ATQAP: Indicators

Indicators

Moving Average Convergence Divergence (MACD)

• Momentum indicator calculated by taking the difference of two moving averages of an asset price (typically 12 period MA and 26 period MA).
• A signal line is also calculated which is again a MA (typically 9 period) of the MACD line
• The MACD line cutting the signal line from below signals bullish period and the former cutting the latter from above signals bearish (also called crossover strategy)
• Many false positives -- especially during sideways market
• Suggested to be used in conjunction with other indicators
• Lagging indicator - trails behind the actual price action

Bollinger Bands

• Volatility based indicators
• Bollinger band comprises two lines plotted n (typically 2) standard deviations from a m period (typically 20) simple moving average line. The bands widen during periods of increased volatility.

Average True Range (ATR)

• ATR takes account the market movement each day in either direction and averaging them out.
• It focuses on total price movement and conveys how wildly the market is swinging as it moves
• Traders typically use bollinger bands and ATR in conjunction as tehy approach volatility differently and are complimentary

Relative Strength Index (RSI)

• RSI is a momentum oscillator which measures the speed and change of price movements
• RSI value oscillates between 0 and 100
  • with values above 70 indicating that the asset has now reached overbought
  • with values below 30 signifying oversold
• Overbought and underbought conditions can persist for long periods

Average Directional Index (ADX)

• ADX is a way of measuring the strength of a trend
• Values range from 0 to 100
  • 0-25 = weak
  • 25-50 = strong
  • 50-75 = very strong
  • 75-100 = extremely strong

• ADX is non directional and only tells us the strength of the trend
• The calculation involves finding both positive and negative directional movement and then calculating the smoothed average of the difference of these

On Balance Volume

• OBV is a momentum indicator that assumes volume precedes movement and changes in trading volume are an indicator of future asset price moves
• Leading market indicator but prone to making false signals. Typically used in conjunction with lagging indicators such as MACD
• Is simply the cumulative sum of volume traded adjusted for the direction of the corresponding asset move

KPI

Compounded Annual Growth Rate (CAGR)

• CAGR = End Value / Beginning Value ^ [1/years] - 1

• CAGR is the annual rate of return realized by an asset/portfolio to reach its current market value from its initial value

• CAGR calculation assumes profits are continuously reinvested

• Provides ease of comparison between different trading strategies

• Does not reflect investment risk and therefore should always used in conjunction with a volatility measure

Annualized Volatility

• Volatility of a strategy is represented by the standard deviation of the returns. This captures the variability of returns from the mean return
• Annualization is achieved by multiplying volatility with square root of the annualization factor
• Widely used measure of risk, however assumes normal distribution of returns (which if often not true)
• Does not capture tail risk

Sharpe Ratio

• Sharpe Ratio = Expected Return - Risk Free rate of return / Op
• Sharpe ratio is the average return earned in excess of the risk free rate per unit of volatility
• Widely used measure of risk adjusted return
• Investors pay close attention to this metric when comparing funds
• Sharpe ratio greater than 1 is considered good, greater than 2 is very good and greater than 3 is excellent

Sortino Ratio

• Sortino ratio is a variation on Sharpe ratio which takes into account the standard deviation of only negative returns
• One of the criticism of Sharpe ratio is that it fails to distinguish between upside and downside fluctuation. Sortino makes that distinction by only measuring harmful volatility

Maximum Drawdown

• Largest percentage drop in asset price over a specified time period (distance between high and low)
• Investments with longer backtesting period will likely have larger max drawdown and therefore caution must be applied in comparing across strategies

Calmar Ratio

• Calmer Ratio is the ratio of CAGR and Max drawdown and it's a measure of risk adjusted return