July 6, 2011
This site is dedicated to a single concept and that is: it is not only possible to beat the Buy & Hold strategy; it can be done easily and by a wide margin. Doing so requires changing slightly the point of view of the stock trading process and is summarized in the graphic below:
Boosting the Buy & Hold Strategy
(click to enlarge)
Alpha Power Equation. See Livermore Simulations Tests
My Alpha Power Trading Methods
My trading methods advocate building on the Buy & Hold strategy by using the excess equity not only to accumulate shares but to trade over market cycles while gradually increasing bet size.
The alpha wealth function is the result of an inventory accumulation process to which is added a trading program over an incremental bet sizing function. Results for the first few years might be hard to differentiate from the Buy & Hold, but long term, they are more than impressive. In the above graph, the covered call program, as well as the leveraging function, have been intentionally omitted in order to simplify the presentation; both functions have for mission to provide added performance (see my latest paper: Alpha Power: The Implementation). Neutralizing the inventory management holding functions would return the alpha wealth function to its origin: the Buy & Hold equation.
The Alpha Power trading methods instead of looking at fundamental or technical indicators look at predefined trading and holding functions, mathematical functions designed to regulate the whole trading environment. As a system, the trading method wants to do it all at the same time. It is a compromise of sort between hindsight (what you should have done) and an unknowable future. The method makes no stock predictions, buys on the way up, meaning indirectly that it is a trend following system, and is also risk-adverse. Its predefined functions are designed to do the following:
- Accumulate shares long term at an exponential rate
- Trade over short to mid-term market cycles
- Scale in and out of positions
- Increase bet size in relation to portfolio weight
- Run a covered call program
- Use leverage to boost performance
- Reinvest part of profits generated by the accumulation, short-term trading and covered call programs into accumulating more shares which in turn generate more profits to be reinvested in accumulating more shares…
- The more a stock rises in price, the more all these functions will push performance higher.
Some of the beneficial side effects are:
- Will allocate funds in relation to performance
- Will end up with highest portfolio weights on top performers
- Will end up with lowest portfolio weights on non-performers
- Will have an incremental Sharpe ratio over time
- Can be totally automated
- Can be scalable to portfolio size
- Will use over-diversification to minimize the risk
- Will generate alpha points
- And thereby easily outperform the Buy & Hold.
Each programmed function will contribute to overall performance as compared to the Buy & Hold. Should the price of a stock not rise, its inventory stays the same or declines. Applying all these procedures will result in having the biggest positions in the highest rising stocks in the portfolio while having the smallest bets on the worst performers. The whole process seems to act as a portfolio asset allocation function (see the Livermore Challenge 2nd and 3rd act).
You still won’t know what the future will bring. You still won’t know which stocks will outperform. You still will not know how much profit any of the stocks will bring. But based on your preset trading behavior, you will know what you are going to do when the price of any stock in your portfolio triggers one of its entry or exit points. You technically did pre-program your whole trading behavior from the start after all.
The alpha wealth function is controllable; you want more performance, then you can put more pressure on the objective trading functions (this will require more funds). The added pressure will be distributed incrementally over the entire trading interval. There is a genuine revolution in the way this trading method operates. It looks at the problem of portfolio management with a set of mathematical equations made capable of extracting performance on a what if basis. It will allocate funds to the best performers while starving non-performers; thereby making big bets on winners and small bets on losers. It will distribute in time its stock accumulation process, scale in and out of positions while managing its bets size incrementally.
This is not a get rich quick scheme; the methods take years to develop and expand. It is a trading philosophy which clearly advocates the use the excess equity buildup to trade over your Buy & Hold strategy instead of letting it go to waste. Use your long-term vision of the markets as a reassuring view of your objective trading functions and accumulative stance.
All over this site, you will find different facets of the Alpha Power trading methods, the mathematical explanations as to why they perform the way they do and the underlying philosophy that glues it all together. It is a change in perspective that is required; a different view of the trading game where you set your own game within the game. You set your own rules of engagement. Predefine years in advance your future trading behavior. What prices will trigger your entry and exit points, how many shares will be traded and leave the market to tell you when? But, in the end, it is up to the market to foot the bill, and pay for it all.
It is all about position sizing and portfolio weights since in the end, just as Mr. Buffett once said: long term, the market is a weighing machine. Following the Alpha Power trading methods does not say you might (with some luck) outperform the Buy & Hold strategy; it says that you will to a large extent. The methodology is made to produce alpha points and they can be designed right in from day one.
Like most, I’ve tried really hard predicting stock prices. And when that failed to give me an edge, I tried reacting to stock prices but that turned out to be the same as trying to predict prices from a different starting point. All the academic papers I’ve read since the late 70’s have had about the same predicate: you can beat the Buy & Hold strategy but most likely, your most expected long-term outcome will be close to the long-term market average since probabilistically that might be all the markets have to offer. That you use Modern or Stochastic Portfolio Theory as the basis for your trading environment does not really matter; the long-term expected portfolio return should be close to the US secular market average which over the last 200 years has been close to a 10% compounded return (including dividend reinvestment).
Said another way; whatever you tried, whatever method you wanted to use, your long-term performance would tend to the secular market average. And if you look at the whole of stock portfolios on this planet, what you will see is that the average portfolio performance by professional or individual investors tended to the market average to the extent that over 75% of investors even fail to beat the market average. So the real question should be: what makes you different? What makes you think that you can outperform the brightest, the best equipped or the luckiest of the investor community? Just as a hint, it is not by using traditional trading methods that have already been proven to have results that tend to the market average - like using an index fund for instance - that you will outperform the average.
If you want to outperform, you will have to bring something new to the equation, a different point of view, you will need to think differently. Jump over the barriers of the efficient frontier, skip over the capital market line, and escape from the efficient market hypothesis. For whatever the market is, it is simply a marketplace.
Created on ... July 6, 2011, © Guy R. Fleury. All rights reserved.