Thursday 2 December 2021

My trading system

I realise that I've never actually sat down and described my fully automated futures trading system in all it's detail; despite having runit for around 7.5 years now. That isn't because I want to keep it a secret - far from it! I've blogged or written books about all the various components of the system. Since I've made a fair few changes to my  over the last year or so, it would seem to make sense to set down what the system looks like as of today.

You'll find reading this post much easier if you've already read my first book, "Systematic Trading". I'm expecting a christmas rush of book orders - I've bought all of my relatives copies, which I know they will be pleased to receive... for the 7th year in a row [Hope none of them are reading this, to avoid spoiling the 'surprise'!].

I'll be using snippets of code and configuration from my open source backtesting and trading engine, pysystemtrade. But you don't need to be a python or pystemtrade expert to follow along. Of course if you are, then you can find the full .yaml configuration of my system here. This code will run the system. Note that this won't work with the standard .csv supplied data files, since these don't include the 114 or so instruments in the config. But you can edit the instrument weights in the config to suit the markets you can actually trade.

In much of this post I'll also be linking to other blog posts I've written - no need to repeat myself ad infinitum.

I'll also be mentioning various data providers and brokers in this post. It's important to note that none of them are paying me to endorse them, and I have no connection with them apart from being a (reasonably) satisfied customer. In fact I'm paying them.... sadly.

Update: 5th January 2022, added many more instruments

Research summary

I basically had the same system from 2013 to the start of 2021, although in 2020 I did switch over the implementation to pysystemtrade from my legacy code (which wasn't open source.... because too ugly!). 

With my new dynamic system which I put into production about a month ago, which was a very significant change, I took the opportunity to look at all the research I'd done and see what was worth putting into the new system.

With that in mind I thought it might be fun to finish with a summary of the outcome of the various bits and bobs of research I've done in the last three years or so. 

Things I knew wouldn't work, but someone asked me to look at them:

Things I hoped would work, but didn't:

Things that worked, but I decided not to implement:

Things that worked and I did implement during 2021:

Having made these fairly serious changes to my system I don't plan on doing very much in the near future. I will however be looking at implementing some very different trading systems - watch this space.

Which markets should we sample / trade

I've already written about market selection at some length, here. But to summarise, here's the process I currently follow when adding new instruments:

  • Periodically survey the list of markets offered by my broker, interactivebrokers
  • Create a list of markets I want to add data for. Gradually work my way through them (as of writing this post, my wish list has 64 instruments in it!)
  • Regardless of whether I think I can actually trade them (see below), backfill their data using historic data from
  • Add them to my system, where I will start sampling their prices
  • At this stage I won't be trading them until they're manually added to my system configuration

Because of the dynamic optimisation that my system uses, it's possible for me to calculate optimal positions for instruments that I can't / won't actually trade. And in any case, one might want to include such markets when backtesting - more data is always better! 

I do however ignore the following markets when backtesting:

  • Markets for which I have a duplicate (normally a different sized contract eg SP500 emini and micro; but could be a market traded in a different exchange) and where the duplicate is better. See this report.
  • A couple of other markets where my data is just a bit unreliable (I might delete these instruments at some point unless things improve)
  • The odd market which is so expensive I can't even just hold a constant position (i.e. the rolling costs alone are too much)

Then for trading purposes I ignore:

  • Markets for which there are legal restrictions on me trading (for me right now, US equity sector futures; but could be eg Bitcoin for UK traders who aren't considered MiFID professionals)
  • Markets which don't meet my requirements for costs and liqiuidity (again see here). This is why I sample markets for a while before trading them, to get an idea of their likely bid-ask spreads and hence trading costs
Again to reiterate, I can backtest these instruments and calculate optimal positions, I just won't actually take any positions.  Notice that I don't care here about contracts that are too big for me to trade; again my dynamic optimisation handles this. The size of contracts is only an issue 

There is some more pysystemtrade specific discussion of this here.

Note, if I wasn't using dynamic optimisation I'd use the methodology I discussed here to select a list of markets to trade, given my capital.

Which trading rules to use

I currently use the following trading rules:

Trend like:
  • Momentum - EWMAC (See my first or third book)
  • Breakout (blogpost)
  • Relative (cross sectional within asset class) momentum (blogpost)
  • Assettrend: asset class momentum (blogpost)
  • Normalised momentum (blogpost)
  • Acceleration 
Not trendy:
  • Slow mean reversion within an asset class 
  • Carry (See my first or third book)
  • Relative carry (blogpost)
  • Skewabs: Skew (blogpost)
  • Skew RV (blogpost)
  • Mean reversion in the wings

Some of these are not discussed in blogposts, but they will be in my forthcoming book (next year, hopefully - so that's Christmas 2022 sorted!).

