For history on how we got here…
The first runs will test a very basic system as I want to be able to see if adding any more complexity to the system improves it (and how it improves it) in any way over simpler versions.
The system will calculate the momentum/strength of each ETF in the portfolio, and then based on that metric, rank the ETFs. Version V1.0 will use RSI as the proxy for momentum.
- The top 4 highest ranked ETFs will be bought on the next open after the signal to rotate.
- Each ETF will be held for a minimum number of trading days.
- At the end of the minimum hold time, the ETF portfolio will be ranked and re-balanced.
Version 1.0 will be using only 2 factors, which are RSI(x) where x represents the periods, and the minimum number of trading days to hold the ETFs, represented by y.
Lets take a look at how these factors play together, using AmiBroker’s 3D Optimization graph.
The most obvious feature of these graphs is that they are peaky. This is not a good thing. You know you have a robust interplay of factors when rather than looking like some crags in Switzerland, the graph looks like a nice grassy knoll.
I’ve circled the area that looks the most promising. We’ll be optimistic and call it the grass knoll. You can see that on either side of this area, performance begins to roll off.
So how do we choose the figures for x and y to plug into our factor calculations? Initially, I tend to eyeball things. I look for the area that seems to fall in the middle of the grassy knoll. If we choose a number near the edge of the knoll, it means that any change in the market may serious affect the system.
To my eyes, this looks like a value of near 65 for x and 65 for y. Even as I’m writing this, I haven’t tested those values, but I like them because they correspond nicely to 3 calendar months (approximately 22 trading days in a month). Keep in mind that if we choose the highest peaks for our x and y value, we will likely have curve fit the system.
Come Back for Part 2
In Part 2, we’ll backtest our x and y values over our ETF portfolio, take a look at the statistics and equity curve, and decide what we might do to improve performance.