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TradeLike aHedgeFund20 SuccessfulUncorrelated Strategies& Techniques toWinning Profits
JAMES ALTUCHER
John Wiley & Sons, Inc.
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TradeLike aHedgeFund
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Founded in 1807, John Wiley & Sons is the oldest independent publishingcompany in the United States. With offices in North America, Europe, Australia and Asia, Wiley is globally committed to developing and marketingprint and electronic products and services for our customers’ professionaland personal knowledge and understanding.The Wiley Trading series features books by traders who have survived themarket’s ever-changing temperament and have prospered—some by reinventing systems, others by getting back to basics. Whether a novice trader,professional or somewhere in between, these books will provide the adviceand strategies needed to prosper today and well into the future.For a list of available titles, visit our Web site at www.WileyFinance.com.
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TradeLike aHedgeFund20 SuccessfulUncorrelated Strategies& Techniques toWinning Profits
JAMES ALTUCHER
John Wiley & Sons, Inc.
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Copyright © 2004 by James Altucher. All rights reserved.Published by John Wiley & Sons, Inc., Hoboken, New Jersey.Published simultaneously in Canada.No part of this publication may be reproduced, stored in a retrieval system, ortransmitted in any form or by any means, electronic, mechanical, photocopying,recording, scanning, or otherwise, except as permitted under Section 107 or 108 ofthe 1976 United States Copyright Act, without either the prior written permissionof the Publisher, or authorization through payment of the appropriate per-copyfee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA01923, 978-750-8400, fax 978-646-8600, or on the Web at www.copyright.com.Requests to the Publisher for permission should be addressed to the PermissionsDepartment, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, 201748-6011, fax 201-748-6008.Limit of Liability/Disclaimer of Warranty: While the publisher and author haveused their best efforts in preparing this book, they make no representations orwarranties with respect to the accuracy or completeness of the contents of thisbook and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by salesrepresentatives or written sales materials. The advice and strategies containedherein may not be suitable for your situation. You should consult with a professional where appropriate. Neither the publisher nor author shall be liable for anyloss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages.For general information on our other products and services, or technical support,please contact our Customer Care Department within the United States at 800762-2974, outside the United States at 317-572-3993 or fax 317-572-4002.Wiley also publishes its books in a variety of electronic formats. Some contentthat appears in print may not be available in electronic books.For more information about Wiley products, visit our Web site at www.wiley.com.Library of Congress Cataloging-in-Publication Data:Altucher, JamesTrade like a hedge fund : 20 successful uncorrelated strategies &techniques to winning profits / James Altucher.p. cm.Includes bibliographical references.ISBN 0-471-48485-7 (CLOTH)1. Stocks. 2. Hedging (Finance) 3. Hedge funds. 4. Speculation. 5. Indexmutual funds. 6. Stock exchanges. 7. Profit. 8. Investments. I. Title.HG4661 .A58 2004332.6—dc222003020609Printed in the United States of America10
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To my father, Seymour Altucher, who taught me
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his book could not have been completed without the guidance andsupport of Victor Niederhoffer. Practical Speculation, by VictorNiederhoffer and Laurel Kenner, is a must-read.Thanks to Jim Cramer, for answering my 5,000 e-mails and bringingme on board as a writer for TheStreet.com. Thanks also to Dave Morrow,the editor-in-chief of TheStreet, for not telling Jim to go to hell when hesuggested me. The great community among the writers is a tribute to theleadership of Dave and Jim.Susan Lakatos, the editor at Street Insight has been a huge help inediting both my writing on Street Insight as well as many of thetechniques in this book. George Moriarty and Gretchen Lembach at TheStreet have also provided valuable guidance and editing. Many of thewriters on Street Insight provided valuable insight and conversationsduring this process. Particular thanks to Worth Gibson for not onlycheering me up on down days, but also placing that bet on Funny Cide forme during the Kentucky Derby.Dan Kelly, my business partner over the past several years has beenan incredible steady rock through the swings that this business oftenentails. Every system in this book has undergone trial by fire with Dan’sand my personal money. Thanks also to Michael Angeledes, Jim Moore,and John Clifford for providing support and advice over this past year.Dion Kurczek wrote the software, Wealth-Lab, that allowed me to testmost of the systems in this book.Thanks to Pamela van Giessen, my editor at Wiley, for quite possiblybeing the smartest person in the world, and Lara Murphy at Wiley forhelping guide this baby through its final stages.Finally, thanks to Anne, Josie, and Mollie for providing the sweet andthe spice on the days that were particularly sour.
