Great article on the power of combining factor investing with a systematic momentum overlay. It’s rare to see a strategy that effectively mitigates the decade-long underperformance periods often seen in pure factor plays.
Have you tested how sensitive the CAGR is to the specific look-back period—for instance, does using a 6-month vs. a 12-month momentum window significantly change the drawdown protection results?
I have tested every possible look-back period with the monthly data. The CAGR stays significantly above market level, regardless of the lookback period, but the alpha gradually declines the further I move away from the selected monthly intervals, as you would expect.
So, it seems the system would do well with most settings, but I optimized it for the most consistent outperformance based on the 2000-2020 data.
You can feel the years of trial and patience behind this. The discipline to stick with a system is what most people struggle with. It’s a steady approach that seems to value consistency over excitement.
It does require discipline to stick with a system.
And yes, my main priority was to build a system with high consistency in the returns. There are lots of trading systems available that deliver higher CAGRs but with much higher volatility. Personally I don't have the risk profile to stick with these, so I had to invent my own.
You should execute the trade after you receive the monthly trade signal in your inbox. Ideally on the first day of the month, but the sooner the better.
The whole back-test and my five years of trading the system in real life have been based on trades executed at the turn of the month or on the first trading day of the month.
Thanks for the article. As a fellow computer scientist I loved reading this and your approach. I've downloaded the stock data for the last few years, calculating all the technicals for each stock and running various queries with a view to something similar in an individual sock basis, but your approach is so elegantly simple (appreciate the work to get there wasn't!). Will definitely give this a try.
Thanks, I really appreciate your comment! I've been down that road with individual stocks as well, attempting to build a similar system, but I didn't manage to find the same consistency as I did with the ETF setup. It was too volatile for me :-)
The quality factor section resonates most. The reason quality outperforms over long periods isn't random. It's because businesses with high ROIC and consistent profitability have structural advantages that compound the same way the returns do.
The psychological challenge you describe is real. Most investors abandon quality factor strategies during underperformance because they don't understand why quality works. The fundamentals tell you why.
That's what makes it possible to hold through the difficult periods.
Factor investing is academically credible and practically humbling. Value was dead for a decade. Momentum crashes violently. Low volatility underperformed in the longest bull run in history. The factors work — on a timeline most investors can't emotionally survive.
Action: Look up the maximum drawdown and longest underperformance period for each factor cited — then decide honestly if your patience actually matches the strategy's requirements
Exactly. Investing in individual factors is practically impossible to hold on to during the inevitable bad periods. That's what my strategy aims to solve by rotating into the recently strongest factor and abandon the rest. But you are absolutely right regarding the use of individual factors.
Really interesting blend of factor rotation and momentum filtering. The consistency of returns and drawdown control is probably the most impressive part here, especially compared to traditional buy-and-hold indexing.
This looks like a good system but CAGR alone is insufficient for me. I would take a lower CAGR for less drawdown and volatility. From the chart, your system looks like it has low volatility. What is the Max Drawdown, Max Recovery, Sharpe, and volatility?
We're in the same boat :) You can find other systematic strategies with higher CAGR than mine, but it usually means higher risk, more volatility, deeper drawdowns. Here are the numbers I have calculated for the strategy:
Sharpe ratio: 1,13
Sortino ratio: 2,01
Max drawdown: 15,23% in 2020
Max recovery: 20 months in 2007-2009
These numbers are only based on monthly closing prices. The max drawdown was most likely higher at some point intra-month.
Thanks for the data! Good numbers. Yes, the daily MaxDD will be higher by probably 2 percentage points. I have a related system (rotational momentum) that I will write about in the future on my Substack, but it’s through the lens of retirement where you don’t have time to make up for deep drawdowns if you are drawing down your portfolio to live on. So you give up CAGR for MaxDD of around 10% or less.
So great to read about your system! So few on Substack are discussing systematic ETF investing. We share a similar journey as engineers experimenting to create our own systems, sheepish to share it at first, but now doing so. I was seeking a buy-and-hold system, but our goals and thinking are similar.
One ETF in my ACE Portfolio is EZRO, which does a monthly tactical sector rotation with bear market protection just like your system. It's based on a subscription-based DIY tool they have called SectorSurfer. You might enjoy checking it out. Lots of similarities. I'm quite familiar with that system, and that's why I'm comfortable giving their new ETF, EZRO, a try in my portfolio. Let me know if you want to know more about them.
That's great to hear! You're right, there are not many of us. Most people in this field seem to be stock pickers. While I get the excitement in this, I'm all in on probability and expected returns 😊
It does indeed sound like a similar journey! I guess the engineering background makes it more natural for us to focus on the data rather than the narrative.
EZRO sounds interesting. Unfortunately, in the European Union we have regulatory policies restricting us from trading US-listed ETFs, so I can't even buy it. But thanks for the tip anyway, it seems like an interesting approach!
