This article describes an ETF trading strategy with mean-reversion and momentum regime switching. The Sharpe ratio of the strategy is greater than 1.
The long-only trading strategy with four liquid ETFs may be used as the basis for developing more advanced strategies that incorporate regime switching. Mean reversion usually works well in bear markets due to short-squeeze rallies, and momentum may work well in bull markets. The strategy uses a regime switch indicator to trade the mean-reversion and momentum regimes.
The rules of the strategy are available separately or as part of a bundle of strategies. Contact us for more details and prices.
Strategy rules
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Backtest range: 01/03/2003–12/31/2024
The annualized return is 10.2%, and the maximum drawdown is 16.7%. The Sharpe ratio is 1.14. The win rate is 54.2%, and the number of trades is 1,558. The strategy’s P/L skew is 1.64 and the equity skew is 0.18 in the test period.
The strategy fell 12.1% in 2022, but in 2023 it more than recovered with a gain of 22%. The best year has been 2020, with a nearly 29% return.
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About the risks of mean-reversion strategies
Mean-reversion methods are risky since the trades typically go against the short-term trend. Stop-loss orders cannot be employed efficiently because, in the majority of instances, they destroy profitability.
Mean-reversion strategies are only good for experienced traders who know how to manage risk and are willing to take on big risks.
When using a profitable mean-reversion strategy, inexperienced traders may lose money because they are afraid to act on signals that are risky at first but pay off in the long run.
Disclaimer: No part of the analysis in this blog constitutes a trade recommendation. The past performance of any trading system or methodology is not necessarily indicative of future results. Read the full disclaimer here.
Copyright notice: Any unauthorized copy, reproduction, distribution, publication, display, modification, or transmission of any part of this report is strictly prohibited without prior written permission.
Charting and backtesting program: Amibroker. Data provider: Norgate Data
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