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Contents
Introduction
TECHNIQUE 1
xi
The Bread and Butter Trade—Playing Gaps
1
How to Play the QQQ-SPY SpreadUsing Unilateral Pairs Trading
23
TECHNIQUE 3
Buying Bankruptcies
49
TECHNIQUE 4
Using the TICK
55
TECHNIQUE 5
Playing the Bands
67
TECHNIQUE 6
Stocks Less Than $5
77
TECHNIQUE 7
The Slow Turtle
83
TECHNIQUE 8
The QQQ Crash System
97
TECHNIQUE 9
The Relative Fed Model (and OtherFun Things You Can Do with Yields)
111
TECHNIQUE 10
Deletions from the Indexes
119
TECHNIQUE 11
Everything You Wanted to Know Aboutthe 200-Day Moving Average but WereAfraid to Ask
133
TECHNIQUE 2
ix
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xTECHNIQUE 12
CONTENTS
End of Quarter, End of Month,Outside Month
141
TECHNIQUE 13
Ten Percent Down—Panic 101
147
TECHNIQUE 14
Taking Advantage of OptionExpiration Day
155
TECHNIQUE 15
Extreme Convertible Arbitrage
163
TECHNIQUE 16
Intraday Bollinger Bands
169
TECHNIQUE 17
All Good Things Come in Fours(“4” Is a Magic Number)
179
TECHNIQUE 18
The Wednesday Reversal
189
TECHNIQUE 19
What Does Not Work?
205
TECHNIQUE 20
Reading List
211
Index
221
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Introduction
hen I first told my investors and partners I was doing a book, mostof them were somewhat upset. One of my investors, a prominenthedge fund manager in his own right, was very upset at thethought of sharing good research with people. One of my partners, afterreading a few of the sample techniques, told me he was going to buy all ofthe books when they came out and hold a big bonfire. And then there is always the question I wonder when I read investment books: If these systemsare so good, why not just use them to print money all day long? Why writeabout them?Well, I have several answers. For one thing, I have learned a lot duringthe process of researching this book. Although I have been using many ofthese systems for years, there are always new subtleties, new twists, inevery system. Despite being a systematic trader, I am a personal believerthat it is impossible to just rest on your laurels and use a black box thatprints money forever. Every system needs to be constantly researched andfurther developed, new avenues explored, former old paths disbanded.Many of the new twists I have looked at during the process of putting together this book actually helped make me money over the past severalmonths—money I perhaps would not have made for myself and my investors if the research had not been so focused. System development andtrading is a constantly evolving process. It is that process of continual development that makes someone a successful systematic trader, not the systems themselves.For another thing, while I believe the systems and patterns mentionedin this book will bring success to those who apply them with discipline,I also feel they should be viewed as stepping stones for further research.The markets are a very big place with many hidden pockets of inefficiency.And yet those pockets are constantly changing. I think the ideas in thisbook are great places to start when looking for further inefficiencies, and Ithink the ultimate success readers will enjoy is when they start findingthose inefficiencies for themselves.
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In addition, I like to correspond with an interested community of otherdevelopers, traders, and researchers. Unlike many people I do not believethat the sharing of systems (in most cases) degrades the system. Every yeartrillions of dollars are put to work in the markets. There are trend followers,countertrend followers, buy and hold mutual funds, day traders trading offgut, and thousands of other types of traders and system followers out there.No matter what system you have or approach you use, it is a guarantee thatthere is someone out there more than happy to fill your trade in general. Bysharing ideas with a community of interested parties, I hope to learn fromtheir ideas as well. The saying, “give and you shall receive” certainly applieshere.Finally, I like to write. I hope people enjoy reading what I write.In terms of how I would use the ideas in this book: No one system is aHoly Grail for the markets, in the same way that no investor should bet onone stock to blaze his or her way to riches. Just like the buy and hold stockinvestor, the hedge fund trader relies on diversification, only it is diversification of uncorrelated systems, rather than diversification of uncorrelatedstocks. Having a portfolio of systems whose successes do not depend onthe successes of other systems is the best way to smooth out any volatilityin your personal equity.Almost all of the systems used in this book were built on top of a simulation software package called Wealth Lab. I cannot recommend this package enough to people. The software can be found at www.wealth-lab.comand comes equipped with a Pascal-like language for building very sophisticated trading systems that can be tested easily on indexes as well as baskets of stocks. The support desk responds quickly to any queries, and thecommunity of developers that can be found on the discussion of forums atthe Web site is a useful starting point when developing one’s own systems.One thing to keep in mind is that although testing and research in themarkets requires a scientific approach, there is an element that is art aswell as science. In other words, do not believe everything you see. Just because something works 500 times out of 500 times does not mean that thedeveloper has not curve fit a system to the data. With every system you everplay, try to ask: Why does this system work? What aspect of the psychologyof mob behavior can possibly produce this result?The markets can only be exploited when there are inefficiencies. Thatsaid, there are a lot of smart people trying to find those inefficiencies, andwhen they occur, they just as often quickly disappear. The inefficienciesthat are exploitable, year in and year out, and even decade after decade, arethose that have deep roots in the fears and greeds that drive investors andgamblers alike to the world’s markets. Keeping this fact in mind will helpyou avoid the perils of data mining and curve fitting, and will ultimatelylead to your own ideas that can be used to trade the markets.