Can you show precisely which ETFs were your factor ETFs and sector ETFs? And how did you know which factor or sector to switch to? You just picked the best performing one over the last twelve month window? And when did you know to switch to cash?
Actually I have received a lot of requests for specific ETF tickers. I didn't originally include these because the availability of each ETF depends on the country you live in. But I will assemble lists of suggested ETF tickers specifically for the US and EU markets in the next article I send out! 👍
Regarding the ongoing selection, I have revealed most of the process in this article. The only thing I'm not disclosing is the exact details about the timing intervals (it's not just 12 months). The only inputs the system requires are the monthly prices of all the indices. At the end of each month, the system compares relative momentum over the specific intervals across all the indices and simply picks the strongest sector and the strongest factor.
The same applies for the rare occasions when the system switches to cash. Again this is entirely based on monthly price levels of the past 12 months. Notably, it hasn't been allocated to cash since early 2009, so it only happens during extended declines with high mathematical probability of continued downtrend.
Although I'm not revealing the timing details of the system, subscribers receive the output (the trading signals) each month before the opening of the first trading day. 😊
Great article mate. I subscribed because I was kind of coming to the same conclusion about sector rotation. I've created my own database with eod data and charting software (With the use of some available libraries). Witnessing the 2025/26 sector rotation out of tech into commodities had me thinking and I was going to code up a page to show returns of different sectors against each other so I could visualize when one kicks on. I was also going to pit all known ETF's against each other which would show the sectors anyway.
I'm interested to read more on "factors" which I'll do tonight. I didn't know these were a thing and covered by ETF's.
Looking forward to reading more of your stuff. Thanks for sharing!
Thanks for your comment! Sounds like you were already moving in the same direction. This has been a true game changer for my returns.
I definitely recommend studying factors. These are the historical premiums identified by academic research with well-documented outperformance over decades. The problem with factors is they are inherently inconsistent. That's why a rotation approach can make a huge difference.
Great article on the power of combining factor investing with a systematic momentum overlay. It’s rare to see a strategy that effectively mitigates the decade-long underperformance periods often seen in pure factor plays.
Have you tested how sensitive the CAGR is to the specific look-back period—for instance, does using a 6-month vs. a 12-month momentum window significantly change the drawdown protection results?
Thank you! Appreciate your comment 🙏
I have tested every possible look-back period with the monthly data. The CAGR stays significantly above market level, regardless of the lookback period, but the alpha gradually declines the further I move away from the selected monthly intervals, as you would expect.
So, it seems the system would do well with most settings, but I optimized it for the most consistent outperformance based on the 2000-2020 data.
Thank you for the knowledge 👏
You can feel the years of trial and patience behind this. The discipline to stick with a system is what most people struggle with. It’s a steady approach that seems to value consistency over excitement.
Thanks for the words! 🙏 You are absolutely right.
It did take many years to reach this point.
It does require discipline to stick with a system.
And yes, my main priority was to build a system with high consistency in the returns. There are lots of trading systems available that deliver higher CAGRs but with much higher volatility. Personally I don't have the risk profile to stick with these, so I had to invent my own.
I love this! This is exactly the kind of edge I’ve been looking for 🙏 Subscribed and looking forward to follow!
When exactly are the trades supposed to be executed?
Thank you so much, I really appreciate this!
You should execute the trade after you receive the monthly trade signal in your inbox. Ideally on the first day of the month, but the sooner the better.
The whole back-test and my five years of trading the system in real life have been based on trades executed at the turn of the month or on the first trading day of the month.
Thanks for the article. As a fellow computer scientist I loved reading this and your approach. I've downloaded the stock data for the last few years, calculating all the technicals for each stock and running various queries with a view to something similar in an individual sock basis, but your approach is so elegantly simple (appreciate the work to get there wasn't!). Will definitely give this a try.
Thanks, I really appreciate your comment! I've been down that road with individual stocks as well, attempting to build a similar system, but I didn't manage to find the same consistency as I did with the ETF setup. It was too volatile for me :-)
The quality factor section resonates most. The reason quality outperforms over long periods isn't random. It's because businesses with high ROIC and consistent profitability have structural advantages that compound the same way the returns do.
The psychological challenge you describe is real. Most investors abandon quality factor strategies during underperformance because they don't understand why quality works. The fundamentals tell you why.
That's what makes it possible to hold through the difficult periods.
Factor investing is academically credible and practically humbling. Value was dead for a decade. Momentum crashes violently. Low volatility underperformed in the longest bull run in history. The factors work — on a timeline most investors can't emotionally survive.
Action: Look up the maximum drawdown and longest underperformance period for each factor cited — then decide honestly if your patience actually matches the strategy's requirements
Exactly. Investing in individual factors is practically impossible to hold on to during the inevitable bad periods. That's what my strategy aims to solve by rotating into the recently strongest factor and abandon the rest. But you are absolutely right regarding the use of individual factors.
