Stock Market Trading Rotation System

[ljean]

A few months ago I bought and read the book Stocks on the Move: Beating the Market with Hedge Fund Momentum Strategies, by European fund manager Andreas Clenow.

Basically, the premise of the book is to buy top-performing stocks and sell them when they cease to be top-performing stocks and then use the cash generated from the sales to buy the now current top-performing stocks. Investing in this manner will align your portfolio with the macro trends and hot sectors in the marketplace.

I coded up the system described in the book as a starting point and added some twists and mods to suit my trading style. The strategy as I designed requires only a few minutes once every two weeks to manage. The yearly returns are all over the place but the average CAGR as tested is just under 35% per year.

I plan to take this live soon and will post updates on the portfolio and performance here.

 

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[ZCP]

So buy stocks that are going up until they stop going up?
Wow.

 

[ljean]

And here is my 6-month performance history.

 

[bringitnow28329]

You have to protect from single stock failure. For example, one of my positions is down over 50% on the month due to accusations of securities fraud. If I have a 10 stock portfolio that is a -5% drop.

Don't trade lower priced, penny stocks/ low floaters and you won't experience a -50%. While securities fraud can happen with any company, or other similar problems, the fact is lower priced stocks trade at a low price because they are generally unprofitable and merely exist only due to massive ongoing dilution. If you want to trade these then manage the risk by reducing the position size and using hard stops. Also learn to read a chart and don't go buying/shorting over extended stocks trading several standard deviations or greater from their mean... I was a professional trader (self employed) for 12 years and now trade for an institution with $1.4 billion. We never would mess with these type of stocks. If you are trading those then it should only be for day trading and you have to be watching them every second the market is open in order to manage risk with extreme volatility that is very common in these crap stocks.

 

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[bringitnow28329]

You can't really trade systematically without hard stops. If you do it comes down to discipline and considering you are done 50%, sorry to say it, but your discipline is lacking. Yes you will get stopped out sometimes when you use a hard stop, but the point is your limit your losses by defining you risk and don't need to take 90 positions to diversify when you max loss is defined.

 

[ljean]

Year end results - I'll call it a win based on the benchmarks.

 

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[loop101]

That looks interesting, but remember, since the book was written in 2015, you should disregard the results before 2015. In 2015 it had a return of -7.1%. In 2016 it had a return of 5.6%. Would you have continued to use it in 2017, when it had a (so far) 35% return?

If you are using Amibroker, I assume you are already familiar with the work of Cesar Alvarez, Larry Connors, and Howard Bandy? I have posted about them on this website.

 

[ljean]

October was pretty uneventful for me. My account went up a bit at the beginning of the month, then dipped, then ended flat. Here is my best stock that more than doubled:




And here is my worst stock that fell in half:

 

[ljean]

November was good until the last two days and I ended pretty much flat again.

My most profitable position this month:


I got buy signals a few days ago in a couple crypto-influenced stocks that are crazy volatile. It will be interesting to watch what these positions do over time:




I've been in Overstock.com for a few months. Its been on a tear since announcing they would accept Bitcoin as payment for goods. Unfortunately it fell off a cliff a few days ago in conjunction with the increased volatility in cryptos.

 

[ljean]

44% win ratio
2% equity per position (50 stocks max)
-14% avg trade loss
+34% avg trade win
200 trades/yr
3 mo. avg trade duration

 

[ljean]

Got clobbered in this position today. Luckily, other stocks were up enough to still give me a decent gain on the day.

 

[ljean]

Shorting stocks [profitably] is a difficult proposition for several reasons:

The stock market has an upward bias so you have that working against you.
You have to pay interest & dividends on shorted shares.
Losses are theoretically unlimited while max gain is only 100%.

For these reasons I do not participate on the short side.

 

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[ljean]

Finally closed out a big winner today. I bought this for $5.50 a few months ago for a 65% gain.

 

[ljean]

Its hard to believe i've been running this strategy for about 2 years now. I'm under performing my benchmark (IWM) by about -15% over that time. I'm under performing the S&P by 2x that but I just cant bring myself to pile in to those stocks like AAPL, AMZN, GOOG, FB, etc trading at 30x earnings. With this recent correction I'm starting to rotate out of stocks and into gold & bonds so if there is another V shaped recovery over the next few weeks/months I'm going to really be lagging.

