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Tuesday, November 27, 2012

A simple strategy that beats most traders

I often find myself thinking about possible strategies and end up playing with historical data whenever I have the time. I like to come up with some experiments or simply have some fun enjoying the exercise of trying to design trading systems for different portfolio sizes and risk tolerances. Needles to say it is a tough exercise and most of the time I end up frustrated, but that's not the point for this article.
The other day I thought about a simple idea, so simple that I'm pretty sure many traders have thought about. A simple strategy that despite its simplicity beats most traders out there over the long term, and most mutual funds as well.

We know that 90 to 95% of traders lose money, and we also know that 70 to 75% of professional  money managers can't beat the S&P500 year after year. That means if you achieve the returns of the S&P500 you are doing better than most.

The core of the strategy is owning SPY shares. The SPY is the Exchange Traded Fund (ETF) designed to track the performance of the S&P500 index. By owning SPY shares you are essentially obtaining the same return as the S&P500, which means you are beating the majority of traders and professional money managers.

One added benefit of owning SPY shares is that they pay dividends. These dividends have oscillated between 2% and 4% per year during the last few years. So, not only would you be beating most professional money managers by simply tracking the S&P500, but you would also be getting paid quarterly dividends that would add up to somewhere between 2% to 4% of your capital year in and year out.

Notice that in a Bear market, like the one we have had for the last few years, with the 2001-2002 crisis, the 2008 crisis, the 2010 recession in Europe, the issues with US National debt etc, the major indices are around where they were in 2000. Yes, you wouldn't have had much capital appreciation, in fact almost none, but you wouldn't be negative either, and with the added benefit of the dividends you would be better off than with a savings account offering 0.75% yearly returns in any of the major banks.

Of course, this is a hard to stomach strategy, subject to the mercy of the S&P500 and psychologically tough draw downs such as the one experienced in 2008. But anyways most Mutual funds didn't escape the 2008 calamity either and we realized they were not as "safe" as it had been promised for years.

Finally, I just have a little upgrade to the strategy just to make it a little better in my opinion.

You simply leave 10% of the portfolio available in cash in order to apply the Covered Call strategy. For every 100 shares of SPY you own, you simply sell 1 SPY Call option from time to time. But you don't do it randomly. You patiently wait like a sniper for very overbought markets: 70% of stocks being above their 20 Simple Day Moving average combined with an oscillator of your preference being overbought. That should happen 3 to 5 times a year. At that precise point you sell your out of the money Calls in the front month, 5% to 10% above current price, simply trying to add returns of 2% - 5% per year with this little add on.

By using the SPY Etf you are also avoiding all the crazy and insane costs and fees imposed by the Mutual Funds industry. You are automatically free of things such as Administration Fees, Performance Fees, Early Redemption Fees, Deferred Sales Charges, etc. Most people are trapped in this industry full of fees. Fees charged for under performing services most of the time.

No wonder they say the industry is in crisis. If a very simple strategy like the one I described could easily beat the highly priced and under performing Mutual Funds industry, then it is an industry in a permanent crisis. Investors wouldn't need hundreds of hours monitoring their positions or investigating particular stocks or anything like that. A simple, cost effective strategy for long term investing that would allow them to keep their daily jobs.

Unfortunately, most people are lazy, and don't want to make an effort and just learn the basics to apply something like this. Or they simply don't question the status quo of going to a professional for him to manage your money believing he will do better. Seriously? How much better? There's no guarantee.

If you have another basic, yet effective idea, I'd like to hear about it. traderlazy@gmail.com or simply add it in the comments sections for discussion.

Happy trading folks!



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3 comments:

  1. Great post!
    It is true: simple things works better.
    We leave our money in the hands of some Investing fund and if things goes right they win, if things goes wrong we lose!
    With this simple strategy an investor could obtain superior results.
    Very large iron condors on index can also be a good investment for a smart and more evolved investors.

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  2. I like the idea ! I'd go one step further and add to sell puts when the market is oversold too. A rebound has you keep the premium or reduce your dollar cost average of the SPY position you have. I think you have to view this (as you have done) as a long term strategy not a trading one per se, or you'll end up losing by buying back the puts if the markets fall !

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  3. Yes, that's definitely a good idea. Specially because in that environment volatility has gone up and options premiums are juicer. Thanks for dropping by.

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