July 3rd, 2015

More DEVX V6

One of the hardest part in managing a stock portfolio is designing a workable and profitable long term trading strategy. It needs to be based on sound principles and provide a foundation as to how it will handle an unknown future. Trading automation presents an added dimension to the problem.

One could go live based on some concept or other, and see how the conceived trading protocols would fair out over time. This could be a very expensive way to test if an automated trading strategy has merit or not, not to count the amount of time and money that could be wasted with nothing to show for it except for a notice to go back to the drawing board.

A better solution is to do some back testing where the cost is only the time spent developing a trading script and testing how it would have faired over some past market data. And then decide if the strategy is worth it or not. At least you would have some data to analyze to corroborate the methodology used.

The back test duration will suddenly become important. A one or two year back test on a single stock can not be considered significant. It's not enough time, not enough stocks to show what markets are capable off. Portfolio management is a long term endeavor, it's not an overnight operation. Even HFT firms have a long term vision of things. They intend to survive and prosper for a long time.

While a Buffett like trading/investing strategy does not require to be back tested even if it could; it has proven itself to be a long term (50 years) successful discretionary portfolio management methodology. You automate because you want more than a Buy & Hold, and intend to have your computer do all the work and calculations for you.

Automated trading strategies can go from HFT (high frequency trading) to very slow trading scripts. In the first case to provide speed of execution to a large number of trades where the profits are measured in pennies per share with trading intervals as short as a few microseconds. In the second case automation is used more as a procedure accelerator where time is not that critical; the machine is there to make all the calculations and follow its trading script.

But both strategies, at each extreme should be designed in such a way as to be coherent with their respective time frames. At the very short term as in HFT, you are not developing a variation of a Buy & Hold strategy. It would appear as a contradiction in purpose.

Maybe the point to be made is that whatever trading strategy one wants to develop, a total understanding of its purpose and trading environment is required. Everything should be consistent and coherent within the methodology used. HFT and Buy & Hold are not synonyms, not in stock trading anyway.

More Testing

Last month, to answer some questions on stock selection I performed a back test on 10 stocks to show the merits of a particular trading script. The selection criteria was that none of the stocks would have been tested before, and that they should have been part of a larger pool of selectable stocks 10 years ago.

This would make the test an out of sample test using out of sample stocks. Stuff the program has never seen before. It would have to confront all new price signatures, all with their own unique paths. No over-optimization or curve fitting available. Just some code designed to extract what it could, if it could.

Here are the 10 selected stocks, over a 10 year interval, using a $10k trading unit:

   ABT – 10 years
ABT 10 years


   ALL – 10 years
ALL 10 years


   BIIB – 10 years
BIIB 10 years


   CVS – 10 years
CVS 10 years


   FDX – 10 years
FDX 10 years


   GD – 10 years
GD 10 years


   GILD – 10 years
GILD 10 years


   HD – 10 years
HD 10 years


   LMT – 10 years
LMT 10 years


   LOW – 10 years
LOW 10 years


After the test, I realized that HD has been tested last year, but this should not change, or interfere, with the reasons for the test. It was sufficient that HD has never been part of any of the strategy's design development phases.

Each of those stocks behaved differently, yet each managed to provide more than excellent returns over the 10 year period as can attest their respective CAGRs. To show that it was not that much work, the alerts for the next Monday were: 2 buys and 1 sell. The alerts are in black at the bottom of the charts. And once those orders are processed, one can be free for the rest of the day, should they desire so.

All were at the $10k trade unit level. For the $5k trade unit, divide the initial capital, the ending profit, and the number of accumulated shares by 2. It should be a good enough and reasonable approximation. The CAGR would however stay about the same.

To give a summarized view, I've compiled some of the relevant numbers over this 10 stock portfolio over its 10 year trading interval:

   Trade Summary – 10 years
Trade Summary 10 years


The intention was to show that the stock selection itself might not be that major a problem in a long term trading strategy. It's the trading methodology that might matter the most. Hopefully, the above test makes that point.

Giving More Time

The previous section tried to show that the trading strategy mattered more than the stock selection. As if any reasonable selection out of a reasonable pool of candidates would have done the job. I hope the above test partly answered that question.

Now the hard part: providing more time.

How about going back 20 years? Do the test using the same program. What then? Shouldn't this all fall apart? Will adding 10 years of unseen price data cause the strategy to break down, as so many think that all trading strategies have to, or will it survive and prosper?

