Australian Trading Strategies – Formulation, Backtest, and Performance Assessment

As the world has become more connected online and many regions are opening up their financial markets to the global investing community, diversifying your investment portfolio into other economies has never been easier. The Australian market is a simple choice for portfolio diversification. Can we make profitable Australian trading strategies?

Yes, backtesting reveals a few very profitable Australian trading strategies. Let’s show you the trading rules.

There are several ways to gain access to Australian financial markets. The most common ways are through exchange-traded funds (ETFs) that track the Australian market and the American Depository Receipts which trade on the OTC markets and can easily be purchased through a broker. You can also buy Australian stocks directly through international brokers such as Interactive Brokers. If you just want to speculate, you can trade stock CFDs via an Australian CFD broker that offers the instrument.

In this post, we take a look at Australian trading strategies. We end the article with several backtests. We use the US-traded ETF EWA as a proxy for the Australian stock market.

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How can you trade Australian markets?

Diversifying portfolios into different industries and sectors in one’s native stock market is a strategy shrewd investors use nowadays. Exposure to global markets lowers risk, and the Australian market gives investors access to some of the world’s most distinctive mining companies. The country’s abundant mineral and energy resources also make its equities markets a stand-in for the cycles of the world’s commodities.

Thanks to financial market deregulation and online trading platforms, you can readily access the Australian market. The four typical methods are as follows:

  1. Exchange-traded funds (ETFs): Purchasing ETFs that track the Australian stock market indexes is one of the simplest methods to invest in the Australian market. Such ETFs invest in equities of businesses that have their headquarters or conduct a substantial portion of their operations in Australia. ETFs that track Australian market indexes offer an already diversified portfolio. Investing in such index ETFs is much cheaper than trying to build your own portfolio of Australian stocks.
  2. Depository Receipts: Purchasing depository receipts of Australian stocks from a major bank in your home nation is another simple option to invest in the Australian market. A depositary receipt (DR) is a physical certificate that a bank issues to represent shares of a foreign corporation that are traded on a domestic stock exchange. The depositary receipt offers an alternative to trading on an international market and enables you to hold equity in other nations. One of the most popular kinds of DRs is the American depositary receipt (ADR), which offers businesses, investors, and traders opportunities to invest in international markets. If you reside in the US, you can simply purchase an ADR of any Australian stock of choice from the OTC marketplace through your broker. In this article, we use the ETF with the ticker code EWA. It’s liquid, has a history back to 1996, and is thus suitable for backtesting.
  3. Directly trading the stocks: Another option is to directly buy Australian stocks. Although it is more challenging than buying ADRs, you can buy and sell stocks directly on a few international stock exchanges thanks to the particular services offered by a number of online brokerages. Interactive Brokers is one broker that provides access to the majority of stock exchanges worldwide. There may be other brokers, such as TradeStation and E*Trade. Ask your broker about direct access to Australian equities if you are interested in that market; you may be surprised they offer them.
  4. Australian stock CFDs: While this is not usually recommended, it is a good option for speculation purposes. You can trade Australian stock CFDs via a CFD broker, such as IG, eToro, and so on; an Australian CFD broker, such as Fusion Markets, is more likely to offer Australian stock CFDs than other ones. If your interest is just to gain from price movements rather than own the underlying stocks, explore this option. It is best used for short-term trading and speculation, not investing, as it does not offer you the ability to own the asset. Always keep in the back of your mind that the majority of CFD traders lose money.

Australian trading strategies backtest (strategy)

Backtests are a great way to assess the risk associated with a particular strategy and identify potential opportunities for increased profitability. By using the backtest tool, traders can develop more informed and profitable strategies for their portfolios. Backtesting trading strategies is the best tool for making informed investment decisions, although it’s far from perfect.

With that said, let’s look at some specific Australian trading strategies for stocks by using the ETF with the ticker code EWA:

First, the Australian market has much more exposure to commodities than most markets, like Canada and Norway. This makes these markets slightly different and sometimes harder to trade than the US stock market.

Let’s show you an example of the difference by using the following trading rules:

Trading Rules

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Pretty simple, and we get the following equity curve for EWA:

Australian trading strategies

For comparison, this is how the same strategy looks for SPY (S&P 500):

Australian trading strategies backtest

As you can see, the strategy performs better and more consistently in the US markets. Thus, mean reversion strategies are less efficient for commodity-related markets.

We traded many classical strategies for EWA with no success, like the 200-day moving average strategy and the Golden Cross strategy.

So, what does work?

Let’s turn to the old faithful: Seasonal trading strategies work on most markets:

Australian seasonal trading strategy

The Santa Claus effect has been particularly strong for Australian stocks. We made the following trading rules:

  • We buy at the close of the US OPEX Friday in December (normally sometime between calendar days 14 and 22,
  • And we sell at the close of the month (close of December).

The performance and return look like this:

Australian seasonal trading strategy for stocks

Since 1996 it has only had two negative years: 2002 (-0.1%) and 2020 (-0.2%). Thus, the win rate is so far 92%. The average gain per trade is 2.4%. These are pretty solid results but based on a small sample since it only trades once a year. By being invested only 2.3% per year, you get 1.87% annual returns, compared to buy&hold’s 7.34% (dividends included).

Australian ETFs (stocks, currencies, etc)

If you live in the US, there are many Australian ETFs trading on US stock exchanges. These include equity ETFs and currency ETFs.

