Trading Strategies (Short Term): Filter Rule: Finance Trading Times

Trading Strategies (Short Term): Filter Rule

In this article, I will explain one of the trading strategies that is attempted by traders to benefit from the price movements of the stocks.

This trading strategy is called the “Filter Rule” and falls under the so-called serial correlation strategy.

In a filter rule, an investor gets into a buying position i.e. buys a stock if the price rises X% from a previous low of the stock and then holds the stock until the stock price reaches to below X% from a previous high. The magnitude of the change (X%) that triggers the trades varies from filter to filter depending upon the value of X selected by the trader. However, smaller changes result in more transactions per period and higher transactions costs.

The simple assumptions that are followed in this trading strategy are:
Price changes are serially correlated and that emerges from price momentum theory, i.e., stocks which have gone up strongly in the past are more likely to keep going up than go down.

The following table summarizes results from a study on returns, before and after transactions costs, on a trading strategy based upon filter rules ranging from 0.5% to 20%. ( A 1% rule implies that a stock is bought when it rises 1% from a previous low and sold when it falls 1% from a prior high.)
(Table based upon empirical results available in various books and internet)

Results and interpretations of Table above:

􀁑 The one and only filter value that beats the returns from the buy and hold
strategy is the 0.5% value, but it does so before transactions costs.
This strategy creates 12,514 trades during the period which generate
enough transactions costs to wipe out the principal invested by the
􀁑 While this test is dated, it also illustrates a basic problem with
strategies that require frequent short term trading. Even though
these strategies may earn excess returns prior to transactions costs,
adjusting for these costs can nullify the returns completely.

So in conclusion, this strategy may work provided each time your bets are good. However, a good and justified way of making money from this strategy is through efficient money management. Try and attempt to double and triple your bets if the previous one goes wrong, and look for opportunities. Then and only then this strategy may give some fruitful results. Remember, be ready to get wiped off completely, and be prepared with big money if following this strategy.

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6 Comments: Post your Comments

Aniruddha said...(on 13 December 2007 at 00:46 )  

Hi Shobhit
this is very interesting article, could you please elaborate it with simple examples in you style?


Shobhit said...(on 14 December 2007 at 00:23 )  

Hi Andy,

Actually this has been a repetitive problem - readers not able to understand the examples I quote. Like that happened in DCF analysis article.

I try to be as clear as possible, whether it is about the examples, formulas, articles and data items. Unfortunately, It may not be always possible for me to keep on elaborating things.


Vinay said...(on 14 December 2007 at 01:49 )  

Hi Shobhit,

I have read many of your articles and understand how ULIPs work. I saw a very interesting ULIP which Bajaj Allianz came up with very recently "Century Plus".

Their website quotes "98% allocation in Year 1 and Year 2 and 100% allocation Year 3 onwards."

I have gone through their broucher and could not spot the catch point (if any). Please suggest if there are any hidden points or if this is a new breed among ULIPs.

The link to this product is given below

Shobhit said...(on 14 December 2007 at 03:02 )  

Please read teh comments section of this articel:

I have responded to the similar comments from shashi

Aniruddha said...(on 14 December 2007 at 03:03 )  

No issues, Shobhit
I have started again reading your blog since day 1. trying to understand again and again. situation described in those pages and current situation. everything.

Thanks Again

Unknown said...(on 9 January 2008 at 07:27 )  

Hey Vinay,
I was also wondering over the same plan as to where the catch lies..
Please look under the section "How does plan work?"

"The insurance cover charges, policy
administration charges and the additional rider benefit charges (if any) are deducted through
monthly cancellation of units"

Thus one can see that they would allocate units worth 98% of the premium but would subsequently cancel your units to meet for the various charges. So it is no way different from other ULIPs.

Mutual Funds+Term Life Cover were always a far better option than ULIP and now after introduction of no-load MFs, they have gained further edge over ULIPs.

-Shobhit(another one! :) )
P.S. - Good work that you are doing Mr. Shobhit

Wish you all happy and fruitful trading and investing activities with safety! = = = Post a Comment

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