Durable Concepts Learned From Extensive Research or From The School of Hard Knocks
Note: Apparently there were some questions about how to calculate Aggregate M, please email us at firstname.lastname@example.org to receive spreadsheet later this weekend. Note we use a cleaner version of data than Yahoo Finance adjusted for splits and dividends with verified closing prices. I have been made aware that the backtest results using Yahoo are different from ours (note we calculated the same values as our readers using Yahoo Finance), and that is because their data is not entirely accurate.
1) Follow the long term trend: go long above the 200 ma or even better a rising 200 ma. When the market falls below this level favor CASH first and only at the initial stages do some selected shorting. Shorting has much lower edges than long strategies in testing on a risk/reward and absolute basis.
2) Keep an Eye on The Big Picture: Most of the fluctuation in individual stocks is driven by the S&P500 or Nasdaq Composite, secondly fluctuation is driven by the sector or industry that the stock is in, in last place is the unique movement of the stock itself. LESSON: don’t delude yourself into thinking that you will be sheltered from recessions or market crashes because you hold a “good business or quality management.” Valuations and dividends are also often poor consolation.
3) Follow Relative Strength only in Bull Markets: Follow Relative Strength (percentile rank of 52-week price returns relative to the universe) only above the 200 ma , this is the best and most tradeable stock selection tool of any factor. My research shows that with the exception of small and microcap stocks, there is no alpha using relative strength strategies below the 200 ma. In fact, the more the market falls, the worse this strategy does as it tends to pick up only the low-beta stocks. When the market gets really stretched the worst relative strength stocks vastly outperform the market and high relative strength stocks.
4) Mean-reversion strategies do better in periods of high volatility: and/or under the 200 ma. Day-trading strategies also thrive in these environments primarily with few exceptions. Trading mean-reversion outside of these “zones” is difficult because of commissions relative to average gains per trade. Also the market has lost money intraday net of the overnight return for the last 15 years
5) Don’t Always Believe the Backtest: Short-term strategies in general are FAR less likely to match backtest results in real-life than long-term strategies. This is because the half-life of any good short-term strategy is short, and because the commissions and executions/slippage have a significant effect on performance.
6) Don’t Become a Perma-Bear: Ironically being overly realistic or pessimistic will hurt your performance badly as a trader. Being calm with a small dose of optimism and a willingness to make mistakes and learn from them is crucial to being a good trader. All of the crusty bears are so worried about appearing smart and being vindicated with bold calls, that they are unwilling to change their minds. At times it seems they would rather be right and broke than make money by following the herd. As Ed Seykota says: “Everybody gets what they want in the stock market.” From a pure mathematical standpoint the odds favor longs because stocks can go up 200% and 300%, but they can only drop to “0”—I have yet to find a short or long term strategy for shorting that remotely compares with the risk/reward of long-only strategies.
7) ALWAYS REMAIN HUMBLE!!!