Non-random price behaviour is not a myth.
It exists and if you are not exploiting
it you should be. Here is a closer look
The CET Capital investment strategies aim
to exploit persistent price behaviour of
the small-cap stock indices and mutual funds.
While some of CET Capitals' methodologies
are proprietary, exploiting persistent price
behaviour which is the foundation of what
we do is not. Persistency, as defined by
Gil Blake, is a combination of volatility
and historical reliability. Below I will
summarise an interview in Jack Schwagers'
book, The New Market Wizards, which eloquently
describes how a successful money manager
named Gil Blake capitalised on persistency
in the 1980s. My aim is to demonstrate two
ways of identifying non-random, persistent
price behaviour. The first will describe
non-random price behaviour in terms of probability.
The second will show persistency in terms
of compounded annual return and drawdown.
My goal is to convince you that exploitable
persistent trends have existed as far back
as your grandparents can remember and they
exist today. Simply put, you should be invested
with a manager who exploits these trends.
The History of Persistency
Gil Blake was one of the first money managers
to exploit non-random price behaviour and
talk about it. Below is a summary of the
chapter called "Gil Blake: The Master
of Consistency" in Jack Schwagers'
The New Market Wizards.
Gil Blake was a mutual fund timer who was
able to achieve gains of over 20% per year.
Blake's life changed in the early 1980s
when a friend presented him with evidence
of non-random market behaviour. When choosing
which mutual funds to trade he "would
rank each sector based on a combination
of volatility and historical reliability,
which he called persistency". He became
so confident in monetising these persistent
trends that he took out four successive
mortgages on his house over a three-year
period so he could invest more money in
his strategy. When he started to examine
managed sector funds he was amazed "that
the daily average price change in a given
sector had anywhere between a 70% to 82%
chance of being followed by a move in the
same direction the following day."
One of the things that Blake said was, "If
the odds are 70% in your favour and you
make 50 trades, it's very difficult to have
a down year". His high trading frequency
eventually got him banned from Fidelity
and was also a large influence on the introduction
of what are now known in the mutual fund
industry as early redemption fees.
A more familiar way of looking at "Persistency
of Price" (POP) is to think of it in
terms of "winning streaks". Below
POP is shown for consecutive up days ranging
from two days (POP2) to six days (POP6)
for three of the major US indices.
date of analysis: 9 September 1988.
End date of the analysis: 30 December
2005. Statistics were compiled using
FastTools analysis software and FastTrack
Simply put, the Russell 2000 is the most
persistent index in this group. An up close
has a 62% chance of being followed by an
up close in the same direction the following
day (POP2), while the probability of having
three up closes in a row is 39% (POP3).
Like Blake, I look at it like this: if you
are trading something that has a 62% probability
of closing up tomorrow if today is an up
day and you are making between 40 and 60
trades per year, it will be difficult to
have a down year.
Therefore if you simply buy on an up close
and sell on a down close in the long run
you capture the heart of the price move
and beat buy and hold. Below there are two
sets of charts which compare trading for
persistency versus using the buy-and-hold
approach of the respective index from its
inception. These charts represent the simulated
compounded growth of a US$1000 using the
above simulation rules for the S&P 500,
NASDAQ 100 and our trading vehicle of choice,
the Russell 2000. The bottom table takes
a closer look at each strategies compounded
annual return (CAR), maximum drawdown and
ulcer index (UI).
Trading for Persistency
Growth of US$1000 Click on the image for an enlarged view
A Closer Look at the
Statistics Behind the Strategies
Buy & Hold
Buy & Hold
Buy & Hold
In each of these examples, trading for
persistency blows away buy-and-hold. Historically,
using this simple approach not only increases
your compounded annual return it reduced
drawdown significantly. The point I want
to drive home here is short-term trading
for persistency works and it works better
on the more persistent indices (Russell
2000) than the less persistent ones (S&P
500) and this is why CET Capital trades
the Russell 2000. The point is you should
have a manager who focuses on persistency
in your portfolio.
Gil Blake's successes
were also a tremendous influence on CET
Capital. I want to note here that with the
introduction of high beta inverse mutual
funds from fund families like ProFunds and
Potomac hedging can be used instead of selling.
As of March 2006, CET Capital is trading
a short-term strategy which incorporates
hedging instead of selling, therefore actively
trading these managed mutual funds is now
once again possible.
CET Capital uses this
short-term trading approach as one of our
triggers in all of our short-term strategies.
We have also identified periods of time
in which the markets are more persistent.
Our job is to sit on the sidelines when
the day-to-day consistency of the market
is low and invest when it is high. To further
capitalise on market persistency we have
identified the best periods of time in which
to use leverage.