 

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[ljean]

Holy crap another crazy one today!

 

[ljean]

Closed out a nice gain on this today. I think it was one of the high short interest stocks bid up by the folks on WSB. I'm not sure why the short interest is high because its a decent business with good sales & income. But thanks anyways, they can have my shares at this price.

 

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[ljean]

I wont have another one like this for a while. Bought a couple months ago at $2, turned $11,000 into $45,000.

 

[ljean]

Interesting.

Top performing in what metric?

My system simply looks at stocks with the highest price change with a 6-month look back. The book utilizes a more complicated method but the additional rules didnt add much in my testing.

 

[ljean]

I'm a few hours early, but I'm going out of town shortly and I wanted to post a month end update. It was a good month, my portfolio is up 4%. I have about 90 positions on. Aside from the initial loading of the portfolio, no other trades were triggered this month. But I will likely get out of a few losing positions next week.

For fun, here are charts of my best performing stocks.

 

[ljean]

When you buy 90 stocks you are essentially buying an index fund and the return potential will be muted. Diversification is good but too much diversification means you limit your upside. 10 - 20 would be more reasonable

You have to protect from single stock failure. For example, one of my positions is down over 50% on the month due to accusations of securities fraud. If I have a 10 stock portfolio that is a -5% drop.

 

[ljean]

Here is my worst position from September. I bought this on a dip near $30 then the bottom fell out.

 

[ljean]

You can't really trade systematically without hard stops. If you do it comes down to discipline and considering you are done 50%, sorry to say it, but your discipline is lacking. Yes you will get stopped out sometimes when you use a hard stop, but the point is your limit your losses by defining you risk and don't need to take 90 positions to diversify when you max loss is defined.

There is no right answer, you can trade 10 positions with hard stops; I can trade 90 positions without hard stops. Feel free to start your own trading thread and post your results.

 

[bringitnow28329]

this looks like finviz how do you make hard stops with that

Finviz has nothing to do with trading. It just a website for charting. You enter stop losses through a broker and I personally use stops that sit on my side, rather than ones that go out to the exchange so that the market making algo's can't see them and pick them off.

 

[S.Y.]

That looks interesting, but remember, since the book was written in 2015, you should disregard the results before 2015. In 2015 it had a return of -7.1%. In 2016 it had a return of 5.6%. Would you have continued to use it in 2017, when it had a (so far) 35% return?

If you are using Amibroker, I assume you are already familiar with the work of Cesar Alvarez, Larry Connors, and Howard Bandy? I have posted about them on this website.

When you buy 90 stocks you are essentially buying an index fund and the return potential will be muted. Diversification is good but too much diversification means you limit your upside. 10 - 20 would be more reasonable

You can read Quantitative Momentum - by Wesley Gray & Jack Vogel. A bit more recent with a lot of data. I really like the way they dont simply dismiss momentum investing, look at different things such as worst drawdown.

They find that holding fewer stocks and rebalancing more frequently leads to higher compound annual growth rates.

** Interestingly enough, combining value and momentum gives the highest annual compounded return

 

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[Milkanic]

I've been researching Dual Momentum to use a similar system on index funds (rotates US, International, and Bonds). Averages around 1.6 trades a year (rebalance monthly), greatly reduces drawdowns, and has escaped the bear markets in back testing. CAGR of 21.4% since 1971 with minimal drawdows.

Momentum trading seems almost too good to be true but this has been back tested to the early 1800s and holds up. Its based on human psychology more than market efficiency.

From my research, doing this on individual stocks in a taxable account is tough due to taxes and fees. Have you figured out how taxes and fees eat into your model?

GEM Track Record - Optimal Momentum
https://robotwealth.com/dual-momentum-review/
Why Does Dual Momentum Outperform? | Seeking Alpha

 

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[karakoram]

Momentum trading seems almost too good to be true but this has been back tested to the early 1800s and holds up. Its based on human psychology more than market efficiency.
View attachment 17327

I realize your post was not directed at me specifically, but I can speak to this. Momentum is not too good to be true and there is a cost, both psychologically and financially that you may not be aware of. But even with this cost, it is the most profitable way to invest/trade.

