Objective research to aid investing decisions

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Allocations for October 2023 (Final)

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Allocations for October 2023 (Final)
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Technical Trading

Does technical trading work, or not? Rationalists dismiss it; behavioralists investigate it. Is there any verdict? These blog entries relate to technical trading.

RSI 14/Threshold 30 Applied to SPY with Fixed Holding Interval

Referring to commonly used Relative Strength Index (RSI) oversold parameter settings, but seeking to avoid exiting rebounds too soon, a subscriber asked about performances of the following four rules as applied to SPDR S&P 500 ETF Trust (SPY):

  1. Buy when daily RSI 14 falls under 30 and hold for six months.
  2. Buy when daily RSI 14 rises above 30 and hold for six months.
  3. Buy when weekly RSI 14 falls under 30 and hold for six months.
  4. Buy when weekly RSI 14 rises above 30 and hold for six months.

To investigate, we use a 126-day (26-week) holding interval for daily (weekly) calculations. We assume that overlapping signals reset the clock. In other words, if there are buy signals while already in SPY, we extend the holding interval to six months after the last overlapping buy signal. We ignore frictions for switching between SPY and cash and assume no return on cash. We ignore tax implications of trading. We use buy-and-hold SPY as a benchmark. Key metrics are compound annual growth rate (CAGR) and maximum drawdown (MaxDD), but we also look at average 6-month returns and return volatilities while in SPY. Using daily and weekly raw (for RSI calculations) and dividend-adjusted (for return calculations) SPY closing prices from the end of January 1993 through mid-August 2023, we find that:

Comparing Ivy 5 Allocation Strategy Variations

A subscriber requested comparison of four variations of an “Ivy 5” asset class allocation strategy, as follows:

  1. Ivy 5 EW: Assign equal weight (EW), meaning 20%, to each of the five positions and rebalance annually.
  2. Ivy 5 EW + SMA10: Same as Ivy 5 EW, but take to cash any position for which the asset is below its 10-month simple moving average (SMA10).
  3. Ivy 5 Volatility Cap: Allocate to each position a percentage up to 20% such that the position has an expected annualized volatility of no more than 10% based on daily volatility over the past month, recalculated monthly. If under 20%, allocate the balance of the position to cash.
  4. Ivy 5 Volatility Cap + SMA10: Same as Ivy 5 Volatility Cap, but take completely to cash any position for which the asset is below its SMA10.

To perform the tests, we employ the following five asset class proxies:

iShares 7-10 Year Treasury Bond ETF (IEF)
SPDR S&P 500 ETF Trust (SPY)
Vanguard Real Estate Index Fund (VNQ)
Invesco DB Commodity Index Tracking Fund (DBC)

We consider monthly performance statistics, annual performance statistics, and full-sample compound annual growth rate (CAGR) and maximum drawdown (MaxDD). Annual Sharpe ratio uses average monthly yield on 3-month U.S. Treasury bills (T-bills) as the risk-free rate. The DBC series in combination with the SMA10 rule are limiting with respect to sample start date and the first return calculations. Using daily and monthly dividend-adjusted closing prices for the five asset class proxies and T-bill yield as return on cash during February 2006 through July 2023, we find that:

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How to Identify and Follow Trends

Why is trend following so persistently popular among investors? In their March 2022 paper entitled “A Guide to Trend Following Strategies”, Stuart Broadfoot and Daniel Leveau describe popular trend identification methods and provide an example of how to build/test a multi-asset class trend following strategy in four steps. Using trend following index data during January 2000 through May 2022 and prices for 52 futures contract series during January 2000 through January 2022, they find that: Keep Reading

