Sector rotation model back-testing and optimization

Alpha Asset Allocation investment strategy was developed based on sector rotation model and market timing model. In this post we will review the back-testing optimization results of the sector rotation model. For this purpose we will use 19 years of historical data from 1/1/1994 to 10/22/2013.

Many trading systems suffer from over-fitting, this is the reason big share of the trading systems in the market which shows very good back-testing results fail when it comes to real trading.

In order to avoid over-fitting our sector rotation model is built using only two parameters (the less parameters the less the chance for over-fitting) and also major parts of the model are adaptive, that  means they automatically adapt to market environment. On top of this the model shows good parametric stability, as seen in the 3D optimization chart when we alter the model parameters (PERIOD and LENGTH) the results measured by CAR (capital annual return) does not show strong drift and remain within the range of 18.7% - 23.7% .