Description
The Stress strategy is based upon the Stress Indicator, a stochastic type study developed by Perry Kaufman. Data derived from the Stress Indicator is adapted for hedging and expanded with several safety techniques, such as stop-loss and minimum price. In addition to adding standard simulated buy and sell orders, the Stress strategy marks time points where hedging the instrument with an index could be or could have been useful. It also calculates the hypothetical hedging size for these points.
Simulated Trade Orders
An initial simulated buy order is added when the Stress Indicator falls below the specified entry level and the index is in uptrend. After an exit, the simulated buy order is only added when the Stress Indicator falls below the entry level from above 50.
The simulated sell order is added when any of the following conditions are true:
-
Stress Indicator goes above the exit level;
-
Decline in price from the entry point exceeds the stop-loss percentage value;
-
Price falls below the minimum level at least once during the specified
min price lengthperiod.
Hedging
Hedging is treated by the strategy as an independent process solely based on the trend of the chosen index. When index is in downtrend, the strategy indicates that hedging could be useful and calculates the hypothetical hedge size. Here, the downtrend is identified when the average close price of the index falls. The hedging size (i.e., the trading of the index) is calculated as hedge ratio times stock position times stock to index volatility ratio. Both stock volatility and index volatility are calculated using the standard deviation formula.
Input Parameters
| Parameter | Description |
|---|---|
index
|
Defines the index to be used in hedging with the specified stock. |
length
|
The period upon which the highest and the lowest prices of both the index and the stock are found; used in stochastic calculation. |
investment
|
Defines hypothetical investment for simulated buy orders. Trade size of the stock is equal to this value divided by close price. |
entry level
|
Defines the entry level for the simulated buy condition. |
exit level
|
Defines the exit level for the first simulated sell condition. |
stop loss
|
Defines the critical percentage of the price decline from the entry point; used in the second simulated sell condition. |
min price
|
Defines the critical percentage of the price decline from the entry point; used in the third simulated sell condition. |
min price length
|
Defines the period for the third simulated sell condition. |
hedge length
|
Defines the period for calculation of standard deviations and average close price of the index. |
hedge ratio
|
Defines the ratio of the hedge-protected position size to the size of the entire position; used in the index trade size calculation. |
Plots
| Plot | Description |
|---|---|
HedgeSignal
|
Displays possible opportunities for hedging. |
HedgeSize
|
Displays hypothetical hedging size. |
Further Reading
1. "Timing The Market With Pairs Logic" by Perry Kaufman. Technical Analysis of Stocks & Commodities, March 2014.
Backtesting is the evaluation of a particular trading strategy using historical data. Results presented are hypothetical, and there is no guarantee that the same strategy implemented today would produce similar results.
Technical analysis is not recommended as a sole means of investment research.
For educational purposes only. Not a recommendation of a specific security or investment strategy.