Regime Filters: Teaching a Strategy When to Sit Out

[Fairman]

Regime Filters: Teaching a Strategy When to Sit Out

Most strategies work in one type of market and struggle in others. A regime filter is a rule that tells you which conditions are suitable, and lets you skip the rest.

Common regimes include trending, ranging, high-volatility, and low-volatility markets. A trend strategy wants trending conditions, and a mean reversion strategy wants ranges.

Several simple filters exist. ADX above 25 indicates a trending environment, below 20 a ranging one. ATR relative to its longer-term average shows whether volatility is elevated or depressed. The slope and position of a long moving average, such as the 200, reflect trend direction. Bollinger Band width signals compression or expansion.

Apply the filter before the signal. For example: take breakout signals only when ADX is above 20 and rising, and take range-fade signals only when ADX is below 20.

Filters reduce the number of trades, and the skipped periods are those where your strategy has no edge. Test whether the filter improves results out of sample, rather than assuming.

Avoid stacking too many filters. Each one adds a parameter and a risk of overfitting.

Sometimes the best regime filter is the calendar, avoiding trading around high-impact news or illiquid holiday periods.

Practical step: label each trade in your journal with the regime at entry and compare results by regime.

[Fairman]

Simplest filter I've used: is the daily ATR above or below its 20-day average? Not fancy, but it splits sessions into quiet and active pretty well and some setups clearly prefer one or the other.

[Fairman]

Labeling each trade with the regime is the bit most people skip. Do it for a month and you'll often find your losses are bunched in one condition.