Strategy | Portfolio Yoga

CNX Nifty – First day of the month

One of the rational behind trading systems is to ensure that we are able to capture as much of the return as possible without having to go through a draw-down similar to what a Buy & Hold strategy would entail. This is achieved by being exposed to the market for as less a duration as possible.

One of the strategies which I stumble quite often is the strategy of the First day. The concept here is simple enough – Buy at close on the last day of the month and sell on close on the first day of the month (both trading days and not calendar).

I tested that idea for CNX Nifty (Spot) and while we are exposed just 1 day (out of average 20 trading in a month), we are able to capture 26% of the total move that happened in the interim period. For a strategy that has no major rationale behind it, this number is pretty awesome.

The testing period was between 1st Jan 1996 to 1st April 2015. The expectancy of the system comes in at 8.62. The system has 141 Winners and 90 losers. Average win is 38.04 points vs a Average loss of 37.39 points

A interesting point to note is the fact that not all months are the same in terms of profit potential (or at least, that has been the case historically speaking). June, March and July are the best months for the strategy while December, August and February turn out to be pretty bad months.

To get a better understanding, here is the chart showcasing month-wise break up of the return.

If one were to ignore months that were not in our favor, the odds increase even further. But then again, unless we have a clue as to why some months are better than the others, treating all months as the same would be the best way to trade strategies such as these.

The Equity Curve (points) generated by the system shows no major hiccups other than in 2008 when it saw quite a bit of volatility.

To get a better sense of the risk, here is the chart of the draw-down it would have faced.

The period between 2003 and 2007 was when it had the best performance with the equity more or less hitting a new peak every month or so. 2000 and 2008 were times when even the most disciplined trader who traded this strategy would have been shaken off by the incessant losses. Post 2009, while markets have been on a consistent rise, the strategy has had quite a few setbacks with one seeing multiple instances of 5% draw-downs.

The fact that this strategy has generated just 282 points from September 2011 till date shows that maybe, just maybe the strategy is getting out of favor with the rewards not worth the risk it entails.

But before we dump this strategy, lets run a Bootsrap on the returns to see whether the returns out here are due to pure luck or is there something more.

The p-value one gets is 0.55. For anyone who was not put off by the high draw-down one saw earlier, this should definitely be a deal breaker. Then again, the lack of any substantial profit over the last 43 months in itself says that the markets may have changed and this strategy no longer works as it did in a earlier time.

On a side note, it seems that this strategy has been under-performing since 2011 even on $SPY. Food for thought I think on how global markets may have become.

Capital Requirement for a trader

When one starts any business, one has a pretty clear idea as to what would be the cost of starting the business. This may go from a few thousands (if you are starting a web based company) to a few crores (say to get a start in the construction business). But when it comes to trading, there is not much of clarity on what capital is required. This post is a attempt to calculate what you will need if you want to get into the business of trading for a living.

The biggest negative of trading for a living is the fact that the number of failures are humongous in number. I have been in the Industry for nearly 17 years now and I do not know of a single trader who was active when I started off and is still active as a trader now. Of course, there will always be folks who have been active for even more a period of time, but the numbers will be pretty small in nature.

One of the key reason why many a trader cannot sustain this venture is due to lack of a viable strategy. It does not matter how big a capital you start with, if you are chasing the wrong end of the stick, you will end up suffering total capital loss.

A second reason for many a trader to be unable to sustain this business is due to them starting with insufficient capital and then hoping to make a living of it. Markets are not a cow that will provide milk every day or a tenant who shall provide the landlord with a monthly income. Even the best of traders go without having a income (or even worse, having a loss) for months together.

Stress for the trader is guaranteed regardless of the methodology he follows if he has a payment to make and markets are not providing him with the moolah. Many a advise I have heard is to keep 3 years of expenses in a separate account so that you are not troubled by the lack of ability to buy milk the next day because you are having a streak of loses and cannot afford to withdraw capital at this juncture.

I constantly keep meeting traders and the one thing that is constant among many is that they are very well capitalized. This with a decent strategy assures that one will be able to survive the thrills and spills that accompany a traders life.

So, what would be the ideal capital for a trader?

The answer actually is dependent on a lot of factors including the style of trading. For example, capital requirements of a intra-day trader is very small compared to a positional non leveraged trader.

I did a small exercise as to what is the optimal capital requirement for a trader and the results are as shown in the pic underneath.

The above expenses sheet are based on my assumptions on what would be the cost that one needs to account for.

While the costliest data feed would be having a Bloomberg Terminal, I have assumed that not many a trader would actually go for that and instead based it on eSignal. I personally use Global Data Feeds and the amount I pay comes closer to the Average.

So, considering the above expenses, what is the capital requirement if one assumes that the system will over time generate X% / year (not consistently, but on a long enough time frame).

Most simple strategies do not beat the markets and this means that while its nice to be optimistic and think of generating 4 – 5% per month (48 – 60% per annum), in reality you shall find the returns somewhere between 1 – 2% per month (12 – 24%).

Assuming that you are a Average spender, that would mean that you would need a minimum capital of 2 Million to start with. And since we cannot be pulling out money month on month, you would need to store away half a million so that you do not have to worry about your expenses for a year at least. Totaling that up, you will need around 2.5 Million Rupees for one to get started.

The biggest disadvantage for a trader who needs to dip into the capital for expenses (removal even every year) is that he literally misses out on the Eight wonder of the World – Compounding.