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TECHNIQUE 1
The Bread andButter Trade—Playing Gaps
he gap trade is the bread and butter trade for many day traders andhedge funds. Many day traders only play gaps. They wander into theday trading firm at 9:25 AM, coffee and New York Post in hand, settledown, look for the stocks that are gapping up or down, and then fade them.They go the opposite direction: shorting gap ups until they get back to flatwith the prior day’s close, or going long gap downs. Four times out of fivethey make money and life is great; they can spend the rest of the day at themovies. But the fifth trade will wipe out all the profits and then some whenthe gap continues in the direction it started and all the gap-fillers getsqueezed in one direction or other.Research and the systems described in this technique will help the hitrate of the gap filler. The key is to identify those situations where it is moreprobable than normal that the gap is actually fadable. Making sure in eachinstance that, through testing and a commitment to research, you knowthat your edge is real and quantifiable off of all these day-trading wannabesis a key to success in playing gaps.A gap occurs when a stock opens lower or higher than the previousclose. For instance, on October 10, 2001, QLGC closed at 27.98. The stockopened the next day at 29.45 and kept running until it closed at 34.24. Inother words, it never “filled the gap,” or moved back to the close the day before. Shorting that open would have resulted in a disastrous 17 percent lossthat day. (See Figure 1.1)
T
Note: All example trades are simulated with $100,000 unless otherwisespecified.1
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39.00
QCGC Daily@2003 Wealth-Lab, Inc.as of 6/2/2003
38.5038.0037.5037.0036.50
36.1036.0035.50
Short 3573 @29.45
35.0034.5034.0033.5033.0032.5032.0031.5031.0030.5030.0029.5029.00
Cover 3573 @34.24–17,114.67
28.5028.0027.5027.0026.5026.0025.5025.0024.5024.00
Volume15.00M10.00M5.00M
FIGURE 1.1
QLGC on October 10, 2001.
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Before deciding to play gaps, first ask the question, “do gaps fill in general?” and then see if one or more trading strategies can develop out of theanswer.
SYSTEM #1: FILLING THE GAPThe following is a test of the basic gap-fill approach:• Buy a stock when it opens more than 2 percent lower than the priorclose.• Sell at yesterday’s closing price or at the close if yesterday’s closingprice is never hit.Test All Nasdaq 100 stocks (including deletions), from January 1, 1999, toJune 30, 2003.Result See Table 1.1. This is not a bad result, but it is not something Iwould want to play either. While 0.58 percent is a great result per trade ifyou are dealing with Nasdaq or S&P futures, it is only barely adequate whendealing with individual stocks where commissions and slippage have moreof an effect.This system gets a modest boost if the day before is down, possibly because short-sellers would already be modestly in the money and then thegap gives them an additional profit that they might, at that point, want totake.
TABLE 1.1
Filling the GapAll Trades
All TradesAverage Profit/Loss %Average Bars HeldWinning TradesAverage Profit %Maximum Consecutive Winning TradesLosing TradesAverage Loss %Maximum Consecutive Losing Trades
9,8210.58%16,174 (62.87%)3.21%583,647 (37.13%)–3.97%20
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SYSTEM #2: FILLING THE GAP AFTER DOWN DAYThe rules for System #2 are the same as for System #1 except only buywhen not only is there a 2 percent gap down or greater, but also when theday before was a down day for the stock.Result See Table 1.2. The improvement is decent. The average return pertrade goes from 0.58 percent to 0.75 percent. While across 5,000 trades anincrease in the average return per trade generates a significant return, it isstill not enough per trade if you take into account commissions and slippage, which could be as high as 0.40 percent per trade or more.A 2 percent gap down does not give us as much to work with as a 5 percent gap down, so let us try a third approach.
TABLE 1.2
Filling Gap after Down DayAll Trades
All TradesAverage Profit/Loss %Average Bars Held
4,9380.75%1
Winning TradesAverage Profit %Average Bars HeldMaximum Consecutive Winning Trades
3,157 (63.93%)3.40%144
Losing TradesAverage Loss %Average Bars HeldMaximum Consecutive Losing Trades
1,781 (36.07%)–4.04%0.9815
SYSTEM #3: THE 5 PERCENT GAP• Buy a stock if the stock was down the day before and if the stock isopening 5 percent lower than the close the day before.• Sell either if the stock hits the close the day before or the stock closeswithout hitting the profit target.Result
See Table 1.3.
