Distribution of Stock Price Movements

So maybe this will be a boring post, maybe not. I found it interesting as I'd tried to google information on this subject before and had been unable much that was useful.

My basic question was "what is the distribution of stock price movements?" (what % of the time do they go up, down, and by how much when they do?)

I didn't really feel like a "normal" distribution made sense as down moves "seem" larger and more violent than upward movements in stock prices. (A normal distribution is the normal "bell shaped" distribution we've all come to "assume" in many cases so we can use basic statistical tools such as standard deviations and allows us to constrain probabilities - example if a normal distribution applied we could assume 95% of price movements would fall within +or- 2 standard deviations of the mean of the distribution. This is particularly useful understanding risk).

Well, I was reading Jack Schwager's "The New Market Wizards" this morning - the chapter on trader William Eckhardt and the topic comes up, and when asked about statistics and stock price movements - and he is talking about only using "blunt statistical instruments" and says "I believe that price distributions are pathological." Ha. I kindof cracked up when I read it, but he goes on to talk about fractals and the problem seems to be that sample variance increases as data increases when you look at stock price movement. The more you look at, the more weird, unusual, unexpected moves you find... The implication of this being "it means that lurking somewhere out there are more extreme scenarios than you might imagine". This book came out in 1992, so the term "black swan" wasn't used then, but what he was talking about is the "black swan" concept that's so popular now after the financial collapse of 2008. Market outcomes that you think might be so highly improbable as to not exist might in reality be far more likely than we expect.

By now I've read alot of the stories of these traders in both "Market Wizards" and "The New Market Wizards" and one theme that they keep coming back to is cut your losses fast - and keep your risk small so that no one event can wipe you out. It seems the field is littered with traders who can make money for years but then "blow up" when they run into something unexpected and haven't properly respected risk. Assume risk is much larger than you expect it is, because how you manage risk makes the difference between surviving and getting wiped out.

Stock update

It's interesting to me that there have been alot of upside earnings surprises out there. Many commentators are reporting the dichotomy between earnings reports and employment, and it is a bit confusing, but there have been several good earning reports from companies I track.

Of those I track and/or own that seem to have business going well for them: CTSH, EBIX, HANS, DECK, KMB.

I'm actually looking to add to the EBIX position again. I want to be careful and not get top heavy without the market validating reported results, but I feel like EBIX's results deserve upping the ante a bit.

KMB Kimberly-Clark has had a good run (I recently purchased this consumer staple company as a dividend stock and it's up nearly 10% since then - so I'm considering cashing out and waiting for a pullback as KMB has pretty much traded in the same price range for nearly a decade and I've more than made what I was expecting to get from the dividend in the first place.).

Other recent additions to the portfolio including PEP Pepsico and WMT WalMart. I may try a similar in-out on PEP like KMB as I bought it similarly for dividend and have more cap gain than dividend in short period. All of this is in retirement accts so no tax implications.

Anyhow, overall I've been pleasantly surprised with earnings so far, especially given such a pervasive bearish mood that seems out there.

Inspectd.com

Inspectd.com is a very cool website that presents you with historical stock charts and lets you pick which way the stock should move based purely on price and volume data.

Once you start, it's hard to stop.

Free Trades?

I use Scottrade as my primary broker, but I came across this company named Zecco today featuring $0 stock trades. I haven't tried it yet but it sounds like checking out if you're thinking of opening an account.

I'm not sure how they make money, but it sounds like they don't pay interest on cash balances. With a broker offering free trades you'd have to worry about executions, but they post a study on their site claiming above industry average execution quality.

What I've been reading

"Trend Following" by Michael Covel. Trend following is a trading philosophy designed to capture benefits of longer term trends. It details successes of many trend followers and along the way bashes about every other method of investing. I found it good to have read, although like most books it's padded with too much fluff. Could've gotten the same point across in 100 pages. Suggestion - read the first couple of chapters and turn to chapter 10 to get the gist of the trend following approach.

"Hot Commodities" by Jim Rogers. I'm reading this right now. Jim Rogers is a well respected investor (you probably see him on the financial news occassionaly) who advocates moving some of your asset exposure into what he sees as a long term commodities bull market. I've been learning about trading systems and many trading systems (including trend following) incorporate trading in commodities (like oil, natural gas, wheat, cocoa, corn, cotton, pork bellies, etc).

"Foreign Currency Trading" by Russell Wasendorf (Jr and Sr). I'm still reading this too, but is an introduction into foreign currency trading. Just trying to expand my options as I work on a trading system. Many traders trade currencies.

Transactions Today

Down markets seem like a good place to weed out some losers and move money into some different places, so made a couple adjustments today.

I sold the Palomar Medical Tech (PMTI) in my taxable accounts today to take tax loss. Still have some in another account, but will re-evaluate after 30 days.

Moved funds into a position in Immucor (BLUD). They had strong earnings announcement last week and I like the company characteristics in general. Also considered putting into CTSH Cognizant, but held off there.

I almost bought a big chunk of the general market Nasdaq Index QQQQ, but decided I'll stay with companies instead of the index for now while I'm research the general market trading system.

Working on trading strategies

A short while back I was studying the beneficial impact of buying on down days and that got me to thinking about trading strategies in general - something I've never given serious thought.

This weekend I've put in a lot of effort working on a trading system - trying to see if I can come up with an automated trading system that can outperform the market.

I'm still working on it and I'm thinking "maybe" it's possible, but it seems to be much more doable in sideways or downward moving markets like 2000-2003. When I transition the strategies that work into more bullish environments, it's tough to beat a strictly buy and hold approach. By this I mean the models are decent at making money in bad markets and picking decent exit/re-entry points, but aren't as good at staying in in good markets. Market timing in bull markets seems somewhat counter-productive unless highly productive and timely sells can be targeted.

I'm trying to build logic to improve performance in bull markets, but it's tougher than it seems it should be at first glance.

Time for a test

A slight variation of this trading strategy discussed a short while back is giving a buy sign right now.

I'm curious to see the outcome. Current status of SPY - the exchange traded index of the S&P500:
- Down Day
- Down market trend vs both 20day and 40day intervals
- 4 or more of last 7 trading days have closed down
- Sentiment indicator Neutral

In the 40 instances the market has had this setup since 2004, after 4 days the SPY has closed up 83% of the time, with an average gain of 1.32%. SPY is at 148.02 in after hours trading right now. Lets see if closes next Thursday up from this point, and by how much. I'm unsure if there are any dividends between here and there, but if so we'll adjust the prices to account for them.

Still investigating how to get the leverage to make these types of expected moves play out, but it's interesting to think about.