Wednesday, April 27, 2011

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

In my last post 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 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.

Sunday, April 24, 2011

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.