This section allows you to set rules on how often your model rebalances and what, if anything, will trigger that rebalance.
Rebalance or Replace:
This section determines what your model will do when a trade is triggered based on your model's rules. If Rebalance is chosen, the portfolio will be rebalanced back to equal-weighted whenever a trade occurs. If Replace is chosen, new holdings will assume the weight of the holding they are replacing.
For example, in a model with 10 holdings, each holding will have a target weighting of 10%.
If Rebalance is selected, each time a trade is made all holdings will be rebalanced back to 10% and any new holdings will be purchased at 10%.
If Replace is selected and a holding that is currently at 9% of the portfolio falls below the sell threshold, the new holding chosen to replace it will be purchased at 9%. All other remaining holdings will maintain their current weighting within the portfolio.
Ask yourself "Do I want to stay closer to target weighting (Rebalance) or do I want to minimize the amount of trading in the portfolio (Replace)?"
Rebalance/Replace Occurs...
The "Rebalance/Replace Occurs" section determines if your model will monitor for Drift Tolerance violations even if a trade has not been triggered based on your model's rules. A Drift Tolerance violation occurs when a holding deviates from its target weight by more than the designated Drift Tolerance. If you select Every Evaluation, your model will check for Drift Tolerance violations at every evaluation date. If any position violates the Drift Tolerance, the portfolio will be rebalanced. If you select On Trade Only, your model will only check for Drift Tolerance violations on the evaluation dates that result in a trade based on your model rules.
Drift Tolerance
Drift tolerance is the amount one of your holdings' weightings can deviate from its target weighting before the model triggers a rebalance. For example, in a 10 holding model, each holding will have a 10% target weight. If Drift Tolerance is set at 2%, a Drift Tolerance violation would occur if a holding were to shift to greater than 12% or less than 8% of the portfolio.
If you believe in "letting your winners run" choose Replace and widen your Drift Tolerance to allow for larger deviations from the target weight. In that case, you may also want to choose "Every Evaluation" in the "Rebalance/Replace Occurs" section so your model can help you avoid having a holding become too large of a position in your portfolio.
Avoid turning off drift monitoring altogether as it may lead to more risk from overconcentration and may leave your backtest more susceptible to extreme outliers in your universe skewing the backtest results.