Article / 27 July 2016 at 13:00 GMT

Aggressive equities and algorithms

Hypothesis Testing
United Kingdom
  • 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

Stock ticker board
 There's a mind-boggling range of stocks to choose from. Image iStock


By fxtime*

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?

Automation
 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 hereLikewise the joys of a 5-day relative strength index (RSI) on a end-of-day basis are outlined hereCombine 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
BHP Billiton share price
















Source: Saxo Bank

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.

Piggy bank
 Or then there's this method of saving for retirement. Photo: iStock


— Edited by John Acher

*fxtime is a pseudonym

1y
fxtime fxtime
Update on the equity trade BHP....further trades opened at 921 and 938 and covered today at 980p both trades exceed any risk free rate of return after all costs and tax :-)
1y
Michael O'Neill Michael O'Neill
Another brilliant strategy, fxtime.
1y
zefy zefy
Yeah, I will definitely test this strategy.
1y
fxtime fxtime
Thanks guys.....I will post some fx scenarios for this soon which may be more relevant to the site :-)
1y
fxtime fxtime
Chart is USDCAD on a H4 setting......the inefficient pricing theory is that markets always overshoot on rallies and bearish moves in the short term. View it like a ship at sea...it takes time to slow the momentum enough for a ship to turn and it is the same with markets. It takes time for market momentum to stall and then rebalance to a price that reflects current market fair value. The chart shows (arrowed) the potential for a long but clearly you can see the bearish potential trades on the overbought values too. Trade small and like the BHP trade above you will soon see a positive return :-) I am assuming all readers will enhance profits by scaling their trades once in profit but even the basic single trade works but as I said trade small as the RSI2 only highlights market stresses it doesn't give the exact lows or highs hence the trade small.
1y
fxtime fxtime
Another of interest....remember you need economies of scale if buying equities outright to maximise ROCE....initially if funds are stretched ; scale your trades. Start small and scale up once in profit if you prefer. Chart is end of day TWITTER.
1y
fxtime fxtime
Update....I took a small scale long based on the above chart for usdcad. So afr I am in profit and stop at b/e
1y
fxtime fxtime
Twitter bought as suggested at $16.00
1y
fxtime fxtime
Risk free savings rate in the UK is a meagre 1.1% on average per annum which means over the next 12 mths I need to surpass $16.18 to cover/exceed the risk free rate.
There is a London Capital Finance Bond at 3.9% fixed return over 1 year but again this is a one year holding period. Thus it implies $16.63 needs to be attained in the next 12mths to ensure this trade is profitable.
1y
fxtime fxtime
Twitter now at $16.26....in one day. My costs are covered and I have exceeded the annual risk free rate :-)
1y
zefy zefy
Well done, congrats :)
1y
fxtime fxtime
Thanks Zefy ...did you have a go ?
1y
zefy zefy
Not yet, things are running late here and running business took all priority so this strategy is on queue still waiting for implementation :).
1y
zefy zefy
My programming team (which is me) and trading team (which is me) are arguing about priorities LOL.
1y
fxtime fxtime
LOL...I know what you mean....I am the kids taxi team, business team, etc etc. Priorities are best described as ''fluid'' when it comes to the order of priorities.
1y
zefy zefy
Indeed.
1y
Feders Feders
Hello !, great articule/idea. Is it posible to implement such automatization (not sure about this term) in saxo trader?
Regarding your comments on twtr, going from 16,00 to 16,26 you cover the 15 u$s to get in and the 15 u$s to get out of the trade ( aprox fee, and maybe you pay less). Meaning you bought around u$s 1800 of twtr? Those cost are you referring to?
1y
fxtime fxtime
I buy equity of 10,000 lots for large accounts or utilise cfd accts at the same value stake size.
Automisation for Saxo via Meta is not available however you can link your excel or R/Stan/Jags via Ensign or Genesis.
1y
fxtime fxtime
Feders I am no longer in this trade as exceeded the risk free rate easilly yesterday and covered and took my profits today as we rallied to $16.60 +...remember I seek economies of scale and if need be leverage to make an aggressive ROCE in a very short time frame. I can use near dated options, cfds. equity purchase is always there with a cov call facility if req'd. This trade surpassed all minimum ROCE levels and I am only talking of a bare bone strategy here with absolute minimum stakes and this is a suggestion for you to build from. All my articles overlap with each other for you to build a stronger trade parameter/strategy. Economies of scale on inefficient pricing models can be applied to any equity as long as it is liquid and volatile. Price can be $1 or $500 per equity !
Remember also this is a new series for algo scenarios ...last Wednesday was the first...link for you attached.
https://www.tradingfloor.com/posts/may-the-force-be-with-your-algo-7928840
1y
Feders Feders
Thanks!, I will read it over the weekend. Regards!
1y
fxtime fxtime
Clearly I covered too early as onwards and upwards it goes but I will no doubt catch this one again soon enough :-) Feders if you traded this you should be +4% up on equity and far higher if you traded via a leveraged CFD :-)
1y
augustus augustus
Fxtime, are you familiar with Larry Connor's RSI2 strategy? It has similarities to yours but adds 200 and 5 SMAs as filters for entering trade
1y
fxtime fxtime
I am not but would I am always interested to learn...do you have any info?
1y
fxtime fxtime
Sorry Augustus my predictive text on my phone seems to be mixing the grammar above.....I don't know the Larry Connors RSI2 or his SMA filters but if you have a link or more info then post it as I always like to see other scenarios.
1y
augustus augustus
Fxtime I had an ebook which listed 15 years of quantified backtested results but cannot find it at the moment . Here is a link to stockcharts outlining the strategy. I think the fundamental difference is he replaced your Beta rule with moving averages as a filter : http://stockcharts.com/school/doku.php?id=chart_school:trading_strategies:rsi2
1y
fxtime fxtime
Thx augustus...I will have a look later today. Still plowing through a back log of emails and client requests LOL.
1y
fxtime fxtime
Augustus I have just read the article....I totally disagree with the use of sma (I will explain later on that point) however using RSI2 or RSI5 relies on the Law of Large Numbers (you can wiki search that) which is a long established theorem. Basically if you toss 100 coins you will not get 50 heads and 50 tails showing...probably 60% heads or tails which is a skew of data due to the small sample size. Toss 100,000 coins and you will probably show 53.1% are say Heads or Tails....again this is a skew of data but the data set is larger and far more accurate. It would take millions of coin tossing before you get nearer than the 53.1% value because of the chance element involved when tossing a coin....you may toss some coins faster or higher or indeed change coins size and weight. BUT you can take advantage of the skew. You know that the Law of large numbers suggest that a more normal data spread will occur which is why your L.Connors guy eschews the use of stops because the odds are......
1y
fxtime fxtime
.....heavilly in his favour as he can average weight his trade. I am struggling with internet issues at present due to BT maintenance programme occurring around here grrrrrrr so I am unable to post a chart for you. But I will make my next article on zero sum games and why they can be very profitable even without average weighting the worst case scenario is break even and the best is obviously a profit.
1y
augustus augustus
The downside to taking a holiday lol. I look forward to your explanation on the SMAs. By the way your USDCAD setup is working flawlessly for me too
1y
fxtime fxtime
LOL....I still don't have any charting but my bank balance is up so I assume the usdcad has been generating an income so good news for you mate :-)
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