Tuesday, March 14, 2017

How to test a Sector Rotation strategy

This is the last chapter of the book Sector Rotation: 3rd Edition (from Amazon) summarizing the strategies. We have a total of 12 strategies not including Andrew’s: Buy strong sectors which have pulled back onto support and avoid overbought sectors at resistance and using Elliott Wave.

Some strategies use market timing: When the market is plunging, most sectors will be down and most contra ETFs will be up. Daily news would affect sector performance.  Which strategy works best today? The following is a suggestion using two tests.

Test without a historical database

Even with a historical database, this test is useful as most vendors do not include all metrics from finviz.com or other sources such as RSI(14), SMA20, SMA50, Rel. Volume and EPS Q/Q. Select the two best-performed sectors from many sources from last month and include the above metrics in a spreadsheet or on paper. Test how the metrics performed. Perform this test at least once a month. Only invest with real money when you’re satisfied with the result. The market may change so are the results.

Test with a historical database

Many vendors provide a historical database and usually at a fee. The following are guidelines for your own implementation.

·         Include a list of ETFs and you can find them in the chapter on sector ETFs and other ETFs such as bond ETFs, SPY and DOW. Include contra ETFs that should perform well in a down market. Include country ETFs if you use country strategy.
·         Define the test period. I use Jan., 2007 to Jan. 2017. I have two tests a year. If you have more time, start from 2000 and have 12 tests a year instead of 2.
·         Duration is one month; I add two months as my annuity allows switching for holding 61 days without a penalty.
·         Use annualized rate of return and compare it to SPY if they’re available.
·         I select two of the best-performed ETFs and get the annualized returns.
·         Average the totals and see how the strategy performs. The last three months may be more important than older results. When the market plunges, buy contra ETFs such as SH.

My vendor’s timing grade does not perform so I stick with mine described above.  Dividends are not considered.

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