Momentum Strategy for ETF Trading

The Momentum Strategy is a systematic trading approach designed to select and trade sector ETFs based on momentum shifts. The strategy aims to capture short-term market trends by selecting ETFs with the strongest increasing momentum.

Q-Score Momentum Model

The Q-Score Momentum Model reflects the underlying trend strength of an asset. Our proprietary quant models analyze price action and technical indicators to determine whether an asset exhibits bullish or bearish momentum.

A higher momentum score suggests strong positive price action, while a lower score indicates weakness or potential downside pressure. Traders can use this score to align their positions with prevailing market trends. Our model assigns a score ranging from 0 to 5:

• 0: Bearish Momentum
• 3: Neutral Momentum
• 5: Bullish Momentum

You can read more about our Q-Score in our dedicated Guide.

Asset Universe

The strategy focuses on the following ETFs:

• XLE (Energy)
• XLF (Financials)
• XLU (Utilities)
• XLI (Industrials)
• XLK (Technology)
• XLV (Healthcare)
• XLY (Consumer Discretionary)
• XLP (Consumer Staples)
• XLB (Materials)
• IYR (Real Estate)
• IYE (Energy Select)
• OIH (Oil Services)
• SMH (Semiconductors)
• IBB (Biotechnology)

Strategy Rules

Entry Conditions:

• Identify the ETF with the highest difference between today’s momentum score and the momentum score 5 days ago.
• Only consider ETFs with a positive difference (i.e., increasing momentum).
• If multiple ETFs have the same momentum difference, select the one with the lowest standard deviation of returns over the past 3 months.
• Buy at the market open.

Exit Conditions:

• Sell at the market open the next day unless the same ETF remains the top pick.
• If no ETFs meet the conditions, no position is taken.

Trading Costs:

• A commission of $2 per trade is applied (total of $4 per round trip).

Backtesting Period:

• January 1, 2014 – January 31, 2025

Initial Capital:

• $100,000

Performance Summary

Now let’s look at the historical backtest of this strategy and look at the performance versus the Benchmark (S&P 500 Index).

Now let’s look at some Key Metrics.

We can also look at the return distribution across years comparing this with the SPX.

• The Momentum Strategy outperforms the SPX in cumulative return and CAGR, showing strong long-term performance.
• It has a higher Sharpe and Sortino ratio, indicating better risk-adjusted returns.
• The strategy exhibits stability with lower drawdowns compared to SPX.

And finally let’s look at the distribution of returns by month historically.

Sensitivity to Initial Capital

The strategy was tested with varying capital levels to evaluate its robustness. Larger capital allocations help mitigate the negative effects of commission costs, leading to more stable and consistent performance over time. Performance across different capital allocations is detailed below.