Value Channel Technique for Pattern-Following Power Futures: Backtest and Optimization

On this article, we’ll discover some of the well-known and extensively used indicators within the buying and selling world: the Value Channel. We’ll dive into how this technical evaluation software works and the way it may be utilized to establish alternatives in systematic buying and selling. Particularly, we’ll give attention to the power futures sector, Crude Oil (CL), Heating Oil (HO), Pure Fuel (NG), and RBOB Gasoline (RB). These monetary devices are listed on the NYMEX (New York Mercantile Alternate) and are recognized for his or her trend-following habits. In different phrases, their costs have a tendency to maneuver in lengthy upward or downward developments, actions that merchants can probably revenue from by following the prevailing path.

How the Value Channel Indicator Works in Systematic Buying and selling

This indicator, often known as the Donchian Channel, named after its creator Richard Donchian within the Nineteen Fifties, consists of two parallel strains: one higher and one decrease. The higher line is calculated by figuring out the very best worth during the last N bars, whereas the decrease line displays the bottom worth over the identical interval (Determine 1).

The Value Channel can be utilized in a number of methods, however on this article, we’ll give attention to the standard trend-following strategy, which fits the traits of the markets we’re analyzing.

Determine 1. Graphical illustration of the Value Channel.

Constructing a Pattern-Following Technique with the Value Channel

Let’s begin by testing a trend-following technique, which intuitively aligns effectively with this sort of channel: we’ll purchase when the value hits the higher band and promote when it hits the decrease band, anticipating the value to proceed shifting in the identical path. Moreover, as soon as these ranges are reached, the place will likely be reversed, from lengthy to quick and vice versa.

This technique will likely be utilized to a portfolio composed of the beforehand listed power futures, utilizing a 60-minute timeframe. For the calculation of the indicator, we’ll use the default setting discovered on most platforms: 20 bars. To run the backtest and make sure the platform capabilities appropriately, we’ ll set an preliminary portfolio capital of $1,000,000 for educational functions solely.

Backtest Outcomes: Value Channel Pattern-Following Technique on Power Futures

Analyzing the backtest outcomes from January 1, 2010, we observe, as proven in Determine 2, a wonderful preliminary efficiency, notably contemplating the consistency of the fairness curve. Regardless of the simplicity of the technique, it has generated a internet revenue of simply over $1,000,000 through the years, with a comparatively low drawdown of solely $96,000.

Determine 2. Fairness line of the trend-following technique utilizing the Value Channel utilized to power futures.

Determine 3. Efficiency report of the trend-following technique utilizing the Value Channel utilized to power futures.

Determine 4 reveals that this technique produced income throughout all 4 futures included within the take a look at. The outcomes had been particularly robust on Heating Oil and RBOB Gasoline futures, although the opposite two additionally delivered optimistic returns, confirming the trend-following nature of those devices.

Determine 4. Particular person efficiency of the Value Channel trend-following technique on the power futures within the portfolio.

Nevertheless, trying on the Whole Commerce Evaluation (Determine 5), and extra particularly on the common commerce of the technique utilized to the portfolio, we discover a worth of simply $89. That is clearly inadequate to cowl the fee prices and slippage related to buying and selling these devices.

Determine 5. Whole Commerce Evaluation of the Value Channel trend-following technique utilized to power futures.

Optimizing Value Channel Settings for Greatest Efficiency

We initially used a 20-period setting to calculate the higher and decrease bands of the Value Channel, as that is the default worth on most buying and selling platforms. Now, let’s consider by means of an optimization course of whether or not 20 is actually the best setting, or if different values might yield higher outcomes.

As proven in Determine 6, which illustrates the outcomes of optimizations starting from 10 to 50 durations in steps of 5, we will observe a decline in internet revenue because the Value Channel interval will increase throughout this basket of futures.

Determine 6. Optimization outcomes for the Value Channel calculation interval.

This decline is no less than partially because of the decreased variety of trades executed with longer durations. Nevertheless, when utilizing values as much as 40, the outcomes stay passable general. Interval settings of 10 and 25 appear to supply viable alternate options, however they don’t outperform the 20-period setting used within the earlier backtest, which reveals the perfect internet revenue of all.

The best way to Enhance Technique Efficiency Utilizing the ADX Filter

At this stage of improvement, we’ll attempt including an operational filter to enhance the technique’s common commerce worth, which, as famous earlier, is presently too low to make the technique viable for stay buying and selling.

The thought is to introduce a situation that enables trades solely throughout phases when breakouts are more likely to be more practical, thus decreasing the variety of false indicators. To do that, we’ll use the ADX (Common Directional Index), some of the well-known indicators for measuring pattern power.

The ADX is a technical evaluation indicator that estimates the power of a market’s directionality, no matter whether or not it’s bullish or bearish. It ranges from 0 to 100: decrease values point out a non-directional (sideways) market, whereas increased values recommend a powerful pattern.

On this case, we’ll use the ADX calculated over 5 each day bars, equal to at least one buying and selling week, and we’ll solely open new positions if the ADX is beneath 30. This helps us goal durations the place the market hasn’t proven robust directional motion not too long ago. The absence of a transparent pattern might point out {that a} new directional section is about to start, which our system will try to seize with a breakout-based entry.

It’s essential to notice that this situation will likely be utilized solely on the entry of a commerce, not on the exit. That’s as a result of the technique is designed to make use of breakout ranges as the only exit standards, to keep away from getting caught in unprofitable trades as a result of overly restrictive filters.

Efficiency of the Pattern-Following Technique on Power Futures with the Addition of a Filter

After introducing the ADX as an operational filter, we observe a transparent enchancment within the technique, as evidenced by the fairness line in Determine 7, which seems extra secure and linear, notably within the latter a part of the backtest.

Determine 7. Fairness line of the trend-following technique on power futures with ADX-based filter.

As proven within the report in Determine 8, the entire internet revenue is available in at round $541,000, decrease than the model with out the operational filter. Nevertheless, the utmost drawdown can also be decrease, at roughly $64,500.

Determine 8. Efficiency report of the trend-following technique on power futures with ADX-based filter.

Trying on the common commerce in Determine 9, we see a major enchancment: the common commerce worth rises to round $134, in comparison with $89 within the earlier model. It is a very encouraging determine, because it signifies that utilizing the ADX as a filter helps keep away from many false indicators and permits the system to give attention to circumstances extra favorable for breakouts.

Determine 9. Whole Commerce Evaluation of the trend-following technique on power futures with ADX-based filter.

Is the Value Channel Efficient for Power Futures? Key Takeaways

At this level, there are a number of methods to additional enhance the technique. One possibility could possibly be to introduce a cease loss to reinforce danger administration. Though the Value Channel ranges are already used as exit factors, they’ll typically be fairly removed from the commerce’s entry value, probably resulting in extreme losses. These could possibly be higher managed by making use of a cease loss. Alternatively, one might optimize the ADX threshold used as a filter.

In any case, the Value Channel proves to be a precious software for constructing automated buying and selling methods. Whereas the common commerce worth remains to be on the edge of what is acceptable for a whole technique, we’ve seen that with the best changes, this indicator can be utilized successfully, particularly in sure markets.

Glad buying and selling,