Well if nothing else, you’ve got to admit that that's a pretty gutsy headline.  Some may look at a headline like this and think, "Wow, sounds interesting."  Others may look at it and think, “Wow, the guy’s finally lost it.”  Either way, the most important thing to note is that the head line says “The Easiest” strategy, not necessarily “The Best” strategy, or “The Sure Thing You Can’t Lose Ad Infinitum into the Future” strategy.

There is a lot of potential in things that are “easy.”  While we are constantly reminded of the pitfalls of “taking the easy way”, the fact remains that in most endeavors there comes a point of diminishing returns.  In other words, there comes a point when additional work and effort yields only incremental or even worse, no additional benefit.   

A person could easily spend 24/7 analyzing trading strategies for the financial markets (trust me on this one).  But the question that the average person would ultimately ask is “is this really worth it?” (or the more succinct corollary, “perhaps I should get a life”, as the case may be.) 

So if one can find a strategy that is easy to use yet still holds the promise, or at least the potential, to not only make money but to vastly outperform the overall market over time, it might be worth considering.  So what the heck, let’s give it a try

Jay’s Ridiculously Easy Market Beating System

For the purposes of this strategy we are going to make the following assumptions:

-The test begins at the close on 12/31/1934.

-When in the market we will hold a non-leveraged index fund that tracks the Dow Jones Industrials Average.  For example, we can use Diamonds, ticker DIA.

-When out of the market we will assume that we are earning interest at a rate of 1% per year.

So how simple is this strategy?  Here are the rules:

-On the fifth, sixth and seventh to last trading days of every month we will hold cash.

-During all other days we will hold a Dow Index fund.

That’s it.  Now as simple as this is, the reality is that concepts like “the seventh to last trading day of the month”, tend to make some people’s head hurt.  So let’s consider an example, looking at July of 2012.

July 31, 2012 = last trading day of the month

July 30, 2012 = 2^nd to last trading day of the month

July 27, 2012 = 3rd to last trading day of the month

July 26, 2012 = 4^th to last trading day of the month

July 25, 2012 = 5^th to last trading day of the month

July 24, 2012 = 6^th to last trading day of the month

July 23, 2012 = 7^th to last trading day of the month

July 20, 2012 = 8^th to last trading day of the month

We want to be out of the market on the 5^th, 6^th and 7^th to last trading days of the month. So we would:

a) Sell our DIA position at the close on July 20 (the 8^th to last trading day)

b) Remain in cash on the 23^rd, the 24^th and the 25^th

c) Buy back our DIA position at the close on July 25^th (the 5^th to last trading day)

Figure 1 which displays the buy and sell dates for June and July of 2012.

Figure 1 – Buy and sell dates on ticker DIA using Jay’s Ridiculously Easy Market Beating System

In this case we would have sold DIA at the close of 7/20 at 128.04 and would then have bought it back at the close of 7/25 at 126.51, thus missing out on a decline of -1.19%.  Now this may not sound like much, and of course this three day period will not show a loss every month.  Still, it is sitting out losses like this that leads to market beating returns over time as we will see in a moment.

We will hold the long position in DIA until the close of trading on the 8^th to last trading day of August 2012 (August 22, 2012), selling at the close that day.  We would then buy DIA again at the close of the 5^th to last trading day of August (August 27, 2012). 

And so on and so forth.

Can a strategy as simple as this really offer any advantage?  Let’s take a look.

Results

First the bad news.  Because this strategy is essentially a replacement for buy-and-hold, it is long the Dow about 86% of the time.  Therefore it is by no means without risk (remember, I said “easy to use”, and not “you can’t lose”). 

The maximum drawdown was a not insignificant -42.5%.  Still, this is better than the worst drawdown experienced using a buy-and-hold approach of -53.8%.

Now the better news, between 12/31/1934 and 8/7/2012:

-$1,000 invested in the Dow on a buy-and-hold basis grew to $126,572 (+12,557%).

-$1,000 invested using our strategy grew to $578,035 (+57,704%).

Figure 2 – Cumulative Results using System (blue line) versus Buy-and-Hold (red line)

Here are a few more “statistics” for those who are numerically inclined.

Out of 78 calendar years:

-The system showed a gain 59 times (76%) and a loss 19 times (24%).

-Buy and hold showed a gain 54 times (69%) and a loss 24 times (31%).

-The system outperformed buy and hold 51 times (65%).

Now let’s look at 5-year rolling returns (at the end of each calendar year we look at the performance over the previous 5 year period):

-There were 74 5-year look back periods (starting at the end of 1939 and including 2012 year to date.

-The system showed a gain during 68 of those periods (92%).

-Buy-and-hold showed a gain during 57 of those periods (77%).

-The system outperformed buy and hold 54 times (73%).

Lastly, let’s look at 10-year rolling returns (at the end of each calendar year we look at the performance over the previous 10 year period):

-There were 69 10-year look back periods (starting at the end of 1939 and including 2012 year to date.

-The system showed a gain during 68 of those periods (99%).

-Buy-and-hold showed a gain during 61 of those periods (88%).

-The system outperformed buy and hold 59 times (86%).

So for the inconvenience of switching in and out once a month, this system shows some pretty laudable results.  There was only one single 10-year period (out of 69) that showed a loss using the system and that loss amounted to -0.6% (for the record the worst 10-year loss registered using a buy and hold approach was -29.5%).

Summary

So is this simple system – sit on the sidelines during the 5^th, 6^th and 7^th to last trading days of each month – really a viable approach?  Well, the numbers seem to suggest that there’s something to it.  Still, and as always, there are certain caveats, not the least of which is the age old adage, “future results may vary.”

For anyone who decides to embark on this journey a few “reality notes” are also in order:

-Come around about the 8^th to last trading day during some months things may be looking pretty “rosy” and you may be tempted to “let it ride” this time around. 

- Likewise, if you get out when you are supposed to and the market does in fact sell off during the three ensuing days, the urge to “wait a little while longer” to get back in may be pretty strong.  But in order to achieve the expected results, the system – or any system – must be followed ardently. 

And that’s the hard part – even for “The Easiest Market-Beating Strategy of All.”

Which reminds me of:

Jay’s Trading Maxim #146: Circular System Logic: If you are going to follow a system precisely, make sure it’s a pretty good system.  And if your system is pretty good you should follow it precisely (HINT: It’s not as easy as it sounds).

Jay Kaeppel
Staff Writer and Trading Strategist

Optionetics.com ~ Your Options Education Site

NOTES:

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