How to make $16 billion, starting with $100!

Is this an outrageous claim?  One researcher believes that it would have been possible if you lived in 1900 and had $100 and lived to 2001. You would have invested the money in the US stock market using the Dow Jones Industrial Average (DJIA) when the price rose above the 5 day EMA (exponential moving average). You would sell it all whenever the DJIA fell below the 5day EMA, and would have opened a short DJIA position until the price crossed the 5day EMA again when you would have closed your open short position, and you would have then opened a long (buy) position again.

This is information I gleaned from reading 'The Encyclopedia Of Technical Market Indicators, Second Edition by Robert W Colby. His researchers crunched the numbers and reckoned that this was the best simple trend-following strategy that they back tested against daily DJIA from 1900 to 2001.

However, there were a couple of assumptions made in the research that would have massively reduced the profitability of the strategy: firstly, and most importantly, they assumed no transaction costs. This trading technique would have had massive trading costs, as trading frequency would have been'hyperactive' to quote Colby, with a trade every 6 calendar days. Secondly, they assumed no taxes, which is probably acceptable, given the opportunity to shelter trades within ISAs and SIPPs these days.

This approach would have produced a profit of $16billion! Most traders would salivate at this theoretical result. So, could I do it too? I think not. If you click on the daily chart of DIA below:

2015 01 11 DIA daily

Have a look at the trades that I would have to do: frequently buying the DIA, and then the next day closing the position and  selling it short to open the next day! Rinse and repeat the other way round again the following in. It could do my head in!

Colby reckoned that in his period of study only 38.33 percent of the trades would have been profitable. Remember that this is an 'always invested' strategy, either long or short. I don't know if I could stomach trading my whole assets day in, day out, relentlessly.

He also looked at longer-term strategies and found that of the EMA periods in excess of 100 days, the 120-day crossover strategy was the most profitable. A buy and hold strategy would have netted $20,105. The 120 EMA crossover strategy would have netted $508,772.91 (again, this assumes, no trading costs, slippage etc, so it would be nowhere near this, in reality). Trading frequency would have been on average once per month. Psychologically this technique would have been different to the 5EMA technique because only 22% of the trades would have been profitable, which is apparently 'typical of longer-term trend-following strategies'. Also interesting was that short-selling would not have been profitable since 1987 until the study finished in 2001 (ie the last 14yrs of the study).

One disappointment of Colby's book was that he did not crunch the numbers for a 2-moving average crossover strategy, but I guess that might give me something to do on a quiet winters day, or week/month!


Popular Posts