a simple rotation trading strategy…

During the Covid crisis, a lot has been written by analysts about which sectors we should be in to get the favors of Mister Market.

I remember during march 2020, a hard time, that all the technos and new economy stocks were surging, giving up all realistic fundamental valuations models…Zoom stock went from 100 bucks to more than 550. Amazon and other new virtual economy equities skyrocketed while traditional businesses like Energy stock continued to suffer, despite solid fundamentals for some of them. The adage was: “the old economy is dead!”.

On top of that, this behavior was accelerated by the cohort of new wanabee traders , the retails, which exacerbated the strength of that momentum.

But it seems that every body forget that Mr Market has a short memory and few months after, wall street started to talk about the fear of inflation based on the persistence of Fed actions. This turnaround gave birth to a brutal switch toward value stocks more resilient to inflation fears.

I started to realize that momentum had never left the market but more over, it was more strengthen even. So yesterday, i tought why not trying to design a strategy who could surf on the best sector to take benefit of those categorical switching forces coupled with this resilient momentum behavior.

The base idea is to work with broad sectorial etf of all the economy: XLY, XLP, XLE, XLF, XLV, XLI, XLB, VNQ, XLK, XLU…10 etf for 10 super sectors. In order to compare them we must normalize them to the same scale. Once done, i thought that the obvious way to capture the next best winner is to: Be sure that the current momentum is strong and try to modeling them as a sinusoidal wave.

I let you the choice of the tools but there are a multitude of way to measure momentum, from the simple MACD to frequency decomposition/wavelet or what ever signal processing technique you think. The main idea is to uncover the main PERIOD of the main momentum currently occurring in the etf and build a signal on top of that that you can compare with each others.

Here is below the results from 2007 up to now on a daily basis. The left scale is the accumulated rate of return, 1 for 100%.

its not to bad if you wish to beat the index with no so “super” analyst knowledge.

it took me one day for that, but i need another day to make that strat really tradable. What i mean, is that this rotation strategy can be HUGELY, HUGELY, HUGELY improved….believe me. How ?

If we add a dynamic hedging model on top of that we could easily, prevent 90% of the market collapses which occurred during the GFC, the euro crisis, the QE crisis and the covid crisis. So think the same orange equity curve but without 2008, 2011, 2018, 2020…Wow!!

The class of model i am talking about are models which try to handle and measure systemic risk. This kind of model tells you be fully invested in your etf or be in cash…Once again there is a variety of way to do dynamic hedging: copulas, vix term structure, delta hedging, systemic factor pca, etc, etc, etc…

I will not do it here because its out of scope. I just wanted to show the powerlNESS of quantitative investing when its done as it should, that is to say: SIMPLY. I hope you enjoyed.

Cheers ;+)


Quant prop trader and enthusiast investor