Systematic Relative Strength

Investors have used momentum or relative strength to implement sector rotation strategies for many years. Our latest whitepaper (which can be found here) takes a look at some sector rotation strategies using a momentum factor that isn’t commonly used.

Most of the research you will see on using momentum for sector rotation uses a time-based price window to calculate the momentum factor. That means you would take the trailing 6 months price return, for example, and rank the sectors in your universe from best to worst. All of the research shows that these types of strategies work over an intermediate term time horizon, which is often around 3-12 months.

Another way to determine relative strength or momentum is to use Point and Figure charts. Point and figure charts remove time from the equation and only look at price movement versus a market benchmark or another security in the universe. It is a very different way to calculate momentum, but also does an effective job at capturing the strong sectors. It also speaks to the robust nature of the momentum factor. There are many different ways to calculate what is “strong,” and as long as you are capturing intermediate price movements all of the different calculation methods work over time.

In the paper we look at two different sector rotation strategies. One strategy uses broad macro sectors and would be similar to an investor that is using 10 ETF’s to rotate among broad sectors of the U.S. market. The growth in the ETF market over the past several years has allowed investors to get much more granular when picking sectors. Investors have the option to pick Biotech, Pharmaceuticals, or Healthcare Providers instead of just a broad Healthcare ETF. There are also different weighting and factor tilts that allow investors to get even more granular than broad, cap weighted ETF’s. We also ran a strategy that looks at getting more granular in sector selection.

Point and figure matrices are very effective in determining rankings for a sector rotation strategy. It is also very advantageous to get more granular in your security selection when running a sector rotation strategy. The details can be found in the whitepaper.

This entry was posted on Wednesday, October 8th, 2014 at 9:20 am and is filed under Momentum, Relative Strength Research. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.