Question regarding volatility and preferable stock selection

Discussions about Money Management and Risk Control.
Post Reply
dispassionate
Full Member
Full Member
Posts: 15
Joined: Wed Jan 11, 2006 9:02 pm
Location: London

Question regarding volatility and preferable stock selection

Post by dispassionate » Thu Jun 01, 2006 8:00 pm

Which is the more preferable stock to trade?

A) a stock that moves 30% which is equal to an 8 ATR target

B) a stock that moves 50% which is also equal to an 8 ATR target

ecritt
Roundtable Knight
Roundtable Knight
Posts: 134
Joined: Sat Aug 28, 2004 3:44 am
Location: Phoenix, AZ
Contact:

Post by ecritt » Fri Jun 02, 2006 12:55 am

If you position size based on volatility (or distance to volatility derived stops) neither is preferable. They are essentially the same trade.

Paul King
Roundtable Knight
Roundtable Knight
Posts: 207
Joined: Mon Feb 23, 2004 9:13 am
Location: Vermont, USA
Contact:

Post by Paul King » Fri Jun 02, 2006 9:04 am

For me it would depend on which trade took the least capital/margin to implement at a size that achieved the desired risk (assuming you couldn't put them both on).

"Those who have knowledge don't predict. Those who predict don't have knowledge." Lao Tzu, 6th century BC poet

"Those who know the probability of their predictions being wrong have true knowledge" Paul King, 21st century trader.

dispassionate
Full Member
Full Member
Posts: 15
Joined: Wed Jan 11, 2006 9:02 pm
Location: London

Post by dispassionate » Sun Jun 04, 2006 8:55 pm

Thank you PK.

I do think there is an assumption that stock B would face a rockier ride in collecting the 8 ATR target profit.

Assuming that both companies were equally risky, then B would indeed be preferable. If stock A had a better covenant and balance sheet than B, then I'd say that A was probably the better trade.

ecritt
Roundtable Knight
Roundtable Knight
Posts: 134
Joined: Sat Aug 28, 2004 3:44 am
Location: Phoenix, AZ
Contact:

Post by ecritt » Wed Jun 07, 2006 1:15 am

dispassionate wrote:
Assuming that both companies were equally risky, then B would indeed be preferable. If stock A had a better covenant and balance sheet than B, then I'd say that A was probably the better trade.

"Those who have knowledge don't predict. Those who predict don't have knowledge." Lao Tzu, 6th century BC poet
Are you not guilty of making the prediction that a "better" balance sheet in the past will lead to superior stock price appreciation in the future? I'm curious as to why you would suggest that this information isn't already reflected in the current stock price.

dispassionate
Full Member
Full Member
Posts: 15
Joined: Wed Jan 11, 2006 9:02 pm
Location: London

Post by dispassionate » Wed Jun 14, 2006 11:08 am

ecritt wrote:
dispassionate wrote:
Assuming that both companies were equally risky, then B would indeed be preferable. If stock A had a better covenant and balance sheet than B, then I'd say that A was probably the better trade.

"Those who have knowledge don't predict. Those who predict don't have knowledge." Lao Tzu, 6th century BC poet
Are you not guilty of making the prediction that a "better" balance sheet in the past will lead to superior stock price appreciation in the future? I'm curious as to why you would suggest that this information isn't already reflected in the current stock price.
Let me ponder on this. The problem I am trying to solve is on deciding which is the riskier trade. Automatically deciding that the company which involves a smaller trade size (smaller price, larger ATR) won't do.

ecritt
Roundtable Knight
Roundtable Knight
Posts: 134
Joined: Sat Aug 28, 2004 3:44 am
Location: Phoenix, AZ
Contact:

Post by ecritt » Wed Jun 14, 2006 11:31 am

Last year I published a study of a simple trend following strategy applied to every stock that traded on U.S. exchanges between 1983 and 2004 (all properly adjusted for dividends & corporate actions). Stocks were purchased the day after hitting new all time highs. They were exited the day after they declined by 10 ATR's from the highest close that occured after entry.

10 ATR's, on average, was 27% away from the entry price. But it ranged from 5% for very quiet stocks to as high as 80% for extremely volatile stocks.

I broke down the performance results several different ways, including by volatility (% of stock price 10 ATR's amounted to on the day of entry).

I found no evidence that the volatility had any impact on the winning percentage; it was approx 50% across the board. Nor was there any noticeable difference in risk adjusted performance (%return / %initial risk). I had expected to find that the lower volatility stocks were superior in both categories. Testing showed otherwise.

ec

BARLI
Roundtable Knight
Roundtable Knight
Posts: 650
Joined: Sat Jan 17, 2004 6:01 pm
Location: USA

Post by BARLI » Wed Jun 14, 2006 12:29 pm

ecritt wrote: I had expected to find that the lower volatility stocks were superior in both categories. Testing showed otherwise.

ec
so higher volatility stocks returned more than the lower ones?
another question: in MBF www.mbfcc.com they have a risk manager who cannot control himself when he's trading, BUT he's controlling the entire prop trader's group perfectly, is it always that those who cannot control themselves turn out to be a great risk managers of the others?

ecritt
Roundtable Knight
Roundtable Knight
Posts: 134
Joined: Sat Aug 28, 2004 3:44 am
Location: Phoenix, AZ
Contact:

Post by ecritt » Wed Jun 14, 2006 12:44 pm

No, there wasn't any material difference in the results. If you are position sizing as a function of volatility (as well as using volatility derived stops) you are neutralizing its effect on the outcome; at least that is what the evidence suggests.

