In order to develop profitable trading strategies, it is essential to know the characteristics of the markets on which you want to operate. Usually the strategies that we at the Unger Academy show are created on futures, which have various advantages for systematic trading. In this article, however, we will focus on the stock market and, more specifically, on a single stock, namely TSLA (Tesla). It is one of the best known and most capitalized companies in the world, which operates in the field of renewable energy, electric vehicles, robotics and artificial intelligence. The objective will be to discover which edges we can systematically exploit on this stock.
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Characteristics of TSLA, Tesla’s stock
This is a particularly volatile stock, which is often referred to as one of the “hot stocks” of recent years, i.e. those stocks with excellent performances and for which there is a lot of demand from investors. In fact, it is a title that over the years has accustomed us to dizzying performances. In 2020, for example, the value of TSLA increased by 743%. Unfortunately, the performances of the last two years have not been up to the previous ones. In fact, TSLA is currently far from the highs reached in November 2021, a level from which the stock suffered a decline of over 75% which led it to reach the relative low of the beginning of 2023.
Given the explosive characteristics of this instrument, we proceed by developing a trend following strategy with the aim of riding and profiting from these violent price excursions. To do this we will use a very well-known indicator among traders and technical analysts, namely the Parabolic SAR.
Figure 1. Buy & Hold trend of Tesla shares (TSLA).
Parabolic SAR Indicator Logic and Application to Tesla Stock (TSLA)
The Parabolic SAR is an indicator created by Welles Wilder that allows you to identify market trends and reversal points. On major trading platforms the indicator is usually depicted as a series of dots located below or above the price line. If the points are below we will be facing a bullish trend while if they are above we will be facing a bearish trend.
To be able to calculate it, we first need what is called the “extreme point” of the previous trend, which we can observe in Figure 2. Once this point has been identified, the value of the indicator begins to increase or decrease (based on the trend trend) by 2% until reaching a maximum increase of 20%.
Figure 2. Graphic representation of the Parabolic SAR indicator with identification of the extreme point.
Settings and structure of the trend following trading system on Tesla shares (TSLA)
Let’s move on to the next step: creating the strategy. Considering that our intent is to develop a trend following strategy, and keeping in mind that stock markets tend to rise in the long term, we could operate on a 60 minute time frame by placing buy stop orders on the Parabolic SAR levels in the phases of a bearish trend. In this way we will enter a position trying to ride the trend when it reverses its direction. As for the opposite signal, instead of reversing the position by opening a short one, we will proceed by closing the long position.
Note that by using this exit technique we will be using a sort of trailing stop. In fact, since the value of the Parabolic SAR increases based on the trend trend, the stop loss will be automatically readjusted, effectively protecting profits.
A limitation of this operation may be associated with particularly volatile days that do not show a precise trend. In these cases the risk is that the trend frequently reverses direction, generating false signals. Furthermore, in order to compare results correctly over the years, we will purchase shares worth $10,000 instead of buying a fixed quantity of contracts.
Results of the trading system applied to Tesla shares (TSLA)
Taking a look at the results of this simple strategy we notice an excellent performance from the start. The backtest shows a net profit of approximately $61,000 with a maximum drawdown of $7,000, leading the strategy to have an excellent ratio between these two metrics, i.e. an 8.71. As regards the average trade of the strategy, we note a value of $70, which represents approximately 0.7% per trade considering that the backtest was carried out with a capital per trade of $10,000. This is already large enough to cover operating costs. However, we will attempt to further refine this strategy.
Figure 3. Equity Line of the trend following trading system on Tesla shares (TSLA).
Figure 4. Performance Report of the trading system on Tesla shares (TSLA).
Figure 5. Total Trade Analysis of the Tesla share trading system (TSLA).
Application of an operational filter to exclude false signals and improve the effectiveness of the system
As mentioned previously, by using this strategy we are limited to days of high volatility in which the price lateralizes without taking a specific direction. At this point we could insert a simple condition to filter some entries, that is: if in the current session we have already exited a long position, we will stop trading until the next session. In fact, as we can see from Figure 6, due to the way this strategy was designed, an exit coincides with a reversal of the trend, and if the price reverses again within the same session, we are most likely finding ourselves in one of those days when it would be wiser to avoid operating.
Figure 6. Second Parabolic SAR signal within the same session.
Analyzing the performance of the strategy after inserting this simple operational filter we notice an excellent improvement. The equity line is more linear than the previous strategy, and this is also confirmed by the net profit to drawdown ratio, which went from 8.71 to 10.32. This increase is certainly due to an improvement in the drawdown, which fell from the $7,000 of the previous strategy to around $5,400. Unfortunately, regarding the net profit there was a small deterioration of around $5,000. This decline is certainly due to the fact that, using an operational filter, the number of trades carried out was reduced. Over the years the strategy would in fact have carried out 689 trades, or approximately 200 less than the previous version. But we find the positive aspect by analyzing the average trade, which instead increased from $70 to as much as $81.
Figure 7. Equity Line of the trading system on Tesla shares after adding the operational filter.
Figure 8. Performance Report of the trading system on Tesla shares after adding the operational filter.
Figure 9. Total Trade Analysis of the Tesla stock trading system after adding the operational filter.
Final thoughts on the Tesla stock trading system (TSLA)
In this article we have shown how it is possible to systematically profit from stocks. Obviously the work shown here is not yet complete. First of all, the strategy could be further refined by applying, for example, better risk management, calculating the capital to be dedicated to each trade based on the percentage distance between the entry price and the extreme point of the Parabolic SAR. But above all, since it is a long-only system on one stock, it is essential to diversify our portfolio to avoid our performance being linked to the performance of just one stock. Finally, it must be considered that, due to the way the strategy is set up, a capital of $10,000 is invested per trade, but by reinvesting the profits generated from time to time the results would improve, in terms of net profit, by as much as 12 times.
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Good work!
Andrea Unger