- Can traders avoid the nightmare of stock-picking through automation?
- Here's an aggressive method for CFD and self-invested pension fund trading
- Such a strategy needs highly liquid and volatile (beta) shares
- If buying stocks outright, you need economies of scale to offset dealing costs
- This strategy takes advantage of market skew and distortion
There's a mind-boggling range of stocks to choose from. Image iStock
Stock picking can be a nightmare. You put time and effort into analysing a company, take the plunge and buy the stock, only to see a competitor release bad news that knocks your investment too. So, can we automate our selection of stocks and beat the market returns?
Obviously we need an underlying view of the market we trade in. Determine also if you are trading in an environment that only permits long trades, such as pension accounts.
Next consider your timeframe: are you seeking trades of two days to one week, for instance, or swing trades lasting at the very least one month? Both can be successfully automated, or we could simply apply the programme structure manually to maintain a controlled portfolio position.
Most equity traders are positional and seek medium-term returns via their pension accounts. If they wanted a more aggressive portfolio, they would consider CFD trades and reduce short-term costs.
To build a trading model that can enhance asset value via options/CFD/equity purchases we need a consistent measure of success and profitability. We do not want trades that only succeed in making small profits when a savings account offers a higher return without the dealing costs, taxes, interest charges and, more importantly, has virtually no risk.
So our first ''litmus test'' is for each individual to determine their risk-free return objective: what percentage return would you gain for the same amount of money if you simply deposited the funds in a ''high-return'' (as if that's what they now should be called!) account?
This is too simplistic a model, but let's initially stick with it as a benchmark, as it sets an annualised minimum you must obtain to consider your trades ''successful'' after all the costs are stripped out. Your trading must, after costs, exceed the highest return you could get from a bank deposit over a one-year period.
But we also need to look at how much the market where you buy your stocks rises or falls in percentage terms and compare that with your investment. This may seem very obvious, but in all honesty, did your trading account/portfolio gain and outperform the index, or did it underperform? If you matched a rise in the index, then well done.
But surely that implies a buy-and-hold strategy only, and your equities only tracked what the general index did with no effort or additional costs involved. But that isn't an efficient return. There's an opportune cost missed: what else could you have done with the account to beat the marketplace?
Machines can't do it all. Image: iStock
Let's consider the more aggressive type of trade first.
Please remember we are seeking growth. This is not a dividend-seeking or average weighted growth strategy as we all know the pros and cons of those approaches. This is purely an aggressive utilisation of funds for CFD traders and self-invested pension fund trading.
I have earlier discussed three-day trading in an article available here
. Likewise the joys of a 5-day relative strength index (RSI) on a end-of-day basis are outlined here. Combine both articles and you have a robust trading strategy, but not an aggressive one.
For an aggressive strategy we need a volatile share and equity with beta, as it is known. Mining and financial-sector shares seem to be current high-beta stocks, likewise such well-known names as Google, Tesla, Microsoft, Facebook and so forth. Once you have identified the really liquid fast-moving majors that you feel comfortable trading, then break down the costs involved. If you are buying stocks outright, then in the UK you need to consider stamp duty, a tax levied on share purchases, plus all dealing costs to buy and sell the shares, and determine the true breakeven.
Secondly, if buying shares outright, you need economies of scale. My rule for UK purchases is for a 1p movement to cover all deal costs. So typically look at 10,000 equity stock purchases minimum. That equates to £100 earnings per 1p movement (e.g. 10,000 x 1p = £100). So if you cannot afford economies of scale on certain stocks, then don't buy the stock. I have come across many who have bought one share of Apple and are convinced it will make them a fortune, and it will never happen because the costs of buying and selling will wipe out any meaningful return and you would earn more with a risk-free savings account.
If economies of scale can only be obtained with CFDs and leverage, then you cannot hold such stocks for long. Remember CFDs incur dealing costs and daily interest charges.
So our strategy (relying on the contents of the above two links) takes advantage of market skew and market distortion. The typical RSI 14 works well as an on-balance overview. I highlight a tighter timeframe for the RSI 5, which has the central value line as its focal point of entry. So now we need to look at the RSI in conventional overbought and oversold values, but with one alteration. Let's use RSI 2. Remember this should only be used against high-beta stock, very volatile equities. We are seeking enhanced profits quickly.
Now you will think I'm raving mad with this suggestion. But consider the facts — the bare-bone results. The trades have not been enhanced to maximise profits, nor do they include the use of near-dated options, which can be fantastic for achieving compounded returns.
Consider the following information for trades on shares in mining group BHP Billiton (clearly a beta stock) using the LSE. I have used 2016 details only to keep things current.
Number of trades opened: 13
Average trade duration: 4.15 days, though many were for just one day
Total successful trades: 13
Total losing trades: 0
Total revenue: 860p
Average profit: 66p
BHP Billiton share price - 2016 end-of-day detail
Effectively I have doubled my account holding as the average share price this year is 859p. If I had used CFDs, my trades would have been even more successful.
So I beat the market index for returns and beat the risk-free savings rate. You would need to keep your money in a UK savings account for 20 years at current rates to match the net profits made over the past six months. That I would regard as a success.
Remember we are not seeking anything other than inefficient market pricing. So look for RSI 2 showing a value below 13 and cover above the 50 value line or trail to 80+.
To keep this article from getting too long, it will be better to provide real-time updates on various stocks and then write another article for a skewed ATR series for positional trades to permit swing traders a very worthwhile return.
This can be automated, and trades can be scaled or near-dated options can be used. Due to lack of space, I haven't dealt here with earnings releases or dividends, and shorting is a whole other strategy, so consider this as strictly a long-only trade set-up.
I can provide a real-time variant for indices and major forex pairings with the necessary adjustments.
Or then there's this method of saving for retirement. Photo: iStock
— Edited by John Acher
*fxtime is a pseudonym