Strategy Design And Performance
The Asset Class Rotation System rotates between 9 ETFs that represent some key asset classes.
- SPDR S& P 500 for big stocks in the U.S.
- iShares Russell 2000 Index Fund for small U.S. stocks
- iShares MSCI EAFE for international stocks in developed markets
- iShares MSCI Emerging Markets for international stocks in emerging markets.
- PowerShares DB Commodities for a basket of commodities
- SPDR Gold Trust for gold
- Vanguard MSCI U.S. REIT for REITs
- iShares Barclays Long-Term Treasury for long term treasury bonds
- Barclays Low Duration Treasury for short term Treasury bonds
In order to be eligible, an ETF has to be in an uptrend, meaning that the current market price is above the 10-month moving average. If no ETF is in an uptrend, the system goes for the safest asset in the group, which is Barclays Low Duration Treasury.
Among the ETFs that are in an uptrend, the system buys the top 3 with the highest relative strength. Relative strength is measured by a ranking system that considers total returns over 3 months and 6 months, and it includes volatility as a negative factor.
The ETF portfolio is rebalanced monthly, and the benchmark is a globally diversified portfolio that is allocated 60% to stocks and 40% to fixed income.
Since January of 2007, the Asset Class Rotation strategy has produced a cumulative return of 332% versus 95.6% for the benchmark in the same period. In annual terms, the strategy gained 12.3% per year, more than double the 5.5% produced by the quantitative strategy.
Relative Strength Strategies For Investing
How Does Relative Strength Work
Now that we have understood what RS actually means and how we can calculate the same, let us discuss how we can trade stronger stocks using RS with the help of an example-Reliance India Ltd.
In the above daily chart of Reliance India Ltd. We have plotted the RS line compared to Nifty 50 of the last 55 periods.
One should note that when the RS line crosses above 0 then we can say that the stock is outperforming the index and when it crosses below 0 the stock is underperforming the index. So, from the above chart, we can see that on 24th March, how the RS line crossed the 0 line when the bullish phase of the stock started. This shows that the stock is getting strong and outperforming the index as the prices are moving up. Traders can ride the trend and gain profits till the RS line goes beyond the 0 line.
One should also note that traders should also use other technical indicators such as supertrend, moving average, volume etc. along with the RS line. Also using point and figure charts will help the traders to filter out noise in the market.
But the question comes how we identify the stocks that crossed the 0 line and are either outperforming or underperforming the index or the sectors. For that, we can take the help of StockEdge.
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Learning From Mebane Faber’s Relative Strength Strategies For Investing
The paper explores Relative Momentum strategy on Equities Sectors.
In this article, Absolute Momentum will be used interchangeably with trend following or time series momentum. Relative Momentum will be used interchangeably with cross-sectional momentum or relative strength.
The paper explores investing in sectors based on Relative Momentum. The paper explores various permutations, investing in the top 1, 2, 3, up to 9 sectors on equal weighted basis. Relative Momentum method works on all of the measurement periods from one month to twelve months, as well as a combination of the 1, 3, 6, 9, and 12 month time periods. As investing in Equities Sectors is inherently high risk with high max drawdowns, the resulting performance of a Relative Momentum strategy on Equities sectors also displays high max drawdowns.
To reduce the max drawdowns, the holdings can be moved entirely to 100% cash when the S& P 500 is below its 10 month Simple Moving Average .
What Is Relative Strength In Investing
Relative strength is a strategy most commonly used in identifying value stocks and in momentum investing . It focuses on investments that have performed well compared to the market as a whole or a relevant benchmark.
In relative strength investment strategies, the goal is not to buy low and sell highthe goal is to buy high and sell even higher. Relative strength investing relies on the basic assumption that current market trends will continue long enough into the future for investors to capitalize on them. This means that the strategy works best in stable markets with minimal disruption. Otherwise, any sudden disruption will lead to negative results.
Like the Great Recession, for example. In a period of extreme turbulence, investor psychology flips on its head and yesterdays great investments are cast away.
Because its most often used in momentum investing, the strategy is most commonly associated with individual stocks. However, you can use index funds or exchange-traded funds to apply the strategy to a complete market or sector. But as a strategy, you can apply it to other investments if you know how to use it correctly.
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Relative Strength Index Vs Stochastic Oscillator
RSI is sometimes confused with stochastic oscillator, another type of momentum oscillator. They have similar objectives , but the underlying theories are quite different.