All the code for these rules is here. Some of this duplicates example code elsewhere, but it's nicer to have it in one place.

Trading rule performance

Here are the crude Sharpe Ratios for each trading rule: 

breakout10      -1.19
breakout20 0.06
breakout40 0.57
breakout80 0.79
breakout160 0.79
breakout320 0.77
relmomentum10 -1.86
relmomentum20 -0.46
relmomentum40 0.01
relmomentum80 0.13
mrinasset160 -0.63
carry10 0.90
carry30 0.92
carry60 0.95
carry125 0.93
assettrend2 -0.94
assettrend4 -0.15
assettrend8 0.33
assettrend16 0.65
assettrend32 0.70
assettrend64 0.62
normmom2 -1.23
normmom4 -0.22
normmom8 0.41
normmom16 0.76
normmom32 0.82
normmom64 0.75
momentum4 -0.17
momentum8 0.46
momentum16 0.75
momentum32 0.78
momentum64 0.73
relcarry 0.37
skewabs365 0.52
skewabs180 0.42
skewrv365 0.22
skewrv180 0.33
accel16 -0.08
accel32 0.06
accel64 0.18
mrwrings4 -0.94

I say crude, because I've just taken the average performance weighting all instruments equally. In particular that means we might have a poor performance for a rule that trades quickly because I've used the performance from many expensive instruments which wouldn't actually have an allocation to that rule at all. I've highlighted these in italics. In bold are the rules that are genuine money losers:

  • mean reversion in the wings
  • mean reversion across assset classes

What these all have in common is they are non trendy, mean reverting, and hence highly diversifying rules. I haven't dropped them, because a proper handcrafting process would give them a positive weight: they are strongly negatively correlated to the trendy rules, and whilst their negative Sharpe Ratio tilts their allocation down a little, the uncertainty about backtested Sharpes means they are still justified a positive weighting.

Fun fact: If you could only trade one rule, I guess it would be carry. If you could trade two, well that would be carry and a slowish momentum

Vol attenuation

As discussed here for momentum like trading rules we see much worse performance when volatility rises. For these rules, I reduce the size of the forecast if volatility is higher than it's historic levels. The code that does that is here.

Forecast weights

I toyed with - and briefly implemented - the idea of fitting forecast weights in a rather complex way, but I've now reverted to the method I used to use: a very simple set of handcrafted weights (this is for live trading: when running proper backtests I still use an automated handcrafting method). The weights are as follows- working from the top down:

weights = dict(
trendy = 0.6,
other = 0.4)
# Level 2
weights = dict(
assettrend= 0.15,
relmomentum= 0.12,
breakout=    0.12,
momentum= 0.10,
normmom2= 0.11,
skew=        0.04,
carry= 0.18,
relcarry= 0.08,
mr= 0.04
accel= 0.06)
# Level 3
weights = dict(
assettrend2= 0.015,
assettrend4= 0.015,
assettrend16= 0.03,
assettrend32= 0.03,
assettrend64= 0.03,
assettrend8= 0.03,

relmomentum10= 0.02,
relmomentum20= 0.02,
relmomentum40= 0.04,
relmomentum80= 0.04,

breakout10= 0.01,
breakout20= 0.01,
breakout40= 0.02,
breakout80= 0.02,
breakout160= 0.03,
breakout320= 0.03,

momentum4= 0.005,
momentum8= 0.015,
momentum16= 0.02,
momentum32= 0.03,
momentum64= 0.03,

normmom2= 0.01,
normmom4= 0.01,
normmom8= 0.02,
normmom16= 0.02,
normmom32= 0.02,
normmom64= 0.03,

skewabs180= 0.01,
skewabs365= 0.01,
skewrv180= 0.01,
skewrv365= 0.01,

carry10= 0.04,
carry125= 0.05,
carry30= 0.04,
carry60= 0.05,

relcarry=         0.08,

mrinasset160= 0.02,
mrwrings4= 0.02,

accel16= 0.02,
accel32= 0.02,
accel64= 0.02

Next all I have to do is exclude any rules which a particular instrument can't trade because the costs exceed my 'speed limit' of 0.01 SR units. So here for example are the weights for an expensive instrument, Eurodollar with zeros removed:

assettrend32: 0.048
assettrend64: 0.048
breakout160: 0.048
breakout320: 0.048
breakout80: 0.032
carry10: 0.063
carry125: 0.079
carry30: 0.063
carry60: 0.079
momentum32: 0.048
momentum64: 0.048
mrinasset160: 0.032
mrwrings4: 0.032
normmom32: 0.032
normmom64: 0.048
relcarry: 0.127
relmomentum80: 0.063
skewabs180: 0.016
skewabs365: 0.016
skewrv180: 0.016
skewrv365: 0.016

Forecast diversification multipliers will obviously be different for each instrument, and these are estimated using by standard method.

