Milk The Market Investment Blog

I have found that entering long positions has not been as profitable as one would like in this current market. However, doing the reverse, by shorting the worst MOS stocks has.

It seems like we are getting into a period of serious correction at the very least, and perhaps something a bit drastic. Only time will tell, but right now the value of a stock is coming under higher scrutiny because of it. Everyone with their hand in the market is evaluating their holding for dogs and cutting accordingly. A stock that may have had low MOS but kept running would be overlooked in the raging market of yester-months. But now, funds are looking to shift their equities for more efficiency. So what we can do is look for low MOS stocks, research them to see if that MOS has any justification, and short accordingly.

For me, I don’t believe I have to be on the long side to make use of Rule #1 strategies.

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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.

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Our scanner tool based on the principles outline in Phil Town’s Rule #1 strategy is in beta testing. We are working on making the criteria very flexible while still giving you results in line with the Rule #1 strategy in a user friendly interface. Once beta testing is done, we will start offering monthly subscriptions. This will save you countless hours trying to find Rule #1 criteria stocks, and allow you to search with varying degrees of liberalness to get more results instead of being locked down to the criteria in a concrete formula.

This tool will become a must have for any serious long term investor and possibly even swing traders. We have came up with interesting strategies as well that can be applied with this as well. Start thinking like a junior quant or hedge fund manager and you’ll know what I am thinking also.

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Rule #1 is don’t lose money. If you’re not losing, well, you are not losing. That doesn’t mean you are winning either, but odds are that are winning. Rule #1 Ivesting is also a book by Phil Town on his investing strategy that was taught to him by mover and shaker while he was guiding them on a river rafting adventure. His methodology is practically the same as Warren Buffet and Benjamin Graham. Of all the books I’ve read or skimmed, this may be the only one I would recommend for someone interested in long term stock market investing.

The principles are quite easy. Find a solid company whose stock that is selling very cheap, well below it’s sticker value (true worth) and you can buy it with a high degree of confidence it will go up quite a bit. When the stock is no longer cheap (overvalued) you sell it, take your profit, and if and when it does become cheap again, you buy it back. You do this with as many stocks in as many sectors as possible. The problem is, in this current market, despite the recent downturn, almost everything is overvalued (likely a good part of the reason for the downturn outside the obvious credit, housing and employment issues).

Every time you find a stock to research and spend the 10 or 20 minutes to calculate the formula and back check everything, you find out it falls well outside the realm of a solid Rule #1 stock. What I decided to was not spend months waiting to stumble upon good buys, but to screen every stock on the three majors and get a list of them all. This wasn’t an especially easy task to program, but I did, and it turned out to be quite profitable as one would expect. Truth be told, at this very moment there are no Rule #1 superstars. There are Rule #1 applicable stocks in sticker price and margin of safety (MOS), but they are mostly ADRs. To find superstars right now, you need to bend the rules a little.

I will discuss this more in a future entry.

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