Dynamic Portfolio Using Technical Analysis

In the past ten years, we have seen so many developments in Indian markets, and so many new investment platforms, investment strategies, and investment products are available in the market. Choosing one depends on a person’s risk appetite, investment horizon, and understanding of the financial product. One can do a fundamental analysis of ratios and then screen the stocks and hold it for many years, one can buy the index funds, one can buy active mutual funds, one can choose to automate their trading strategies, or one can use technical analysis to buy their shares and many more. Each approach has its pros and cons. Rather than defending any system, we wanted to present an investment strategy that uses technical analysis, doesn’t take much time to implement, and can be automated.

This article will discuss developing one strategy and the back-testing results, the most important to validate a system. We have used the back-testing period from January 2012 to December 2021, which is approximately ten years of data, so it is sufficient to pass the market’s bull, sideways and bear phase. We have chosen the NIFTY 500 index as the benchmark. Before jumping into understanding, I wanted to show you this strategy’s statistics and equity curve.

Equity Curve for of Strategy:

Equity Curve for NIFTY 500:

The above graphs and results show that strategy has outperformed the benchmark by approximately 14% and has a Sharpe ratio of 0.83. Now let’s discuss this strategy in detail.

Logic behind the strategy:

Most of us wanted to make timing in the market or pick up those stocks that were in momentum. Timing the market means reversion strategy, while momentum strategy is a trend following. Here we are using momentum strategy. This strategy assumes that the securities whose prices are rapidly increasing outperform the stocks that are not moving that much for a defined period. I have used technical indicators to quantify momentum, which I will explain further down here. I have used weekly charts to calculate technical indicators.

1. Relative strength
2. ADX
3. Moving averages
4. Volume averages
5. Relative strength (RS) with respect to benchmark

I have not defined the subjective setup and depends upon one’s risk appetite and understanding of the market. One can also convert this momentum strategy to a mean reversion strategy by changing the parameters of the above indicators. The security satisfies all the conditions (Number of stocks depends upon market condition); I have put the top 15 (set in descending order by the RS with benchmark) securities into my portfolio and let it run for one month.

Strategy:

1. Screen the securities by the given technical indicator on weekly charts. You can use chartink.com. (Relative strength is not there, so you have to calculate on excel or python)
2. Rank them based on descending order of RS and select the portfolio of 15 stocks, and if there are not sufficient stocks in the screener, then fill that gap using liquid bees because we are not finding any opportunity anywhere in the market, so it’s better to keep it safe rather than losing on equity holdings.
3. Wait for one month, and on the first trading day of next month, again run the screener buy which are not in holdings, sell which are not in the screened list and keep it as it is in both lists.
4. Keep this long enough to see the results.

Pros of strategy:

1. On the back-testing results, It has beaten the market for approximately 10 years by whopping 14%
2. The portfolio is dynamic, so it does not depend upon the non-systematic risk of any firm.
3. The screener can choose to invest in liquid bees if opportunities are not available in market
4. This strategy has tones of a combination of the indicators, which can be used as per the psychology of investors.
5. Most of the investment techniques use fundamental analysis to choose securities. We don’t know if they have to wait long enough to see the results and shift the growth from fundamental to real stocks price or if it has already been incorporated; we don’t know. This portfolio uses technical analysis to choose securities that are already based on the security price and can have a shorter time horizon for investment.

Cons of strategy:

1. The main problem with this strategy is one has to incur more brokerage costs and have to pay tax in capital gain, which can be pretty significant, but one can choose running screener with different rebalancing periods and with a different set of parameters to tackle this problem
2. This strategy has a 43% drawdown, which is significant but can be reduced by changing parameters and being more conservative.

Choosing the right investment strategy depends on the system’s understanding and logic, not just back-tested results and numbers. We have tried our best to explain this new way of investing and creating a dynamic portfolio. We hope you will like it.

Written by Kaushik Sanghani (ksanghani624@gmail.com)