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Inverted Long Strategy = Short Strategy?
Jay B
posted

Hi there,

Just getting started with algo trading and I'm currently in the phase of implementing a couple of FOREX trading strategies that appear to be profitable in backtesting and out-of-sample tests (now in incubation/paper-trading).

From various articles it appears that many strategies can be used either way, i.e. a long strategy with inverted logic can be used as a short strategy.
I was wondering if this is a general rule that applies to virtually any trading strategy based on technical analysis, i.e. once a profitable long strategy has been identified that captures an actual characteristic of the underlying security (and not just randomly works great in backtesting due to being overfitted..) should the inverted logic always work as a short strategy?

Any thoughts appreciated!

Cheers,
Jay

2 responses
Adam Wu

I'd be cautious with assuming it will always work, as the fact that the long-strategy is no longer profitable suggests that market dynamics are changing, and this inverted strategy could as well at some point in the future.

However if you could argue or think of a reason why the inverted strategy might be valid, that could work. For example, since you're using technical analysis, suppose we had a long strategy based on a number of indicators meeting certain criteria that was initially profitable. As more and more traders follow this strategy, alpha decay may be so significant as to completely reverse the strategy (i.e. when it meets the same criteria, these expectations of future behavior is already captured into the market movements). However, if the alpha decay is due to market makers adapting or a number of other factors such as actual changes in the market dynamics, then this inverted strategy might be harder to justify.

Jay B

Thanks for your comments!

Actually I was thinking of a much simpler concept when talking about 'inverted' strategies - more along the lines of e.g. Three White Soldiers vs. Three Black Crows and many other strategies that (supposedly..) go both ways.

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