Momentum is just another name for Trend-Following aka "outliers" or the opposite of mean reversion - large deviation from the mean. Historically, trend-following has always worked, and I would be willing to bet, always will work, with the caveat that the appearance of large trends comes and goes. They usually appear when the largest number of people are not expecting them. People declare that "trend following is dead" or "momentum is dead" and then boom, we have the stock market 1995 to early 2000 or 2003-2008 or even better, 2009 to 2018.

If you do a lot of back testing of various strategies you will discover that pretty much every strategy is just a variation on one of two strategies: 1) Mean reversion or 2) Trend following. You will also discover that one is pretty much the inverse of the other.

I just closed out a trade yesterday in the cryptos on the idea of "the Trend is my Friend except at the end, when it bends" and it worked out very nicely for me.

Mean-Reversion aka Counter-Trend aka "short volatility" aka "risk-on" has the following characteristics

• Relatively easy to use psychologically because of
• high numbers of winning trades. Most of your time is spent winning.
  
• winning trades are small in profitability
• large losing trades that wipes out all the small profits + a bunch more

Famous examples: the Long Term Capital Management blowup, 1998. Not only was their strategy mean-reversion, they LEVERAGED it up to boost returns when they were winning. Well, that also boosted their loss to a huge degree, as we know now.

A far more ubiquitous example is the sub-prime lending debacle. The banks and lenders were "investing" in all of these sub-prime loans. Banks and Lenders were short volatility. They were happy to "sell insurance" or Credit Default Swaps to the guys like Paulson, Burry et. al. who wanted to be on the other side of their bet. Note that Paulson, Burry, et. al. were paying millions to the banks for these CDS (small losses) Well, we all know how that turned out. They made BILLIONS.

Another example of Short Volatility is selling insurance as an insurance company. Most of the time they get away with it because they spread their risk over many people. But what happens when all of their customers make claims simultaneously? This is why they don't want to insure against earthquake or flood.

Another example is "writing" options or selling options. Its no coincidence that this is analogous to "writing" insurance policies.

Trend-following aka "Risk-off" aka "long volatility" aka momentum has the following characteristics

• Hard to use psychologically because of
• high numbers of losing trades and
  
• losing trades are usually small in losses. Most of your time is spent losing!
  
• a few, infrequent large winning trades i.e. more money is made in the few winners than is lost in all the small losing trades
• It is NEVER known when the next large move (winning trade) will appear, so if following a mechanical system with fixed buy/sell rules, every signal MUST be taken or that one winner that could make you profitable could be missed.

Going back to "The Big Short" example: While their trade direction was short, they were long volatility, i.e. they were betting against the banks.

(Don't confuse trade direction with strategy type, ie, I can be "long volatility" but trade the short side of a market - in other words, I am trend following the down-trend - example: I shorted the stock market in 2008 by following the down trend and made out quite nicely - I was long volatility but short in my trade direction)

Buying options or long options is another example.

Going back to the insurance example: When you buy insurance, you pay a relatively (compared to the potential payout) small premium every month (small losses) and you get a big payout if the unlikely event occurs. Of course, making insurance claims is not a recommended vehicle for creating wealth so this is just an analogy.

Now if you want to get REALLY interesting, it may be possible to hedge either of the above, ie Market Neutral. I've found that the key is that you must get your hedge very cheap and when it kicks in, it must be able to counteract most or all of the loss incurred by the primary strategy. I'm not yet clear on the details, as I am still investigating this idea. A simple example is to buy an index fund, and hedge it with a 3x leveraged bear fund. It does not work to be a "straddle bug" where you buy a particular instrument and simultaneously short it, like with another broker. Your gains/losses would be cancelled out 1:1 minus your transaction costs, so you are net loser.

More complicated examples are combined options strategies, where you combine buying and selling options in the same trade.

Famous money manager trader that uses a market neutral strategy that works: Edward O Thorp. He's one of my heros.

 

[ljean]

I havent posted here in a while, havent had much to report. Its pretty much been one step forward, one step back over the past few months. I did close out this position this morning for a quick 30% profit.

 

[ljean]

Yes, its a value strategy with a trend-following overlay.

 

[ljean]

Closed out a couple big winners today. I bought EGY at $1.00 and sold at $1.50. Then bought it back at $2.50. TGA I bought in three chunks near $2.00.

 

[ljean]

Here is my big winner this week.

 

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