A powerful shorting strategy for the week

If you follow the daily movements of equities, you are often confronted with the case of the price of any given stock rising rapidly. In some of these instances you think to yourself, '...there's no reason for this rise, I know it is going to come back down...' In many cases it does come down, and you wish you had shorted when you had the chance. If only you had a good metric to REALLY know when this move was unjustified and were not forced  to act just on instinct.

Well, you're in luck because I'm going to give you just THAT.

In one of my earlier posts, I gave you the equation for my Share Strength Indicator (SSI), a measure of how much a single share could move the stock price.

http://thequantinvestor.blogspot.com/2011/03/share-strength-indicator-how-much-bang.html

Here, I stated how a high share strength was an indicator that a stock was susceptible to manipulation or uncharacteristically large moves. To test this, lets look at a strategy of shorting stocks that are UP on HIGH share strength. We will short a stock with:

1. A stock price being 10% or more above its 20 DMA price. 


2. A high share strength defined as 20 DMA share strength being greater than 2 standard deviations above the past year's average 20 DMA share strength.

And for the results....

Here we wait 20 days till we cover our short position, and for the results over the past 4 years...

Market          Price Change       Stocks Meeting Criteria
NYSE                 93% (-7%)                       1980
Nasdaq               94% (-6%)                       1272
AMEX                82% (-18%)                       30


Scatter plot of returns for NYSE shorted stocks.

As you can see, once again we have impressive results. If the past 4 years are any indicator, a high share strength along with a big price increase makes for a good time to get in on the short side.

A further examination of the 'buy at 52 week high' rule.

Two weeks ago, I demonstrated that the simple strategy of buying any stock at a 52 week high provided the fanciest of returns.
http://thequantinvestor.blogspot.com/2011/04/how-to-lose-money-by-buying-lowor-make.html

I expanded on that last week and showed some amazing gains with a refined strategy.
http://thequantinvestor.blogspot.com/2011/05/perfecting-strategy-of-buying-high.html

In response, I was asked by many readers if there were any specific sell rules, besides waiting a specific amount of time. There wasn't. To respond to my readers, in my post this week I'm going to examine whether, if by implementing a simple 'sell rule', we can further improve upon this already nice performance. For my sell rule, I'm going to implement William O'neil's hard and fast law of selling any stock that has taken an 8% loss, which is followed by many.

To implement my strategy I'll use my same rules as last week:

1. Buy any stock that is at a 52 week high
2. Hold for a specific period of time (1, 3, or 6  months I'll look at here)
3. Sell after that amount of time, or keep if it is still at a 52 week high

and I'll add another rule

4. Sell if, at any point, the stock drops me below an 8% loss (this INCLUDES intraday prices). To make it even more realistic I'll assume 1% slippage meaning I take a 9% loss when trying to sell at an 8% loss.

1 Month Hold

                 1 Year performance       Avg. Return

 NYSE                   +7.4%                     0.6%

 Nasdaq                 -9.0%                    -0.8%

 Amex                   -13.5%                   -1.2%

3 Month Hold

                 1 Year performance       Avg. Return

NYSE                    9.95%                     2.4%

Nasdaq                  2.8%                      0.7%

Amex                    -1.6%                     -0.4%

6 Month Hold

                 1 Year performance       Avg. Return

NYSE                    8.4%                     4.1%

Nasdaq                 3.6%                     1.8%

Amex                    0.4%                     0.2%

As you can see, the implementation of a simple sell rule, in fact, truly hurts our performance. This makes for an interesting point of discussion...if sell rules truly work. In all my experimentation, I've found them to have very little effect. If I remove the slippage effect, the gains become comparable to the normal strategy, but still under-performing.

   Troy

Perfecting the strategy of 'buying high' while returning 4381% in ten years!

Last week I demonstrated to my readers that a simple strategy of buying a stock at a 52 week high and holding for any given period of time, can be a very successful LONG investment strategy.
http://thequantinvestor.blogspot.com/2011/04/how-to-completely-outperform-market-by.html

Like any strategy it can be improved on, and in this post I'll try to do just that. Here I'll add another important consideration when buying a stock, the volume backing its price movement. To do that, let me introduce what I call the Volume Moving Average Ratio (VMAR). What this simply is, is the ratio of the 20 day volume moving average to the 75 day volume moving average (you can use other lengths of time as well):

VMAR = VMA(20 day) / VMA(75 day) 

What this tells us is how much the recent average volume is compared to the longer term volume. I used the simple moving average but an exponential would work as well. In theory, a VMAR >> 1 means a stock has significantly more investment activity than usual and, correlated with a price gain, indicates that perhaps its price movement IS warranted.

Now we could potentially cover a huge combination of VMARs and hold times. I'll leave it up to you, the reader, to find the best combination. But now I present to you two scenarios of short (1 or 3 month) hold times with VMARs greater than 1 or 2.

What we see is impressive...enormously impressive. In fact a strategy of 'buying high' backed with volume can make you a very wealthy person. Of course I make no promises, and any strategy that worked last decade may not this decade, and you should consider that. Also, don't forget commissions, as with any trading strategy, can easily take 1-2% off every trade. But these are the facts, and the numbers, and of that I am 100% certain. So here you go...enjoy!

