The concept of trading for persistency is simple. The rules
are this; buy on an up day and sell on a down day. The results
of this strategy have blown away buy and hold and were demonstrated
in the article: - The Non-Random Walk Theory Persistency.
The article also showed that the day to day upward consistency
of the market deteriorated around and during the Bear Market;
this could be seen in the growth of $1000 equity charts in
the above mentioned article. Some people argue that this deterioration
was due to program trading, I would argue that is was caused
by the Bear Market and the after affects of September 11,
2001. The conclusion is persistency is an exploitable phenomena
and while it may have deteriorated for a while it never disappeared
in the small cap markets.
Note: It is also important to remember day to day persistency
is only one of the ingredients CET Capital uses in our over
all methodology.
First I Will Address the Issue of "Program Trading"
After it is all said and done an increase in "program
trading" is just another way of saying an increase of
volume. When investors talk about volume they are talking
about liquidity. One way to measure "program trading"
is to look at the Commitment of Traders open interest. As
of March 7, 2006 open interest was 695,690 contracts for the
S&P 500, 74,882 contracts for the NASDAQ 100 and 34,247
contracts for the Russell 2000. The action is, has been and
will be in the S&P 500. The reason why "program traders"
or "big money" play the S&P is because of its
attractive liquidity. Small cap stocks by their nature are
illiquid. The less liquid a market the larger the bid-ask
spread. Try liquidating a billion dollar position of small
cap stocks. You can do it but it will take awhile and you
might not get the price you like. It is the small cap illiquidity
issue that deters active trading and it is the lack of active
trading or volume which is one ingredient that leads indices
to higher persistency. That said as long as the Russell 2000
stays small cap dominated it should remain more persistent
then the larger cap indices.
The Golden Rule of Investing is Preservation of Capital
The easiest way to lose money in the markets is to sit
on a losing position. Trading for persistency forces you to
sell after one down day therefore you do not hold losing positions.
The flip side to that coin is you can lose money if you are
trading during choppy market conditions. For example, if you
buy on an up day and the market closes down the next day forcing
you to sell.
Persistency is Here to Stay
Lastly I want to show you a chart of trading for persistency
on the Russell 2000 vs. buy and hold of the S&P 500 from
1998 until February 2006. During this period the Russell 2000
had a 55 percent chance of closing up two days in a row. Trading
for persistency during this time produced a compounded annual
return of 13.27 percent with a maximum drawdown of 34.53 percent.
Buy and hold of the S&P 500 produced a compounded annual
return of 3.45 percent with a maximum drawdown of 49.15 percent.
There comes a point in every money mangers life when they
have to take what they have been testing and trade it with
real money. That point for CET Capital was in the beginning
of 2003. So far our managed account performance has been good
and drawdown has been low. It is also important to remember
day to day persistency is only one of the ingredients CET
Capital uses in our management programs.
Damian Campbell is President and head money manager
of CET Capital, a Registered Investment Advisory firm. He
oversees the testing and execution of all CET Capital investment
programs. Low Minimum, Low Management Fee, Small Cap Focused,
No Leverage. Please visit us on the web at http://www.cetcapital.com
or call.
