SWOT Trading Strategy — What Is It? (Backtest, Example, and Insights)

Identifying core strengths, weaknesses, opportunities, and threats leads to fact-based analysis, fresh perspectives, and new ideas, which are the benefits of a SWOT analysis.

SWOT analysis is a technique for assessing the performance, competition, risk, and potential of a business, a product line, an industry, or any other entity. Stock market analysts and traders can use it to estimate the fair market value of a company’s stock, while credit analysts use it to better understand a borrower’s creditworthiness. At the end of the article, we present what we consider the best SWOT strategy.

Let’s find out what SWOT trading strategy is about:

What does SWOT analysis mean?

SWOT analysis is a framework for assessing the performance, competition, risk, and potential of a business, a product line, an industry, or any other entity. It is designed to facilitate a realistic, fact-based, and data-driven assessment of an entity.

SWOT stands for Strengths, Weaknesses, Opportunities, and Threats. Those constitute the internal and external forces that may create opportunities or risks for an organization. Strengths and weaknesses are internal factors, which are characteristics of a business that give it a relative advantage — or disadvantage, respectively — over its competition.

Opportunities and threats are external factors. Opportunities are elements of the external environment that can be used to improve performance (revenue sources), while threats are elements of the external environment that may hinder performance or even the ability to operate as a going concern — for example, regulatory issues or technological disruption.

Warren Buffett refers to companies that can shake off competition as having a wide moat (we cover moats in detail further down).

The SWOT Table

Here is the SWOT table:

Internal factors External factors
Strengths Opportunities
Weakness Threats

The components of SWOT

Here are the elements of a SWOT analysis:

  • Strengths: These refer to those areas an organization excels at, which separates it from the competition — a strong brand, loyal customer base, a strong balance sheet, unique technology, and so on. For instance, an investment fund may create a proprietary trading strategy that returns market-beating results and can use those results to attract new investors.
  • Weaknesses: They refer to those areas the entity needs to improve to remain competitive: a weak brand, higher-than-average turnover, high levels of debt, an inadequate supply chain, or lack of capital.
  • Opportunities: These refer to favorable external factors that could give an organization a competitive advantage. Examples include technological innovations that might help improve efficiency or changes in social norms that are creating new markets or new sub-segments of existing markets.
  • Threats: These refer to factors that have the potential to harm an organization. Examples include things like rising costs for materials, increasing competition, tight labor supply, and so on.

Uses of SWOT analysis

SWOT Analysis was first used to analyze businesses, but now it’s often used by governments, nonprofits, and individuals, including investors and entrepreneurs.

Businesses use it to guide their operations toward strategies that are more likely to be successful and away from those that are likely to be less successful. Independent SWOT analysts or competitors can use it to assess whether a company, product line, or industry might be strong or weak and why.

The analyst and investor community, on the other hand, may use it to seek to understand (and quantify) strengths, weaknesses, opportunities, and threats in order to assess the business more completely. Findings from a SWOT analysis may help inform model assumptions among analysts. For example, an equity analyst can use SWOT analysis to estimate the fair market value of a stock, while a credit analyst may perform a SWOT analysis to understand a borrower’s creditworthiness.

SWOT trading strategy – backtest and example

As you might imagine, making a trading strategy based on SWOT is not easy. Because we quantify trading rules and settings to get quantified buy and sell signals, we struggled to make a SWOT strategy backtest.

Instead, we decided to rely on data from Morningstar. Morningstar is a data driven financial firm that specializes in providing company specific metrics for stocks.

One of Morningstar’s best products is their rankings of stock based on their perception of having a moat or not. In simple terms, how likely is any company likely to keep competitors at bay over the next 20 years? If Morningstar reckons that is likely, the stock gets a higher moat. However, the vast majority of stocks don’t have any moat at all. A company/stock has either wide, narrow, or not moat at all.

SWOT trading strategy

Based on the moat rankings, Morningstar has constructed an index that only includes wide-moat stocks. As of writing, the index has the following stocks in order of ranking (the ten most weighted stocks):

  • Kellogg’s (K) 3.1%
  • Veev (VEEV)
  • WU (WU)
  • Polaris (PII)
  • Microsoft (MSFT)
  • Masco (MAS)
  • MMM (MMM) 2.5%

The top 10 stocks have a total weighting of about 28%. In other words, the index has a many components ind is well diversified. The index is rebalanced four times annually. Thus, if you want to follow the index, you need to buy and sell four times per year.

SWOT trading strategy performance

How has the SWOT and moat index performed? The index started as long back as 2002 and the performance looks like this:

SWOT trading strategy performance
SWOT trading strategy performance

The CAGR has been spectacular: 14.1% and is significantly better than the S&P 500.

There exists an ETF with the ticker code MOAT that tracks Morningstar’s Wide Moat Index. This is how the performance has been since its inception in 2012:

SWOT trading strategy backtest
SWOT trading strategy backtest

Again, the ETF has beaten S&P 500 even after fees and management costs.

SWOT trading strategy – ending remarks

The SWOT trading strategy can be employed by simply buying an ETF that tracks Morningstar’s Wide Moat Index (ticker code is MOAT). Perhaps even better would be to use a mean reversion strategy on MOAT, but this is a subject for another article.


Who uses SWOT analysis and for what purposes?

SWOT analysis is used by businesses, governments, nonprofits, investors, and entrepreneurs. It guides strategic decision-making, assesses performance, and helps in understanding the competitive landscape.

What is the SWOT trading strategy based on Morningstar’s moat rankings?

The SWOT trading strategy involves using Morningstar’s moat rankings to construct an index of wide-moat stocks. The strategy’s performance, as shown in the content, has a CAGR of 14.1%, outperforming the S&P 500.

How can investors implement the SWOT trading strategy?

Investors can implement the SWOT trading strategy by buying the ETF MOAT, which tracks Morningstar’s Wide Moat Index. Alternatively, mean reversion strategies on MOAT could be explored for potential optimization.

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