Episode 041 - Cesar Alvarez - A Novel Way to Combine Trend, Reversion, ETFs, Volatility & More!
Dynamic Strategy Deployment - Solving Two Key Questions: What to Trade Now & When to Retire a Strategy
When I sat down recently with Cesar Alvarez of Alvarez Quant Trading, I knew I'd be tapping into a deep reservoir of quantitative trading wisdom. Cesar’s journey into systematic trading began similarly to many of us—starting with discretionary trades, dabbling in mutual funds, and eventually stumbling into the quant world. From his early days at Connors Research to managing sophisticated portfolios today, as well as building strategies for probably thousands of private clients over the years, Cesar has seen it all. Still, he remains a humble and down-to-earth guy. Here’s what he shared about strategy creation, testing, and portfolio management in ETF and equities markets.
The Quantitative Journey: From Discretionary to Systematic
Cesar began his career trading mutual funds and individual stocks, influenced by William O'Neil’s Investor's Business Daily strategies. It was in the early 2000s that quant trading captivated him, especially due to his strong programming background. Tools like AmiBroker transformed his approach, making systematic testing accessible and scalable.
His professional breakthrough came at Connors Research, where he spent a decade deeply immersed in mean reversion and volatility strategies. “Working alongside Larry Connors,” Cesar reminisced, “was like drinking from a firehose of trading ideas.” This was where he first discovered the counterintuitive finding that mean reversion strategies performed best without stops.
Building a Robust Portfolio
Today, Cesar’s personal portfolio is diversified across several strategy types:
• Mean reversion: Targeting both long and short opportunities in universes such as the Russell 3000 and S&P 500.
• Breakouts: Primarily in small-cap stocks, harnessing their volatility.
• Momentum & Rotation: Utilizing ETFs like SPY, TLT, and NASDAQ-100 stocks.
• Volatility: Trading the VIX and SVIX, though acknowledging volatility strategies can be brutally hit-or-miss.
• Tactical Asset Allocation: A slower-paced, dual-momentum method for retirement accounts, focusing heavily on managing drawdowns.
“Now that retirement looms,” Cesar explained, “I’m less about shooting for the moon and more about cushioning my falls.” His tactical ETF strategy reflects this philosophy perfectly, keeping him in cash or stable assets during turbulent times.
Strategy Creation: Start with a Clear Goal
For Cesar, quant strategy design starts with well-defined objectives:
1. Identify the Universe: Whether it’s S&P 500 stocks or a broader range like the Russell 3000, clearly defining the universe in line with your objectives.
2. Set Return and Drawdown Expectations: Cesar sets realistic goals—for example, aiming for high-teens returns with manageable drawdowns in short strategies.
3. Define the Trading Style: Short-term holds, momentum, or breakout—each style dictates its own rules and parameters.
This targeted approach prevents the trap of endless parameter tweaking and over-fitting.
Testing Robustness and Avoiding Overfitting
We got a few insights into the robustness testing methods Cezar uses:
• Parameter Sensitivity Testing: Cesar adjusts parameters by 10-20% around his base values, performing thousands of runs. He then calculates averages and standard deviations to gauge robustness.
• Standard Deviation Checks: If the selected parameter set is significantly outside one standard deviation from the average, it’s likely overfit, warranting reconsideration.
Deciding When to Retire a Strategy
One major quant trading challenge is knowing when to pull the plug on underperforming strategies. Cesar elegantly sidesteps subjective judgments by employing a rotation system:
• Portfolio Ranking: He maintains around ten strategies, ranking them monthly or quarterly based on recent performance.
• Top Performers Only: The top five strategies earn their place in the live portfolio. Poor performers rotate out.
This methodical, evidence-driven approach removes emotional bias. If a strategy fails to make it back into rotation for a year or two, Cesar gracefully retires it. "Strategies don't usually die dramatically; they slowly fade away," he noted wryly.
Is It Getting Harder to Find Profitable Strategies?
Absolutely, according to Cesar. Competition and efficiency continue to escalate. Edges become thinner, and strategies' shelf lives shrink. To combat this, Cesar emphasizes diversification and continual innovation, regularly revisiting strategy ideas and adjusting approaches. He doesn't necessarily hold a conviction that just because something worked in the distant past, it will work in today's market. There are implications for in sample / out of sample testing. This also highlights why he has chosen a rotational / dynamic approach to strategy deployment - only keeping high-performance strategies in the live portfolio.
Combining Strategies: Zen and the Art of Diversification
Managing multiple strategies requires a careful balancing act. Cesar avoids heavy correlation by blending different styles—mean reversion, breakout, momentum, and volatility. He also uses a rotation mechanism to manage correlation dynamically, ensuring a stable and robust portfolio performance. I did fail to ask one question, which I should have: 'When you sub-off a strategy and sub-another in, do you swap it with a 'like' strategy?". Meaning, I think it would be interesting if you could sub strategies in and out, while still maintaining desired correlation and strategy-type exposures!
Amibroker vs. RealTest: Quant Trading Tools
When discussing software, Cesar praised both AmiBroker and RealTest, but noted clear distinctions:
• AmiBroker: Highly flexible, and nearly anything can be custom coded. This makes it suitable intraday or options strategies.
• RealTest: User-friendly, does multi-strategy trading which Amibroker simply doesn't do, is incredible fast and can handle almost anything you can throw at it. However, doesn't yet to intra-day strategies or options. Some flexibility may be lost for certain customizations.
Practical Tips for Effective Mean Reversion Trading
Mean reversion is Cesar’s bread-and-butter. I couldn't resist asking for some insights from the MR Master:
• Focus on exits and ranking, not just entries. I can attest to that.
• Constantly refine: Keep exploring new ideas, as markets evolve rapidly.
• Review execution regularly: Ensure backtested results match real-world performance closely.
Closing Thoughts
In Cesar’s words, "Quantitative trading isn’t just about being smart—it’s about being methodically and systematically smarter." Given how markets evolve, staying systematically smarter is more crucial than ever. Loved his dynamic portfolio adjustments, I'm going to explore that further!
Let me know if you have any comments or questions!
Trade Well & Prosper,
Simon
Get in Touch with Cesar