For long, a concept that has gained some amount of acceptance is that by selecting stocks using a combination of Technical Analysis and Fundamental Analysis, one might be able to get much better returns compared to using either of them on a standalone basis.
I myself long back believed in such a thing to the extent that I even created a new yahoo group where I felt we could have these kind of discussions. Since I am due to give a talk to a group of friends at a Value Investing club, I decided that rather than just claim that mixing up the two would be profitable, why not test out the theory and see the results.
For the test, I chose the current set of CNX 500 components (a total of around 495 stocks). I did not run and use the output from a fundamental screen such as say the “Magic Formula Investing” simply due to non availability of the stocks that would have got chosen in 2000 (Start of Test).
I used 3 different scenario’s. In Scenario 1, I just bought 1 share each of all the companies whenever I got a signal. If that trade went into a loss (max loss of 20% from purchase price), it did not alter my position size which was kept the same for the next trade as well. Maximum Capital I envisaged that would be required, 200K.
In Scenario 2, I bought the max quantity that would be allowed based on a initial capital of 10K for each stock. If the stock had a loss trade, the next trade would have a lower quantity based on the capital left in that stocks’ account. Only Max stop of 20% from the purchase price was used.
In Scenario 3, I bought the max quantity that would be allowed based on a initial capital of 10K for each stock. If the stock had a loss trade, the next trade would have a lower quantity based on the capital left in that stocks’ account. Along with max stop loss, I also used a trailing stop of 20% from the high point it had reached.
Buy & Hold was simply buying on the first trading day and selling on the last.
The time period for all the above tests was from 1st Jan 2000 to 31st December 2014
Here are the results (Click on the image for a bigger picture)
As can be seen, Scenario 2 / Logic 2 was the best performer. Of course, the results have to be taken with a fist of salt since the stocks I used for this test were those that had survived and are currently part of the CNX 500. But since the whole test is to compare B&H vs using Technical’s, I feel that the same can be safely ignored.
What surprised me was the huge difference between the system that used Trailing stop and one that did not. I am not a strong believer of using stops since market volatility can easily take the best placed stops out, but this result was a revelation as to the damage it can create in long term. Then again, its not only psychologically tough but also makes one look stupid as well to buy a stock at 100, see it move to 1000 before getting stopped out at 80. Maybe, one needs to look at a middle path, something I hope to explore in a future blog post of mine.