rotational trading systems -...

Rotational

Trading Systems

A new and very different alternative?

By: Bruce Wood

Disclaimer:

This presentation is for educational purposes ONLY.

I am a Private Trader, and I DO NOT provide any personal financial advice, or offer any Financial Services.

The trading of shares can result in financial losses.

There is no implied suggestion that buying shares will be beneficial for your personal circumstances.

"Rotational Trading Systems" - A new and very different alternative? 2

What are the origins of Rotational Trading?

Rotational trading first came to notice, in the 1990’s, and originated in the US, mainly for trading Mutual Funds.

Today, Rotational Trading is better associated with ETF’s – (Exchange Traded Funds).

This method of trading is sometimes referred to as “Fund-Switching”.

Researching the results of what has been publicly reported, it would appear that this method of trading / investing has been a very successful, both pre and post GFC.


For Australian Investors, this method of investing will also work successfully with a portfolio of stocks.

US investors do have the appeal of ETF’s that have better diversification, and not be exposed to individual stocks.

Unfortunately for those wanting to trade the Australian market, there are probably an insufficient number of actively traded ETF’s to consider a portfolio based purely on ETF’s.

I believe that Rotational Trading is a successful trading strategy for Stocks, which is the primary interest of this audience, and throughout the presentation, I will use the terminology “Stock/s”.


What is Rotational Trading?

Rotational Trading works on the principle that we will use Technical Analysis indicators to apply a measurement that will allow us to “Score” and “Rank” a group of stocks .

Our trading objective is to hold a Portfolio with the strongest performing stocks in the market. We need a measurement process to identify these stocks, therefore our Technical Analysis formula designs should be based on indicators that reflects strong price action or trend /momentum strength.

We will then have our Stock Analysis software apply the formula, and provide reporting showing every stock and the calculated “score”. Sorting the stocks on their scores will enable us to “Rank” the stocks in order of strongest to weakest.


Scoring / Ranking can also be used to identify the weakest stocks in the market i.e. stocks with the lowest scores.

The strategy of “Shorting” stocks through CFD’s has more complexity, so for the purpose to today’s presentation, the scope will be for long positions only.


Our Portfolio, (depending on number of positions) will comprise of the stocks with the highest “score” ranking values.

Our Trading Plan would have a documented cycle on how often we re-score and rank and “Rotate” (re-balance) our portfolio.

This cycle could be – Weekly / Fortnightly / Monthly / Quarterly etc.

Typically, those who trade Rotational Trading Systems do not want “short-term price noise” to influence the ranking process, and will have medium-term cycles.


On our chosen cycle when we “re-Rank” (and Rotate) our portfolio, the required actions will be:

• Stocks already held in the Portfolio, which are still ranked in the top group, will continue to be held.

• Stocks which have fallen out of the “top ranked group”, will be sold. (*See below).

• New stocks which have now entered the “top ranked group”, will be bought into our portfolio.

• *It is common practice that once a stock has entered the portfolio, the ranking must drop 1 - 2 places below the “Portfolio Position number”, before the stock is actually sold from the portfolio.


Trend Trading vs Rotational Trading

With our Trend Trading Rules based Trading Systems we tend to have predefined specific entry rules for the Buy signal, i.e.

• A breakout of a 60 day high

• A breakout above a Moving Average

• A “Fast Moving Average” crossing above a “Slow Moving Average”.

Rotational Trading Systems do not have these same specific rules. All we are doing is identifying the strongest stocks in the market, based on our methodology, as at that date, to identify the best stocks for our portfolio.


Trend Trading vs Rotational Trading With our conventional Trend-Trading Systems, a stock having made the portfolio will typically be held until such time that there is a pull-back, triggering a Stop Loss (or Trailing Stop) exit. The stock could be in a very weak (slow) upward trend, or maybe it is in a sideways consolidation pattern? The question arises on whether our Capital would be better utilized on a stock displaying more strength and more profit potential? Rotational Trading Systems, through the regular “Ranking and Position Score” process will identify the stocks displaying the strongest momentum (price action).


How do we identify “Strong Stocks”

There are numerous Technical Analysis indicators (and Oscillators) which can “calculate measureable values” which can be used for Ranking the strength of a trending stock. Examples of these Indicators may include: ROC – Rate of Change (Smoothed) RSI – Relative Strength Index (Say EMA of RSI) TSI – True Strength Index ADX - Average Directional Index Your Ranking process may be a combination of multiple “strength” related indicators.


Re-capping our Thought process

Our objective is that on our chosen cycle, we will use TA to score and rank our universe of stocks from strongest to weakest, and on this cycle, we will re-balance (Rotate) our portfolio to hold the best performing stocks.

Can we also consider that when a Stock is relegated from the Portfolio, it is not necessarily a reflection that the stock is performing badly (like a Stop Loss exit), it just means that maybe there are better performing, stronger stocks to allocate our capital on.


Does Rotational Trading work?

This method of trading is not widely publicised.

Many Investors do not publicly disclose their results.

My research into the majority of the data I have reviewed, I believe to be accurate, and in my opinion, there are compelling reasons to seriously consider this method of trading.

.


Trading the Australian market?

Like all Trading Plans, we need to choose a suitable universe of stocks. I personally like to stay clear of stocks with low liquidity, and also stocks under 50 cents. I will generally use the ASX200 or ASX300 as my chosen universe of stocks.

There may still be some illiquid or low value stocks, you need to be cautious of.

