Free Friday #12 – Noise Test

Happy Friday. This week’s Free Friday strategy is for $XLP or the ETF that tracks US Consumer Staples. However, it was designed taking input from two other popular ETFs.

freefriday12Here is the equity curve and backtest results. The left is a graph created by TradeStation and the right is a graph showing our backtest results (blue) and XLP buy and hold (grey). The chart on the right, created by Build Alpha, is plotted by date whereas the TradeStation chart is plotted by trade number – both software have the ability to plot both x-axis styles.

This strategy uses only 3 rules for entry

  1. XLP’s 2 Period RSI must be lower than it was 1 bar ago
  2. XLU – Utility ETF – must close below its midpoint
  3. XLE – Energy ETF – must be below its 3 period Simple Moving Average

The exits for this strategy are two-fold

  1. Maximum hold of 4 days
  2. Exit on the first profitable close

Below are the trade statistics for this Free Friday Strategy.

ff12_statsI know want to introduce another, and new, Build Alpha test to help validate trading strategies. I first mentioned this test here: Better System Trader Podcast. The Noise Test is a popular test that allows the user to randomly add AND subtract noise from the historical price data. The user can specify how much of the data he/she wants to adjust and by how much he/she wants to adjust the data.

For example, the user can change 50% of the data by 25% of the average true range. This means we would adjust the data by either adding or subtracting up to 25% of the average true range to any of the opens, highs, lows or closes until we’ve adjusted 50% of the data.

We now have a “new” data set that contains a different amount of noise. Build Alpha will continue to create 100 new data sets all with differing noise characteristics. Finally, we will re-trade our strategy on these 100 new data sets to see how well it performs had the noise been different.

The idea is… does your strategy fall off a cliff if some other amount of noise is introduced or subtracted to your underlying data set?

I will show results for two noise tests I ran on this Free Friday strategy.

My first configuration was to adjust all the opens, highs, lows and closes at the same rate (20%). Furthermore, I only wanted to add or subtract up to 20% of the average true range whenever making a change.

noisetestsetting1
noisetest1As you can see the strategy is not very “anti-fragile”. That is, changing the noise amount never produced better results than our backtest. This can be a major red flag. However, the strategy still maintained general profitability over the 100 tests. I was pleased enough to run a second test. This time more creative with the adjustments to the data.

noisesetting3
noise3Adding or subtracting up to 55% of the average true range to differing amounts of the opens, highs, lows, and closes produced the above graph. This Noise Test has me much less confident in the strategy. For instance, our original backtest is now a significant outperformer. This generally means that it was too reliant to the underlying data. However, it does maintain overall profitability across the tests so may contain some actual edge nonetheless.

If up to me, I would continue researching this strategy and others as this is not an overwhelming pass.

The Noise Test is just another robustness check that Build Alpha offers to give traders and money managers every tool possible.

Happy Friday,

Dave

Old Posts:

Thanks for reading,
Dave


2 thoughts on “Free Friday #12 – Noise Test

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Risk Disclosure

FUTURES AND FOREX TRADING CONTAINS SUBSTANTIAL RISK AND IS NOT FOR EVERY INVESTOR. AN INVESTOR COULD POTENTIALLY LOSE ALL OR MORE THAN THE INITIAL INVESTMENT. RISK CAPITAL IS MONEY THAT CAN BE LOST WITHOUT JEOPARDIZING ONES FINANCIAL SECURITY OR LIFE STYLE. ONLY RISK CAPITAL SHOULD BE USED FOR TRADING AND ONLY THOSE WITH SUFFICIENT RISK CAPITAL SHOULD CONSIDER TRADING. PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS.

Hypothetical Performance Disclaimer

HYPOTHETICAL PERFORMANCE RESULTS HAVE MANY INHERENT LIMITATIONS, SOME OF WHICH ARE DESCRIBED BELOW. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE SHOWN; IN FACT, THERE ARE FREQUENTLY SHARP DIFFERENCES BETWEEN HYPOTHETICAL PERFORMANCE RESULTS AND THE ACTUAL RESULTS SUBSEQUENTLY ACHIEVED BY ANY PARTICULAR TRADING PROGRAM. ONE OF THE LIMITATIONS OF HYPOTHETICAL PERFORMANCE RESULTS IS THAT THEY ARE GENERALLY PREPARED WITH THE BENEFIT OF HINDSIGHT. IN ADDITION, HYPOTHETICAL TRADING DOES NOT INVOLVE FINANCIAL RISK, AND NO HYPOTHETICAL TRADING RECORD CAN COMPLETELY ACCOUNT FOR THE IMPACT OF FINANCIAL RISK OF ACTUAL TRADING. FOR EXAMPLE, THE ABILITY TO WITHSTAND LOSSES OR TO ADHERE TO A PARTICULAR TRADING PROGRAM IN SPITE OF TRADING LOSSES ARE MATERIAL POINTS WHICH CAN ALSO ADVERSELY AFFECT ACTUAL TRADING RESULTS. THERE ARE NUMEROUS OTHER FACTORS RELATED TO THE MARKETS IN GENERAL OR TO THE IMPLEMENTATION OF ANY SPECIFIC TRADING PROGRAM WHICH CANNOT BE FULLY ACCOUNTED FOR IN THE PREPARATION OF HYPOTHETICAL PERFORMANCE RESULTS AND ALL WHICH CAN ADVERSELY AFFECT TRADING RESULTS.