Sharpe Ratio vs ETF Relative Strength Model

Sep 14, 2016 in Relative Strength | Screener

 Why does your Relative Strength ranking of ETFs, work better than ranking them using the Sharpe Ratio?

The ETFreplay Relative Strength ranking methodology has the Sharpe Ratio concept at its core but it also reflects some more modern financial modelling methodologies.

So the Sharpe Ratio has volatility in the denominator.   The thing about this is that the Sharpe Ratio effectively overrates very low volatility ETFs.  In reality, investors value returns more than they do extreme low volatility.   For example, a 12% return with 8% volatility is view much more positively than an 8% return with 4% volatility.   That move from 8% down to 4% is not nearly as meaningful as the return differential.   What investors really want is a solid return with acceptable volatility.  Investors can tolerate some level of drawdown with a long-term focus -- just not large drawdowns.   

Another thing we did was enable the user to use 2 timeframes for return.    The reason is that it is well-accepted that a model can have up to 3 factors as the factors can help each other out.   More than 3 factors starts to run into data-mining, which is something we need to be careful of.  

Sometimes 1 factor which backtests well over longer time periods can have a rough patch.  Another factor can help mitigate the problems and by using 2 return periods, we are not overly reliant on a single return factor.

Hope that helps and let us know if you have any other questions or comments.

See also our FAQ's for common questions:


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ETF Screener Feature Added

Dec 14, 2010 in Screener

Screenshot of ability to combine multiple ETF portfolios into a single list on the ETF screener.    This example takes a list of 25 commodity ETN's (tracking the underlying commodity) and combines this list with 25 commodity stock ETF's.   You can combine as many lists as you would like and/or 'Select All.'



Best ETF Broker Offer Is Currently TD Ameritrade

Oct 29, 2010 in Screener

Per user requests, we have added a prepared list for the TD Ameritrade offer within the ETF screener.  Note that Ameritrade chose not to include many very popular ETFs such as Gold (GLD/IAU),  the Russell 2000 (IWM) and some Agriculture ETFs (DBA, MOO etc) -- among others.   They also did a few odd things like add the S&P 500 Value index but not the S&P 500 Growth index -- they added the MSCI Mega Cap 300 Growth index --- go figure. Nevertheless, the inclusion of many country and regional funds and an overall wide assortment makes this the most compelling offer yet.

Note that the ETF/ETN database covers roughly 500 products (including inverse/leveraged) and this results in coverage of 97% of overall ETF/ETN assets and >98% of ETF/ETN trading volume.

The bottom ~600+ ETFs make up just ~2% of overall assets and trading volume.   

While we will continue to add to our database, we will do so in a controlled manner so that we can continue to offer a product that acts as a filter for an otherwise problematic process.  As a Chartered Financial Analyst, experienced professional money manager and long-time user of financial databases, I think we understand the needs of the sophisticated investment analyst.  The team at will continue to work hard to deliver tools and techniques that leverage a process based on accurate data validation of total return and robust functionality within easy-to-use, browser-based applications.

Here is the snapshot of the Ameritrade ETF list and link to the screener page:


ETF Screener Link


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Where Is Global Money Flowing Now?

May 03, 2010 in Screener | Strategy

Here is our read on global money flows as we begin May:

Asset allocations are the most important aspect to portfolio management. Our ETF Screener helps tell us where global money is flowing. We think it’s a good idea to use experience and market savvy in conjunction with the quant models. There are countless ways to actually implement a given higher-level ‘strategy.’ We would strongly suggest staying with the theme of the backtested models -- but also keeping a watchful eye on overall portfolio volatility as a sanity check. Volatility is a good way to think about the potential for drawdown – so this focus protects you when there are strong rotations within the global marketplace.

Our models have not seen much change recently. Stay overweight US equities and underweight (or short) international equities, particularly Europe. Given instability in Europe and the already large outperformance of US Equity this year, a large divergence like this is a bit of a concern.

Other regions of the world, such as Latin America, Emerging Asia and the Pacific countries do not appear to be worth an investment at this time --- these regional ETFs have high volatilities and are not showing relative strength.  Interestingly, US REIT’s have been showing strong movement within the rankings – indicating global money continues to have a risk appetite for segments of the U.S.

It makes sense to us to stay aggressive on the non-equity portion of the investment landscape. U.S. treasuries do not look interesting at this point as yields are low and the global economy – outside of Europe – appears to be fine. If the U.S. were not strengthening, why are junk bonds continually making new 6-months highs?

Outside of the primary indexes (and REITs) – 2 interesting developments we have noticed over past 4-6 weeks:

1) Precious metals are rising in the relative strength rankings
2) Emerging market bonds look good in the rankings (note that EMB/PCY are dollar-denominated) -- they tend to trade a lot like U.S. high-yield bonds -- and they have pulled back recently.

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ETF Performance Analysis for S&P -2.0% Day -- April 27, 2010

Apr 28, 2010 in S&P 500 | Screener | Volatility

Volatility spiked on April 27th, lets take a closer look.

First note that while the S&P 500 dropped -2.0%, the higher volatility ETF's are in steeper drawdowns:

What performed well? The usual suspects --- those with negative correlations to equities, including the VIX ETF's, the inverse ETFs from ProShares, long duration US treasuries, precious metals, the U.S. Dollar and the Japanese Yen.


The last chart goes back to focus on U.S. Sector SPDR ETF's. Note again that those with higher volatilities led to largest drawdowns.

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Simple Strategy Using The Relative Strength Themes of our 'Screener'

Apr 26, 2010 in Screener | Strategy

While it may not be particularly interesting from a global perspective -- the relative strength model in our Screener has been quite clear for past few months. Long US Equity and Negative on Europe. Here is an example using the relative strength model as of the last day of February to create a subsequent long-short portfolio that is representative of the broad themes in the marketplace:

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Video: Find Relative Strength Ideas -- Then Integrate Ideas Into A Portfolio

Apr 20, 2010 in Backtest | Screener | Video


4 minute video going over a few recent examples:



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Global Asset Class Rotation

Mar 30, 2010 in Backtest | Relative Strength | Screener

This is to highlight some specific thoughts on the important topic of global money flows and its implications for investors.   ETF’s have caused a major shift as they allow cheap ways to access new markets.  It is our belief that this innovation will cause the discussion to increasingly become ‘which MARKETS should I own?’ – and less about ‘which stocks should I own?’

Below are some performances of a few of the major ETFs over the past three years.  I am starting at a very high level here and then working towards my ultimate point of coming up with a process for interpreting global money flows.  (Note that all returns posted here make the proper dividend and distribution adjustments as total return is absolutely essential in any professional discussion of performance)

The point of this slide is to simply highlight that even if trading long-only, a well-executed high-level rotational strategy could have produced strong, consistent returns.

The next image highlights how a combination of 80% bonds and 20% emerging markets has performed over the past 3 years.  Most investors think myopically about returns.   The discussion of returns, without the context of risk, is meaningless to professional investors.  

Note how despite a massive volatility spike in the overall marketplace, the standard deviation of daily returns for our 80/20% portfolio was quite low.   This assumes no rebalancing.  Value could have easily been added over this return with a relatively simple re-balancing rule.

This brings us to the Sharpe Ratio. The important aspect the Sharpe Ratio framework brings is to factor in ‘drawdown potential.’   If you own securities with higher relative volatility, the high to low moves will be larger and cumulative negative returns become increasingly difficult to overcome.  By thinking in terms of a sharpe ratio rather than returns-only, you will inherently adjust for the ever-present possibility of drawdown.  You cannot fully know the risk that awaits -- but you can at least think in terms of reward/risk.

To make this practical and to keep this from becoming a dissertation, I will just simply show one way to de-compose the Sharpe Ratio into a multi-factor model that allocates toward the segments of the market that show strong combinations of high relative strength and lower relative volatility.  This model uses two timeframes to calculate return and one part volatility.   It is considered a statistical model, a subset of the APT framework – and can more easily be thought of as ‘risk-adjusted relative strength.’

Below is an image of the model as it stood on June 30, 2007.  I can 'roll back' the model to any historical date through the calendar control in the top right corner.  Global asset classes are color-coded for ease of understanding what is showing strong relative strength.  International equities and select US equity segments were leading the market on a risk-adjusted basis during the middle of 2007.  Though not shown in the image, you can go to the site and view what was lagging (hint: housing and financial segments).

Fast-forward 1-year through setting the calendar control to June 30, 2008.  At this point, the screen is dominated with fixed-income ETFs. One way to interpret this is that global money is flowing INTO bonds.  These kinds of shifts are likely not whipsaws as you might find with the US-based Sector SPDRs --- which can have violent rotations even within a secular bull move.

This was one example of a global asset flow shift.  I could run this ETF Screener 50 times, run the results through our Backtest ETFs page and then post all of those images here.  But to truly understand this, it is better to interact with the data yourself.   It takes time to understand complex financial relationships and it is nearly impossible to see this in just one-dimensional snapshots in time through some images.   Change the model inputs, vary the timeframes.  This tool is meant to enable users to interact with each other at a fundamentally higher (risk-adjusted) level of conversation.


Putting it together -- ETFreplay screener helps point to Market Leadership

Mar 23, 2010 in Screener is a platform built in part for finding market leadership ideas to consider.    We believe that there is a lot of 'market generated information' to be interpreted by the relative price performance of well-defined trading baskets (indexed ETFs).  Global asset flows into and out of regions and sectors are important --- and these flows can be understood by seeing how market segments are performing relative to each other.

A quantitative process can help give ideas as to what is going on in the marketplace.   This can be achieved with relatively simple models.   Simple is better than complex.   The more filters you build into your backtesting, the more UNLIKELY it is to work in the future.    
I ran the ETFreplay screener ( ) for 1 year ago today.  You can do this by setting the calendar control in the top right corner to the final date for which you would like to capture.    I set the screener parameters to pick-up short term relative strength.   The idea would be that the strongest ETF's out of the bear market might very well be the new market leadership.   Using ETFreplays backtesting tab -- I entered the top 5 ETF's into the text boxes at equal 20% weights (make sure it sums to 100%).   I then ran the subsequent 12-month performance.   
Investing is not a purely quantitative process.   Thought and insights and forecasts are crucial.   But a quantitative process can help guide you in the right direction and looking in the right places for ideas.  Even if you don't invest or trade ETFs,  it will certainly be helpful for any investor to understand global asset flows into and out of certain market segments (int'l stocks vs us stocks vs commodities vs fixed-income etc)...
Below are the results of the above idea:


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