Using a Regime ETF Backtest To Address Market Cap Weighting Skewing Benchmark Returns

This model is simple yet addresses an important issue for those that want to compete against a benchmark.

In order to compete against a specific benchmark, it makes sense to understand that benchmark.   If you totally ignore it, you can do great but at times you will probably get frustrated because your strategy is totally out of sync.

So take the example of a logical model of  S&P Equal Weight vs NASDAQ Equal Weight.   This is a pretty good indicator but at the same time, the S&P Equal Weight is wildly different portfolio than the weighted S&P because of the fact that market weight S&P is strongly skewed to the big, very profitable money-making S&P names (AAPL, AMZN, MSFT etc).  

This backtest addresses that by using our Regime model.  It still uses S&P EW vs NASDAQ EW as its indicator -- but then when it comes to actually buying and selling, it uses market cap weighted QQQ and market cap weighted OEF (S&P 100).  

Take a look;

Backtesting Stocks

Q.  "I have seen a few examples using ETFreplay to backtest stocks. This is something I would like to do but I don't see where this can be done on the website. Can you help?"

A. To see the list of available stocks hover over 'Summary' in the main menu, under 'U.S. Equity', click on 'Stocks'.  The list is prmarily made up of the main holdings of the large ETFs, which are obviously our focus. There are also a few other interesting names and a small number of ADRs. These stocks can be added to portfolios, just like ETFs and mutual funds, and can be used with all backtesting modules and tools.

 

 

Sequential Relative Strength Stock and ETF Backtesting

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.

The idea behind this module is to more easily combine intermediate-term relative strength with short-term mean reversion. Short term weakness within a strong long-term trend is normal. Try running your backtest with this mean-reversion added and then compare it to a model which does the opposite. Analyze the results. Think about the volatility of the resulting equity curve. Look at sub-periods. Are the results highly lumpy? Were the results achieved in earlier years but fade in recent years? These are some of the things ETFreplay was created to do -- not just look at the return of a strategy -- but to decompose it and analyze it to try to find something that is more robust. #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.