SMA Signal Effectiveness Across Stock ETFs

Simple moving averages (SMA) are perhaps the most widely used and simplest market regime indicators. For example, many investors estimate that a stock index, exchange-traded fund (ETF) or individual stock priced above (below) its 200-day SMA is in a good (bad) regime. Do SMA signals/signal combinations usefully and consistently distinguish good and bad regimes across different kinds of U.S. stock ETFs? To investigate, we test regime signals of 50-day, 100-day and 200-day SMAs and combinations of them across broad equity market (DIASPYIWBIWM and QQQ), equity style (IWDIWFIWN and IWO) and equity sector (XLBXLEXLFXLIXLKXLPXLUXLV and XLY) ETFs. We consider also three individual stocks: Apple (AAPL), Berkshire Hathaway (BRK-B) and Wal-Mart (WMT). We focus on compound annual growth rate (CAGR) and maximum drawdown (MaxDD) for comparisons, but also look at a few other performance metrics. Using daily dividend-adjusted closes of these 18 ETFs and three stocks during late July 2000 (limited by IWN and IWO) through early May 2023, we find that: Keep Reading

Speed of Stock Index Decline as Future Return Indicator

Does the speed of a stock index decline from a recent high help decide whether to buy-the-dip or wait? In his April 2023 paper entitled “The 5% Canary”, Andrew Thrasher evaluates the whether the duration of initial 5% declines from 52-week highs for the S&P 500 Index and Dow Jones Industrial Average (DJIA) help quantify severity of subsequent drawdowns and attractiveness of buying the dip. Specifically, he defines:

  1. A Canary signal as a 5% index decline within 15 trading days after a 52-week high, and two consecutive index closes under its 200-day simple moving average (SMA) within 42 trading days of a Canary signal as a Confirmed Canary signal.
  2. The start of post-Confirmed Canary index uptrends (Buy-the-Dip signals) as the 50-day SMA crossing above the 200-day SMA.

Using daily closing levels of the S&P 500 Index during January 1950 through October 2022 and of DJIA during January 1900 through March 2022, and for some non-U.S. market indexes, he finds that: Keep Reading

Day Trading with an Opening Range Breakout Strategy

Can day traders reliably get rich quick? In their April 2023 paper entitled “Can Day Trading Really Be Profitable? Evidence of Sustainable Long-term Profits from Opening Range Breakout (ORB) Day Trading Strategy vs. Benchmark in the US Stock Market”, Carlo Zarattini and Andrew Aziz test the performance of a 5-minute Opening Range Breakout (ORB) strategy applied to Invesco QQQ Trust (QQQ), as follows:

  • If QQQ rises (falls) during the first 5-minute interval of trading, buy (sell) QQQ at the start of the second 5-minute interval. Take no position if the first 5-minute open and close are about the same.
  • For a long (short) position, set a stop-loss at the low (high) of the first 5-minute interval.
  • Set a profit target (stop-gain) at 10 times the absolute difference between entry and stop prices.
  • If neither stop-loss nor stop-gain trigger during the day, liquidate at the market close.

For testing, they use recorded trade prices at exactly 9:35AM, the stop-loss/stop-gain prices and recorded trade prices at exactly 4:00PM. They assume $25,000 starting capital, maximum 4X leverage and $0.0005/share commission (in the range 0.0001% to 0.0005% for QQQ), with no bid-ask spread, no impact of trading (slippage) and no other execution price uncertainty. They size each trade such that a stop-loss would deplete 1% of current capital. Their benchmark is buying and holding QQQ. They also test the same ORB strategy applied to ProShares UltraPro QQQ (TQQQ) to circumvent broker leverage constraints, plus a TQQQ variation with stop-loss equal to 5% of the 14-day average true range (ATR) and no profit target (exit at market close). Using the specified QQQ and TQQQ intraday price data during January 1, 2016 through February 17, 2023, they find that:

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10-month vs. 40-week vs. 200-day SMA

A reader requested: “I would love to see a backtest pitting a 10-month simple moving average (SMA) against a 200-day SMA for SPDR S&P 500 (SPY). I assume trading costs would go through the roof on the latter, but do performance gains offset additional costs?” Others asked about a 40-week SMA. To investigate, we use the three SMAs to time SPY since its inception and compare results. Specifically, we buy (sell) SPY at the close as it crosses above (below) the SMA, anticipating crossing signals such that trades occur at the close on the signal day (assuming calculations can occur just before the close). The baseline SMA calculation series is dividend-adjusted, but we also check use of unadjusted prices and underlying S&P 500 Index levels. We assume return on cash is the 3-month U.S. Treasury bill (T-bill) yield (ignoring settlement delays). We use a baseline 0.1% one-way SPY-cash switching frictions and test sensitivity to frictions ranging from 0.0% to 0.5% (but assume dividend reinvestment is frictionless). We ignore tax implications of trading. Using daily dividend-adjusted and unadjusted closes for SPY, daily closes of the S&P 500 Index and daily T-bill yield from the end of January 1993 through mid-April 2023, we find that:

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Suppress SACEVS Drawdowns in Combined SACEVS-SACEMS?

