Regime Classifier Demo

The important thing to note about this strategy is the buy and sell signals are static. In this case, the buy condition is when the 2-period RSI crosses below five and the sell condition occurs when the 2-period RSI crosses above 50. These threshold values never change. Even if the market changes over the months or years the buy/sell threshold doesn't change. Let's write code to make those values dynamic so our strategy changes based upon the conditions of the market. We'll do that by creating a classifier that will divide the market into different regimes.

Creating A Regime Classifier

The idea of a regime classifier is to change the behavior of your trading model based upon the different conditions of the overall market you're trading. In this case, we are going to change the buy and sell thresholds based upon the bullishness or bearishness of the S&P futures.

Curtis used a longer period RSI calculation to act as a regime filter. Curtis noticed that a 14-period RSI in the overbought zone often indicates the market is in a strong bull mode. When the 14-period RSI is in the oversold region the market is in a much more bearish mode. Based on this we wish to adapt on buy and sell signals accordingly.

Please see the original article for more information on this classifier.

Strong Bull Markets: When the market is strongly bullish based upon our regime classifier, we want to make it easier to enter a long trade which makes sense. During strong up-trends pullbacks tend to be more shallow. Thus we loosen the threshold of our buy condition. We also want to hold our trade longer during these strongly bullish times. Thus, we change our exit condition threshold as well by making it more difficult to reach.

You can see in the code below we are changing our Buy Threshold based upon what our classifier is reporting. The stronger the market, the higher the buy threshold is raised thus making it easier to enter new trades. In short, we are buying into shallower and shallower pullbacks.

BullMarket = Close > Average( Close, 200 );
RsiClassifier = RSI( Close, 14 );

BuyThresholdV = 30;
BuyThresholdV = IFF( RsiClassifier >= -10, 10, BuyThresholdV);
BuyThresholdV = IFF( RsiClassifier >= 30, 20, BuyThresholdV);
BuyThresholdV = IFF( RsiClassifier >= 50, 30, BuyThresholdV);

BuyCondition = RSI( Close, 2 ) < BuyThresholdV;
SellCondition = RSI( Close, 2 ) > SellThresholdV;

Again, our buy threshold rises from 10 to 20 and then to 30 as our 14-period RSI (our classifier) rises. What this means is, as the market becomes more bullish we make it easier to open new long trades. 

Weak Bull Markets: When the market is weakly bullish or even bearish, we want to make it more difficult to enter a long trade and make it easier to exit any open trades. This makes sense as well.

BullMarket = Close > Average( Close, 200 );
RsiClassifier = RSI( Close, 14 );

SellThresholdV = 70;
SellThresholdV = IFF( RsiClassifier >= -10, 60, SellThresholdV);
SellThresholdV = IFF( RsiClassifier >= 30, 70, SellThresholdV);
SellThresholdV = IFF( RsiClassifier >= 50, 80, SellThresholdV);

BuyCondition = RSI( Close, 2 ) < BuyThresholdV;
SellCondition = RSI( Close, 2 ) > SellThresholdV;

Results With RSI Classifier

In this case, we can see a dramatic difference between our Basic Strategy and the Classifier Strategy. We make over three times as many trades and each trade generates more net profit on average. This seems to be a very positive improvement. On the other hand, our drawdown did not improve. We're taking more trade thus our market exposure has also increased. This is not unexpected since our returns are so much better. More risk, more reward. However, I don't think our risk is unreasonable especially when you consider we don't have any stops.

I did not opimize the classifier settings which one could do rather easily. You could also use a different indicator as the regime classifier. Overall this simple example is a great demonstration on the concept of a multi-state regime classification being used to change buy/sell thresholds. Now it's up to you to test how this concept can be used in your trading.

The code for this strategy is available to download for all EasyLanguage Mastery subscribers. The strategy code has one input which allows you to switch between the Basic Strategy and the Classifier Strategy.