Saturday, March 8, 2008

How to use the index?

The first thing I want to point out is that William O’Neil and the guys over at Investors Business Daily do not recommend buying stocks simply because they are on the list. If you are reading this, you are probably familiar with Mr. O’Neil’s excellent books and the entry criteria he discusses. I will eventually discuss many ways one might integrate this index into their investing and trading methodology but I will hold off until I have collected enough data to backtest and provide supporting evidence for my assertions.

I will discuss one reason for tracking an index however that does not need supporting data. I suspect most people who buy and sell stock more than a few times a year are very much like myself in this way. We do it in an attempt to outperform the broader market. If we are unable to do that on a regular basis, we should just buy ETFs and save ourselves some trouble and the added expense of executions. Therefore, if I choose to use the IBD100 as a trading vehicle, I damn better be able to outperform the index as a whole over the long run or I would be better off just buying the index. Ahhh, but that is the problem, there is no ETF or index fund product out there that tracks the IBD100. There probably never will be either as many of the companies that make it up are too thinly traded to support a large fund moving money into and out of the stocks fast enough to keep up with the list.

So lets assume for a moment that the returns IBD posts on their website are accurate and the IBD 100 has outperformed the S&P in the last 52-weeks by 28.6% (-7.08% for the S&P compared to +21.52% for the IBD100). Now let’s also assume that return is representative of the index over the long run and those returns are good enough. Could one actually just buy the stocks that make up the list and see those types of returns, even though the guys at IBD tell us not to?

The list had a 13% turnover this week (13/100). Assuming a $100,000 trading account that is equally weighted with these 100 stocks, it would cost you $26 in broker’s fees this week using Interactive Brokers. That is .026% of our account which works out to 1.352% annually. Not including slippage, that would have lowered our return for the past 12-months to roughly 27.2%. Did you outperform that? I did not. That tells me I have room for improvement and that is something I suspect we all want to do.

The last point I want to make this week is a trend trader or investor’s individual performance is fundamentally linked to the performance of the universe of stocks one trades from. Your specific correlation simply depends on the details of your system. It may even be inversely correlated if you are shorting it but the point is knowing the performance of your trading universe allows you to not only benchmark yourself, but compare that universe to other ones from which you can trade. If the Nasdaq100 is outperforming the IBD100, my odds are better trading from that basket rather than from this one. Period. The only way to really know that however is to track the IBD100 in a way that makes it comparable. That is the purpose of this index.

No comments: