presenter: siteng jin

Presenter: Siteng Jin

Introduction

During a two-month summer internship at China Universal Asset Management, the fund manager asked me to do researches on applications of technical indicators on the four Industry ETFs (Medicine, Finance, Energy and Consumption) of the company. As a Quantitative Analyst Assistant Intern, I worked on several technical indicators and tested their effectiveness from various aspects. And this is the final presentation of my project, which was greatly complimented by the fund manager for its clearness, preciseness and rigorousness.

Technical Indicator Analysis on Industry ETFs

Part I

• Timing of Technical Indicators on Industry ETFs

Part II

• Pairs Trading Strategy on Industry ETFs

Part I

5

Timing of Technical Indicator on Industry ETFsTiming of Technical Indicator on Industry ETFs

Classification of Popular Indicators

6

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Winning Chances Test

7

• Data: Industry ETF （ 15 minutes）• Vertically: for each indicator, choose

three long signals and three short signals. Judge the winning chances by seeing the actual trends after the signals.

• Horizontally: 5 days, 10 days, 20 days and 50 days

• Calculate the actual returns at the end of each period, and then compare it to the pre-determined return standard for each period to see the trends.

• The pre-determined return standard is: 2% for 5 days, 3.5% for 10 days, 5% for 20 days and 10% for 50 days.

(Note: The result of calculation doesn’t show the real winning chance since it is calculated from only the end of the period.)

Duration5 10 20 50

Winning Chance Test: MACD

8

Long Signals:

1)DIFF and DEA are both greater than zero, and DIFF is going up2)DIFF goes up across DEA from below3)DIFF goes up above zero

Short Signals

1)DIFF and DEA are both smaller than zero, and DIFF is going down2)DIFF goes down across DEA from above3)DIFF goes down below zero

DIFF

DEA

Long Point 1) Long Point 2) Long Point 3)

Short Point 1) Short Point 2) Short Point 3)

Winning Chance: MACD

9

Winning Chance: DMI

10

Long Signals:

1)+DI goes up across –DI from below2)+DI goes up across –DI from below, and ADX is going up3)ADX is greater than 50, ADX and stock price are both going up

Short Signals:

1)+DI goes down across –DI from above2)+DI goes down across –DI from above, and ADX is going up3)ADX is greater than 50, ADX and stock price are both going down

50

+DI

-DI

ADX

50 50

Stock Price

50 50 50

Long Point 1) Long Point 2) Long Point 3)

Short Point 1) Short Point 2) Short Point 3)

Winning Chance: DMI

11

Winning Chance: KDJ

12

Long Signals:

1)K, D are smaller than 30, and K is going up2)K goes up across D from below3)K, D are smaller than 30, and K goes up across D from below

Short Signals:

1)K, D are greater than 70, and K is going down2)K goes down across D from above3)K, D are greater than 70, and K goes down across D from above

30 30 30

70 70 70

K线D线J线

Long Point 1) Long Point 2) Long Point 3)

Short Point 1) Short Point 2) Short Point 3)

Winning Chance: KDJ

13

Winning Chance: BOLL

14

Long Signals:

1)Stock price goes up across mid-line from below2)Stock price has been above mid-line, and goes up across upper-line3)Band is getting wider and stock price is going up

Short Signals:

1)Stock price goes down across mid-line from above2)Stock price has been below mid-line, and goes down across lower-line3)Band is getting wider and stock price is going down

50

Upper-line

Mid-line

Lower-line

50 50

Stock Price

50 50 50

Long Point 1) Long Point 2) Long Point 3)

Short Point 1) Short Point 2) Short Point 3)

Winning Chance: BOLL

15

Winning Chance Conclusion

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Eliminate vertical comparison elements (The difference between different signals of the same indicator)

KDJ DMI

Winning Chance Conclusion

17

KDJ has the highest winning chance in up-trend tests

DMI has the highest winning chance in down-trend tests

MACD is stable but lagging

BOLL is unstable and has low winning chances

Profit/Loss Ratio Test

Profit/Loss Ratio

18

Test Standard:

Draw distribution of returns at all signalsCut 20% of the left tail of the distributionTake average of all positive returns and negative returns, and then find the ratio of the two means

赔率测试

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• No Regularity, hard to choose• Close to 1.5, which is acceptable• Stable distribution, low volatility• Give Winning Chance more priority

Back Testing

Back Testing

20

Signals

KDJ

KDJ

Profit/Loss Control

3% Return

-1% Return

Back Testing - Strategy

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Back Testing

22

Back Testing

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Back Testing

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Back Testing - Conclusion

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Comparing to others, Medicine ETF has greater amplitude, obvious rises and falls, regular fluctuations, and most importantly, it doesn’t have many continuous rising, falling and sideway markets. These are the very properties that determines its compatibility with technical indicators.

During a sideway or continuous rising market, KDJ is too sensitive to small rebounds and recoveries so that it sends out wrong signals.

During a sideway or continuous rising market, ADX line in DMI is also too sensitive to small changes thus sends out false trading signals.

In addition, when the indicated trends are not strong enough, they may result in losses if they do not reach profit control point.

Transaction Examples

Part II

27

PairsPairs TradingTrading onon NegativeNegative--correlatedcorrelated IndustryIndustry ETFsETFs

Buy

BuySell

Sell

Price Spread Index

28

To capture the long and short point of paired stocks, here we calculate the spread index time series, and then use the log function to amplify it.

Standardized s in order to see the potential trends more obviously.

where μis the average historical value of price spread and σis its standard deviation.

Apply technical indicators on the standardized price spread to predict trends of it, and execute trading based on the signals.

价差指数

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Short P1Long P2

Long P1Short P2

ShortP1Long P2

Long P1Short P2

Pairs Trading Strategy

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• If there already exists a position, continue holding the position if it is the same as the signal indicates, otherwise clear and enter a new position.

• Use equally weighted asset allocation

• Transaction cost = 0.05%

Start

If DMI sends Down-Trend Signal on s

If KDJ sends Up-Trend Signal on s

If exceeds profit/loss control

Clear position

Long 0.5 Stock 1Short 0.5 Stock 2

Short 0.5 Stock 1Long 0.5 Stock 2

Update Total Net Asset

Pairs Trading - Medicine

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Pairs Trading - Finance

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Pairs Trading - Energy

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Pairs Trading - Consumption

34

Pairs Trading - Return

35

Pairs Trading - Statistics

36

Conclusion

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The test results show that the application of technical indicators on price spread can lead to a 50% winning chance and profit/loss ratio of 1.5 in the negative-correlated pairs trading strategy.

The strategy works far better in highly negative-correlated stock pairs considering more apparent spread trends and greater profit/loss ratio.

When the indicators send out wrong signals, that is when a signal appears where no opposite stock trend occurs, the long and short asset allocation is hedged against wrong way risks. So that the lost will be minimized.

The strategy seems to be not compatible with Chinese market since the cost of entering a short position is too high and the liquidity is bad as well, thus may bring difficulties to this relatively high-frequency trading strategy.

Technical Indicators should be considered to be reference in investments. It is hard to use purely quantitative methods to gain returns with high probability. So investment decisions should be made by both quantitative methods and fundamental researches of industries.

Thank you!