In this problem, you will develop a drawdown-based trading strategy on the NASDAQ

The problem
In this problem, you will develop a drawdown-based trading strategy on the NASDAQ by following the steps
below:
1. Collect the the historical price of NASDAQ Composite (ticker symbol ∧

IXIC) between 1971-02-0 and

2020-01-14 for your analysis 1
.

2. Identify the trough dates of all the bear and bull markets based on the NASDAQ index. For example,
there was a pull-back (drawdown) of -17.54% during 2018-09-21 and 2018-12-21, indicating a bear
market at its trough on 2018-12-21.
• A bear market: 10% pullback from peak-to-trough
• A bull market: 10% pullback from trough-to-peak.
3. Calculate correlation between the drawdowns on the trough date of a bear market and the 1 year return
afterwards (1 year is equivalent to approximately 250 trading days).

4. Conduct a linear regression analysis using bear market trough drawdown as the factor (independent
variable) to explain the 1-year returns, which is the dependent variable.
• Plot the scatter diagram
• Perform the linear regression analysis (e.g, refer to this website among many others) and summarize
the results and interpret the output
• Perform a residual diagnosis analysis (e.g, refer to this website among many others)
5. Based on the findings, we want to compare two trading ideas:
• Approach 1: Short the bear market: short NASDAQ on the trough dates of bear markets and
close the position 1-year later (i.e., 250 trading days);
• Approach 2: Long the bear market: long NASDAQ on the trough dates of bear markets and close
the position 1-year later (i.e., 250 trading days).
6. Backtest these two approaches to see which one gives you better expected risk-adjusted return measured
by Sharpe ratio, assuming the annual risk-free rate of 4% and commission fee is zero.
7. Please explain what might be the reasons that we can never implement these two trading strategies in
real markets? What potential changes would you recommend to revise these two trading strategies to
make them implementable?
2 Notes on the problem
Note that we are testing strategies on the NASDAQ, which is not tradable directly. In order to implement
these strategies, we need to utilize existing trading vehicles, such as Mutual funds or ETFs. Here are some
ETFS to long the market, and here are some Inverse ETFs (Short ETFs / Bear ETFs) to short the market.