Backtest Engine Scans I Have Known and Loved - The Microcap/SPX Relative Ratio Rank Edition

Jay Kaeppel
2021-08-25
The MicroCap/SPX Relative Ratio Rank indicator is a versatile "risk-on/risk-off" tool. Like many indicators, this ratio can be used in a variety of ways. In Part I, we highlight one approach to using this measure to signal an "oversold" situation in the market.

This is Part I of a 2-part series highlighting potentially useful Backtest Engine Scans. Please note that these scans are not necessarily presented on a "timely" basis. The goal is two-fold:

  • To help you learn more about the Backtest Engine and its potentially powerful uses
  • To help you build an arsenal of scans that may ultimately prove to be very useful at just the right time

Sometimes the same indicator can be used in different ways. This is often due to the non-intuitive quirk of the stock markets that:

  • Deeply oversold can at times be bullish for stocks
  • Strongly overbought can ALSO at times be bullish for stocks

In this piece, we will use the Micro Cap/SPX Relative Ratio Rank indicator to generate an oversold signal. As the name implies, this indicator measures the ratio between the two indexes relative to its range over the past four months. When the relative ratio is high, investors are showing risk-on behavior. When the ratio drops to a low level, they are exhibiting risk-off behavior.

Micro-Cap/SPX Relative Ratio Rank

We will attempt to use this measure as an oversold indicator for this test, intended to help us buy on weakness. In essence, we are looking for a sign of a washed-out market - one that has suffered so much widespread damage that it (hopefully) has little downside potential left. 

By clicking this link and then clicking "Run Backtest" you can run the following test we look for:

  • The 5-day moving average of the MicroCap/SPX Relative Ratio Rank indicator to be below 1
  • While the S&P 500 Index is below its 200-day moving average
  • For the first time in 21 days

The chart below displays the signals.

Note that:

  • There are only 5 signals, so a small sample size is a concern
  • The 2007 signal was followed by an awful 12-month return of -42%. This suggests that a trader relying on this signal should establish some sort of stop-loss or other "fail-safe" exit signal to avoid riding a drawn-out bear market to the bottom
  • The results are hit-or-miss over the first month after a signal but are decidedly favorable 6 and 12 months out.

Note also that:

  • After 1-month, the Win Rate was only 33% (so it might make sense to either look for some confirmation before acting on the signal or simply waiting for a month before acting)
  • The 6-month and 12-month Win Rate is 83%
  • The 6-month Median return is +13.31%
  • The 1-year Median return is an impressive +20.99%

The bottom line is this: This signal from this indicator may at times be a little early, and some further declines are a definite possibility. However, given the 6-month and 12-month results, investors may do well by looking to play the bullish side of the market after this "washed out market" signal occurs.

Now let's look at how you can save this scan (or any scan) so that you will automatically be alerted when it gives a signal.

You can do this by:

  • Clicking "Add to Favorites"

  • Typing "Micro-Cap/SPX Relative Ratio Rank 5-day average below 1" (or whatever label you would prefer)
  • Then click "Save Favorite"

These steps will add this particular scan to your list of Favorites. Anytime you enter Backtest Engine, your Favorites will be listed at the bottom as per below.

More importantly, any Saved scan that is active is listed at the bottom of your Evening Digest email. You can go to My Website Preferences under My Account to ensure you get those (they are on by default).

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