index of the average true range ofhe overall market.

n order to standardize the average true range of the security and the overall market, thendicator calculates the RSI of the ATR. This helps standardize the changes in ATR of theverall market versus the changes in ATR of a stock. The RSI of the ATR is calculated onoth the ATR of the overall market and the ATR of the security you want to trade. Onceoth RSIs are calculated, the RSI spread is determined by dividing the RSI ATR calculationf the tradeable security by the RSI ATR calculation of the market. We then take anverage of the RSI spread and look for trading opportunities by finding occurrences in

which the current RSI spread is greater or less than the average RSI spread. If the RSIpread is above its average, then the tradeable security is currently experiencing higherolatility than normally experienced when compared to the market. This is a bearishignal and the strategy will correspondingly sell. If the RSI spread is below its average,hen the tradeable security is currently experiencing lower volatility than normallyxperienced when compared to the market. This is a bullish signal and the strategy willorrespondingly buy.

To demonstrate the RSI Volatility Spread, I will introduce several indicators that plot theRSI spread idea, as well as a strategy that uses the indicator’s results to generate buy andell signals. The strategy works well on several international market exchange-traded

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unds (ETFs) as well as other sector ETFs. For demonstration purposes, I will present the strategy’s resultsn the iShares MSCI Australia Index. However, I will also present a summary of results for several other ETFsn the Portfolio Spotlight section. In Figure 1 below, you can view several strategy sample trades along withhe accompanying indicator that is plotting the average RSI spread difference. When the average spreadifference is above zero —signifying higher volatility —the histogram color is red to identify a bearishutlook. When the average spread difference is below zero —signifying lower volatility —the histogram colors green to identify a bullish outlook.

Strategy Style Intermediate TermAsset Type StocksSymbol 1 (Traded Symbol) EWA - iShares MSCI Australia Index FundSymbol 2 $SPX.X - S&P 500 IndexAlternative Symbols to Trade IXC, IXJ, EWU, EWD, and EWLData Interval DailyPeriod Tested 19 years

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Buy when the average spread difference (AvgSpreadDiff) is below zero and the RSI of the ATR of themarket (S&P 500) is greater than the RSI of the ATR of the security you are trading.

Sell when the average spread difference (AvgSpreadDiff) is above zero and the RSI of the ATR of the

security you are trading is greater than the RSI of the ATR of the market (S&P 500).

Name Default Description

ATRLen 20Length used to calculate the average true range of thesecurity and of the overall market.

AvgLen 120 Length used to calculate average spread difference.

RSILen 50

Length used to calculate RSI of the ATR of the marketand RSI of the ATR of the security. Also used tocalculate the average RSI spread.

This strategy uses only three inputs and all of them are lengths used to calculate a variable. The same inputs aresed in the accompanying indicator. The first input, “ATRLen ,” is used as the length to calculate the average trueange of both the tradeable security and the overall market, which we define as the S&P 500 Index. The secondnput, “AvgLen ,” is used only to calculate the length of the average spread difference , which is the difference betweenhe current RSI spread and the average RSI spread. The last input, “RSILen,” is used to calculate the RSIs of the ATRsf the security and the market, respectively, and to calculate the average RSI spread. The average RSI spread, whichs defined in the strategy variables section below, is simply the ratio of the RSI of the ATR of the security and the RSIf the ATR of the market.

Variable DefinitionATR Average true range of the security you are trading.RangeMkt Range of the S&P 500 Index.ATRMkt Average true range of the S&P 500 Index.RSIATR Relative strength index of the ATR of the security.RSIATRMkt Relative strength index of the ATR of the S&P 500 Index.

RSISpread

The relative strength index of the ATR of the securitydivided by the relative strength index of the ATR of theS&P 500 Index.

AvgSpread The exponential average of the RSI spread.

SpreadDiffThe difference between the current RSI spread and theaverage of the RSI spread.

AvgSpreadDiffThe exponential average of the difference between thecurrent RSI spread and the average of the RSI spread.

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n essence, this TradeStation Labs report introduces an alternative method by which to analyze a giventock’s volatility. The concepts of RSI and ATR are very common in technical analysis. Here, we combine twoery familiar technical indicators to create a new one. The average spread difference, which is the indicatorhat we use to generate the buy and sell signals, is a derivative of the two common indicators. Once wetandardize the average true range of both the stock and the market, the strategy looks for tradingpportunities in which the current RSI spread ratio is above the average RSI spread ratio. This means thathe current ratio between the volatility of the security and the market is higher than the average ratio

etween the volatility of the security and the market. For high-beta securities, volatility should always beigher than the overall market.

n this case, we are comparing not just volatility, but the ratio of volatility between the security and themarket. Because we are always comparing volatility to the market, in order for the strategy and indicator toalculate accurately, the S&P 500 Index ($SPX.X) needs to be placed into the chart as Data 2. In Figure 2elow, you can see how the different variables appear plotted below the price data. Subgraph 2 plots the RSIf the ATR of the security (purple line) against the RSI of the ATR of the market (orange line). With thisndicator, you can see historically when the security’s volatility was higher than the market ’s volatility andice versa. In subgraph 3, the actual RSI spread (red line), or the ratio between the RSI of the ATR of the

ecurity and the RSI of the ATR of the market, is plotted against the average RSI spread (blue line). When theatio is 1.0, the security’s volatility and the market ’s volatility are approximately equal. Remember that inrder to calculate both the indicator and the strategy, the S&P 500 Index needs to be placed into the chart as

Data 2. In Figure 2, the price data of the S&P 500 is hidden by formatting the symbol and hiding the subgraphn the Scaling tab.

