Weak-stock rotation

By Volker Knapp
Market: Stocks.

System concept: This trading method actively rotates into weak stocks in the expectation they will rebound — in essence, it’s a dip-buying rather than a momentum-following approach. It records the short-term percentage price changes of all the stocks in the portfolio each day and buys the five that made the biggest declines. After a minimum holding period, the stocks are sold when they give evidence of increased relative strength.

This idea grew of the poor performance produced by several variations on the theme of rotating into stocks that were already showing relative strength (upside momentum). Somewhat surprisingly, this general approach — regardless of the specific tool used to measure momentum — produced too many big losing trades. Therefore, we had to reject the idea of simply following the short-term momentum for the purposes of stock rotation.

This type of system can result in a large number of trades. The requirement to hold a trade at least several days before exiting is designed to limit the number of re-entries to a minimum.

Strategy rules:

1.    Go long tomorrow at the open the five stocks that made the largest percentage declines over the past 14 days.
2.    Hold the stocks at least five days.
3.    Sell tomorrow at the open when a stock is no longer among the five biggest percentage decliners over the past 14 days.

Figure 1 shows the system trades relatively frequently. The 14-day rate of change (ROC) indicator in the upper panel represents the percentage change (the close today divided by the close 14 days ago).

Money management: Allocate 15 percent of account equity per position.

Starting equity: $100,000. Deduct $0.01 per share in commissions and 0.05-percent slippage per trade.

Test data: The system was tested on the Dow Jones Industrial Average, which contains the following 30 stocks: Alcoa (AA), American Express (AXP), Boeing (BA), Bank of America (BAC), Caterpillar (CAT), Cisco (CSCO), Chevron (CVX), DuPont (DD), Disney (DIS), General Electric (GE), Home Depot (HD), Hewlett Packard (HPQ), International Business Machines (IBM), Intel (INTC), Johnson & Johnson (JNJ), J.P. Morgan Chase (JPM), Kraft Foods (KFT), Coca Cola (KO), McDonalds (MCD), 3M (MMM), Merck (MRK), Microsoft (MSFT), Pfizer (PFE), Procter & Gamble (PG), AT&T (T), The Travelers Co. (TRV), United Tech (UTX), Verizon (VZ), Wal-Mart (WMT), and Exxon Mobil (XOM). Data provided by Yahoo.com

Test period: December 1999 to November 2009.


For the complete article, see the March 2010 issue of Active Trader magazine. Click here to subscribe.



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