1 Month Hold (VMAR > 1.5) 

                 10 Year performance       Avg. Return      Stocks meeting criteria 

 NYSE                   756%                     1.7%                        1947

 Nasdaq                 597%                     1.5%                       4653

 Amex                  1531%                     2.3%                        885

1 Month Hold (VMAR > 2) 

                 10 Year performance       Avg. Return      Stocks meeting criteria

 NYSE                   4381%                     3.2%                      330

 Nasdaq                  161%                     0.4%                     1507

 Amex                    1936%                     2.5%                      317

3 Month Hold (VMAR > 1.5) 

                 10 Year performance       Avg. Return      Stocks meeting criteria 

 NYSE                   314%                     2.9%                        1005

 Nasdaq                 539%                     4.3%                       2905

 Amex                    918%                     5.7%                        573

3 Month Hold (VMAR > 2) 

                 10 Year performance       Avg. Return      Stocks meeting criteria 

 NYSE                  1068%                     6.1%                        182

 Nasdaq                 248%                     2.3%                       1000

 Amex                    918%                     5.7%                        236

How to lose money by buying low...or make money buy shorting low

In my last post http://thequantinvestor.blogspot.com/2011/04/how-to-completely-outperform-market-by.html I outlined the results of a straightforward strategy of buying any stock that was at a 52 week high and selling after a certain amount of time (no fancy stop losses or sell rules). This time I'll examine the more classic strategy of buying low...at a 52 week low to be exact. Here we'll see if buying any stock, when its at its yearly worst, can be profitable

One of my readers pointed out to me that I may have had a survivorship bias in my last analysis. This was an excellent point and to help account for that, this time, I give you the ten year performance of every stock, still listed, on the major exchanges.

NYSE - +11%

Nasdaq - + 2%

Amex - + 14%

(thanks for the input Gary, but the 'buy high' strategy still works!)

So here you go... the performance of the 'buy low' strategy for different holding periods.

1 Month Hold

                 10 Year performance       Avg. Return

 NYSE                   -79%                     -1.3%

 Nasdaq                -70%                     -0.9%

 Amex                   -62%                     -0.8%

3 Month Hold

                 10 Year performance       Avg. Return

NYSE                    -39%                     -1.2%

Nasdaq                 -62%                     -2.4%

Amex                    -75%                     -3.4%

6 Month Hold

                 10 Year performance       Avg. Return

 NYSE                   -64%                     -4.9%

 Nasdaq                -64%                     -4.9%

 Amex                   -67%                     -5.4%

12 Month Hold

                 10 Year performance       Avg. Return

 NYSE                   +30%                     2.7%

 Nasdaq                -37%                     -4.6%

 Amex                   -23%                     -2.6%

As you can see, buying any stock just because it's cheap seems to be a terrible idea (with the exception of a one year NYSE hold). On the other hand, SHORTING any stock or buying a nice put option may work out very well.

The lesson to be learned from this, and my last post, is that the common strategy of 'buy low and sell ***' should be taken with a large grain of salt. I encourage everybody to investigate what I've presented here and develop their own strategies. Money can be made...if you carefully consider what you are doing and don't just follow everybody else.

How to completely outperform the market by... buying high?

Investing 101 tells you to, 'Buy low and sell high', and there are many, many investors who live by this motto. But is there any truth to it? Or perhaps, might you be better off buying high and selling higher? In this post I'll try to answer that very question by back testing a strategy that goes against that motto.

What I've done is taken all three major exchanges, over the past ten years, and implemented a strategy where I buy any stock that is at a 52 week high. After a certain amount of time I sell it, and perhaps buy it right back if it is again at a 52 week high. I've tested this method over 1, 3, 6, and 12 month holding times for each exchange. To calculate the average return I used the geometric mean to properly account for any volatility.

What I find is quite impressive. In fact, a strategy of buying every stock that is at a 52 week high completely outperformed the market, regardless of how long it is held. For comparison, over the past ten years the Nasdaq has gained 33%, the S&P has gained 2% and the illustrious Berkshire Hathaway A has risen a mere 80%

So here you go... the performance of the 'buy high' strategy for different holding periods.

1 Month Hold

                 10 Year performance       Avg. Return

 NYSE                   230%                     0.7%

 Nasdaq                230%                     0.7%

 Amex                   290%                     0.9%

3 Month Hold

                 10 Year performance       Avg. Return

NYSE                    280%                     2.6%

Nasdaq                 280%                     2.6%

Amex                    290%                     2.7%

6 Month Hold
                 10 Year performance       Avg. Return
 NYSE                   245%                     3.8%
 Nasdaq                212%                     3.2%
 Amex                   177%                     2.4%

12 Month Hold

                 10 Year performance       Avg. Return

 NYSE                   209%                     7.7%

 Nasdaq                158%                     4.7%

 Amex                   167%                     5.3%

An important consideration with each of these strategies are the hidden costs associated with things like commissions. While a 1 or 3 month hold may provide the best returns, you will also be paying significantly more commissions than with a 6 month or 1 year hold strategy. With that in mind I would claim that the 6 month hold strategy is the best, but that depends on what percentage of your investment your commissions take up.

Of course there are no promises of this strategy working over the next ten years, this is just something for you to consider. This strategy also won't make you a millionaire (unless you started with 1/2 a million dollars), but instead seems to be a nice way to slowly grow your money.

********************************

The analysis was run with a new upgrade of my code. It now takes less than one minute to back test a trading strategy over ten years on all three exchanges! With this in mind I invite my readers to propose new trading strategies that I can test and report the performance of on my blog.