In the previous post we presented a trading technique that takes its cue from the classic capital accumulation plan. The rules of the strategy introduced suggested buying $ 1,000 worth of the same financial instrument each month. The positions were to be liquidated at the end of each calendar year to reduce the market risk.
Let’s look at the trading system in action on the AAPL (Apple) title in the years 2012 and 2013.
Readers who know Tradestation (or Multicharts) know that every time we open a position, it is indicated graphically by a dotted line in blue or red: the color is blue if the transaction ended with a profit, red if it has returned a loss.
As already mentioned, the most favorable hypothesis is when, at the end of the calendar year, the stock closes at its highest value. In our graphic example this happened in 2013: all 12 open operations are positive, in fact we only observe blue dotted lines.
Let’s take a look at the equity line of our system in action since January 1980.
I open a small parenthesis: when we face tests like the one above it is necessary to use appropriate software with a consistent database. From this point of view Tradestation has proven an incredible ally in making available all the historical data.
We tested the system on 10 US stocks. In the selection of stocks we have combined historic US companies such as Ford (F), General Motors (GM), Coca Cola (KO), International Business Machines (IBM) and Exxon Mobil (XOM), banks such as Goldman Sachs (GS) and Citygroup (C) without neglecting new phenomena of the Web economy like Amazon (AMZN), Facebook (FB) and Netflix (NFLX).
Here are the securities tested:
- F – Ford
- GM – General Motors
- KO – Coca Cola
- IBM – International Business Machines
- GS – Goldman Sachs
- C – Citigroup
- XOM – Exxon Mobil
- AMZN – Amazon
- FB – Facebook
- NFLX – Netflix
To test the longest possible period we have launched 100 years of history.
A first observation: all equity lines have a positive trend.
The main ratios of the tested systems are shown below.
In two cases, AMZN and NFXL, we observe an incredible growth in the equity line. There is no trick, Amazon saw its prices go from less than 5 to more than 55 dollars in 1998. We must not let ourselves become easily enthusiastic: we are talking about companies that represent exceptions to exceptions and we can not assume that they represent the rule.
Our attention must go on a common feature among all the equity lines: their positive trend.
We also note a huge difference between different titles: General Motors has had a net profit of $ 4,500 since 2010 against more than 120,000 obtained by Netflix since 2015.
So let’s introduce an expression, perhaps, new to many readers (technical analysts and traders specialized in algorithmic trading): stock picking, that is the choice of the shares to invest in.
In our strategy, as well as in investing in a traditional accumulation plan, stock picking, as we have seen, is of fundamental importance.
What we have analyzed is a pure money management strategy, the system does not operate on the basis of technical indications, it merely observes the calendar regardless of what happens on the market.
We have seen how in all the securities tested the strategy has been able to perform well. It remains to answer a question: is it worthwhile to invest with this technique?
It is not so simple to answer: there are too many variables. First of all, we can not fail to consider the incidence of inflation, especially in long-term tests.
In recent years we have been accustomed to an average inflation of 2%, however, going to observe the historical records we realize how there were periods (e.g. late ’70s) in which the annual erosion of purchasing capacity has exceeded 10%.
Secondly, dividends (and the possibility of reinvesting them) were not considered. Finally, the possibility of reinvesting profits was not considered.
Now, taking into account the existence of these variables (all important), it is really difficult to answer the question of whether or not it is advisable to invest in this method.
As a trader specialized in algorithmic analysis, not having, at least at this point of the analysis, the evidence of reliable data, I would not feel like investing using the strategy illustrated.
Before validating this pure money management strategy, traders will have to consider inflation, dividends and reinvestment of profits.
We hope that this reading may have given food for thought to readers.
The next post will be dedicated to stock picking, we will consider a particular technique devised by Joel Greenblatt.
PS: the most attentive readers will have noticed that the longest tests started in 1968, the Tradestation database starts from there. Nobody is perfect.