The ETF Sector models took a hit this week, in large part due to Semiconductors coming off their recent all-time highs. The Sector Conservative is up on the SPY year-to-date, the Moderate is lagging by a small margin, while the Aggressive remains negative.
The U.S. markets sold off from their recent highs. Even a great jobs report on Friday couldn’t provide a boost. SPY and DIA are now both below their 50 DMAs, while QQQ and IWM are sitting just above their 50 DMAs.
There were no position changes this week. We recently made a number of significant changes to the Sector models, including adding two new models and renaming an old one. Please see last week’s strategy article for more information.
Summary of the Sector Models' Performance
This Week’s Strategy Lesson: Stops and Targets Analysis (Part 1)
With the new rollout of some additional trading options for our trend strength-based ETF models, we thought it would be good to look more closely at the performance characteristics, particularly for the new “Sector Moderate” model.
The “Sector Moderate (Stops & Targets)” model is designed to replace the old “Sector Stops & Targets” model. It incorporates stops which gives some additional protection on the downside and the targets, which mean we will be taking some profits and risk off our positions as they move deeper into the money. However, it should be noted that these stops and targets levels are set fairly wide, so a majority of trades will not trigger either the stop or a target.
Depending on the nature of a model and the levels where you place your stops and targets, they can have a positive, negative, or neutral effect on a number of performance measures including total return, volatility, and drawdowns.
With the Sector Moderate (Stops and Targets) model we have an interesting chance to directly see how stops and targets can affect performance and risk in different market environments.
The Sector Moderate model takes its rotation signals from the Sector Conservative model (a list of completely non-leveraged ETFs) and enters a leveraged version of the ETF when there is one available. In addition, once we have entered a position, the stops and targets are applied on top of the trade.
The chart above looks at the overall effect of adding stops and targets to this particular model. The blue equity line is for no stops & targets. The orange line is for the same model with the additional stops and targets and money management rules. As you can see from the chart, the overall effect on total return was negligible. During some periods, one model outperformed the other and vice-versa, but in the end, they both have very similar performance.
However, what you can also see is that the orange line has fewer extreme swings. Sometimes mildly less and sometimes quite a bit less. Each period is different and the holdings, the proximity to a stop or target, and the amount of cash in the portfolio all play a role in the amount of volatility we experience.
The period in late 2008 is particularly relevant. Each of the ETF models have instruments that help us take advantage of bear markets or added volatility. In late 2008, the Sector Moderate model had SDS (ultrashort SPY) as one of its holdings.
As you can see in the chart above, this ETF spiked up many times and had a very high level of volatility to the upside. Bear sell-offs tend to be faster and more violent than bull runs. Part of that is just the nature of human emotions and the power of fear versus greed. This can be one of the best market environments for having stops and targets.
In the chart above, we zero in on this period and can see very clearly the effect of taking profits in that environment. The orange line is the equity for the current “Sector Moderate” model. The SDS position quickly reached profit targets and went to and stayed in a high level of cash. It did not reach the highest maximum return on this period (blue line), but it also had fewer violent swings and because the SDS eventually reversed, the stops and targets allowed the model to lock in a higher overall return.
This analysis is an apples to apples comparison. That is, it looks at the exact same holdings and compares having stops and targets with not having stops and targets.
It is not always the case that every model will perform better with stops and targets than without. The Country Basic model currently outperforms the Country Stops and Targets model from a total return perspective. But total return isn’t the only or most important consideration. Volatility and drawdowns play an important role in making a model trade-able.
Next week, we will continue this series looking at some of these other components and how stops and targets can change the character and performance of a model.
The Current Condition of the Model
Please visit the Model Portfolio section of the member area to see the ETF ranking for each of the three Sector models.
Stay tuned to the daily emails for any position changes and updates.
Best wishes for your trading,
James Kimball
