Entry Scheduling
This parameter is used in all types of strategies. It will be available in static baskets of stocks/MF/ETF and dynamic stock strategy created using the screener or factor model.
In this article, we will discuss the entry and rebalance scheduling. Here we will decide the frequency of rebalancing and on what particular day you want to rebalance. So let’s get started.
Why rebalance?
We need to understand the purpose and importance of rebalancing. When we invest in a strategy, we start with a certain set of stocks (or ETFs/MFs) and a certain position sizing (weights).
But the market is not static. Both prices and metrics change over time. This will lead to a “misalignment” of your model and position sizing with respect to your current portfolio. Let’s take 2 examples.
Example 1: We invest in a basket of 10 stocks and allocate equal weight to each (10%). After 1 month, 7 stocks move up and 3 stocks move down. Therefore, in your portfolio, 7 stocks will have a higher weight than 10% and 3 stocks will have a lower weight than 10%. Your idea is to keep your portfolio equally weighted. That’s where you “rebalance” to bring back the weight to 10% (or as close to 10%) for each stock.
Example 2: We create a screen of stocks in Nifty 100 with a PE Ratio < 15 and ROE > 20. Suppose I get 25 stocks. I assign equal weight to each of them and invest. Now in a months’ time, as prices move and as new fundamental data (quarterly/annual statement in our case) arrives, it is quite possible that the original list of 25 stocks (that constitutes my current portfolio) is stale, and my screen has a new list of 30 stocks. Some stocks can obviously overlap. But we need to rebalance – sell stocks that have moved out of my screen and buy new ones such that I have 30 stocks with equal weight.
How often should we rebalance?
Well, this depends on several factors. But most importantly, it is a tradeoff between “how aligned should be your portfolio to your signal” and transaction costs associated with rebalancing.
For models where stocks are selected dynamically, the turnover can be relatively large, and hence very frequent rebalancing can lead to large transaction costs.
At the same time, you have to factor in “signal decay”. For example, momentum signal decays relatively faster (as compared to value and quality signals), and hence, momentum strategies should be rebalanced more frequently than pure value/quality strategies.
The exact rebalancing schedule will depend on your strategy, your broker, and your own assessment of signal decay.
Setting the entry and rebalancing schedule:
This step is self-explanatory. For dynamic strategy this is the 4th step as shown in the image below and for static MF and ETF baskets, this will be the second or third step.
On sharpely, we provide rebalancing frequency from 1 week to 1 year and we also provide the option to never rebalance the strategy. The never-rebalance option works well if you want to track the performance of a basket of stocks/MFs/ETFs.
Now based on your rebalancing frequency, you will be given the option to choose the day or date. For example, if you choose weekly rebalancing then you will be asked to select the day for rebalancing as shown below.
And if you select quarterly rebalancing then you will have the option to select the months and the date as shown in the image below.
This gives you complete flexibility in terms of deciding when you will rebalance your strategy. Now, this will be a predefined rebalancing schedule. But what if you have separate exit rules that are different from screening/entry rules?
Don’t worry, we have got you covered. We will discuss the ‘Exit Model’ parameter in the next article. Do note that this parameter is only available for the static stock basket and dynamic stock strategy using the screener and factor model.
So, if you are building the MF or ETF basket, you can skip the next article.