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How To Develop A Sector Rotation Strategy

In this post i will share with you some of my investment strategy development experience .

First some basic terminology :

Sector rotation -sector rotation is the act of shifting (investing) your money from one sector of the economy to another .

ROC = rate of change = [(Close - Close n periods ago) / (Close n periods ago)] * 100

We will trade the following Fidelity sector funds ,each represent a deferent sector :FSCPX , FSPTX ,FSPHX,FSDPX,FSUTX,FRESX,FSRFX,FCLTX .

The strategy :Selecting the fund with highest ROC score, and holding it for 4 weeks.

we will start with ROC(4) - that means we will peak the fund with highest 4 weeks rate of change .

Strategy1 results 1994-2013 :

annual return : 8.85%

sharpe ratio : 0.26

Max system drawdown : -58.09%

We can see that this strategy is not giving us very good results .

lets try to use ROC(12) - that means we will peak the fund with highest 12 weeks rate of change .

Strategy2 results 1994-2013 :

annual return : 9.82%

sharpe ratio : 0.29

Max system drawdown : -60.61%

Results are a little better but still Max drawdown is very big.

Lets try and reduce Max drawdown by adding a bond fund : VBMFX this will enable the strategy to rotate to safer assets (bonds) during bear market, we will still be using ROC(12).

Strategy3 results 1994-2013 :

annual return : 8.58%

sharpe ratio : 0.27

Max system drawdown : -43.14%

we managed to decrease the drawdown but the annual return also went lower.

Now lets try to twist the strategy a bit and get a better return ,

Instead of using ROC(12) i will use ROC(12) delayed by 4 weeks, that will lower the chances of peaking sector which had very high positive momentum in the last 4 weeks which usually leads to negative price correction.

Strategy4 results 1994-2013 :

annual return : 11.8%

sharpe ratio : 0.41

Max system drawdown : -39.29%

Wow , now we can see a change , the annual return and the sharpe ration are much better, even the drawdown is a little better.

It is still far from being a strategy i will put my money in but it is a nice learning experience.

Hope you enjoyed it,

Elran

www.alphaassetallocation.com

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.