May 27, 2015

ETF Sector Rotation – Ideas from readers

The post ETF Sector Rotation generated some good ideas on what to try differently. This post will focus on two ideas on the Select Sector SPDR ETFs. The next post will look at two ideas using Fidelity sector mutual funds.

ETF Universe

These tests will use the Select Sector SPDR ETFs. The list is

  • Consumer Discretionary (XLY)
  • Consumer Staples (XLP)
  • Energy (XLE)
  • Financials (XLF)
  • Health Care (XLV)
  • Industrials (XLI)
  • Materials (XLB)
  • Technology (XLK)
  • Utilities (XLU)

Testing will be from 2005 to 3/31/2015.

Dual Momentum Baseline

From the last post, the dual momentum gave the best results which will be our baseline. For the rules go see that post at ETF Sector Rotation

150527a

Idea1: Rank by multiple ROCs

The first idea submitted by multiple readers is to use multiple look back periods for Rate of Change.

Rules

  • Rank the ETFs by the average of the 3/6/9/12 month’s performance. Formula is (ROC 3 month + ROC 6 month + ROC 9 month + ROC 12 month)/4.
  • Buy the top 3 ETFs if the ETF average performance is greater than the average performance of the safe ETF (SHY, IEF, TLT)
  • Buy at open at beginning of the month.

Results1

150527b

The results don’t improve on the baseline.

 

Idea 2: Rank by N month return but ignore the first month

Instead of ranking on the 6 month return of the ETFS, the ranking return is calculation by ignoring the most recent month. If we wanted the 6 month rank on the ETF and today is June 30, we then use the return from Dec 31 to May 31. The idea being that one avoids ETFs experiencing a blow off. I have tested this before on different universes but with no success. Maybe it will be different on these ETFs.

Rules

  • Rank ETFs from high to low using the N month return but ignore the most recent month. If N=6, then return is from the close N months ago to the close N-1 months ago.
  • If the return during this period does not exceed the safe ETF (IEF, SHY, TLT), invest in the safe ETF.

Results 2

150527c

The top item here comes close to matching the baseline. The test includes ignoring the first month (value=1) and not ignoring it (value = 0). The results show little difference. In these cases I always go for the simpler rule, which is use the current month.

Spreadsheet

Fill the form below to get the spreadsheet with lots of additional information. This includes yearly breakdown, different maximum holdings, and additional statistics.

Final Thoughts

Unfortunately the results did not improve from what we had last time. It is always a good to test new ideas. I am always surprised but what works and what does not. Keep the research suggestions coming. The next post will focus on the Fidelity sector mutual funds.

Backtesting platform used: AmiBroker. Data provider:Norgate Data (referral link)

Good quant trading,

Fill in for free spreadsheet:

spreadsheeticon

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Ron - May 27, 2015 Reply

Great system Cesar. How do you code “If the return during this period does not exceed the safe ETF (IEF, SHY, TLT), invest in the safe ETF.” in Amibroker?

    Cesar Alvarez - May 27, 2015 Reply

    I am doing that check in the low level CBT. I store the returns of the safe ETF in a StaticVar and then access it in the CBT right before I enter the position.

    Cesar

Thomas Musselman - May 27, 2015 Reply

My test of Sector funds goes back further than the ETFs can and simply used 10 month return with a good result; did you try 10 months with the Sector ETFs?

Using Sector funds from 12/31/84 forward top 5 by last 10 month returns gave 11.86% cagr when traded every 22 days (to simulate trading monthly plus a day, to avoid any commission at Fidelity). You can go back to 7/14/1981 and still have 19 funds to choose from in a backtest (they go up to 36 funds by 10 years later and 45 funds now). The longer universe and greater # of funds makes it a better datasense IMHO.

I got 10.7% cagr for top 1 on your ETF universe 12/31/2004 forward when using a 10 month lookback (no skip months), and 11.55% cagr using a 1 month skip month.

Cesar Alvarez - May 27, 2015 Reply

@Thomas. I will be testing the Fidelity sector funds in my next post.

I did not test a 10 month hold on ETFs.

Quantocracy's Daily Wrap for 05/27/2015 | Quantocracy - May 27, 2015 Reply

[…] ETF Sector Rotation Ideas from readers [Alvarez Quant Trading] The post ETF Sector Rotation generated some good ideas on what to try differently. This post will focus on two ideas on the Select Sector SPDR ETFs. The next post will look at two ideas using Fidelity sector mutual funds. ETF Universe These tests will use the Select Sector SPDR ETFs. The list is Consumer Discretionary (XLY) Consumer S […]

mikel - May 28, 2015 Reply

Hi Cesar,

Have you put any of your ideas up on Portfolio123 or similar? Do you have a place where these can be shared/invested in publically?

    Cesar Alvarez - May 28, 2015 Reply

    I have not put these ideas on Poerfolio123 or anywhere else. These are meant to be starting points for further research. Not final resutls ready to start trading.

    Cesar

Thomas Musselman - May 28, 2015 Reply

“…combining 33 country-level sector momentum
strategies, global sector momentum long-short return spread is highly consistent over rolling 10-
year timeframes, as compared to individual asset classes.” p. 26

finding that skipping 2 recent months works only in the US; he created 10 month momentum long-short tests past those 2 months, and finds that the momentum effect lasts for 10 months for stocks (back to early 1800s), 7 for commodities (back to 1959)
He also looks at trend following (moving averages, or requiring positive returns over a period, etc.) and finds it works and is similiar but not as good as simple momentum. Outlier exclusions don’t affect test, either.

http://chicago.ssrn.com/delivery.php?ID=770086120101089000118095098074104102097019000017052006005002005125002117010120021098011033116011014051125088014101091073089103119041046028050088097085099114003103030052077045008067092093024006092082096093083078120082127017109023067113028007000081083&EXT=pdf&TYPE=2

ETF Sector Rotation – Ideas from readers | SAMUELSSONS RAPPORT - May 28, 2015 Reply

[…] Källa: | Alvarez Quant Trading […]

Kairi Gainsborough - January 5, 2017 Reply

Thanks for sharing some of your ideas about ETF trading. It’s an interesting idea to rank the ETFs while ignoring the most recent month. Why would you want to leave out the most recent data? It seems to me like you would want to look at that the most closely.

    Cesar Alvarez - January 6, 2017 Reply

    I would agree with you. This is a common thing that you see others doing. The reasoning being that last month gives more info on a mean reversion trade. I personally do use the last month’s data.

Tyler D Harris - November 1, 2018 Reply

It would be interesting to compare a momentum vs value sector rotation strategy. It would take some effort to find and test true value criteria for these ETFs, but we can assume any value criteria will generally pick lagging sectors due to the market overreacting and irrationally overselling them.

Therefore I would like to see a backtest similar to this one where the portfolio buys the one sector with the LEAST momentum (perhaps by averaging 1, 3, 6, & 12 month momentum or some combination of these) and re-balances monthly or quarterly (can be played with in the model). It would be very interesting to see how something like that measures up against these results!

    Cesar Alvarez - November 1, 2018 Reply

    I like the idea. I will put into the potential future post list.

Sean Gallagher - December 8, 2018 Reply

Thank you for your work. Is it possible to post the afl code for this? Thanks in advance.

    Cesar Alvarez - December 8, 2018 Reply

    I am sorry but I do not provide code.

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