Tired of Volatility? This Investment Strategy Could Be For You

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They say a picture is worth a thousand words.

And you know what? I agree.

Images are the foundation of my career. I wouldn’t be writing to you today without them. It’s fair to say that much of my success is due to pictures…and lots of them.

Do you know the type of images I’m referring too?

Charts.

It could be a chart of anything from stock prices to statistics, or currencies to climate changes. Just give me a chart and I’ll start scanning for patterns.

One of the more unusual examples concerns the birth of our first child. My wife was in the early stages of labour, and I was watching a monitor graphing the baby’s heart rate.

I noticed a pattern on the chart. The pulse was rhythmically rising and falling. I asked a nurse why the baby’s heart rate was fluctuating. She calmly said it was normal.

But things were far from normal.

The room was full of specialists in no time. Minutes later it was off to the emergency room. And 20 minutes after that we had our healthy newborn.

The cycle I’d spotted indicated the cord was around the baby’s neck. The heart rate was slowing as the cord tightened during contractions. It’s a chart pattern I’ll never forget.

In the beginning

My introduction to charts was in late 1991. And it came largely by chance.

You see, I had a part-time job on the Bond trading desk at Bankers Trust. I would go in every day after uni to help with admin tasks. It was an ideal springboard to a graduate position.

Things went well on the Bond desk. By the end of the year I had two potential full-time offers. One was on the floor of the Sydney Futures Exchange…the other was in the charting department.

My first thoughts were of the futures floor. I liked that it was full of noise and activity. It seemed much more exciting than looking at charts. At 21 years of age, I didn’t know any better.

But fate stepped in. The head of charting was the first to offer me a position. I wasn’t about to tell him I’d think about it. I accepted on the spot.

It could have all been so different. The timing of a conversation set my career in motion. It was one of those pivotal moments. Looking back, I can say luck was on my side that day.

My boss for the next 12 months was a guy called Scotty. He’s without doubt the most skilful chart analysts I know. And I effectively had an apprenticeship to study under him…it was a gift.

Scotty taught me how to read a chart. It made so much sense. You see, it’s all about three market phases — up, down, and sideways. Get that right, and you can make a lot of money.

I began to develop an eye for recognising patterns in data. I also started to understand the power of a trend. A chart wasn’t just a picture of the past…it was a window to the future.

My year with Scotty was the most valuable of my career. I’ve coded many of my lessons from that time into Quant Trader’s algorithms.

Haven’t I seen you before?

Okay, let’s have some fun. I’m going to put your pattern recognition skills to the test.

Have a look at this next chart…

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Tell me, do you see a familiar pattern in this price data? It resembles a market you know well.

Do you think you have it?

Okay, let me show you…

Source: BigCharts

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This is a chart of the All Ordinaries. Now go back and look at the first chart. You’ll see the two graphs have a striking similarity.

So what is the first graph all about?

Well, it’s interesting. It’s an inverted performance chart of Quant Trader’s short trades. Notice the scale on the left hand axis. You’ll see it’s upside down — the lowest numbers are at the top.

Now let me put the chart the right way around…

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This shows the hypothetical performance of every short signal. It assumes $1,000 on each trade. And as always, it doesn’t take account of costs.

Inverting the chart gives short trading a new perspective. You can see how it closely mirrors the All Ordinaries over the past year. This is why short trades act as a buffer during market downturns.

The flipside of shorting is that it’s a drag on performance in a rising market. This partly explains why shorting is often less profitable than buying — the stock market has had a long term upwards bias.

But shorting is worth considering for some traders. It takes the edge off down periods, and can smooth out performance over time.

Okay, let’s breakdown the numbers behind the chart.

Quant Trader has given 131 short signals — 79 are open and 52 are closed. The following figures combine both groups. Ignoring the closed group would exclude most of the losses.

These are the results up to the close of business on 9 November 2015. All the figures are averages.

The top quarter of short trades show a profit of 39.4%.

The middle 50% are in profit by 1.2%.

And the bottom quarter are in the red by 33.5%.

The average overall profit is 1.8%. This is a little behind the 4.7% fall in the All Ordinaries.

Shorts haven’t added a lot to the bottom line this year. And that’s not unusual. Quant Trader has historically made most of its profits through buying shares. This is typical of most systems.

But remember the purpose of short trading. It is to smooth performance. And that’s exactly what Quant Trader’s shorts have been doing.

Short trading isn’t for everyone. And that’s okay. You can do very well without shorting a single stock.

If you do trade the short side, I suggest having a portfolio of shorts. This makes it more likely you’ll get a result similar to Quant Trader.

Remember, the strategy is about many small trades…not a few big punts.

Until next time,

Jason McIntosh,

Editor, Quant Trader

Editor’s note: If you don’t know which stocks to short, then Quant Trader can help. The system’s algorithms are constantly scanning the market for opportunities. It will then issue a sell signal, and calculate a unique exit stop.

Just this week, Quant Trader identified two new short trades. These could be the hedge your portfolio needs if the market turns lower.

Take the next step…see what Quant Trader could do for you.

Join The Daily Reckoning on Google+

Jason McIntosh

Jason McIntosh

Jason is a professional quantitative analyst. Before he graduated in 1991 he joined Bankers Trust — a Wall Street investment bank — to be a trader. After Bankers Trust was taken over in 1999, Jason, already financially independent, co-founded a stock market advisory and funds management business called Fat Prophets. At 37 he sold his part of that business and retired. These days, he’s a private trader and system developer. In 2014 he launched the wildly successful trading service: Quant Trader.
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