Chances Are the Market Does This Next

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Beautiful one day, perfect the next…

This catchy slogan is one of the greats. It creates an idyllic image of paradise. It has been luring southerners to Queensland since the 1980s.

I remember an early version of this long running campaign. The promoters did something I had never seen before — they backed the tag line with a promise.

The details are now a blur. But it was along the lines of a ‘no rain’ guarantee. Holidaymakers would get financial compensation if the heavens opened.

Giving a guarantee on the vagaries of weather was a bold call. So it’s no surprise this part of the campaign didn’t stand the test of time.

Sure, Queensland has some of the best weather in the country. The warm sunny winter days are the envy of many. They act as a magnet to the sun deprived.

But there’s a dark side. Nothing is ‘perfect’ all of the time.

You see, Queensland also hosts some of the wildest weather. Fierce storms and tropical cyclones are seasonal regulars. It’s all part of life in the sunshine state.

Weather cycles are a part of nature. Clear skies inevitably give way to stormy weather. But no matter how dark it gets, the sun always returns.

Changing moods

The stock market is no different. We know conditions are changeable — it’s always been that way. Bull and bear markets have a constant ebb and flow.

Yes, this week’s sell-off is a big deal. But it’s not unique.

Have a look at the table below. It shows the history of stock market corrections for the Dow Jones Industrial Average. The data goes back to 1900.

Source: StockCharts

Now take a look at this.


This shows the Dow from 1900. The big sweeping up trends are easy to spot — they dominate the chart. A handful of corrections also stand out.

But do you notice all the 10, 15 and 20% corrections? Probably not. They quickly fade into the background as the longer term trend advances.

The Dow’s fall from the May high is currently 16%. This is presently a mid-tier correction.

No one knows how long this bear market will last. But we can be sure of one thing — it will pass. Just like every correction in the past.

I’ve had a number of emails about the market in the past week. Have a read of the one below. It captures the sentiment well.

I’ve been a member of Quant Trader since last December, and I’m going ok.

There is, understandably, a lot of concern that we are heading for a huge crash, deflation, hyperinflation etc. but of course, no one knows when.

My question is, how do you think the Quant Trader portfolio (and I don’t own the entire range due to amount of funds available) would stand up, as compared to other shares, blue chip etc. IF/WHEN there is another, big crash please?

How did Quant Trader stand up on the back-testing during the GFC?

Many thanks

Member, Jill

I think this is an excellent question. Jill is someone who clearly gets what algorithmic trading is all about. She’s not after an opinion. No, Jill is asking about the back-testing.

OK, let’s start with a chart of the All Ordinaries.

Source: BigCharts

This shows the Index from January 2007 to December 2009. It includes the lead-up and recovery from the GFC. The peak to trough decline was over 50%.

Now let me show you Quant Trader’s performance over the same period.

This show the hypothetical performance of Quant Trader’s long signals. It assumes $1,000 on every long signal. There is no allowance for costs or dividends.

Quant Trader is not immune to corrections. There will always be a direct link between long trades and the All Ordinaries. The fact is most stocks fall in a bear market.

Yes, the portfolio takes a hit. But let me put it into context. Quant Trader had 204 positions at its pre-crash peak. The decline was nowhere near as severe as the broader market.

There are two key reasons Quant Trader fares better.

  1. Quant Trader has an exit strategy for each signal. This is vital when prices turn lower. It preserves capital for the inevitable recovery.
  2. The strongest stocks are often the first to recover. Quant Trader’s algorithms identified a portfolio that quickly sprang back.

Now let’s consider the overall returns.

The All Ordinaries lost 13.5% over the three years from 1 January 2007. During the same period, the average annualised return of Quant Trader’s signals was a gain of 8.6%.

There’s one more chart I want to show you.

This is what happens when we include short trades…

This is the hypothetical performance of Quant Trader’s long AND short signals. It assumes $1,000 on every signal. There is no allowance for costs or dividends.

It’s times like this that shorts come into their own. The aim is to buffer the portfolio when the market falls hard. This worked during the GFC — and it’s working again now.

Let me explain the three key phases on this chart.

Phase 1

The market peaks in 2007. Quant Trader’s portfolio gives back its earlier gains. The All Ordinaries declines by about 20%.

Many of the portfolio’s long trades hit their exit levels. The falling market triggers additional shorts.

Phase 2

This is the steepest part of the decline. The All Ordinaries loses over 2000 points in six months. Buy and hold investors are particularly hard hit.

Most of Quant Trader’s long positions are now closed. This safeguards capital. The short trades are now the main game. You can see profits soar.

Phase 3

Now it’s recovery time. This is interesting. It will help you understand shorting.

Look closely at the two Quant Trader charts. You’ll notice the long/short combination (the second chart) doesn’t rally as hard as the long only portfolio (first chart).

You see, the short trades are still open. It takes time for them to hit their exit stops. Shorts are now a drag on performance. This is the price of insurance.

Now let me say this. I know many members don’t trade short. That’s perfectly OK.

The purpose of this report is not to encourage short trades. The fact is shorting carries extra risk. It simply isn’t for everyone. There is nothing wrong with having a long only portfolio.

So what do I think?

The thing I like about system trading is the consistency. You see, algorithms have no bias. They don’t care what the cheerleaders or doomsayers think.

During my 20s, I spent a lot of time reading opinions. I had a particular liking for two forecasters. Both were of the view that a huge crash was coming.

There were a number of scary sell-offs during the 1990s. The merchants of doom would be out saying this was the ‘big one’. But it never was. The markets would always recover.

Have another look at the table you saw earlier. On average, there is a correction of +20% every 3.5 years. That’s normal.

A GFC style collapse is much less common. In fact, it’s a rarity. Only twice in 100 years has the Dow lost more than 50%. The ‘end of the world’ is a low odds bet.

Corrections are challenging times. The headlines of fear and gloom don’t make them any easier. But remember, the worst possible case is an outlier — it’s against the odds.

The best way of dealing with the uncertainty is to have a plan. You might not know what the market will do. But you know what you’ll do. This gives you more control than most.

Quant Trader’s algorithms have seen this type of market before. This isn’t the first sell-off in stocks — and it won’t be the last.

The strategy is simple…

  • Minimise losses while conditions are unfavourable
  • Buy into strength when there are signs of a recovery

Good trading is not about perfect conditions — it’s about consistency and discipline.

Until next week,

Jason McIntosh,

Editor, Quant Trader

Editor’s note: If you are concerned about the recent market volatility, here’s one thing you should do…

Check out Jason McIntosh’s Quant Trader advisory service. It’s a fully algorithmic trading system for ASX stocks. Quant Trader scans practically every company. I can just about guarantee you’ve never heard of many of these unique ideas.

If you’re not familiar with Jason, he was a trader at one of the world’s most powerful investment banks for nearly a decade. He’s seen dozens of market corrections and crashes. This experience is hard coded into Quant Trader’s algorithms. And the results speak for themselves.

So if you are at all worried about the markets…if you’re not sure when to buy or sell…I strongly suggest you looking into Quant Trader now.

Try it. See if it makes sense to you. It could change the way you trade forever.

The Daily Reckoning
The Daily Reckoning offers an independent and critical perspective on the Australian and global investment markets. Slightly offbeat and far from institutional, The Daily Reckoning delivers you straight-forward, humorous, and useful investment insights from a world wide network of analysts, contrarians, and successful investors. Founded in 1999, The Daily Reckoning is published in 7 countries with a worldwide readership of almost 1 million people.

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