Category: Mean Reversion

Reviewing some recent actual trading from the lens of some of ETFreplay backtesting applications

Note: during the launch of our new application called Sequential Relative Strength, we are allowing all accounts to create portfolios using individual stocks. This app module is able to expand on the core Portfolio Relative Strength and add a 2nd stage to help improve entry points.

Reviewing some recent actual trading from the lens of some of our backtesting applications.   This has been a very good market environment for ETF rotation.  #STUDY

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Regime Driven Mean Reversion

Late last year we produced a video that showed how two different strategies, relative strength and mean reversion, could be layered on top of each other.  That example went through each of the constituent backtests separately, in order to explain the mechanics of the process.

The example below shows how such a dual-layered strategy can be run in a single backtest.  The first layer employs the SPY / VEU ratio moving average as a regime switch to dynamically alternate between whichever is stronger; U.S. or International stocks.  Then, the second layer picks the weakest short-term performer within that chosen asset class.

To keep it simple, we have used the same basic U.S. (MDY, IWM, SPY and QQQ) and international (EWA, EWC, EWH and EWS) ETFs that we have used in previous examples.

Picking Up Relative Return in Volatile Times

Related But Different ETFs:

New Mean Reversion Backtest

We have introduced a new backtest for subscribers that is focused on short term mean reversion. It is intended to be used with highly related securities, which are unlikely to drift apart for very long before coming back together. Consequently, when one of the securities underperforms by a non-insignificant margin, an opportunity occurs.

The backtest works by comparing the difference in the x-day Total Return between the securities / ETFs.  When that x-day return difference is more than y standard deviations below the mean, the backtest will buy Security 1. It will then hold that security until it reaches z standard deviations above the mean, when it will be sold in favor of Security 2.

Suitable primarily for non-taxable accounts only, the idea is that these short-term trades among correlated assets can be used to materially enhance the returns through compounding without a material difference in the underlying beta exposure.   More return not for less risk -- but for very similar risk.    Said another way, taking a modicum of extra risk can be quite profitable.

 

 

Go to Total Return Difference - Mean Reversion Backtest

Layering 2 ETF Backtest Strategies For Enhancing Return

Layering 2 strategies on top of each other for better return -- and importantly this can improve the consistency on a year-to-year basis. The mean reversion strategies tend to add more return when things are volatile -- but less relative to the benchmark when the market is rising on low volatility. That said, low volatility uptrends are often an excellent environment for absolute gains anyway and you will naturally participate in such a market because mean-reversion has zero market timing associated with it.  That is, sometimes you will just track rather than outperform a low-volatility uptrend.... and that is a good thing.

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