Really interesting blend of factor rotation and momentum filtering. The consistency of returns and drawdown control is probably the most impressive part here, especially compared to traditional buy-and-hold indexing.
YTD using this?
As of May 1st, it was up 16.31% YTD. You can find more info in the monthly performance reports I publish.
This looks like a good system but CAGR alone is insufficient for me. I would take a lower CAGR for less drawdown and volatility. From the chart, your system looks like it has low volatility. What is the Max Drawdown, Max Recovery, Sharpe, and volatility?
We're in the same boat :) You can find other systematic strategies with higher CAGR than mine, but it usually means higher risk, more volatility, deeper drawdowns. Here are the numbers I have calculated for the strategy:
Sharpe ratio: 1,13
Sortino ratio: 2,01
Max drawdown: 15,23% in 2020
Max recovery: 20 months in 2007-2009
These numbers are only based on monthly closing prices. The max drawdown was most likely higher at some point intra-month.
Thanks for the data! Good numbers. Yes, the daily MaxDD will be higher by probably 2 percentage points. I have a related system (rotational momentum) that I will write about in the future on my Substack, but it’s through the lens of retirement where you don’t have time to make up for deep drawdowns if you are drawing down your portfolio to live on. So you give up CAGR for MaxDD of around 10% or less.
Thanks for the informative article. I subscribed.
Congratulations ... these are impressive results.
Thank you!
Interesting, you have my attention!🍻
Can i have permission to reference your post in my next post? I will do some research on how combining our methods would have performed
Of course you can 😊
thank you
So great to read about your system! So few on Substack are discussing systematic ETF investing. We share a similar journey as engineers experimenting to create our own systems, sheepish to share it at first, but now doing so. I was seeking a buy-and-hold system, but our goals and thinking are similar.
One ETF in my ACE Portfolio is EZRO, which does a monthly tactical sector rotation with bear market protection just like your system. It's based on a subscription-based DIY tool they have called SectorSurfer. You might enjoy checking it out. Lots of similarities. I'm quite familiar with that system, and that's why I'm comfortable giving their new ETF, EZRO, a try in my portfolio. Let me know if you want to know more about them.
Thanks for sharing your system!
That's great to hear! You're right, there are not many of us. Most people in this field seem to be stock pickers. While I get the excitement in this, I'm all in on probability and expected returns 😊
It does indeed sound like a similar journey! I guess the engineering background makes it more natural for us to focus on the data rather than the narrative.
EZRO sounds interesting. Unfortunately, in the European Union we have regulatory policies restricting us from trading US-listed ETFs, so I can't even buy it. But thanks for the tip anyway, it seems like an interesting approach!
Can you show precisely which ETFs were your factor ETFs and sector ETFs? And how did you know which factor or sector to switch to? You just picked the best performing one over the last twelve month window? And when did you know to switch to cash?
Hi!
Actually I have received a lot of requests for specific ETF tickers. I didn't originally include these because the availability of each ETF depends on the country you live in. But I will assemble lists of suggested ETF tickers specifically for the US and EU markets in the next article I send out! 👍
Regarding the ongoing selection, I have revealed most of the process in this article. The only thing I'm not disclosing is the exact details about the timing intervals (it's not just 12 months). The only inputs the system requires are the monthly prices of all the indices. At the end of each month, the system compares relative momentum over the specific intervals across all the indices and simply picks the strongest sector and the strongest factor.
The same applies for the rare occasions when the system switches to cash. Again this is entirely based on monthly price levels of the past 12 months. Notably, it hasn't been allocated to cash since early 2009, so it only happens during extended declines with high mathematical probability of continued downtrend.
Although I'm not revealing the timing details of the system, subscribers receive the output (the trading signals) each month before the opening of the first trading day. 😊
Intriguing read, to say the least. On which day monthly updates come out?
I’m glad you liked it! The monthly trading signal comes out before the markets open on the first trading day of each month.
Great article mate. I subscribed because I was kind of coming to the same conclusion about sector rotation. I've created my own database with eod data and charting software (With the use of some available libraries). Witnessing the 2025/26 sector rotation out of tech into commodities had me thinking and I was going to code up a page to show returns of different sectors against each other so I could visualize when one kicks on. I was also going to pit all known ETF's against each other which would show the sectors anyway.
I'm interested to read more on "factors" which I'll do tonight. I didn't know these were a thing and covered by ETF's.
Looking forward to reading more of your stuff. Thanks for sharing!
Thanks for your comment! Sounds like you were already moving in the same direction. This has been a true game changer for my returns.
I definitely recommend studying factors. These are the historical premiums identified by academic research with well-documented outperformance over decades. The problem with factors is they are inherently inconsistent. That's why a rotation approach can make a huge difference.
Yeah I'll have a read tonight, thank you!