Without compounding of capital, there is really very little of wealth generated over time and while you may feel confident that you can continue to do this till the end of your life, it does put a pressure on one to be correct as far as possible.

The biggest advantage of a trader is the ability to lead a life without having to stick to one place. You can travel around the world and yet continue to make a living. In fact, a guy whose website I recently stumbled upon seems to do the same thing and has claimed to have traveled more than 80 countries even as he day trades for a living. (Link)

At the same time, I have first hand witnessed financial destruction and even death of traders who were not able to sustain themselves. As I wrote in my previous post, the probability of survival for a trader (if this is his only source of Income) is pretty low. Just like not everyone can make it to the IIT, so is the ability to earn a living just through trading.

But if you can succeed, there is nothing more satisfying out there. No clients to argue with, no payments overdue, no employees to worry about. Hell, one is truly one’s own boss and driver of his destiny 🙂

Meb Faber Timing Model on CNX Nifty

For a trader, its essential that any strategy he uses needs to at least in historical testing beat Buy & Hold returns (and since we assume a lot in our back-tests, higher the returns compared to B&H, the better). After all, the argument here is simple. If you spend time and effort in markets, the least you should be expected of doing is beating the guy on the street who may have just bought nifty bees and went into deep sleep.

Then again, that may not entirely essential to a investor whose idea is to get a return better than other asset classes and if one comes with lower risks, the better.

The biggest advantage of Buy & Hold on Nifty Bees is its simplicity. You buy it and you can forget all about it. X years later, your returns shall closely mimic the returns of the Index (some variations shall exist due to tracking error).

The biggest disadvantage is that when Index falls big, your investment gets hurt too. For example, a guy who invested into Nifty Bees 2006 would have seen his returns being absolutely zero if he had checked in late 2008 / early 2009. A FD on the other hand would have paid him much higher returns without a iota of risk.

The best way to beat the markets one is told is to buy good companies and hold on (forever). But here too, it comes down all to when you enter. Let me give a example. I doubt you shall be able to say that buying Warren Buffett’s Berkshire Hathaway is a stupid strategy.

This is what I tweeted a couple of days back

An investment into Berkshire Hathway ($BRK-A) at close of 1998 as of today would have yielded a CAGR of 7.66%.

I do not know whether a CAGR return of 7.66% for Americans is huge, but the fact that you could have bought a Treasury Bond (30 Year) which was yielding 5% returns at the same time (End 1998) says that the results aren’t way out of whack with the expectations that could have been made. But I am digressing from the agenda.

Beating the markets on long term is tough. The survivors we see today hide the huge lot of fund managers who have literally disappeared. And beating the markets without having similar draw-down is even more tough. Even the best managers go through tough draw-downs that can send a chill down any investors spine.

Meb Faber some time back talked about a simple strategy. Rather than repeat what he has to say, I would recommend you to head over and take a look – http://mebfaber.com/timing-model/

I tested this strategy on Nifty (using Nifty Total Returns Index to ensure that we account for Dividends which get missed when one uses only Spot Nifty). The results are outlined here;

Test Period: June 1999 till date (December 2014)

Total Raw Returns: 9162 Points (higher than CNX Nifty since it includes Dividends).
System Returns: 8288 Points.

Raw Draw-down: 48.81%
System Draw-down: 26.71%

Raw Holding Period: 173 Months
System Holding Period: 131 Months

Raw Number of Trades: 1
System Number of Trades: 12 (last one being Long from November 2013)

Buy Price & Sell Price = Opening price of the next bar (1st trading day of next month). No Transaction / Slippage charges used.

But the big issue with directly using above data is that you cannot buy Nifty Total Return Index. Instead, what if one uses Nifty Bees. Nifty Bees has a tracking error (bit outdated data) of around 0.20% and a cost of 0.50%. Compared to other options available, this is the best.

In my search on that issue, stumbled upon Kiran’s blog where he has provided some stats on the same out here

All in all, I think for some one who wants to invest directly into market (some Mutual funds have outperformed strongly, but too much of Survivor bias makes comparing them apples to oranges) and yet not get caught when markets drop like a hot potato, this simple strategy is worth a look.

Sell in May and go away – I say no way

A popular adage in the US markets is “Sell in May and go away”. Over at All Star Charts, JC Parets wrote one showing the huge discreprancy in returns between buying in November and selling in April vs buying in May and selling in October. I decided to check whether Indian markets showed any such trends.

I tested the same on the Sensex for the period from 1st Jan 1981 to 23rd April 2014. The results though show that there is not much of an advantage for a investor to miss the months through May to October.

An investment of 10,000 in the Sensex is assumed on the first day of Jan 81 for Sell in May strategy. and 1st May of 81 for Buy in May strategy. Results are as here under

The difference is not too much between those periods signifying that selling in may and going away makes no sense since you shall leave a large part of the market appreciation on the table (or at least, that is what the back-test conveys)

The reason for this can be seen in the Monthly gains chart of Sensex. As can be seen below, good and bad months are spread all along. A Sell in May strategy misses the best month of September while the reverse strategy would miss out on the gains one sees in December and April.

May on a whole has been negative and it would be interesting how it behaves in the current month especially with results of the election being declared. A dip seems to suggest a buy with a exit target in September

Share this:

Share this:

Share this:

Share this: