Momentum Trading ETFs For Fun And Profit

For the past couple of months I have been dabbling with trading ETFs based on their Relative Strength.  Essentially what I did was get a basket of non correlated or loosely related funds.  In this case it was Guggenheim S&P 500® Equal Weight ETF (RSP), Vanguard Materials ETF (VAW), SPDR Gold Shares (GLD), iShares MSCI Emerging Markets ETF (EEM), and iShares 20+ Year Treasury Bond ETF (TLT).

My reason for choosing these is because at any given time one to three of these will be moving in a positive direction.  If the market is roaring, the RSP, EEM, and VAW will have positive momentum.  If the economy is going to crap, then investors will be flocking to the GLD and TLT funds.  This will allow you to have the opportunity to reap positive gains no matter what the financial climate is at home or globally.

The parameters that I am currently trading are the following:

  • Relative Strength Timing Period – 3 Months
  • Assets To Hold – 3
  • Risk Control – 4 Month (80 Days) Moving Average
  • Out Of Market Asset – iShares 20+ Year Treasury Bond ETF (TLT)
  • Re-balance on the last trading day of the month

Essentially what I do is track the past 3 month price performance of RSP, VAW, EEM, and GLD.  At the last trading day of every month I look at each individual ETFs 3 month price performance and pick the top 3 performers.  If there are only 2 ETFs that are positive or above their 80 Day Moving average then the mix would include the 20 Year Treasury ETF.

So let’s say that the economy was in dire straits like in 2008, this system would automatically have you in 1/3 GLD and 2/3 TLT during the worst parts of the market downturn or 100% TLT when markets are in free fall. September ’08 – March ’09: Realized gains from this model were TLT +15.06% GLD +12.41%, while S&P 500 was -39.72% for the same time period.  How do you know to get out?  You would have moved out because RSP, VAW, and EEM all moved negatively across their 80 day moving averages.  And thus, leaving only the GLD ETF as the sole asset in your “in market” basket. With only 1 slot filled of your in market basket, you would then use TLT would to fill the other 2 slots from your “out of market” basket.  If for some reason all of your in market ETFs move negatively across their 80 day moving averages, then you would hold 100% TLT for that month.

There are a couple exciting things about this method.  It prevents you from getting completely taken to the wood shed in a major market down turn.  And it puts you into securities that have made positive movement, and thus, puts you into ETFs that have the “hot hand” on the way up.  As I mentioned elsewhere on the blog I like to use a free tool called portfolio visualizer (portfoliovisualizer.com).  It lets you back-test portfolios, test asset allocation mixes, and try out various other methods of investing.

So when you back-test the performance of the model I have been explaining, you get a CAGR of 17.79% since August 2006.  Yep, that’s right, through the “Great Recession”, “Housing Bubble”, “Debt Crisis”and all the other apocalyptic events it has fared really well.  What’s even better is that it is much less volatile when compared to the volatility of the overall market.  You can check out the performance on a month to month basis here.  This is just some food for thought, but it definitely does lend some credence to all the momentum traders methodologies out there.  I know some will read this and say “awww bullcrap!”.  But if you put in the time an back-test dozens and dozens of strategies like I have been explaining, you will notice for yourself that models such as these do indeed seem to lower volatility and increase returns versus the market.