John Ehlers Trading Strategy: The Instantaneous Trendline with Backtest

Today we want to delve into John Ehler’s Trading Strategy and an indicator created by this famous author to investigate financial instruments quantitatively.

In August 2006, John Ehlers published an article in Stocks & Commodities titled Modeling The Market = Building Trading Strategies writing about the Instantaneous Trendline. We want to backtest and see how one trading system suggested in the article would have performed on nearly 17 years of out-of-sample data.

Finally, we will propose using the Instantaneous Trendline indicator created by John Ehlers.

However, if you want hundreds of other short term trading strategies, please check out other articles.

Who is John Ehlers?

In the trading community, John Ehlers is well-known name. He is a prolific author of quantifiable indicators to analyze financial price series data.

Ehlers is an electrical engineer specializing in Fields, Waves, and Information Theory who became a private trader in 1976. He became famous for developing and publishing indicators based on the application of concepts from his field of studies to the financial markets.

Backtesting the works of John Ehlers

While John Ehlers has written many books and articles on his indicators, we do not find these texts supplemented with corresponding backtests and equity lines.

So we decided to take one of his published articles and backtest the trading system he suggested after many years after its publication. The article we are referring to is the one that appeared in January 2006 in Stocks & Commodities.

What is the Instantaneous Trendline?

The basic idea is that a price series comprises a trendline and a cyclical curve. The aim is then to decompose the price data series to get a clear direction by looking at the trend component and to get reversal points by looking at the cyclical component. The math behind these analyses isn’t simple, so let’s skip it.

Let’s illustrate the main idea in a simplified way:

The primary step is to filter the cyclical component of the dominant cycle by applying a simple moving average over its period. Doing this removes frequencies equal to and greater than the dominant one.

What remains after filtering is the Instantaneous Trendline. The real implementation is more complex and with additional hints. But still, the main parameter is the period of the dominant cycle.

John Ehlers writes that the value of this parameter varies over time, but since taking this into account is complex, he suggests using a constant value. For the daily data series of ES-mini futures, Ehlers indicates to use a value of 15 periods.

Backtesting John Ehlers Instantaneous Trendline

Ehlers suggests that we can get a trend following trading system if we go long when the Instantaneous Trendline crosses a repeat of itself, lagging a bar or two, and go short when the Instantaneous Trendline crosses below it.

Ehlers also points to other trading system ideas. But he does not provide any backtests, performance statistics, or equity lines for the suggested trading systems.

So now let’s backtest the trend follower trading system by applying it to both the back-adjusted ES-mini futures contract and SPY using daily bars. The results should be reasonably similar for both the futures contract and the ETF, given that the futures contract uses the same open and close time. We use a parameter of 15 for the dominant cycle length for both.

The trading rules for John Ehlers trading strategy

We use the following trading rules to backtest the trading strategy (if you want the code for the strategy, it’s included in our Silver membership):

Buy = Cover = Cross(ITrend, Ref(IT