Backtesting and Enhancing the Bloodbath Indicator
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Backtesting and Enhancing the Bloodbath Indicator
Legendary traders Larry Williams and Ralph Vince’s 2024 Dow Award-winning paper introduced a novel investment strategy designed to circumvent market downturns. This article evaluates the “bloodbath sidestepping” 4% rule’s efficacy in the US stock market and proposes an enhancement framework. Additionally, the strategy is tested across a basket of global equity indices, demonstrating its robustness and potential for universal application.
Introduction:
In their seminal work, Larry and Ralph advocate for a strategic approach to market participation, suggesting investors remain in cash when over 4% of NYSE stocks reach 52-week lows, and re-enter the market once this metric falls below the threshold. This article examines the historical performance of this strategy using Bloomberg’s backtesting platform and proposes refinements to enhance its effectiveness.
The Benchmark Strategy:
Our analysis begins by integrating the NYSE market breadth data, specifically the percentage of members hitting new 52-week lows, as a backtesting variable. The initial strategy dictates entering long positions when fewer than 4% of NYSE stocks achieve new yearly lows and closing these positions once the indicator exceeds 4%.
Backtested on the daily chart of NYSE composite index from January 1st, 2003 to June 14th, 2024, this strategy yielded a 343.1% return with a maximum drawdown of 45.5%, outperforming a simple buy-and-hold approach (246% return and 59% drawdown).
The benchmark strategy made a total of 229 trades, of which only 95 were profitable (41.5% winning ratio). The win-loss ratio is 2.4:1.
Strategy Enhancement:
Recognizing the prevalence of “numerous, short-lived, false signals”, we introduce a smoothing technique employing a simple moving average on the raw indicator, with an initial parameter of 10. The revised trading rule utilizes the moving average to refine entry and exit points, resulting in a 479% total return and a reduced maximum drawdown to 22.7%. This enhancement significantly increases the win rate to 53% and also improves the win/loss ratio to 2.7:1.
Optimization Analysis:
Further investigation into the smoothing factor’s impact reveals an optimal range for the moving average period between 9 and 11. This finding suggests a plateau in total profit within this parameter range, indicating a balance between responsiveness and stability.
Global Portfolio Backtesting:
Expanding the strategy’s scope, we construct a diverse basket of global equity indices and apply the enhanced trading rule. The results confirm the strategy’s profitability across various regions, with an average total return of 443.2%, underscoring its universal applicability.
Conclusion:
The 4% bloodbath sidestepping rule has proven its merit over time and across different market conditions. The enhancements proposed in this article further solidify its position as a valuable tool in the investor’s arsenal. The insights provided by Larry Williams and Ralph Vince are a testament to their legendary status in the field of trading.
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Originally posted 15th August 2024
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