Mastering Relative Strength Trading: Boost Your Profits with 9 Sector ETFs

Last Updated on September 22, 2023 by Mark Ursell

Relative strength trading is a momentum-based strategy focusing on investing in assets and sectors that have outperformed relative to their peers. This systematic, data-driven approach aims to generate consistent returns, beat passive investments, and avoid large drawdowns.

In this article and video, I delve into the world of relative strength trading using nine S&P 500 sector ETFs as an example.

Video – Mastering Relative Strength Trading

Watch the video to see me describe the strategy and analysis results.

What is Relative Strength Trading?

Relative strength trading is based on identifying and capitalizing on market trends by riding the winners and cutting or avoiding the losers.

A relative strength strategy will typically buy an asset when it outperforms relative to its peers. And sell an asset when it underperforms relative to its peers.

Choosing Assets for a Relative Strength Trading Strategy

In my analysis, I have used the S&P 500 sector ETFs. Traders commonly use the S&P 500 sector ETFs for relative strength analysis because they offer liquidity, wide availability, and low cost.

However, you can apply this strategy to any asset class, including indexes, sectors, commodities, and forex pairs.

The S&P 500 sector ETFs are widely held and widely discussed as a way of making a fundamental bet on the economy’s future direction.

These sector ETFs experience cyclical and secular trends, which make them attractive for relative strength trading and investing.

Analysis Results

Scenario 1: Overall Gross Profitability

The best scenario for overall gross profitability was found when going from the very weakest (9th) ETF to an 8 or above. This scenario showed an overall gross profitability of approximately four times the original investment. However, it also showed large drawdowns during the 2008/2009 financial crisis and the Covid crash in 2020.

Scenario 2: Combining with the 200 Period EMA

This scenario is the same as the first, except that we do not buy an individual ETF when it is below its 200-period EMA. Using the EMA gives us a more consistent result with slightly lower overall profitability.

Scenario 3: Strong and Getting Stronger

In this scenario, we buy the ETF when it moves to the third strongest or above and ssell when it becomes weaker than the sixth. This strategy also sticks close to the linear regression but has larger drawdowns during significant market events.

Scenario 4: Strong and Getting Stronger

In this scenario, we buy the ETF when it moves to the third strongest or above and sell when it becomes weaker than the sixth. This strategy also sticks close to the linear regression but has larger drawdowns during significant market events.

Scenario 5: Shorter Look Back Period

Using a shorter look-back period, this scenario aims to be quicker on new trends and more active in trading. However, it also experienced occasional large drawdowns during significant market events.

Scenario 6: Combining Shorter Look Back Period with the 200 Period EMA

This scenario shows the lowest overall profitability but sticks very close to the linear regression, making it smoother and probably easier to follow for most traders.

Conclusion

Relative strength trading offers a compelling approach to consistently invest in the best-performing assets and sectors. This strategy aims to generate consistent returns, outperform passive investments, and mitigate drawdowns by identifying and capitalising on market trends.

My analysis of the S&P 500 sector ETFs using a Tradinformed Excel Backtest Model provides valuable insights into different scenarios and their outcomes. However, there are many other variations that you can test and trade.

You can adapt relative strength trading to suit your trading style and preferences. By leveraging systematic and data-driven techniques, you can enhance your decision-making process and achieve better and more consistent results.