Your Trading System Rules, and analysis explorations should have filters to exclude low-price or low-liquidity stocks.


Trader’s / Investor’s Trading Plan decisions?

Your Trading Plan would need to consider your personal preferences on how the Portfolio would be structured and managed. These decisions will include:

How many stocks do you want to hold in the Portfolio? – (typically 5 – 10 stocks?)

• What is your Capital allocation? • What is your chosen Position size? • What cycle do you want to rotate your Portfolio?

Remember that some of the foregoing decisions will be dependant on your personal time investment.


Will the Market Conditions affect the overall Performance?

The short answer is yes. When we are “Buying into strength”, a strong Bull market should always achieve outstanding results.

However, even in a Bear Market, it is still possible to have some stocks which will outperform, relative to the overall struggling market.

Remember that our objective is to identify the strongest stocks in all market conditions. You will observe that over time, the highest “stock scores” in a strong Bull market, will generally be considerably higher that the highest scores achieved in a weak or Bear market.

You may make the decision that in a struggling market that stocks with a score under a certain value, are not worth the risk of taking into the Portfolio, even if there are vacant positions to fill?


You can consider using “Market Filters” to turn the Trading System off during periods of poor performing or “Bear market” conditions.

I hold the view that there can still be some select “high-performing stocks” even in a Bear market, and my personal preference would be to continue to trade, however maybe at a reduced number of positions, or capital allocation.

Poorly performing markets have to recover some time, and some of the best trading opportunities occur during these initial recovery periods. I hold the view that there can be a considerable cost associated with “being out of the market”.


A word of caution – in my own trading in 2016, my RTS Portfolio comprised of almost all Gold Stocks.

What assumptions and considerations can be learnt from this?

• My Stock selection process was working as designed, by identifying the stocks displaying the strongest momentum.

• A Portfolio comprising of 85% of closely correlated investments (i.e. no diversification). Are there Risks that need to be considered?


Risk Management

Just like all Trading Systems, you need to evaluate all your risk tolerances, including:

• Low value stocks (Price limit rules?)

• Illiquid stocks (Daily dollar turnover limit rules?)

• Under-performing markets. (Filter based on XJO MA?)

• Stop Loss Rules – Typically Rotational Trading Systems enable the Ranking Score to trigger the Exit Signal, rather than using conventional Stop Loss Rules.

• Diversification – If one sector or a select group of closely correlated stocks are out-performing the rest of the market, and all your highest ranking stocks are in these groups – is this a Risk that you need to consider?


Stock Analysis Software.

My chosen Stock Analysis software is Amibroker.

Amibroker has the capability for conducting Rotational Trading Back-test simulations.

The Back-test simulation examples shown, are based on Amibroker reporting.


An alternative to TA Indicator based “Scoring”

Linear Regresion works well with “Scoring a Trend”

What is Linear Regression:

Wikipedia says:

In statistics, linear regression is an approach for modeling the relationship between a scalar dependent variable y and one or more explanatory variables (or independent variables) denoted X. The case of one explanatory variable (independent variable) is called simple linear regression


Our Trading System Preferences:

Capital: $42,000

Number of positions: 6

Position size: $7,000

Rotation Cycle: Weekly

Trading signals: After end-of-day Friday

Trade orders: Monday morning - Open prices

Universe of Stocks:: ASX300

Brokerage allowance: $10.00 per trade


Question:

Should I have some “spare capital” ($45,000) in case the first couple of completed trades lose money, and allowing for some spare capital will enable me to continue with the full position size.


Filters:

Price – No stocks with a Closing price under 50 cents or over $20.00

Turnover – No rule used.

Bear Market – No Rule used

Price Gaps – Not used for this TS. (Exclude “price jumps” due to takeover bids.)


Back-testing Results – Summary:

• Back-test period: 19/9/2011 to 31/3/2017

• Not sensational results – however this is our first back-test

• CAR = 9.9% (Excluding any Dividends)


Portfolio Back-test


Portfolio Equity Curve


Underwater Equity


The Profit Table


What was the market doing in 2015 – 2016?


Final Analysis Summary: (Data still requires audit)

• Trading System profitability is very impressive – 9.89% CAR.

• The drawdown of 21.7% in Q3 2011 and Q1 2017 is a serious concern!

• Trading System made profits every year from 9/2011 to 2015, and then a loss of 16.3% in 2016.

• No Stop Loss Rules are used, and there were 2 losing trades > $3,200- .

• Number of consecutive losing trades – 7.


Final Analysis Summary – Continued

• Annual returns have been very inconsistent, but is a reflection of non-trending “choppy” markets, during the test period.

• The returns for the last 15 months have been very mediocre. (Three profitable months out of fifteen.)

• Average duration of trades – 15 weeks. (20 positions per year?)


What would I do next to improve the Trading System?

• Further analysis is required. Has the market changed that has resulted in lower returns in the last fifteen months? Can we identify what has changed?

• 122 trades in 66 months is low. Should we increase the Portfolio to 10 positions?


Conclusions:

• All Trading Systems are dependant on the right market conditions for success.

• .


XJO 19/9/2011 to 31/3/2017 (Weekly candles)

XJO CAR = 6.15% (4195 to 5865)

RTS CAR = 9.89%


The End Investing can be stressful!

Try and find a good work environment!


The End

Thank-you for listening to my ideas today.

Any post-meeting questions or feedback– my email:

[email protected]


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