Like a stealthy cougar in the deepest of the night staking its prey, I slide through my day perusing the internet for morsels of information I can bring to you each week. One day, while on the prowl, I sprung upon a piece in the Wall Street Journal called “The What-Have-You-Done-for-Me-Lately Stock Market.”
I won’t parse the article – it was a tad political and we are apolitical here – but I thought it had an apropos title for today’s epistle. Today I am going to give you a glimpse into what I’ve been laboring over lately and hopefully, you’ll think it’s as exhilarating as I do.
I’m sure you’ve noticed the changes I’ve made to the SP500 portfolio names. It’s not a huge difference on the surface but it does reflect a consequential change in the universe of symbols these portfolios will consider for entry. Now I’m not going to burrow too deeply into the mind-numbing particulars on what goes on behind the curtain. But I do want to make you aware the candidates for these portfolios will pull from either the SP500, the NDX100 or the Russell 1000 or any combination of. Thus, they are now called Large Cap.
Why am I doing this?
I’m doing this partly because I fell head first into a snare I’ve cautioned against, “Don’t fall for stock market adages unless you test them.”
You know how I rant like a banshee who lost his best friend about all the trading “truths” we take as gospel.
- “Let your profits run and cut your losses”
- “Never trade without a stop loss order”
- “Never short a market above its 200MA”
- “Buy an oversold market. And sell when overbought”
- “Sell in May and go away”
- “Never short a dull market”
How do you know if any of these are true? Who said so?
Come to find out, it’s actually its elementary Dr. Watson to test this hypothesis. All you need to do is compare entries with highest historical volatility (the way I do now) to its inverse, entries with the lowest volatility, with everything else is held static
If the results from trading the highest HV are superior to trading the lowest HV, I can safely say my hypothesis was correct. (There is a great deal more involved in this kind of analysis but I’m giving you the 10,000 ft view).
What I found was, my supposition was true but only at times. And only for different indexes at different times. Not all of the time, and certainly not all indexes.
As the saying goes, “Put that in your pipe and smoke it.”
The one that really blew me away was the Russell 1000. If you sort the potential candidates for a particular set of rules on the 100-day historical volatility and trade those that bubble to the top – the most volatile, the results since January 1, 2016, to date have been dismal compared to the inverse, if you traded the least volatile – the stocks that have lowest 100-day HV.
$RUI since January 1, 2016, to date trading the candidates with the highest volatility.
$RUI since January 1, 2016, to date trading the candidates with the lowest volatility.
Tell me if that doesn’t set some of your old trading ideas on their collective tails?
Much like the tide has different cycles that occur when the earth, sun, and moon are in a line, trading volatility flows in and out of favor as a beneficial tool for trading.That’s a huge piece of information to noodle over but now comes the hard part, “What do I do with it?”
First of all, I’m experimenting with using something other than volatility but I don’t want to throw the volatility baby out with the proverbial bathwater just yet. What if I come up with an indicator that will give me a heads up when an index is losing its luster (for whatever reason, not just volatility) and “rotate” into another index that is just beginning a new cycle?
Chasing vs. rotating
I have always, and still do, advocate you should not jump from one strategy to another pursuing the best performer like a spurned lover longing a long lost love. This is a formula for disaster in love, and it is also a recipe for blowing up an account.
What I’m talking about here is a rotational system based on a PLAN. A plan that has been backtested and well-thought out. Moving from one strategy to another without a plan is chasing. Moving from one to another based on a plan that will improve (or smooth out) performance is “rotating.”
Here’s the Plan
I am testing the SP500 Margin, Retirement and Leverage portfolios using different indexes and combination of indexes. Then, employing a complex set of proprietary indicators built just for this purpose, I can see when one index is losing its luster and coming to an end of a cycle and another is starting to shine.
When I started this article, I loaded a plethora of charts and graphs to show you what I have been up to then realized you probably don’t care, you just want me to take care of what is going on behind the scenes and tell you what I find.
You probably just want me to “Show you the Money.”
My analysis lead me to adopt the NDX100 instead of the SP500 for the “Large Cap” strategies. When my “rotational” indicators tell me its time to rotate to another index, it will happen all under the hood.
This is plenty to absorb in one newsletter so let me drip it out slowly. I’ll get into more detail next week.
We’re the Plan in “Plan your Trade and Trade your Plan” – TraderJanie
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