A stochastic oscillator is a momentum indicator that compares a securitys closing price to its price range over a period of time. Like RSI, its range-bound, meaning the result is always between 0 and 100, which makes it useful for identifying overbought and oversold conditions. Similar to RSI, readings over 80 are considered overbought and readings under 20 are considered oversold. It can be especially confusing because the basic overall theory resembles RSIif the market is trending up, prices close high, but if the market is trending down, prices close low.
However, despite apparent similarities, the two indicators use different measurements and assumptions. RSI tracks the velocity of price movements to track overbought and oversold market levels. A stochastic oscillator is calculated on the assumption that closing prices should confirm the current trend.
What To Buynot When To Buy
We continually scan for high relative strength stocks to always know the best stocks for swing trading.
However, note that relative strength is only for finding the right stocks to buynot for determining when to actually buy.
For example, after our Relative Strength Watchlist is in place, the Morpheus swing trading strategy relies on price, volume, and basic chart patterns to find ideal buy entry points.
Although we look for relative strength on the daily and weekly time frames, note that relative strength works just as well for shorter time frames .
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Global Cape Model Optimization
We use the Shiller CAPE Model proposed by Mebane Faber as a template for the exploration of a variety of portfolio optimization methods. By virtue of the Models systematic allocation to the cheapest markets with the highest theoretical risk premia, the model has the potential to extract high costs from behavioural taxes related to the models extreme volatility and drawdown character. We apply several portfolio optimization techniques with the objective of maximizing portfolio Sharpe ratios and minimizing drawdowns, including dynamic volatility weighting, risk parity, target risk and minimum variance. Consistent with recent published research on robust portfolio optimization, return to risk ratios improve broadly, with the greatest impact achieved from procedures that manage positions and/or portfolios to an ex ante target volatility. A theoretical framework is also proposed.
Definition And Examples Of Relative Strength
Relative strength is a measurement used by day-traders to evaluate the performance of a stock. It tells a trader how a stock’s price trend compares to trends in the market, an index, or a stock.
Learn what a stock’s relative strength is, how to calculate it, and how to use it when trading.
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Politics And Profit: Combining The Presidential Cycle And The January Effect
Does the intersection of two market anomalies set the stage for outsized performance? The first is what is known as the Presidential Cycle. This theory goes that equity returns during the third and fourth years of a Presidents term are more favorable than the first two years. A second market bias is the large outperformance of small cap stocks in January. Historically small caps outperformed large caps in 80% of all Januaries by 3 percentage points per year. Historically across the 48 months in the four year cycle the January of Year 3 is the single biggest outperformer with median returns since 1927 of nearly 8% a month for small caps. Does this mean that January is guaranteed to be great? Again, nothing is guaranteed Year 3 Januaries have varied from 27% to down 10%. While many of these tendencies are just that, investors can view them as head or tailwinds that could give bulls and bears pause.
Finding Rsi Indicator Settings
For every platform, the settings may be different. However, most platforms should have an RSI indicator.
Once you find the RSI indicator in your platforms indicator index, you can edit the settings according to whichever relative strength index trading strategy you want to employ.
In the screenshot above, you can see inside the TradingSim RSI settings. The default parameters are usually set for a 14 period and 80/20 upper and lower threshold.
Within, you can change the period from the standard 14 to whatever you prefer. You can also change the overbought and oversold parameters as you wish.
To that point, well discuss different RSI trading strategies that may require you to modify these settings.
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Growth Stock Investing: Putting The Rs Line To Use
There are certain junctures in stock charts where a stock’s strength relative to the overall market is telling.
- Breakouts: You’d like to see a relative strength line making new highs as a stock breaks out, or even before a breakout. That’s ideal. Sometimes, such as when a stock makes a big move out of a deep base, the RS line is not actually seizing new highs at the breakout. But the direction particularly before the breakout can be an important indicator, corroborating the strength of a stock as you prepare to make an initial buy.
- Follow-on buy patterns: The RS line is also a good secondary reference when deciding whether and how much to buy as a stock enters buy zones in three-weeks tight or 10-week support situations. A lagging RS line counsels a more cautious approach.
- Topping behavior: After a lengthy rally, a stock may send some topping signals, such as a break below its 10-week moving average in heavy trade. These can be signals to lock in profits. How does the RS line look? Relative strength will often begin to break down before the actual stock price, or simply fall into a lull below its highs. If it is holding near highs, which shows the stock outperforming or holding its own against the market, you may want to wait for additional signals before trimming too much of your position.
The RS line acted as a helpful tool in gauging former IBD Sector Leader and ex-IBD 50 member Grubhub. , which took Grubhub’s old ticker symbol.)
Divergences Do Not Always Lead To Meltdowns
The tricky thing about divergences is that the reading on the RSI is set by price action for that respective swing.
