After my last study, I almost opened a small short position on the Nasdaq. I didn’t, ultimately because unprecedented times call for unprecedented thinking. One shouldn’t approach an unprecedented market environment with typical thinking and expect to prevail.
In fact, sometimes we have to turn typical thinking about the markets on its head. And when we do, we realize that keeping things simple is in fact an unprecedented approach. Is this making any sense?
To clarify, my point is that the complicated approach to this market is to try and time the turn. We all know that markets will pullback, and we know that this market has had a huge run. Therefore, we attempt to catch the exact turn. To the day. This is typical thinking, but our current market is a-typical. When we turn that thinking on its head we realize that we should be taking a very simple approach.
There. That reads better.
Let me give you an example.
Take a look at the 20 day moving average of SPY, the exchange traded fund that tracks the S&P 500. Most of the time we would not even think about hedging or building a significant short position when the index is trading above this average. Lately though there’s been a preponderance of traders who want to get short and get hedged, trying to catch the turn. (My evidence for these traders is anecdotal with the data being gathered from tweets, comments, blog posts, etc. Admittedly this is in no way scientific). All the while, SPY has been trading above the 20 day moving average.
So lets see what has happened, over the last year, if we would have just kept things simple, and stayed long when SPY was above the 20 day moving average and went to cash when it was below the average.
Click on the chart to enlarge. The green up arrows show the buys and the red down arrows show the sells.
The Rules:
Buy the close when SPY closes above the 20 day simple moving average.
Sell at the close when SPY closes beneath the 20 day simple moving average.
No commissions or slippage were included. No interest was added for cash. Test period is 1.1.2010 to 1.25.2011.
Results:
Net Profit: 16.71%
Max Drawdown: -8.30%
SPY Buy and Hold Over the Same Period:
Net Profit: 13.94%
Max Drawdown: -16.06%
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One of the hardest parts of trading is sticking with the trend. Traders who have been able to ride significant trends have become part of trader lore, primarily because they got rich doing so. The concept is extremely simple, but in practice it can be an extraordinarily difficult thing to do. Hence, the profits that resulted. If making money in the market was easy…
If you are approaching this market with complicated thinking, you should ask yourself why you are having trouble staying long in a very very strong uptrend. A strong trend is a simple thing and applications for trading it should also be simple.
But I like being stupid.
Yes, in this instance, being stupid wins. Perhaps I should have titled it “Be Simple and Be Stupid.”
Don’t underestimate the power of year 3, particularly during the Nov – Apr timeframe. Historically corrections are shallow except coming off a recession/big bear market when the bottom is retested like 2003.
Are you saying you are looking for a big correction?
How does this rule work out in flat or down years?
Most likely not as well in flat. Not sure about down years. If I have time I might run the test.