Presenter: Siteng Jin

Introduction During a two-month summer internship at China Universal Asset Management, the fund manager asked me to do researches on applications of technical indicators on the four Industry ETFs (Medicine, Finance, Energy and Consumption) of the company. As a Quantitative Analyst Assistant Intern, I worked on several technical indicators and tested their effectiveness from various aspects. And this is the final presentation of my project, which was greatly complimented by the fund manager for its clearness, preciseness and rigorousness. Technical Indicator Analysis on Industry ETFs

Part I Timing of Technical Indicators on Industry ETFs Part II Pairs Trading Strategy on Industry ETFs

Part I

4 Back Testing Classification Winning Chance Profit/Loss Ratio

Classification of Popular Indicators 5 ☐☐☐☐☐☐☐☐☐☐

Winning Chances Test 6 Data: Industry ETF （ 15 minutes ） Vertically: for each indicator, choose three long signals and three short signals. Judge the winning chances by seeing the actual trends after the signals. Horizontally: 5 days, 10 days, 20 days and 50 days Calculate the actual returns at the end of each period, and then compare it to the pre-determined return standard for each period to see the trends. The pre-determined return standard is: 2% for 5 days, 3.5% for 10 days, 5% for 20 days and 10% for 50 days. (Note: The result of calculation doesn’t show the real winning chance since it is calculated from only the end of the period.) Duration Long Signals ① ② ③ Short Signals ① ② ③

Winning Chance Test: MACD 7 Long Signals: 1)DIFF and DEA are both greater than zero, and DIFF is going up 2)DIFF goes up across DEA from below 3)DIFF goes up above zero Short Signals 1)DIFF and DEA are both smaller than zero, and DIFF is going down 2)DIFF goes down across DEA from above 3)DIFF goes down below zero DIFF DEA Long Point 1) Long Point 2) Long Point 3) Short Point 1) Short Point 2) Short Point 3)

Winning Chance: MACD 8

Winning Chance: DMI 9 Long Signals: 1)+DI goes up across –DI from below 2)+DI goes up across –DI from below, and ADX is going up 3)ADX is greater than 50, ADX and stock price are both going up Short Signals: 1)+DI goes down across –DI from above 2)+DI goes down across –DI from above, and ADX is going up 3)ADX is greater than 50, ADX and stock price are both going down 50 +DI -DI ADX 50 Stock Price 50 Long Point 1) Long Point 2) Long Point 3) Short Point 1) Short Point 2) Short Point 3)

Winning Chance: DMI 10

Winning Chance: KDJ 11 Long Signals: 1)K, D are smaller than 30, and K is going up 2)K goes up across D from below 3)K, D are smaller than 30, and K goes up across D from below Short Signals: 1)K, D are greater than 70, and K is going down 2)K goes down across D from above 3)K, D are greater than 70, and K goes down across D from above K线K线 D线D线 J线J线 Long Point 1) Long Point 2) Long Point 3) Short Point 1) Short Point 2) Short Point 3)

Winning Chance: KDJ 12

Winning Chance: BOLL 13 Long Signals: 1)Stock price goes up across mid-line from below 2)Stock price has been above mid-line, and goes up across upper-line 3)Band is getting wider and stock price is going up Short Signals: 1)Stock price goes down across mid-line from above 2)Stock price has been below mid-line, and goes down across lower-line 3)Band is getting wider and stock price is going down 50 Upper-line Mid-line Lower-line 50 Stock Price 50 Long Point 1) Long Point 2) Long Point 3) Short Point 1) Short Point 2) Short Point 3)

Winning Chance: BOLL 14

Winning Chance Conclusion 15 Eliminate vertical comparison elements (The difference between different signals of the same indicator) KDJ DMI

Winning Chance Conclusion 16  KDJ has the highest winning chance in up- trend tests  DMI has the highest winning chance in down- trend tests  MACD is stable but lagging  BOLL is unstable and has low winning chances Profit/Loss Ratio Test

Profit/Loss Ratio 17 Test Standard:  Draw distribution of returns at all signals  Cut 20% of the left tail of the distribution  Take average of all positive returns and negative returns, and then find the ratio of the two means