Australian Equity ETFs

These are a few of the stocks-based Australian ETFs you can trade on the US stock exchanges:

  1. iShares MSCI-Australia ETF (EWA): This ETF offers exposure to Australian equities. It is the most liquid and most popular option for achieving exposure to the Australian economy, and as such, you can use it to diversify your long-term equity portfolio to the international markets. EWA can also be a useful fund for making a short-term bet on the resource-rich Australian economy. Australian equities are a sort of proxy to the commodity market, and this offers you a way to benefit from the commodity supercycle.
  2. Franklin FTSE Australia ETF (FLAU): This ETF tracks an index of small and mid-size companies in Australia. The expense ratio is very low and the instrument trades at a very reasonable price. As of June 2020, FLCH’s management fee is a fraction of the price of the iShares MSCI Australia ETF (EWA); however, the fund continues to trail its iShares rival in size and liquidity. In terms of diversification, FLAU has a deeper portfolio than EWA, with a larger allocation to small- and mid-cap stocks. But sector-wise, the funds have broadly similar sector exposure, with little variation.
  3. Australian Ethical High Conviction ETF (AEAE): This ETF aims to provide long-term capital growth and income by focusing on a relatively concentrated portfolio of Australian and NZ companies that meet the Australian Ethical Charter.
  4. BetaShares Australian Quality ETF (AQLT): This ETF aims to track an index of 40 ‘high quality’ Australian companies, based on metrics of a high return on equity, low leverage, and relative earnings stability.
  5. BetaShares Active Australian Hybrids ETF (HBRD): This ETF invests in an actively managed portfolio of hybrid securities, bonds, and cash. Depending on whether the hybrid market is assessed to be overvalued or to present a heightened risk of capital loss, the Fund allocates more of the portfolio to lower-risk securities, including cash and Australian-issued senior bonds with investment-grade ratings.
  6. iShares Edge MSCI Australia Multifactor ETF (AUMF): This ETF offers cost-effective access to a rules-based multifactor strategy in a single fund. The fund targets four proven drivers of return in Australian equities exposure — quality (financially healthy firms), value (inexpensive stocks), size (smaller companies), and momentum (trending stocks). AUMF also seeks factor-driven outperformance over the long term in a portfolio of Australian stocks with a similar profile and risk to the broad market.
  7. Activex Ardea Real Outcome Bond ETF (XARO): The investment approach is based on generating returns from relative value strategies that aim to exploit mispricing between comparable fixed-income securities which are related to each other and have similar risk characteristics but are priced differently. It tries to exploit the inefficiencies in the fixed-income markets by capturing this mispricing.

Currency ETF

The only currency ETF that offers exposure to the Aussie dollar is Invesco CurrencyShares Australian Dollar Trust (FXA).

The ETF provides exposure to the Australian dollar relative to the US dollar. It increases in value when the Australian dollar strengthens and decreases in value when the US dollar strengthens. The fund may be suitable for investors looking to hedge currency risk or bet against the US dollar. FXA is the only real ETF available to investors seeking exposure to the AUD/USD exchange rate.

How many Australian markets can you trade?

With over 2,000 companies listed on the ASX, there are many stocks in the Australian market. Apart from stocks, there are other securities, including ETFs, bonds, and so on. Depending on your method of accessing the Australian market, you can trade many of the securities in the Australian market.

While ADRs may limit you to the big and popular Australian stocks, brokers like Interactive Brokers offer access to the Australian Stock Exchange, so through them, you can trade most stocks on the ASX, as well as bonds and other securities. On the other hand, with ETFs, you can gain exposure to the entire market or a section of the market. ETFs offer you an easy way to get a diversified portfolio, and some of them, like the HBRD, offer hybrid securities.

What are the biggest Australian markets?

The primary security exchange in Australia is the Australian Securities Exchange (ASX). It is based in Sydney and is one of the world’s leading financial market exchanges. As a fully functioning securities exchange, the ASX provides a number of services, such as listings, trading, clearing, settlements, technical and information services, and post-trade services. It offers both stock and futures exchange services following its merger with the Sydney Futures Exchange in 2006.

Another stock exchange in Australia is the Sydney Stock Exchange (SSX). It has its headquarters in Sydney, Australia, but it is a wholly-owned subsidiary of the AIMS Financial Group. The market license was granted by the Australian Securities & Investment Commission (ASIC) on 5 November 2013.

When are Australian markets open?

The Australian market is open during weekdays that are not Australia’s national holidays. The market opens Monday through Friday by 10:00 am Australian Eastern Daylight Time (GMT+11:00).

When is the Australian trading session (GMT)?

The Australian market’s trading session is between 10:00 am and 4:00 pm Australian Eastern Daylight Time (GMT+11:00). This translates to 11:00 pm and 5:00 am GMT.

Can you trade Australian pairs?

Yes, you can trade the Australian dollar against any major currency. Thus, you can trade AUD/USD, EUR/AUD, GBP/AUD, AUD/JPY, AUD/NZD, AUD/CAD, AUD/CHF, and so on.

FAQ:

How can I gain access to Australian financial markets for portfolio diversification?

Explore various methods to access Australian financial markets, including ETFs, American Depository Receipts (ADRs), direct stock trading, and Australian stock CFDs. The article details each approach and its suitability for different investors.

Which ETFs can I trade for exposure to the Australian market in the US?

Get information on specific Australian Equity ETFs, such as iShares MSCI-Australia ETF (EWA), Franklin FTSE Australia ETF (FLAU), Australian Ethical High Conviction ETF (AEAE), and others. Discover options for gaining exposure to Australian stocks, currencies, and more.

What are the challenges of trading mean reversion strategies in the Australian market?

Understand the differences in performance between mean reversion strategies in commodity-related markets like Australia and more conventional markets such as the US. Gain insights into why some classical strategies may not work as effectively.

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