So after reading the last post, the author of quantstrat had mostly critical feedback, mostly of the philosophy that prompted its writing in the first place. Basically, the reason I wrote it, as I stated before, is that I’ve seen many retail users of quantstrat constantly ask “how do I model individual spread instruments”, and otherwise try to look like they’re sophisticated by trading spreads.

The truth is that real professionals use industrial-strength tools to determine their intraday hedge ratios (such a tool is called a spreader). The purpose of quantstrat is not to be an execution modeling system, but to be a *strategy* modeling system. Basically, the purpose of your backtest isn’t to look at individual instruments, since in the last post, the aggregate trade statistics told us absolutely nothing about how our actual spread trading strategy performed. The backtest was a mess as far as the analytics were concerned, and thus rendering it more or less useless. So this post, by request of the author of quantstrat, is about how to do the analysis better, and looking at what matters more–the actual performance of the strategy on the actual relationship being traded–namely, the *spread*, rather than the two components.

So, without further ado, let’s look at the revised code:

require(quantmod)
require(quantstrat)
require(IKTrading)

getSymbols("UNG", from="1990-01-01")
getSymbols("DGAZ", from="1990-01-01")
getSymbols("UGAZ", from="1990-01-01")
UNG <- UNG["2012-02-22::"]
UGAZ <- UGAZ["2012-02-22::"]

spread <- 3*OHLC(UNG) - OHLC(UGAZ)

initDate='1990-01-01'
currency('USD')
Sys.setenv(TZ="UTC")
symbols <- c("spread")
stock(symbols, currency="USD", multiplier=1)

strategy.st <- portfolio.st <- account.st <-"spread_strategy_done_better"
rm.strat(portfolio.st)
rm.strat(strategy.st)
initPortf(portfolio.st, symbols=symbols, initDate=initDate, currency='USD')
initAcct(account.st, portfolios=portfolio.st, initDate=initDate, currency='USD')
initOrders(portfolio.st, initDate=initDate)
strategy(strategy.st, store=TRUE)

#### paramters

nEMA = 20

### indicator

add.indicator(strategy.st, name="EMA",
              arguments=list(x=quote(Cl(mktdata)), n=nEMA),
              label="ema")

### signals

add.signal(strategy.st, name="sigCrossover",
           arguments=list(columns=c("Close", "EMA.ema"), relationship="gt"),
           label="longEntry")

add.signal(strategy.st, name="sigCrossover",
           arguments=list(columns=c("Close", "EMA.ema"), relationship="lt"),
           label="longExit")

### rules

add.rule(strategy.st, name="ruleSignal", 
         arguments=list(sigcol="longEntry", sigval=TRUE, ordertype="market", 
                        orderside="long", replace=FALSE, prefer="Open", orderqty=1), 
         type="enter", path.dep=TRUE)

add.rule(strategy.st, name="ruleSignal", 
         arguments=list(sigcol="longExit", sigval=TRUE, orderqty="all", ordertype="market", 
                        orderside="long", replace=FALSE, prefer="Open"), 
         type="exit", path.dep=TRUE)

#apply strategy
t1 <- Sys.time()
out <- applyStrategy(strategy=strategy.st,portfolios=portfolio.st)
t2 <- Sys.time()
print(t2-t1)

In this case, things are a LOT simpler. Rather than jumping through the hoops of pre-computing an indicator, along with the shenanigans of separate rules for both the long and the short end, we simply have a spread as it’s theoretically supposed to work–three of an unleveraged ETF against the 3x leveraged ETF, and we can go long the spread, or short the spread. In this case, the dynamic seems to be on the up, and we want to capture that.

So how did we do?

#set up analytics
updatePortf(portfolio.st)
dateRange <- time(getPortfolio(portfolio.st)$summary)[-1]
updateAcct(portfolio.st,dateRange)
updateEndEq(account.st)

#trade statistics
tStats <- tradeStats(Portfolios = portfolio.st, use="trades", inclZeroDays=FALSE)
tStats[,4:ncol(tStats)] <- round(tStats[,4:ncol(tStats)], 2)
print(data.frame(t(tStats[,-c(1,2)])))
(aggPF <- sum(tStats$Gross.Profits)/-sum(tStats$Gross.Losses))
(aggCorrect <- mean(tStats$Percent.Positive))
(numTrades <- sum(tStats$Num.Trades))
(meanAvgWLR <- mean(tStats$Avg.WinLoss.Ratio[tStats$Avg.WinLoss.Ratio < Inf], na.rm=TRUE))

And here’s the output:

> print(data.frame(t(tStats[,-c(1,2)])))
                   spread
Num.Txns            76.00
Num.Trades          38.00
Net.Trading.PL       9.87
Avg.Trade.PL         0.26
Med.Trade.PL        -0.10
Largest.Winner       7.76
Largest.Loser       -1.06
Gross.Profits       21.16
Gross.Losses       -11.29
Std.Dev.Trade.PL     1.68
Percent.Positive    39.47
Percent.Negative    60.53
Profit.Factor        1.87
Avg.Win.Trade        1.41
Med.Win.Trade        0.36
Avg.Losing.Trade    -0.49
Med.Losing.Trade    -0.46
Avg.Daily.PL         0.26
Med.Daily.PL        -0.10
Std.Dev.Daily.PL     1.68
Ann.Sharpe           2.45
Max.Drawdown        -4.02
Profit.To.Max.Draw   2.46
Avg.WinLoss.Ratio    2.87
Med.WinLoss.Ratio    0.78
Max.Equity          13.47
Min.Equity          -1.96
End.Equity           9.87
> (aggPF <- sum(tStats$Gross.Profits)/-sum(tStats$Gross.Losses))
[1] 1.874225
> (aggCorrect <- mean(tStats$Percent.Positive))
[1] 39.47
> (numTrades <- sum(tStats$Num.Trades))
[1] 38
> (meanAvgWLR <- mean(tStats$Avg.WinLoss.Ratio[tStats$Avg.WinLoss.Ratio < Inf], na.rm=TRUE))
[1] 2.87

In other words, the typical profile for a trend follower, rather than the uninformative analytics from the last post. Furthermore, the position sizing and equity curve chart actually make sense now. Here they are.

To conclude, while it’s possible to model spreads using individual legs, it makes far more sense in terms of analytics to actually examine the performance of the strategy on the actual relationship being traded, which is the spread itself. Furthermore, after constructing the spread as a synthetic instrument, it can be treated like any other regular instrument in the context of analysis in quantstrat.

Thanks for reading.

NOTE: I am a freelance consultant in quantitative analysis on topics related to this blog. If you have contract or full time roles available for proprietary research that could benefit from my skills, please contact me through my LinkedIn here.