Select the type of universe from which your stocks will be chosen using the Universe dropdown menu (1). You can select from All Stocks (which includes all Canadian or US stocks available in the Morningstar Database) or a Strategy. For strategies, you have two options: My Strategies or Pre-defined Strategies. If you want to use a well-known benchmark, such as the S&P TSX, choose Pre-defined Strategies, then select S&P TSX Composite Index from the Type dropdown menu (2). If you prefer to use one of your own strategies, select My Strategy (3). When choosing one of your strategies, you'll need to specify whether to use the Buy (4) or Sell list from that strategy. While it is uncommon to use the Sell list, the option is available for flexibility.
After selecting the universe, you will need to choose the variables that will be used to build the ranking system and the Buy & Sell rules for your strategy. There are thousands of variables available in the database, so it’s essential to have a thorough understanding of the ones you select. Incorrect or inappropriate variable selection could lead to results that don't align with your expectations or the typical behavior of financial markets. Therefore, careful consideration is required to ensure that the chosen variables reflect your strategy's objectives and market conditions.
To assist you in making informed choices, please refer to the User Guide in the HELP section for detailed definitions and computation rules of each variable. This resource provides essential information on how the variables are calculated and can help ensure that you are selecting the most appropriate ones for your strategy, avoiding any misinterpretations or unexpected results.
To search for a specific variable, you need to input at least three letters into the Search by keyword box. This will generate a list of variables that match your query. For example, if you're looking for the Forward Price-to-Earnings (P/E) ratio, simply type "P/E" into the search box. Once you do this, a list of related variables will appear in the Available Items box (2), providing options based on your input.
In this scenario, you might find P/E CYM, which matches the definition (3) you're looking for, based on the forward earnings metric. Be sure to carefully review the definitions to ensure you’re selecting the correct variable for your strategy. Once you've identified the variable that aligns with your needs, double-click on it to move it from the Available Items box (2) to the Selected Items box (4), where it will become part of your strategy configuration.
This process ensures that you're accurately selecting the variables you need to define your strategy's ranking and decision-making criteria, helping you avoid errors and ensuring that your selections reflect your intended financial analysis.
To simplify your search, check the Hide Variables with no historical data box (5) to remove single-date data, as these cannot be used to back test your strategy.
Repeat this process for each of the variables you wish to include in building your strategy (1). For instance, in this example, the user has chosen three variables: P/E CYM, P/B, and CFOA (2). Ensure that all relevant variables are carefully selected, as these will form the basis for the strategy's ranking system and decision rules. Once you've selected all the variables you need, click on the OK button (3) to confirm your choices and proceed to the next step in the strategy creation process. This will finalize the variable selection and move you forward in configuring your strategy's core elements.
The next step involves defining the Ranking Weight Criteria as well as the Buy & Sell Rules. First, you need to determine which variables will be used to calculate the ranking score. In this example, the user chooses to rank stocks based on P/E CYM and P/B. To assign importance to these variables, the user inputs a value in the DOI (Degree of Importance) box in the Applying Criteria section (1). Since equal weight is desired for each variable in the ranking algorithm, the user assigns a value of 1 to both P/E CYM and P/B.
The default Order for ranking P/B is Low value is best, as lower Price-to-Book ratios are generally preferred. However, if the user wanted to prioritize stocks with higher P/B ratios, they could adjust the ranking by selecting High value is best from the Order dropdown menu associated with this variable.
In this example, the user does not assign a DOI to the CFOA variable, as it will be used solely to exclude stocks that exhibit negative CFOA (Cash Flow from Operating Activity) (5).
It's important to note that the variable with the shortest data history is CFOA, which starts from August 2004. Therefore, the user will need to select this as the starting date for the backtest in the rules section.
Once the ranking rules are set, the user moves on to the Buy & Sell Rules by clicking the Buy Rules tab (3). First, the user must decide what percentage of the universe (in this case, the S&P TSX Index) will be considered for the Buy List. They choose to focus on the top 20% of the ranked universe (4). After that, the user will include only stock from the list that has a positive CFOA (5). This process ensures that only stocks meeting the desired financial criteria are included in the buy list.
Next, the user needs to establish the Sell Rules by clicking on the Sell Rules tab (1). In this example, the user opts to sell any stock that ranks below the 20th percentile of the universe. Alternatively, to reduce the turnover of the strategy, the user could choose to sell stocks that rank below the 25th percentile instead. This approach creates a buffer where stocks ranking between the 20th and 25th percentiles would be placed in a Hold Position, meaning they wouldn't be sold immediately, but only if their ranking drops below the 25th percentile. This strategy can help reduce excessive trading, which may incur additional costs or inefficiencies.
Additionally, the user decides to sell any stock that starts exhibiting negative CFOA. However, to further reduce turnover, the user could opt to leave this rule blank and tolerate stocks that initially performed well but later exhibit negative CFOA after purchase. While this option may help lower the frequency of trades, it's important to recognize that allowing stocks to stay in the portfolio despite declining fundamentals, such as negative CFOA, could dilute the overall performance and value added by the strategy.
Therefore, it is generally recommended to avoid setting too wide a gap between the Buy and Sell Rules. A tighter range between buying and selling criteria helps maintain the integrity and effectiveness of the strategy, ensuring that stocks are consistently aligned with the desired performance thresholds. Balancing turnover and strategy effectiveness is crucial to optimize results while minimizing unnecessary trades.
Accessing the Strategy Module
Creating a New Strategy
Advanced Configuration
Back-Testing the Strategy
Analyzing Back-Test Results
Sector Weights and Strategy Description
