Trading Strategies: Semiconductors Lead the Stock Market
By Michael Stokes | August 21, 2008 | 10:37 AM | 1 Comment
This trading strategy was inspired by a couple of recent posts from Rob Hanna's Quantifiable Edges. Rob's basic idea is that when the semiconductor sector (^SOXX) takes a leadership role in the market, other stocks tend to follow, portending strong returns in the near future.
I'm going to expand on Rob's idea and share an embarrassingly simple trading strategy with a lot more exposure to the market that is maybe more suitable as a core portfolio strategy.
The strategy: go long the S&P 500 at today's close if the SOXX increases more today (in % terms) than the S&P 500. Close the position at today's close when it increases less. I told you it was embarrassingly simple. This is just a proof-of-concept, so I'll assume a frictionless market (no transaction costs, no return on cash, etc.)
The graph above shows the S&P 500 index (blue), the strategy (green), and what happened in the market when the strategy was in cash (red) from mid-1994 to date. Stats below.
That's a sharp contrast. When the SOXX outperformed the broader market, the stock market performed considerably better the next day.
Three comments about the results above:
First, a look at the graph shows that this strategy underperformed up trending markets, but it also did a VERY good job at protecting against all of the major bear markets of the last 14+ years; and I think that's the idea's greatest strength.
Second, this strategy only spent about half of all days in the market. I think there is a lot of value in staying out of the market as much as possible IF you can still accomplish your trading goals. It frees up capital for seeking out other opportunities and reduces the risk of getting caught looking the wrong way in a catastrophic fat-tail day (a'la Oct. of 1987).
And lastly, bear in mind that this test was frictionless - real world considerations could reduce the returns here. But I think that we clearly proved that Rob's idea has a lot of merit. Would I take a position solely based on SOXX leadership? No. Would I use it as one of many considerations for taking a position? Absolutely.
Happy Trading,
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