Testing a Mechanical System by Sight: SPY Mechanical Renko System

One of the more popular mechanical trading systems out on the web today is the SPY Mechanical Renko System.  It is “mechanical” because all of the trades are entered automatically; there is no subjective decision making.  You either go long or go short based on what the system tells you to do.

Chart Settings

Symbol:  SPY

Chart Type:  Daily Renko, Box Size 0.5, Close

Click here for an overview of Renko charting.

Overlays:

1.  Parabolic SAR, (0.09, 0.2)

The Parabolic SAR is a fairly complex indicator and appears as a dot either above the price if the function determines that price is falling and below price if it is rising.  SAR stands for “Stop and Reverse” and ideally when price changes trend, the SAR indicator will reverse accordingly.  The first number is the Acceleration Factor or “Step” function which dictates how sensitive SAR is to price change.  The second number is the “Maximum Step”.

Click here for an overview of this indicator.

2.  EMA (5)

A 5 period exponential moving average.

Indicators:

1.  RSI (14)

2.  Full Stochastics (14,3,3)

3.  MACD (12,26,9)

4.  CCI (20)

Mechanical Trading System Rules

1.  100% in the market – you are always either long or short the market

2.  Long Entry (when all of the following are true): 

a.  Renko Box is white (an “up box”)

b.  Renko Box closes above the EMA(5)

c.  Parabolic SAR is below price

d.  Full Stochastics confirms long entry by crossing over 20 line

3.  Short Entry (when all of the following are true):

a.  Renko Box is red (a “down box”)

b.  Renko Box closes below the EMA(5)

c.  Parabolic SAR is above price

d.  Full Stochastics confirms short entry by crossing below 80 line

Here is a chart of the first couple of trades:

System Results

No.	Signal	Date	Price	Points Gain/(Loss)	% Gain/(Loss)
1	Long	12/1/2010	117.5
2	Short	2/22/2011	130	12.50	10.64%
3	Long	3/3/2011	130	0.00	0.00%
4	Short	3/7/2011	129	(1.00)	-0.77%
5	Long	3/21/2011	126	3.00	2.33%
6	Short	4/18/2011	128.5	2.50	1.98%
7	Long	4/202011	130.5	(2.00)	-1.56%
8	Short	5/5/2011	132	1.50	1.15%
9	Long	5/10/2011	133.5	(1.50)	-1.14%
10	Short	5/16/2011	131.5	(2.00)	-1.50%
11	Long	5/31/2011	132	(0.50)	-0.38%
12	Short	6/1/2011	130.5	(1.50)	-1.14%
13	Long	6/21/2011	126.5	4.00	3.07%
14	Short	6/24/2011	126	(0.50)	-0.40%
15	Long	6/28/2011	127	(1.00)	-0.79%
16	Short	7/11/2011	131.5	4.50	3.54%
17	Long	7/21/2011	131.5	0.00	0.00%
18	Short	7/27/2011	131	(0.50)	-0.38%
19	Long	8/9/2011	113	18.00	13.74%
20	Short	8/10/2011	114	1.00	0.88%
21	Long	8/11/2011	113.5	0.50	0.44%
22	Short	8/15/2011	117.5	4.00	3.52%
23	Long	8/23/2011	113.5	4.00	3.40%
24	Short	9/2/2011	119	5.50	4.85%
25	Long	9/7/2011	117.5	1.50	1.26%
26	Short	9/9/2011	117	(0.50)	-0.43%
27	Long	9/14/2011	116.5	0.50	0.43%
28	Short	9/21/2011	118	1.50	1.29%
29	Long	9/26/2011	114.5	3.50	2.97%
30	Short	9/29/2011	115	0.50	0.44%
31	Long	10/5/2011	111	4.00	3.48%
32	Short	10/17/2011	119.5	8.50	7.66%
33	Long	10/18/2011	121.5	(2.00)	-1.67%
34	Short	10/25/2011	122.5	1.00	0.82%
35	Long	10/27/2011	124.5	(2.00)	-1.63%
36	Short	10/31/2011	125.5	1.00	0.80%
37	Long	11/3/2011	123.5	2.00	1.59%
38	Short	11/9/2011	125	1.50	1.21%
39	Long	11/11/2011	124.5	0.50	0.40%
40	Short	11/16/2011	123.5	(1.00)	-0.80%
41	Long	11/28/2011	118	5.50	4.45%
42	Short	12/8/2011	123.5	5.50	4.66%
43	Long	12/20/2011	122.5	1.00	0.81%
44	Sell	3/6/2012	135.5	13.00	10.61%

From 12/1/2011 to 3/6/2012 the system took 44 trades.  Not as many as I would like to see but it is a start.  It is mainly meant to keep you in big trends and can have a tendency to create whipsaws often.  When I was “sight testing” the system I picked the high of the bar for our entry if we were long and the low of the bar for our entry if we were short.  This helped keep down any biases.  Of course the system doesn’t account for any commissions, slippage or human error, but it shows some promise.

Let’s take a look at some basic statistics:

No. of Trades		44
No. of Wins		28
No. of Losses		13
Even Trades		2
Winning %		63.64%
Avg Win		4.00
Avg Loss		-1.23
Profit Ratio		3.25
Largest Loss		-2
StDev		4.23

These were calculated from the table above.  I like the profit ratio and the winning % is solid.  The best part is the largest loss is only 2 points.  The standard deviation is a bit high (larger than the average win) so we can’t tell right now how robust the system is.  More samples would help.  Let’s plug this into the Trading Stats calculator and see what we get:

Trading Stats Calculator
Inputs			Outputs
				$	%
Winning Percentage	63.64%		Expectancy Per Trade	209.84	209.84%
Average Win	400		Edge	-	1.40%
Average Loss	123		Fractional Gain (FG)	400	2.67%
Account Size	15,000		Fractional Loss (FL)	123	0.82%
Sample Size	48		Initial Risk Per Trade (Unit Size)	123	0.82%
Standard Dev (All Trades)	423		Win/Loss Ratio (Profit Ratio)	-	3.25
Largest Losing Trade	200		Capital Units Available	-	121.95
			Minimum Win % Required to Be Profitable1	-	24.00%
			Maximum Average Loss to Be Profitable3	700.11	4.67%
			Minimum Avg Win to Be Profitable2	70.27	0.47%
			Risk of Ruin	-	3.30%
Optimal Risk			t-Test	-	6.55
Leibfarth Formula	4.55%		Optimal F	-	0.524593
Kelly Formula	52.46%		Maximum Leverage	381.2479389	-

I assumed we were trading 100 shares of SPY at a time, giving an average win of $400 and an average loss of $123.  Our edge is sharp at 1.4% and our expectancy is 209.84 per trade – both solid numbers.  It is nice to see a maximum average loss of 700 – this means that we could set our stops wider, should we need to or if we were late on an entry it wouldn’t kill the system.  T-test was greater than 1.6 so we know the system result wasn’t just “by chance”.  Finally, the risk of ruin is only 3.3% giving us a nice cushion.

More on Renko mechanical systems to come.

For the basics of this system, check out Breakpoint Trades here.