i was googling for articles on suggested ways to make money in a random market and i came across an interesting site that articulates the theory of the screw, which is a belief i myself hold and recommend this article to you as worthwhile reading. but aside from that, the author writes in another article about momentum investing. Soooo, i decided to do a simple backtest on the system whereby one buys and holds overnight if the market closed that day higher than it opened. For the test, i pulled historical quotes for the ETF that tracks the S&P500 (ticker: SPY), which has been trading since 2/1993.
what i found is an annualized return of 3.59% with annualized standard deviation of 7.36% over this 17.6-year time period. now, this isn't very compelling if you consider one could obtain an annualized return of 3.50% with annualized standard deviation of only 0.57% over that period by holding 3-mo. t-bills. however, if the stock market would have performed better over that period, this system would have undoubtedly performed better, whereas the same upside potential doesn't exist with t-bills. so perhaps the correct benchmark is the s&p500 itself, which provided a return of 5.36% (annualized) with standard deviation of 15.26% (annualized) over that 17.6-year time period. so for this trading system, the return/volatility was 0.49, which compares favorably to the return/volatility provided by the s&p of 0.35.
now to get a truer picture, i'll have to go back later and model in transaction costs, but the purpose of this test was simply to get a feel for whether or not this system even has any potential. i may have to test this system a bit more, but at first blush, it doesn't appear half bad. i mean look at the chart above since 2001; sure it hasn't made any money, but compare that to the crazy volatility and low returns of the s&p 500.
Technical Notes:
1. if you want to buy and hold overnight, you must buy prior to the close (unless you buy in the after-market), but i'm just assuming one can buy a few minutes prior to the close and almost always hit a bid very close to the closing price assuming there are no huge moves during the last few minutes.
2. i did not take the time to model in transaction costs, which would dilute the returns of this system.
