In a previous post I alluded to using this tool to be a mini quant, or hedgie. This strategy is not something covered in Phil’s book, but I myself have found it to be profitable, especially given the instability in the market at the moment. Being market neutral means your portfolio does not care if we are in a bear market or a bull market. Click for details on being market nuetral.
So here is how I do it. I run the screener for the top 20 stocks with the highest MOS. I then run the screener for lowest 20 (worst MOS). I filter out any of these equities based on obvious things that make may make their MOS moderately justified and hence probably not the best choices through individual research. For example, I wouldn’t be going long on financials, even though the prices are dirt cheap, and I wouldn’t be shorting AAPL even though the MOS is quite low.
I then correlate each to their sector, and find pairs (my pairs system is far from as complex a true quant). IE: One very high MOS and one very low MOS that are both part of the Oil Services sector. I buy 500 shares of the high MOS stock and short 500 shares of the low MOS stock.
The theory is that even in a bear market, a high MOS stock will hold its ground or increase in price, while a low MOS stock will surely go down considerably. Any loss from the long position should be outweighed by the short position and vice versa. The reverse would hold true for a bull market.
You can apply this same method to options instead of stocks as well.
Of course, if you know you are in a bear market or a bull market, you can just take a long or short position only. However, the beauty of this strategy is you don’t need to predict what type of market you are in or if it is going to reverse in the near future. The market today is probably a good example of when this strategy is most appealing. Although it looks like we are in for a bear market, you never know what can happen, especially with the Fed ready to intervene at any juncture.
I would try to find about 3 or 4 pairs, let them run for a bit, and cut the 1 or 2 under performing, if any.
September 16th, 2007 at 8:57 pm
Great idea! If it is good enough for the big funds to use it should be worth looking into.