An Introduction to Rotational Trading Strategies for Beginners

Introduction

Rotational trading strategies offer a simple yet effective approach to building a robust stock portfolio. These strategies are ideal for beginners looking to venture into systematic trading. In this article from Your first systematic portfolio series, we’ll dive into the key concepts of rotational trading strategies, their pros and cons, and provide an example strategy with complete systematic rules to help you get started.

What is a Rotational Trading Strategy?

A rotational trading strategy involves periodically rotating the stocks in your portfolio based on a specific set of criteria. This approach generally consists of three main components:

• Trading Universe: A pre-defined group of stocks to choose from, such as the S&P 500 or Nasdaq 100.
• Rotating Period: The time frame for rotating the stocks in your portfolio, typically one month.
• Ranking: A set of rules used to rank the stocks in your trading universe and determine which ones to hold for the next period.

Pros and Cons of Rotational Trading Strategies

As with any trading approach, rotational strategies have their advantages and drawbacks. Let’s examine the pros and cons.

Pros

• Long-term focus: Rotational strategies are typically long-term, making it easily tradeable without automation.
• Low commissions: Since stocks are held for longer periods, commissions and slippage are reduced.
• Simple rules: Creating a rotational strategy is relatively easy, even for beginners.
• Good performance: Properly designed rotational strategies can outperform benchmarks like the S&P 500.
• Overnight gains: Rotational strategies capitalize on long-term upward trends in stock markets.

Cons

• Market exposure: Rotational strategies involve holding positions continuously, increasing exposure to market downturns.
• Correlation with indices: Rotational strategies tend to be correlated with the chosen trading universe, such as the S&P 500 or Nasdaq 100.

Building Your First Rotational Trading Strategy: An Example

1. Trading Universe: For this example, we’ll choose stocks from the Nasdaq 100, which consists of technology stocks that often exhibit strong trends.
2. Rotating Period: We’ll rotate our holdings every month.
3. Ranking: To keep things simple, we’ll rank stocks based on their percentage gain over the preceding 20 trading days.
4. Risk Management: To diversify our portfolio, we’ll hold 10 stocks from the Nasdaq 100 according to the highest ranking.

Complete Rotational Strategy Rules:

• Trade on the first trading day of each month.
• Sort Nasdaq 100 stocks by their percentage gain over the past 20 trading days.
• Buy the 10 highest-ranked stocks.
  • If a stock is already in our portfolio and remains in the top 10, continue holding it.
  • Sell stocks that are no longer in the top 10.

Yes. Thats it. It cant be much more simplier than that, but lets see metrics of such a system.

According to a backtest created in Amibroker, from 1.1.2015 to 1.12.2022, strategy have annual return of 19.86% with maximum drawdown of 34% and total gain of 324%. This is quite ubelievable according to strategy simplicity – such system can be really helpful for your trading portfolio. On the other hand, when we investigate metrics a bit more and create a monte carlo analysis, we will find out that results are quite volatile.

Polish and lets go live!

To be able to trade such a system in my portfolio Ive worked on many improvements, which led me to final rotational strategy Im personally using on my live account called Smart Nasdaq Momentum. Currently backtested metrics from 1.1.2015 – 1.12.2022 are 20.86% annual gain which is slightly better than simple strategy I described before, but with significantly lower max drawdown of 26%. When comparing monte carlo analysis – its clear that improved strategy have much less volatile performance.

Ive massively lowered drawdowns and volatility of such strategy. Such metrics are really sufficient for me to trade this strategy on my live account. Those metrics are very good considering you need to trade only once in a month!

Conclusion

Rotational trading strategies offer a simple yet effective approach to building a strong stock portfolio. Although these strategies have their pros and cons, they are an excellent starting point for beginners in systematic trading. You can trade such strategy with no more than 15 minutes a month. All you need to do is develop systematic rules, scan for entries on every first day of month and create market orders in your broker account. By following the example provided in this article, you can begin to experiment backtesting with different trading universes and ranking rules to create your own rotational trading strategy. Give it a try and see the potential benefits for your portfolio!