By Paul Dunn
In a prior article, we showed how a stop loss could be combined with a simple moving average (or SMA) to achieve higher returns while also limiting drawdowns, as compared to a buy-and-hold strategy. A key concept of the first article was the idea of providing an "alternate" ETF to the ETF targeted for trading. This article expands on that idea to show how to use a larger collection of ETFs, again with a stop loss and SMA. The result is an overall performance that exceeds most (if not all) of the individual ETFs during the period, and with substantially less drawdown during the 2008 financial crisis.
(This does not represent the strategy employed by SimpleAllocation.com in our proprietary model. This is a greatly simplified model, lacking some key benefits and analysis. However it is educational, and useful for investors who chose to not use our proprietary model.)
In the prior article, we selected one ETF for trading, and showed how providing one conservative alternate generally created higher returns. For this article, we will instead start with a collection of 35 ETFs that represent a range of 25 different fund categories. These categories are quite diverse, and represent a broad selection of stock and bond funds. (A full symbol list is included at the bottom of the article.)
In this article, we will again use a moving average on normalized price slope, combined with a stop loss, to make all trading decisions. The stop loss used is a 10% tracking stop loss (tracking, split and dividend adjusted**). Trading decisions are made on a fixed period. On the last day of each period we check the moving average of the normalized price slope for all of the ETFs, select the 5 ETFs with the highest value, and invest 20% of the account in each of these 5 ETFs. When a stop loss is hit, no reinvestment takes place until the start of the next investment period.
We will present one case: a monthly trading period, combined with a 100 day SMA, applied to our list of 35 funds. (All trading decisions are made on the last trading day of each month; closing prices are used in calculating returns.)
The chart below shows the results, with data starting on 02-JAN-2002. (It should be noted some ETFs included in this analysis did not exist in 2002, but they were included as they became available.) The results for each individual ETF are show, as well as the results for our proposed strategy in bold red (labeled SmpAllc). In all cases, we have modeled the results for a hypothetical account starting with $100K.
Results - 100 Day SMA
First, it needs to be pointed out that several of the funds that appear to have outperformed the strategy from 2003-2007, did not have data prior to the mid-2003. Thus they started with the same initial balance of $100K, but after the funds which did exist earlier had already suffered losses during the end of the 2001-2003 bear market. The important takeaway is that, over the long run, the diversification and stop loss pay off. The result is an overall performance that exceeded most (if not all) of the individual ETFs during the period, and with substantially less drawdown during the 2008 financial crisis.
We think this is an important demonstration of how some simple rules eliminated the time consuming search for the best funds, and replaced that with an algorithmic approach that forced some amount of diversification, limited drawdowns, and had excellent return.
The current allocations are shown below.
|VWO||20%||Diversified Emerging Mkts||Vanguard FTSE Emerging Markets ETF (NYSEARCA:VWO)|
|VOE||20%||Mid-Cap Value||Vanguard Mid-Cap Value ETF (NYSEARCA:VOE)|
|IDV||20%||Foreign Large Value||iShares Dow Jones Intl Select Div Idx (NYSEARCA:IDV)|
|SCZ||20%||Foreign Small/Mid Blend||iShares MSCI EAFE Small Cap Index (NYSEARCA:SCZ)|
|EFA||20%||Foreign Large Blend||iShares MSCI EAFE Index (NYSEARCA:EFA)|
We have shown how using a SMA, combined with a stop loss, can be an effective tool set to allow an investor to allocate from a selection of ETFs and generate an overall return better than most of the individual ETFs, while also lowering the volatility and drawdowns. Previously, we showed how an investor can trade individual ETFs using a similar strategy.
Between these two strategies, an investor can either trade individual ETFs that they believe are set to outperform, or use a more diversified approach and benefit from (automated) diversification and a stop loss. Even without the additional complexity of the SimpleAllocation.com proprietary model, these strategies are solid performers.
Thanks for reading!
** Tracking, split and dividend adjusted stop loss - "Tracking" means that the stop loss tracks upward movements, and applies to the highest price since purchasing the security. "Dividend adjusted" means that you adjust price changes for dividends. The "adjusted price" quoted on many websites is just that, dividend and split adjusted.
Disclaimer - Simple Allocation LLC and SimpleAllocation.com do not advise the use of this strategy for anyone. Past performance of any trading strategy is not a predictor of future returns. Check with your financial and investment advisors prior to any trading.
Disclosure: I am long SCZ, VOE. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.