Saturday, February 13, 2010

"A Simple Way to Data Mine"

James Altucher has an article in the WSJ titled 'A Simple Way to Beat Hedge Funds' in which he discusses the 4x2 system:

I’ve traded this system for years, and even though it has no fancy chaos theory, it works. Basically, if a stock falls in price for four days in a row (for instance, after a bad earnings report) chances are the selling is done. Within four days, everyone’s seen the news, everyone’s had a chance to sell and most of the sellers have probably already sold.
He reports the following cumulative performance from 1992-2009.

I had no problem with the article (the idea is creative, the results were impressive), until this statement (bold mine):
But a simple system like this: wait for a stock to go down four days in a row, then buy until it goes up two days in a row, has never had a down year, and has beaten nearly every hedge fund.
Has "never" had a down year is a BOLD statement. And quite possibly true... if a 17 year period is "never".

While I won't question the above data (although it is almost impossible for the average investor [me] to verify), the Nasdaq has been around since 1971 and one can easily test the broader index with the 4x2 strategy over that entire period (I figure this would at least show the broad trend, but I would love to see the actual results).

My results?

Buying at the close at every period in which the Nasdaq was down 4 days in a row and selling when it was up 2 days in a row, the performance from 1992-2009 was exceptional (close to what is detailed above) with an average return for each trade over that period of more than 1% (though there was a massive draw down in 2001 [with a period in August - September where the Nasdaq did not have a 2 day win streak over a 31 day trading window] that I am not sure how individual security selection would miss).

But from 1971-1991?

Not so much.... returns per trade were less than -1% (and there were more trades in this period, thus overall Nasdaq since inception 4x2 performance is negative).

My take?

While James Altucher does write a lot of credible articles, at the end of the day he is trying to do exactly what the hedge fund managers he insults in his article are trying to do:
to impress investors or potential investors
My take? Just like the data mined equity signal I created 'The Pub Power Equity Signal', if it sounds too good to be true... it probably is.

Source: Yahoo