We speak today of a topic basically unrelated to algo trading, but that can still be automated…
The accumulation plan (Savings plan)
The term “accumulation plan” (savings plan) is used to indicate the operations of investors who, at periodic intervals, buy shares of the same financial instrument with the prospect of keeping it in the portfolio for a specific period of time.
For example: we decide to buy $200 of EXON shares each month.
The main objective of those who venture into this operation is to keep the stock in the portfolio for very long periods, thus taking advantage of the increase in quotations.
We have used the PAC calculator (Italian acronym of Capital Accumulation Plan) available on https://www.nef.lu to calculate the theoretical profitability of this long-term operation, simulating a constant increase in quotations. (The website is in Italian).
Suppose we can identify a stock that is constantly increasing by 3% for 30 consecutive years and reinvesting profits, our returns would have been interesting.
ACCUMULATION PLAN AND ALGORITHMIC TRADING
Blog readers would be wondering how the concept of an accumulation plan can relate to algorithmic trading.
Let’s take it one step at a time and answer this first question: is it reasonable to think of an accumulation plan that has a stock as an underlying asset? According to the writer, it is, and there are three solid reasons:
1) investment in equity (shares) is, together with real estate investment, one of the few ways to protect yourself from inflation. The listing of the stock also reflects the increase in inflation;
2) the dividends that separate some shares are often greater than the returns of funds invested in bonds (government or equities);
3) historically, from a long-term perspective, the stock market is characterized by a markedly bullish bias.
A TRADER’S CAPITAL ACCUMULATION PLAN (PAC)
The classic use of PAC is not without criticism. We can identify three major flaws:
1) it exposes us to default risk (see the ENRON and MERRILL LYNCH cases);
2) it has very deep and long lasting drawdowns;
3) operations are characterized by generally low returns.
I would then add that most readers, being traders, would get bored.
Let’s try to test our idea of a share PAC:
a) we divide the capital dedicated to our operations into 12 equal parts;
b) starting from January, at the beginning of each month, we invest a certain sum in the same stock;
c) we liquidate all our positions at the close of the calendar year;
By deciding to dedicate $12,000 to this operation, we should invest $1,000 each month. We will do this mechanically, regardless of our vision of the market.
We see below the activity of three years investing in the Ford (F) underlying.
Observing the graphical representation of the monthly revenue and annual output it is clear that it is a pure money management system rather than a trading system.
The annual output was designed to protect us from the default risk of the company we are investing in. This is a partial protection: in January we would be exposed to only $1,000, $6,000 in June and so on. The worst case would be if the company we are investing in goes bankrupt in December.
In the next post we will try to answer the question “is it convenient to invest in PAC?”