Buy strength, or
buy weakness? In the most concise way possible, that simple
question marks a dividing line between most fundamental
investors (at least of the value ilk) and most technicians
(from the "breakout" camp). Given that, I ran a simple --
very simple -- test to see which strategy proved more
Using the S&P 500
as my sample set, my "buy strength" test had me buying any
stock that had just made a 50-day high. Each trade took 10%
of my equity, and I simply held for 30 days before selling.
The "buy weakness" test was just the opposite. I bought any
stock making a 50-day low, with all other parameters being
identical. Both tests started in mid-1985.
The results were surprising. The strength test consisted
of 1,583 trades, yielding a 10.35% yearly return, with a
whopping 40.45% maximum drawdown. On the other hand, the
weakness test had 1,592 trades, resulting in a healthy
25.28% yearly return, with a manageable 29.17% maximum
So, go figure: Buying weakness trumped buying strength.
For me, that's right up there with admitting golf is not a
Q: What was the
average win for each trade? Average
A: The average win for each trade in the "buy weakness"
was 11.14%. Average loss was 8.56%. Win percentage was
Q: What is maximum
A: Maximum drawdown is the largest percentage drop from
peak to trough (in terms of equity) before
a new peak equity is achieved.
For example, if you started with $100 and moved your equity
to $200, then went down to $100 before getting to $201,
you'd have a 50% maximum drawdown.
Q: Fascinating piece!
But it begs the question ... if this [buying on weakness]
strategy can return an average 25% per annum, then why
bother with any other? In fact, why bother trading at all?
Just set up automatic trades and sit back. Surely a trading
strategy can't get any simpler than this, and yet the return
A: This really gets to the core, doesn't it? So let's
stipulate that the point is well-taken. In fact, with a
little tweaking, one could use this strategy and beat nearly
99.9% of all funds, mutual, hedge and otherwise. Still,
people resist. Why?
traders/investors think they're better at trading than they
really are. A purely mechanical strategy
for them? It'd be a slap in the face, because they
know they can easily do better than 25% per year!
most traders/investors/fund managers are
fundies. For them, the "story"
is everything. No way a
hedgie is going to tell
their clients they bought XYZ simply because it was at a
50-day low. Shoot, if it were that easy, the client could do
it on his own!
a 29% drawdown is a bit hard to take. Of course, if you're
in the market long enough, that's pretty standard. But
again, no one ever thinks that will happen to
them. (See No.