Backtesting & Performance

To ensure that strategy logic works in various market conditions a backtesting of the assumptions over different periods (last 3, 5 and 11 years) has been performed. For the biggest period of 11 years the backtesting starts with TNA inception back to November 2008, right in the midst of the Financial crisis. To ensure that there is no database or software bias backtests have been run on different platforms with independent databases. All tests gave relatively close results. Backtesting result can be seen on the chart (Source TradingView):

Performance
Over the period between 2016 and 2019 the Small Cap Swing strategy has generated 282.90% period return or 56.40% per annum compared to 28.16% period and 8.60% annual return if investor simply buys and holds the underlying TNA. If one have followed this strategy over the 5 years period, between 2014 and 2019, total return would be tenfold, 1024% or 62.40% annualized. Small Cap Swing strategy accuracy proves to be above average with 84% profitable trades for the 2016 – 2019 period. Even in long run percent profitable trades does not fall below 75.95%.

Strategy risks
In order to control draw down risk the following risk mitigation techniques have been employed: Strategy does not use leverage - no use of margin. Every long position is opened with stop loss. Entries per direction are limited to two - 50% of capital per trade. This helps average down initial purchase price if market turns against opened position.

Detailed description

Small Cap Swing Strategy takes advantage of both directions of the market and focuses on short term swing trading of Russell 2000 companies trough long only positions in ETFs – Direxion daily TNA and Direxion daily TZA.

Mentioned are leveraged ETFs mimicking daily performance of Russell 2000 index. TNA follows x3 positive changes, while TZA is inversed i.e. rises (x3) with negative change of the underlying index. This strategy is low turnover with up to 3 trades per month and average time in position 21 days. Indicative return based on backtesting is 30-50%. Indicative account drawdown 28%.

The small cap size effect is one of the few widely accepted by nearly the whole academic community. It says that low capitalization stocks earn substantial premiums against stocks with large capitalization (without additional risk). This anomaly is the best described in the classical Fama and French research paper (1993).

The so called small cap premium leads the stocks with market cap between $300 mln to $2 billion outperforming large caps stocks. As research from CME group shows investors in this market segment could ensure considerable advantage, especially in certain phase of the market cycle.

However direct investment in small, rapidly growing companies hides considerable risk for the average investor. In addition, most individual investors lack time or expertise to pick specific stocks like full time professionals do.

Diversification is another very important issue and it is one of the biggest problems for most individual investors as they simply cannot buy the whole market. Using ETF (exchange traded fund) like TNA gives individual investors the opportunity to gain exposure to portfolio of the 2000 smallest US stocks.

TNA is leveraged ETF which means that it replicates daily performance of Russell 2000 index multiplied by 3 - a daily 1% rise in the index leads to 3% rise in the ETF.

Strategy logic
Small Cap Swing Strategy is an algorithmic trading system. The trading is based on market sentiment and trend confirming/reversing indicators, which explore Russell2000 index price patterns in order to generate excessive returns over long term. Entry/exit signals generated are based on underlying traded instrument normalized volatility and periodic relative price performance. Whenever system criteria is met, it generates signal. This strategy is draw down optimized.

Why Russell2000 index companies?
Russel2000 index consists of the 2000 smallest US companies with size between with $300M and $2B market cap. Most of them are domestic with bigger space to grow than large caps. According to a research small cap stocks outperformed large cap over the last 90 years. Recent data published in the "Stocks, Bonds, Bills, Inflation (SBBI) Yearbook" shows that small-cap stocks returned 12.1 percent annually between 1926 and 2017 compared with large-cap stocks, which returned 10.2 percent annually during the same period . The reason for this outperformance could be explained with the investor demand for high return investing in small stocks.

Why using ETFs?
Exchange Traded Funds are instruments allowing investors to overcome one of their biggest disadvantages – size and diversification limitations. For relatively small sized portfolio in reality is difficult to gain broad market exposure as it can buy only limited number of companies. The advantage of investing in ETFs following indices is getting exposure to the whole market with relatively small investment, thus eliminating mentioned hurdles.

Why leveraged ETFs?
Elevated daily changes of the leveraged ETFs provide great profit opportunities which makes them most suitable instrument for the strategy goal – short term swing trading.

Why inversed ETFs?
Using inversed instrument allows investors to take advantage of the market drop without shorting any instrument and thus saving the cost of maintaining short position.