I have no idea how to comment on the risk manager that can't control himself. Most humans can't. That's why we write computer programs to do the opposite of what humans do, where it counts.

ec

BARLI
Roundtable Knight
Roundtable Knight
Posts: 650
Joined: Sat Jan 17, 2004 6:01 pm
Location: USA

Post by BARLI » Wed Jun 14, 2006 12:59 pm

Could you expand on your counter-human programs?

ecritt
Roundtable Knight
Roundtable Knight
Posts: 134
Joined: Sat Aug 28, 2004 3:44 am
Location: Phoenix, AZ
Contact:

Post by ecritt » Wed Jun 14, 2006 1:34 pm

A long time ago I worked for a family office that had 5 traders. They all blew up spectacularly. I also had several friends/acquaintances that were "day traders" and "swing traders". They blew up too. I noticed that they basically did the same things:

1. They bought dips.
2. They bought only stocks of companies that CURRENTLY had excellent fundamentals.
3. They bought arbitrarially chosen share amounts (Ex: 500 shares or $10,000 per stock).
4. They focused on low priced stocks (sub $15 priced stocks).
5. They sold all or part of the their winning positions to add to their losing positions (roll eyes).
6. They increased their risk when they were losing money.
7. They thought the key to long term success was a high winning percentage.
8. They focused most of their time/energy on entries and news.
9. They traded frequently (every day).
10. They maintained narrow portfolios (less than 20 stocks).

Assuming that these were normal human tendencies, and collectively amount to a losing strategy overall, I attempted to design a complete system that does the opposite of what a typical human would do.

1. Buys new highs only.
2. No fundamentals are considered.
3. All positions are volatility weighted (based on distance to volatility-derived stops).
4. Doesn't buy stocks under $15.
5. Winning positions only sold partially and only to rebalance positions that have become risk concentrations. Losing positions are never added to.
6. Risk is never increased as a function of losses (portfolio level & trade level).
7. No effort to capture a high winning percentage.
8. Entries are simple new highs, no news is ever considered.
9. Stops are far enough away so that average holding period is approx 1 year for winning positions; longer for big winning positions.
10. Portfolio averages over 1,000 open positions on any given day.

Works great.

ec

BARLI
Roundtable Knight
Roundtable Knight
Posts: 650
Joined: Sat Jan 17, 2004 6:01 pm
Location: USA

Post by BARLI » Wed Jun 14, 2006 1:59 pm

All looks good except:
9. Stops are far enough away so that average holding period is approx 1 year for winning positions; longer for big winning positions.
10. Portfolio averages over 1,000 open positions on any given day.
with very large stops you can go broke quickly as well. Livermore and other great traders taught to never hold a position which shows loss from the start. Concetrating on 1000 stocks is not sound, there are about 8700 stocks traded in the US, I believe only about 400 of those have good volume and thus are liquid, all of those 20 k per day stocks can be manipulated easily and you cannot take the size. Another thing is that once you are bullish/bearish on something lets say Gold, you dont have to buy all of the gold stocks in the sector. I'll give you an example, take a look at TGB and DROOY, I know that you dont buy stocks under 15$ but TGB was the strongest gainer in the gold sector just a month ago, but DROOY moved sideways, same goes for other sectors. Buying/shorting strongest/weakest stocks in the sector is something to think about...

ecritt
Roundtable Knight
Roundtable Knight
Posts: 134
Joined: Sat Aug 28, 2004 3:44 am
Location: Phoenix, AZ
Contact:

Post by ecritt » Wed Jun 14, 2006 2:22 pm

with very large stops you can go broke quickly as well

*Not if total open risk at the portfolio level is kept under a certain number and is only allowed to move higher due to opportunity or profit.*

Livermore and other great traders taught to never hold a position which shows loss from the start

*No disrespect intended but I do not care what J Livermore said. He was blow up city and benefited & suffered due to extremely persistent trends during his time and 10:1 leverage in stocks*

Concetrating on 1000 stocks is not sound, there are about 8700 stocks traded in the US, I believe only about 400 of those have good volume and thus are liquid

*Your beliefs and my beliefs are different. there are 4,000 stocks currently meeting my liquidity requirements. They have not been a problem to trade. There are multi-billion dollar equity hedge funds that have even more open positions than us; they aren't having a problem with it*

Another thing is that once you are bullish/bearish on something lets say Gold, you dont have to buy all of the gold stocks in the sector. I'll give you an example, take a look at TGB and DROOY, I know that you dont buy stocks under 15$ but TGB was the strongest gainer in the gold sector just a month ago, but DROOY moved sideways, same goes for other sectors. Buying/shorting strongest/weakest stocks in the sector is something to think about

*When you are ONLY buying stocks at new all time highs neither of those gold stocks make the cut*

ecritt
Roundtable Knight
Roundtable Knight
Posts: 134
Joined: Sat Aug 28, 2004 3:44 am
Location: Phoenix, AZ
Contact:

Post by ecritt » Wed Jun 14, 2006 2:27 pm

Total return chart of TGB & DROOY:
Attachments
TGB_DROOY.jpg
TGB_DROOY.jpg (72.93 KiB) Viewed 12173 times

BARLI
Roundtable Knight
Roundtable Knight
Posts: 650
Joined: Sat Jan 17, 2004 6:01 pm
Location: USA

Post by BARLI » Wed Jun 14, 2006 2:31 pm

Whatever suits your trading/investing style :wink:

Post Reply