赔率测试 18 No Regularity, hard to choose Close to 1.5, which is acceptable Stable distribution, low volatility Give Winning Chance more priority Back Testing

19 Signals K < 30 D < 30 K  K ✗ D DMI -DI ✗ +DI ADX  DMI ADX > 50 ADX  Price  KDJ Profit/Loss Control 3% Return -1% Return

Back Testing - Strategy 20

Back Testing 21

Back Testing 22

Back Testing 23

Back Testing - Conclusion 24  Comparing to others, Medicine ETF has greater amplitude, obvious rises and falls, regular fluctuations, and most importantly, it doesn’t have many continuous rising, falling and sideway markets. These are the very properties that determines its compatibility with technical indicators.  During a sideway or continuous rising market, KDJ is too sensitive to small rebounds and recoveries so that it sends out wrong signals.  During a sideway or continuous rising market, ADX line in DMI is also too sensitive to small changes thus sends out false trading signals.  In addition, when the indicated trends are not strong enough, they may result in losses if they do not reach profit control point. Transaction Examples

Part II

26 Buy Sell

Price Spread Index 27 To capture the long and short point of paired stocks, here we calculate the spread index time series, and then use the log function to amplify it. Standardized s in order to see the potential trends more obviously. where μis the average historical value of price spread and σis its standard deviation. Apply technical indicators on the standardized price spread to predict trends of it, and execute trading based on the signals.

价差指数 28 Short P1 Long P2 Long P1 Short P2 ShortP1 Long P2 Long P1 Short P2

Pairs Trading Strategy 29 If there already exists a position, continue holding the position if it is the same as the signal indicates, otherwise clear and enter a new position. Use equally weighted asset allocation Transaction cost = 0.05% Start If DMI sends Down- Trend Signal on s If KDJ sends Up- Trend Signal on s If exceeds profit/loss control Clear position Long 0.5 Stock 1 Short 0.5 Stock 2 Short 0.5 Stock 1 Long 0.5 Stock 2 Update Total Net Asset

Pairs Trading - Medicine 30

Pairs Trading - Finance 31

Pairs Trading - Energy 32

Pairs Trading - Consumption 33

Pairs Trading - Return 34

Pairs Trading - Statistics 35

Conclusion 36  The test results show that the application of technical indicators on price spread can lead to a 50% winning chance and profit/loss ratio of 1.5 in the negative-correlated pairs trading strategy.  The strategy works far better in highly negative-correlated stock pairs considering more apparent spread trends and greater profit/loss ratio.  When the indicators send out wrong signals, that is when a signal appears where no opposite stock trend occurs, the long and short asset allocation is hedged against wrong way risks. So that the lost will be minimized.  The strategy seems to be not compatible with Chinese market since the cost of entering a short position is too high and the liquidity is bad as well, thus may bring difficulties to this relatively high-frequency trading strategy.  Technical Indicators should be considered to be reference in investments. It is hard to use purely quantitative methods to gain returns with high probability. So investment decisions should be made by both quantitative methods and fundamental researches of industries.

Thank you!

Back Testing – Loss Analysis 38 Finance ETF, KDJ gives wrong signal in a bear market Bac k

Back Testing – Loss Analysis 39 Finance ETF, KDJ gives wrong signal in a sideway Bac k

Back Testing – Loss Analysis 40 Finance ETF, DMI give wrong signal in a sideway Bac k

Back Testing – Loss Analysis 41 Energy ETF, KDJ gives wrong signal in a bear market Bac k

Back Testing – Loss Analysis 42 Finance ETF, KDJ gives wrong signal in a bear market Bac k

Back Testing – Loss Analysis 43 Consumption ETF, DMI gives wrong signal in a bull market Bac k

Back Testing – Loss Analysis 44 Consumption ETF, DMI gives wrong signal in a sideway Bac k

Back Testing – Profit Analysis 45 Medicine ETF, KDJ gives correct long signal in fluctuation Bac k

Back Testing – Profit Analysis 46 Medicine ETF, KDJ gives correct long signal in fluctuation Bac k

Back Testing – Profit Analysis 47 Medicine ETF, KDJ gives correct short signal in fluctuation Bac k