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n this paper, we ’ve presented the strategy’s results for the iShares MSCI Australia Index Fund. However, thistrategy would most likely be applied to a portfolio of securities, as it is an intermediate-term strategy andoesn’t generate many trades. In addition, the diversification effects of adding securitie s that are noterfectly positively correlated to a portfolio would help to reduce your portfolio’s overall risk.

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Symbol Description K-Ratio RINA Index Buy and Hold Return Return on AccountEWA iShares MSCI Australia Index Fund 3.89 41.81 164.71% 742.45%IXC iShares S&P Global Energy Sector Index 3.74 23.89 72.26% 675.24%IXJ iShares S&P Global Health Sector Index 2.77 27.51 15.84% 728.60%

EWU iShares MSCI U.K. Index Fund 3.76 61.16 48.34% 535.57%EWD iShares MSCI Sweden Index Fund 4.82 67.61 226.14% 625.93%EWL iShares MSCI Switzerland Index 4.88 72.86 256.33% 777.48%

PBJ PowerShares Dynamic Food & Beverage 3.96 16.30 1.75% 2226.70%PWC PowerShares Dynamic Market Portfolio 3.23 38.19 9.03% 3219.42%XLP S&P Select Consumer Staples SPDR Fund 2.57 17.73 -1.28% 166.79%

Return on Initial Capital 177.75%Buy and Hold Return 164.71%Return on Account 742.45%Annual Rate of Return 5.45%Profit Factor 4.52Avg Monthly Return $120.02Std. Deviation of Monthly Return $685.44Net Profit / Maximum Drawdown 5.06Weekly Underwater Equity -15.64%Buy and Hold Weekly Underwater Equity -68.25%K-Ratio 3.89RINA Index 41.81

The strategy’s profit factor of 4.52 signifies that for every $1.00 lost, $4.52 was earned in profit. The return on account —742.45% over the approximately 19 years that the strategy was back-

tested —far exceeded the buy-and-hold return of 164.71% (generated by simply buying at thebeginning of the testing period and holding the security) .

The K-ratio, which is a risk-adjusted performance measure, is 3.89 . The higher the K-ratio, the betterthe strategy in terms of risk-adjusted performance. The industry standard is 2.50 .

The strategy’s weekly underwater equity of (-15.64%) is much better than that seen under the buy-and-hold strategy of the security (-68.25%).

Average profit by month was positive 9 of 12 months, with January being the worst-performingmonth.

The detailed equity curve is fairly linear over the 19 years that the strategy was back-tested. Thestrategy was back-tested over the entire period during which the security was tradeable.

Risk-adjusted performance is consistent across several ETFs, as presented in the Portfolio Spotlighttable.

The net profit divided by maximum drawdown ratio was 5.06, signifying low drawdown during theback-test.

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Because the strategy is intermediate-term, it has a low number of total trades during the period (33).However, if the strategy were implemented on a portfolio of securities, the total number of tradeswould increase, allowing for more diversification and lower total risk.

The standard deviation of monthly return is 571% times the average monthly return, signifyinghigher risk in the strategy.

The last trade the strategy generated is currently a losing trade.

The strategy had negative annual returns in 7 of the 19 years it was back-tested, with 2008 being theworst-performing year (-8.20%).

This report introduced a new indicator to compare a given security’s volatility to overall market volatility inrder to generate buy and sell signals. As displayed in the relationship between the CBOE Volatility Index$VIX.X) and the S&P 500 Index ($SPX.X), a spike in volatility may indicate a market downturn. This isecause a spike in the VIX usually means there is fear in the market. It is common knowledge that whenhere is fear in the market, investors sell. This indicator and strategy try to take advantage of thiselationship by buying when volatility is lower than average compared to the market and selling whenolatility is higher than average compared to the market. Although the relationship does not always hold —ince higher volatility does not guarantee lower stock prices —it appears to hold more often than not over theong term, allowing you to exploit these trading opportunities.

Alexandra Guevara is a Market Technician for TradeStation Securities.

n order to open the sample workspaces provided, you may first need to import the custom EasyLanguage file with thextension .eld. Copy the attached .eld file and workspaces to your computer. Then import the indicators or strategiesy double-clicking on the EasyLanguage .eld file. This will automatically start the TradeStation import wizard. Click

Next’ until the Analysis Techniques and/or strategies have been imported. The indicators are now available and youan now open the provided workspaces. Other supportive documents or files may also be attached to this email.

All support, education and training services and materials on the TradeStation Securities website are for informationalpurposes and to help customers learn more about how to use the power of TradeStation software and services. No type oftrading or investment advice is being made, given or in any manner provided by TradeStation Securities or its affiliates.

This material may also discuss in detail how TradeStation is designed to help you develop, test and implement tradingstrategies. However, TradeStation Securities does not provide or suggest trading strategies. We offer you unique tools to

help you design your own strategies and look at how they could have performed in the past. While we believe this is veryvaluable information, we caution you that simulated past performance of a trading strategy is no guarantee of its futureperformance or success. We also do not recommend or solicit the purchase or sale of any particular securities or derivativeproducts. Any symbols referenced are used only for the purposes of the demonstration, as an example ---- not arecommendation.

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