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Proxy Financial Stress Index Strategy

This strategy is based on a Proxy Financial Stress Index constructed using several key financial indicators. The strategy goes long when the financial stress index crosses below a user-defined threshold, signaling a potential reduction in market stress. Once a position is opened, it is held for a predetermined number of bars (periods), after which it is automatically closed.

The financial stress index is composed of several normalized indicators, each representing different market aspects:

VIX - Market volatility.
US 10-Year Treasury Yield - Bond market.
Dollar Index (DXY) - Currency market.
S&P 500 Index - Stock market.
EUR/USD - Currency exchange rate.
High-Yield Corporate Bond ETF (HYG) - Corporate bond market.

Each component is normalized using a Z-score (based on the user-defined moving average and standard deviation lengths) and weighted according to user inputs. The aggregated index reflects overall market stress.

The strategy enters a long position when the stress index crosses below a specified threshold from above, indicating reduced financial stress. The position is held for a defined holding period before being closed automatically.
Scientific References:

The concept of a financial stress index is derived from research that combines multiple financial variables to measure systemic risks in the financial markets. Key research includes:

The Financial Stress Index developed by various Federal Reserve banks, including the Cleveland Financial Stress Index (CFSI)

Bank of America Merrill Lynch Option Volatility Estimate (MOVE) Index as a measure of interest rate volatility, which correlates with financial stress

These indices are widely used in economic research to gauge financial instability and help in policy decisions. They track real-time fluctuations in various markets and are often used to anticipate economic downturns or periods of high financial risk.