A subscriber asked about the performance of a variation of the monthly reformed 50-50  Simple Asset Class ETF Value Strategy (SACEVS) Best Value-Simple Asset Class ETF Momentum Strategy (SACEMS) Equal-Weighted (EW) Top 2 combination that substitutes 100% SACEMS EW Top 2 whenever both:

  1. SPDR S&P 500 ETF Trust (SPY) is the selection for SACEVS Best Value at the end of the prior month.
  2. SPY is below its 10-month simple moving average at the end of the prior month.

The objective of the variation is to suppress SACEVS Best Value drawdowns. To investigate, we compare performance results for this variation (“Filtered”) with those for baseline 50-50 SACEVS Best Value-SACEMS EW Top 2. Using monthly returns for SACEVS Best Value and SACEMS EW Top 2 since July 2006 (limited by SACEMS) and monthly dividend-adjusted prices for SPY since September 2005, all through March 2023, we find that: Keep Reading

Use First Hour High/Low to Guide SPY Rest-of-day Trading?

A subscriber asked about practical exploitation of the hypothesis that the high and low of an exchange-traded fund (ETF) during 9:30AM-10:30AM are informative about its high and low during 10:31AM-4PM. To investigate, we obtain minute-by-minute open, high, low and close prices for SPDR S&P 500 ETF Trust (SPY) for 2019. From that data, we extract the high and low during 9:30AM-10:30AM and the high, low and close for 10:31AM-4:00PM for each trading day. To test explicitly whether the 9:30AM-10:30AM high (low) is indicative of the 10:31AM-4:00PM high (low), we:

  • Sell SPY during 10:31AM-4:00PM if it rises to the 9:30AM-10:30AM high and close the short position at 4:00PM.
  • Buy SPY during 10:31AM-4:00PM if it falls to the 9:30AM-10:30AM low and close the long position at 4:00PM.

Using the specified SPY price data for 2019, we find that:

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Conditionally Substitute SSO for SPY in SACEVS and SACEMS?

A subscriber asked about boosting the performance of the Simple Asset Class ETF Value Strategy (SACEVS) and the Simple Asset Class ETF Momentum Strategy (SACEMS), and thereby the Combined Value-Momentum Strategy (SACEVS-SACEMS), by substituting ProShares Ultra S&P500 (SSO) for SPDR S&P 500 ETF Trust (SPY) in these strategies whenever:

  1. SPY is above its 200-day simple moving average (SMA200); and,
  2. The CBOE Volatility Index (VIX) SMA200 is below 18.

Substitution of SSO for SPY applies to portfolio holdings, but not SACEMS asset ranking calculations. To investigate, we test all versions of SACEVS, SACEMS and monthly rebalanced 50% SACEVS-50% SACEMS (50-50) combinations. We limit SPY SMA200 and VIX SMA200 conditions to month ends as signals for next-month actions (no intra-month changes). We consider baseline SACEVS and SACEMS (holding SPY as indicated) and versions of SACEVS and SACEMS that always hold SSO instead of SPY as benchmarks. We look at average gross monthly return, standard deviation of monthly returns, monthly gross reward/risk (average monthly return divided by standard deviation), gross compound annual growth rate (CAGR), maximum drawdown (MaxDD) and gross annual Sharpe ratio as key performance metrics. In Sharpe ratio calculations, we employ the average monthly yield on 3-month U.S. Treasury bills during a year as the risk-free rate for that year. Using daily unadjusted SPY and VIX values for SMA200 calculations since early September 2005 and monthly total returns for SSO since inception in June 2006 to modify SACEVS and SACEMS inputs, all through February 2023, we find that: Keep Reading

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