Position scaling: volatility calculation

As discussed here, I now estimate vol using a partially mean reverting method. The code for that is here. We use a combination of recent vol (70% weight) and vol averaged over the last 10 years (30% weight).

Instrument performance and characteristics

Of the 146 instruments in the dataset, 109 have positive Sharpe Ratios, with the median Sharpe Ratio coming in at 0.27.

The average correlation between subsystem returns is basically zero: 0.05. 

Instrument weights

Again, although in backtest I use an automated handcrafting, for live trading I prefer the weights I've built manually using just Excel. Not even Excel - just a pencil. Not even a pencil! A stick, and some mud! (that's enough, Ed). I won't paste in the weights here - lifes too short, but the weights by asset class are as follows:

{'Ags': 0.15, 
'Bond & STIR': 0.19, 
'Equity': 0.22, 
'FX': 0.13,
'Metals & Crypto': 0.13,
'OilGas': 0.13,
'Vol': 0.05}

The IDM is 2.5; somewhat below the estimated value (readers of Systematic Trading will know that I set a ceiling on this value of 2.5).

Dynamic optimisation

At this point I'll have a list of optimal positions in nearly 150 instruments. The vast majority of those will be less than one contract, because I don't have the tens of millions of dollars in my account that I'd need to actually consistently hold reasonable sized positions in all of those instruments.

As discussed here and here, the biggest change to my system this year has been the introduction of a dynamic optimisation system. This means I won't really have a position in 100+ instruments! I find the portfolio with the lowest tracking error to the optimal portfolio, accounting for the fact that we can only take integer contract positions. 

It's at this stage that I ignore instruments in the following categories when I do my optimisation:
  • Markets for which there are legal restrictions on me trading (for me right now, US equity sector futures; but could be eg Bitcoin for UK traders who aren't considered MiFID professionals)
  • Markets which don't meet my requirements for costs and liqiuidity (again see here)

As discussed in the blog post here, this is done using buffering to reduce trading costs.

Backtest properties

Let's finish with a look at the final backtest. Many words of warning here, since this backtest is stuffed full of in sample calibration and hence is likely to be massively better than you could realistically have expected. 

Looks nice, doesn't it? What about the daily returns?

So in case we were in any doubt 'black friday' (just on the end there) was indeed an exceptionally bad day. 

And drawdown:

Here are some stats. First daily returns:
('min', '-13.32'), ('max', '11.26'), ('median', '0.09578'), ('mean', '0.1177'), ('std', '1.44'), 
('ann_mean', '30.11'), ('ann_std', '23.04'), 
('sharpe', '1.307'), ('sortino', '1.814'), ('avg_drawdown', '-9.205'), 
('time_in_drawdown', '0.9126'), ('calmar', '0.7017'), ('avg_return_to_drawdown', '3.271'), 
('avg_loss', '-0.9803'), ('avg_gain', '1.06'), ('gaintolossratio', '1.081'), 
('profitfactor', '1.26'), ('hitrate', '0.5383'), 
('t_stat', '9.508'), ('p_value', '2.257e-21')

Now monthly:
[[('min', '-21.84'), ('max', '45.79'), ('median', '2.175'), ('mean', '2.55'), 
('std', '7.768'), ('skew', '0.9368'), ('ann_mean', '30.55'), ('ann_std', '26.91'), 
('sharpe', '1.135'), ('sortino', '2.177'), ('avg_drawdown', '-5.831'), 
('time_in_drawdown', '0.6485'), ('calmar', '0.8371'), 
('avg_return_to_drawdown', '5.239'), ('avg_loss', '-4.465'), ('avg_gain', '6.741'), 
('gaintolossratio', '1.51'), ('profitfactor', '2.527'), 
('hitrate', '0.626'), ('t_stat', '8.193'), ('p_value', '1.457e-15')]

Oh, and costs come in at a very reasonable 1.06% a year: well below my speed limit (1.06 / 25 = 0.042 SR units)


Any questions are welcome as usual. If you want to get into an extended discussion, it's probably best to do so here.

Otherwise it's just for me to wish you all (as this is my last blog post of the year) a merry christmas, a happy new year, and let's all hope that 2022 is an improvement on the previous couple of years.

Postscript (6th December 2021)

I thought it might be interesting to compare my backtested results with live trading. Of course, these are very different systems - until the last couple of weeks or so - but it's still interesting.