In this month's issue, author Ron McEwan presents a simple, intuitive yet seemingly effective new indicator whose purpose is to act as a filter in a trading strategy, facilitating it to adapt to changing market conditions. A change from a trending mode to a mean reverting one is measured through a ratio dividing the number of bars when the Historical Volatility (HV) of the daily close price change in a given lookback period was lower or equal to today's daily ROC's HV.

To take advantage of Volatility Switch in Wealth-Lab's charts, code- and interactive rule-based strategies, all it takes is to install (or update if you haven't done that already) the TASCIndicators library from the www.wealth-lab.com site to its latest version.

To illustrate the application of the new regime filter, we created a demo system that takes entries and exits depending on the market's volatility switch state: above 0.5 it's considered choppy with a potential for mean reversion, and at or below 0.5 it's more likely to trend.

Entry rules

• If volatility switch is in trend mode, buy at market next bar when today's close crosses above the 10-day simple moving average of close price

• If volatility switch is in mean reversion mode, buy at market next bar when the 7-day RSI crosses above 30

Exit rules

• If volatility switch is in trend mode, sell at market next bar when today's close crosses below the 10-day simple moving average of close price

• If volatility switch is in mean reversion mode, buy at market next bar when the 7-day RSI crosses below 60

We ran a backtest with $10,000 per trade on 5 years of SPY's Daily data. With real world position sizing and trading costs rules applied, the simplistic system was able to beat Buy&Hold, returning a 26% net profit figure (vs. -6%), proving that the regime switch filter can become a valuable addition to a trader's arsenal.