Unfortunately, there are times where the price action itself changes from one of impulse to a slow grind.
To this point, look at the above chart and notice that after the divergence takes place the stock pulls back to the original breakout point. But then something happens, the stock begins to grind higher in a more methodical fashion.
If you are long the market, it doesnt mean you should panic and sell if the high is broken with a lower RSI reading. What it means is that you should take a breath and observe how the stock behaves.
If the stock beings to demonstrate trouble at the divergence zone, look to tighten your stop or close the position.
However, if the stock blasts through a prior resistance level with a weaker RSI reading, who are you to stop the party?
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Maintaining A Relative Strength Watchlist
Although our Wagner Daily timing model is still on a Sell signal, it is never too early to build a watchlist of stocks showing high relative strength.
By the way, our daily swing trading report now includes full access to our weekly Relative Strength Watchlistan awesome free bonus for all paid subscribers!
How Not To Use The Formula
Most traders use the relative strength index simply by buying a stock when the indicator hits 30 and selling when it hits 70. You can see these levels on the RSI indicator above.
However, if you remember anything from this article, remember that if you buy and sell based on this relative strength index trading strategy alone, YOU WILL LOSE MONEY.
The market does not reward anyone for trading the obvious. Now that doesnt mean that simple methods dont work. But simple methods that everyone else is following typically have low odds.
With that in mind, lets discuss how to properly use this dynamic formula.
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Difference Between Relative Strength And Relative Strength Index
As we said at the beginning that RS is different from RSI. Relative Strength Index is a momentum indicator that measures the magnitude of recent price changes for evaluating overbought or oversold conditions in the price of a stock or other asset.
The main difference between relative strength and RSI is a difference of perspective. The relative strength tells us about the value of a stock in comparison to another stock, index or sector, whereas the RSI tells about the performance of a stock in comparison to the recent performance of the same stock.
How To View It
Creating a process to perform relative strength analysis can help show an investor which areas of the economy are performing and which are not good places to invest. The sectors in the lead often tell what part of the economic cycle we are in and what sectors may be strengthening and weakening in the near future.
Relative strength analysis can also determine which asset classes would be appropriate for a tactical overweight or underweight decision. If equities are performing well, is large cap the place to be? Or would mid or small cap equities be doing better relative to blue-chip stocks? How do international or emerging markets compare to U.S. equities?
If considering specific securities, is a Home Depot versus a Lowes comparison necessary in order to see which has the advantage of better relative strength? A simple chart comparison can go a long way toward improving investment decisions.
â By Steve Economopoulos, chief investment strategist and managing partner, Econ Wealth Management
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Finding Yield In A 2% World
Many investors are surprised to learn that the largest asset class in the world is foreign debt. US investors often allocate very little to foreign bonds, and when they do, it is through capitalization weighted indexes. These indexes allocate the highest weighting to countries with the most debt outstanding. Is there a better way to invest in global bonds? We examine a simple value approach applied to global sovereign bonds and find that it works well across decades. In a world of very low and even negative yields, a value approach could potentially add a well needed source of income to a diversified portfolio.
Calculation Of Relation Strength
Now let us come to the calculation of RS. RS is calculated by using the below formula for comparing a stocks price change to a change in index prices.
RS= Stocks Price / Indexs Price
For calculating the RS of one stock to the another where N is the first stock and N2 is the stock we are comparing it to is as below:
RS= N Stocks Price/ N2 Stocks Price
One should note that the period of both the assets should be the same such as one day or one year.
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Stomp Out Downside Moves
It is always a good idea to limit your downside risk and exposure. This is especially true with volatile and speculative shares, The great news is that this can be easy to do by using stop-loss limits, you can protect yourself from any significant downside moves. This simply involves having a “trigger price” slightly below the price at which you first bought the shares. Then, you sell immediately if the investment drops to that level for any reason.
For instance, you buy the stock at $4.50. Then, you could set a stop-loss, or trigger price, at $4.20. Then, if the shares drop to that level at any point, you instantly sell the investment. No questions asked.
Most brokers will allow you to set an automatic stop loss once you buy. That way you don’t even need to keep an eye on the shares. If they begin to decline, you know that your sell order instantly goes live and the investment is sold. Often, this will keep you from seeing any larger losses. Even when and if the shares keep tumbling, your total loss would be limited to 30 cents per share, in our example above.
Setting a good stop loss trigger price can be difficult in some cases. Each specific stock and situation will call for unique details. Depending on the volatility of the underlying shares, in some cases, it may work and be appropriate to place your trigger price just 3% below your original purchase. In other situations, you would be better served to aim even lower, such as 20% beneath your original buy level.
