Sector Rotation Strategy: Should Trading Rules Make Sense?

I was doing my usual reading when I came across a sector rotation strategy. I have seen lots of these strategies but this one had a different twist. The strategy was a momentum strategy but instead of buying the top three, it was buying the middle three. The article gave no reason other than it works and gives the best results.

In general, people fall into two camps about trading rules.

1. The trading rules need to make sense on why they are there.
2. Don’t care about the rules if the stats are good and over-fit tests pass.

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Reducing Whipsaws When Using 200-day Moving Average for Market Timing

I was working on testing a market timing indicator that I read about it. It was showing some promise and the next step was to compare it to my benchmark. My benchmark is using the 200-day moving average. But an additional rule removes a lot of the whipsaws that can happen.

After doing the comparison, the market timing indicator compared well. But then I realized I had not written a blog post about my additions. I touched on it in the Market Timing with a Canary, Gold, Copper, LQD, IEF and much more post.

For me, the goal of using the 200-day MA to trade the SPY is to get about the same CAR but with a significant reduction in MDD.

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VIXY & SVXY Strategies

My recent research has been on the volatility Exchange Traded Products. My focus has been on long trades using VXX and XIV. Although VXX has a very strong downtrend, I am not a fan of developing short strategies on it due to the huge upside risk.  I wrote about XIV here and expressed some of the dangers of trading these ETFs.

UPDATE: These original results were published on October 26, 2016. Since then there have been lots of changes in the volatility ETFs/ETNs. Scroll down to Updated Results Through June 30, 2023 to see the updated results.

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Efficiency Ratio and Mean Reversion

While reading the January 2023 issue of Technical Analysis of Stocks & Commodities, I came across an article about Efficiency Ratio (ER) by Perry Kaufman. In the article, he discusses using ER to decide when to trade mean reversion strategy vs a trend following one.

My curiosity on this was could I use the ER to filter trades in my mean reversion strategies.

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Volume and Mean Reversion Part 2

From the Volume and Mean Reversion post, a reader sent a suggestion to instead use the ratio of 10 day moving average of the Close times Volume divided by the 63-day moving average of the Close times Volume (CV10/63). I had not tried this before and wanted to see how well it would work.

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Volume and Mean Reversion

Overall, I have had very little success integrating volume into any of my strategies. Either volume would have no predictive value or if it did, using it reduced the number of trades too much to be worthwhile. It has been a long while since I have looked into this and I had some new ideas.

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Mean Reversion Check Up 2022

A common question I get is whether mean reversion is still working. My response is I am still trading a mean reversion strategy but the edges seem to get smaller. Over the year I have investigated this. I was asked again recently and wanted to investigate again. Here are the results of my 2022 investigation.

The Rules

Test date range 1/1/2000 to 9/30/2022. I wanted to keep the rules simple. I tested various ways with the 200-day moving average. The reason for this is that some people only trade stocks above the 200, while I like to trade without. In general, this will have more volatility but better returns.

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Three Factor ETF Rotation Strategy

I am drawn to ETF rotation strategies. What likely draws me to them is that in general, these are simple strategies that do not trade that often. My goal with these strategies is to match buy and hold with less drawdown.

What follows is a strategy I have known about for a while and tested but never written about.

Correction on January 18, 2023

This post was corrected on January 18, 2023, after an error was discovered in the code. What is rare, the results with the correct code are better.

The Concept

From a set of ETFs, select the one to three that have had the best short-term return, best mid-term-return with the least volatility.

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Avoiding Volatile Trades

In my last blog post, Using Historical Volatility for Parameter Adjustment, I tested using historical volatility to determine trade rules. While reading the July 2022 Technical Analysis of Stocks & Commodities, I came across an article, “Is It Too Volatile To Trade?” by Perry Kaufman. I always like his work so I was interested to see what he had to say. He uses standard deviation from the median historical volatility to decide if a stock is too volatile. He points out that even though returns may be positive during volatile times, it comes with higher risk.

From my own research, I frequently use historical volatility (HV) in my strategies. Most of the time focusing on high HV because these are the stocks that are moving. But when I am trying to tame down drawdowns, I change the focus to low HV stocks. Kaufman’s concept is similar but not something I had tried.

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Using Historical Volatility for Parameter Adjustment

The AllocateSmartly website often has interesting posts. Recently I was reading the article Trending Fast and Slow and thought about other ideas to test. The article is based on research on trading the SPX and depending on the current historical volatility one would either use a 12-month or a 1-month lookback to decide whether to enter or exit the trade. I had tried similar ideas before but not this one.

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