I say that the program will not only survive, it will produce more profits because of the underlying applied trading principles. The methodology was primarily designed with a long term perspective. Therefore, a 20 year test should show by design, as if by default, if the strategy could have stood on its own merits or not.

The portfolio behavior can be anticipated from the program's structural design. The 10 year test showed the system tended to accumulate too much in cash reserves, something it should do again. This will put a drag on system performance since all that cash will remain idle. Cash reserves after that 10 year test were about 60% of the portfolio's value and was producing nothing at all, while in real life it could have been put to some productive use. This left only 40% of the portfolio at work.

Therefore, a slowdown in CAGR performance is expected, but good performance money wise nonetheless. I expect more trading activity: more positions taken, more closed positions, more still opened positions, more profits all over, more accumulated shares and even more accumulated cash, which, in many regards, could also be viewed as a good thing.

Here are the test results, same stocks, same program, but this time 20 years of price data:

   ABT – 20 years
ABT 20 years

   ALL – 20 years
ALL 20 years

   BIIB – 20 years
BIIB 20 years

   CVS – 20 years
CVS 20 years

   FDX – 20 years
FDX 20 years

   GD – 20 years
GD 20 years

   GILD – 20 years
GILD 20 years

   HD – 20 years
HD 20 years

   LMT – 20 years
LMT 20 years

   LOW – 20 years
LOW 20 years


As can be seen in the above charts, the trading strategy did not break down. It continued to prosper, to outperform, producing what was anticipated. It did this not just of a few charts but for all of them, every single one of them. Here is a summary in numbers:

   Trade Summary – 20 years
Trade Summary 20 years


The above table resumes the trading activity, it has for payoff matrix:

A(t) = A(0) + Σ(H(1 + g)^t.*ΔP).

All the stocks continued to improve profit wise. It's not a partial victory, it is a total one.

I could not determine beforehand what the output of the test would be except in general terms, as described above. As for the actual numbers in the table, well that is what came out of the computer program. I find them more than acceptable.

Concluding Observations

The program made 135,347 trades of which 118,585 were closed at a profit. The 16,752 remaining opened positions already show positive results in over 95% of the positions; meaning that some of the remaining shares show a relatively small average paper loss. 77.5% of the portfolio's value is in cash. As the market makes new highs, shares are converted to cash as a byproduct of the methodology. Again, not a bad thing. Closing all opened positions would result in the net liquidating value at the bottom of the table.

With the considerable amount of cash reserves, it leaves only 22.5% of the portfolio to generate more profits. It's understandable why the CAGR is decreasing as you near the 20 year threshold.

A set of new trading procedures are needed to better use the untapped cash reserves to generate even more profits. For me, it says: there's room for improvements...

What you see in those charts can be done by anyone with some understanding and programming skills. It's not something esoteric, some secret sauce, or requiring a PhD. All you see are the results of administrative procedures of some kind, some code saying: if this happens then do this if not do that.

It can be the basis for a long term trading plan, and I think it is an interesting one.


All I can do, and am willing to do, is describe the methodology without providing my code, meaning my own programs. But I don't see a "secret" sauce in what I do. As a matter of fact, it's pretty boring. Even more, I think that there are hundreds upon hundreds of other trading solutions that can lead to the same thing I do or about; some better, some worst. But understand that I can not know any of this before a finish line is reached, portfolio wise.

The presented test results use a program that is time-stamped as last modified June 21 2014. That's over a year ago. Market wise, an old program.

The program was not only doing some out of sample tests over 10 and 20 years; it was also doing a walk forward test with totally unseen data for the added year.

Applying last year to that program is the same as looking at what it would have done with its future; the program having been frozen in time. A walk forward for a whole year on entirely new and unpredictable price data since its last modification.

One should note another implied test that very few dare do: the walk backward test. The test of what would a strategy have done going back further in time. The first test covered the last 10 years with the last year being its future. On the second test, over the same stocks, the trading interval was increased to 20 years. Ten years of walk backward test on stocks that the program has never seen and of which none had served in the design of the trading strategy.

Since no predictions or forecasts are used in that program, it had to survive on its own merits. The code, the trading strategy, being the central and most critical element to this automated trading script.

I describe what I do in one sentence: accumulate shares for the long term and trade over the process. That's it. It's by understanding all the ramifications implied in such a descriptive that one can start building their own (and what I would call improved) trading systems. The emphasis is on: their own systems. This means your systems. I already have mine.

The future has only one take, there are no reruns.

Created... July 3rd, 2015 © Guy R. Fleury. All rights reserved. 

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