Is Now A Good Time To Make A Trade?

Is Now A Good Time To Make A Trade?

Recently a comment came across my Twitter feed in reference to an exceptional trade that the OP (original poster) was riding. Here’s the comment:

“Lesson : Don’t ignore 52 week high strength when overall market is weak.”

The OP is certainly on a great trade and he’s a good trader. However, it also offers an insight into a very common bias that most new or inexperienced traders can fall prey to; that is, that it’s okay to buy a stock making a 52-week high when the broader market is weak.

Data Snooping

Unfortunately this is a classic example of Data Snooping which is a sub-set of Sample Bias. In layman terms the OP has made a single observation then extrapolated the conclusion to be a firm rule.

What we need to know is whether or not this observation was just a random occurrence or whether it does actually have statistical merit.

Thankfully we don’t need to go too far to find the answer. In Unholy Grails (pages 55 through 66) we tested a 52-Week High System using an entry at any time, i.e. regardless of whether the market was weak or strong. We then tested using a Regime Filter which defines a strong or weak market by way of a 75-day moving average. When the market was weak no trade was taken.

1995 through 2012

Below are the results from that test run from 1995 through 2012. Whilst there is some variance in the data the main one is the Max Drawdown which details the maximum loss the account would have suffered. As can be seen the use of the Filter decreased that drawdown from -50% to -26.17% based on 459 observations.

Let’s use some more up-to-date data and a different strategy, specifically the Weekend Trend Trader. We’ll use the default system settings and test from 2000 through 2015 on the Australian All Ordinaries Index (XAO), including all historical constituents to remove survivorship bias.

Yet again we have a compelling argument for using the Regime Filter. With a more advanced strategy we see an across-the-board rise in all metrics and, similar to above, the maximum drawdown has been significantly reduced based on 614 observations.

In summary, there can be situations where a single stock defies the odds and flies high when the broader market is weak. If you can pick those with consistency then you’re pretty skilled. However, if you’re like the rest of us mere mortals, the evidence suggests that buying stocks when the tide is falling is not as fruitful and has considerably higher pain involved.

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