Validating Use of Wilder Volatility Stops to Time the U.S. Stock Market

Can investors reliably exploit the somewhat opaquely presented strategy summarized in “Using Wilder Volatility Stops to Time the U.S. Stock Market”, which employs Welles Wilder’s Average True Range (ATR) volatility metric to generate buy and sell signals for broad U.S. stock market indexes? To investigate, we each trading day for the SPDR S&P 500 ETF Trust (SPY):

1. Compute true range as the greatest of: (a) daily high minus low; (b) absolute value of daily high minus previous close; and, (c) absolute value of daily low minus previous close.
2. Calculate ATR as the simple average of the last five true ranges (including the current one).
3. Generate a Wilder Volatility Stop (WVS) by multiplying ATR by a risk factor of 2.5.
4. When out of SPY, buy when it closes above a dynamic trendline defined by a trend minimum plus current WVS (breakout). When in SPY, sell when it closes below a dynamic trendline defined by a trend maximum minus current WVS (breakdown).

We perform the above calculations using raw (not adjusted for dividends) daily SPY prices, but use dividend-adjusted prices to calculate returns. We assume any breakout/breakdown signal and associated SPY-cash switch occurs at the same close. We initially ignore SPY-cash switching frictions, but then test outcome sensitivity to different levels of frictions. We ignore return on cash due to frequency of switching. We further test outcome sensitivity to parameter choices and to an alternative definition of ATR. We use buy-and-hold SPY as a benchmark. Using daily raw and dividend-adjusted prices for SPY during January 1993 (inception) through most of October 2024, we find that: (more…)