Exploring Relative Strength Systems with These 11 ETFs

With markets roaring back and the SPY having broken $110

for the first time in over a year just moments ago, it seems that Relative Strength Rotation methods have come back into vogue.

There are literally dozens of ways to define relative strength, and it is important to recognize that different computations will serially and stably outperform their peers during various behavioral epochs. Furthermore, inflection points can be harsh using this method. Various smoothing methods, use of multiple time frame references, and standard money management techniques can be a big help with that. All in all, it's a hard strategy to beat over time for those interested in always being invested.

Below I present two very basic mechanical trading systems employing rankings of current price divided by variously weighted simple moving averages among the selected ETFs. (The specific relative strength readings for which are provided every night in ETF Rewind* under the "Weighted Strength" column.)

Asset Class Rotation

The chart below indicates the equity curve that would have resulted from rotating into the single top performing major asset class ETF among the SPY, EFA, EPP, EEM, DBC and AGG, as ranked according to relative strength, then re-balancing weekly on a simple/ non-compounded basis, with no friction/ trading costs assessed.

Click to enlarge:

The compound average annual growth rate for the nine-year study period would have been +10.7% with a simple Sharpe Ratio of +0.5 and a maximum peak-to-valley draw down of -19.4% (versus the S&P500's -51.8%). The equity curve is not optimized in any way, and involves no use of leverage or shorting: This is merely an extremely simple macro-asset-class switching method.

Currency Rotation

As currencies have been highlighted in the news lately, attached is a graphic highlighting another simple strategy rotating into the top two performing Currency ETFs among UUP, FXA, BZF, FXE and FXY, re-balancing weekly on a reinvested/compounded basis, with no friction/ trading costs assessed.

Click to enlarge:

The compound average annual growth rate for the

three-year

study period would have been +14.2% with a simple Sharpe Ratio of 2.4 and a maximum peak to valley draw down of -8.9%.

Conclusion

At the very least, relative strength systems can provide natural stops for equity traders and additionally inform them as to which classes, sectors, styles and countries are running hot or cold in the current market environment. At their best, they can make for powerful trading systems in their own right.

Comments

[Baboon:]

Whether the 'relative strength' rotation method outperforms the plain vanilla buy and hold asset allocation ( rebalanced once a year ) that's another story.

Oct 20 04:13 AM

[jgpietsch:]

a) EEP is a typo, should read EPP

b) The orange S&P line may be considered buy and hold.

Oct 20 10:43 AM

[sdfsdf:]

How did you pick these five or so ETF's out of all that are available. Is there a method to identify which ones should be picked and as you said there are several measures of RS out there which one did you use? Would I be able to construct such a screen on lets say yahoo or msn?

Oct 20 01:33 PM

[Augustus:]

The orange line only represents a buy and hold of the S&P. Can you write exactly why that should be used as the benchmark? What would cause you to change to another benchmark?


On Oct 20 10:43 AM jgpietsch wrote:

> a) EEP is a typo, should read EPP
>
> b) The orange S&P line may be considered buy and hold.

Oct 21 12:15 AM