We are finally getting to the point where we might have a system toplay. We need to make one more tweak before we arrive at a significantly
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TABLE 1.3
5% GapAll Trades
All TradesAverage Profit/Loss %Average Bars Held
9931.97%1
Winning TradesAverage Profit %Average Bars HeldMaximum Consecutive Winning Trades
605 (60.93%)6.02%118
Losing TradesAverage Loss %Average Bars HeldMaximum Consecutive Losing Trades
388 (39.07%)–4.47%0.9710
profitable trading system. So far, gaps get filled more often than not on average, and the results are slightly better when things are even worse (theday before is down and the gap is 5 percent instead of 2 percent). What happens when the market as a whole is gapping down?
SYSTEM #4: THE 5 PERCENTGAP WITH MARKET GAP• Buy a stock if the stock was down the day before, if the stock is opening 5 percent lower than the close the day before, and if QQQ is alsogapping down at least one-half percent.• Sell if the gap is filled or at the end of the day.
Example: RFMD, 6/26/02On June 26, 2002, the market had a double-header. Intel had warned onearnings the night before of and on the morning of June 26, consumer confidence numbers came in well below expectations. Basically June 26 was inthe middle of a death spiral that culminated in a major low for the marketon July 24, 2002. That said, the market backlashed at least for the day onJune 26 and buying gap downs produced great profits to the buyers asshown in Figure 1.2. The June 26 bar is in the center of the daily chart inFigure 1.2. After a down June 25, which closed at 25.46, June 26 opened24.43, almost 4 percent down from the close the day before.RFMD (in Figure 1.3) closed on June 25 at 6.44 and opened the nextmorning at 5.70—a disastrous result for those longs who might have felt
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28.2028.0027.8027.6027.4027.2027.0026.8026.6026.40
26.3426.2026.0025.8025.6025.4025.2025.0024.8024.6024.4024.2024.0023.8023.6023.4023.2023.00200M
Volume
150M100M50.0M
FIGURE 1.2
QQQ on June 26, 2002.
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8.808.608.408.208.007.807.607.407.407.207.006.806.606.406.206.005.80
Volume
12.50M10.00M7.50M5.00M2.50M
FIGURE 1.3
RFMD on June 26, 2002.
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that the world was ending and the worst was yet to come. However, buying that open and selling when RFMD hits the price it had closed at the daybefore (i.e., it fills the gap), 6.44 would have resulted in a 12.98 percentprofit.
Example: YHOO, 7/11/02On July 11, 2002, the QQQs opened at 23.76 (see Figure 1.4). Having closedthe afternoon before at 23.90, which was a gap down of slightly more thanhalf a percent. YHOO opened at 11.15, down from 12.19 the night before.After the close on July 10, Yahoo beat earnings but did not guide up. Themarket was clearly disappointed in this, hoping for the second-half recovery in 2002, which did not look like it was going to happen.As demonstrated in Figure 1.5, buying the open and closing out at theopen the next day at 12.79 resulted in a profit of 14.71 percent. This was stillin the middle of a steep market slide that lasted until July 24, but profits onthe long side were still available to those looking for the right opportunity.
Simulation of 5% GapStarting with $1,000,000 and using 10 percent of equity per trade fromMarch 10, 1999 (the inception of QQQ) to January 1, 2003, we get the resultas shown in Table 1.4 (on all Nasdaq 100 stocks including deletions). As wecan see from the equity curve of the simulation (Figure 1.6), there were veryfew trades generated in 1999. The interesting thing is that as the market hadits most extreme falls (note the buy and hold line in Figure 1.6, the equitycurve spikes upwards despite the fact that this is a long only strategy. Themyth of a bear market is that only going short works. This strategy demonstrates the complete falsehood of that myth.Figure 1.7 illustrates the annual return.Average annual return of 28.32 percent with a Sharpe ratio of 1.29.Many fund of funds take the view that the way to smooth out volatilityof returns during both bull and bear markets is to have a long/short strategy. This way, during bull markets the longs will hopefully outperform theshorts and the market (the presumed alpha of the strategy), and duringthe bear market the shorts will greatly outperform the long positions. However, this strategy demonstrates it is possible to have a long/long strategyduring both bull and bear markets by diversifying the method of going long.As an example, we can take the reverse approach of shorting gaps downand try shorting gap ups, as described in System #5.
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TABLE 1.4
Simulation of 5% Gap with Market Gap SystemAll Trades
Starting CapitalEnding CapitalNet ProfitNet Profit %Exposure %Risk-Adjusted Return
$1,000,000.00$2,593,543.00$1,593,543.00159.35%5.22%3053.37%
All TradesAverage Profit/LossAverage Profit/Loss %Average Bars Held
525$3,035.322.07%1
Winning TradesGross ProfitAverage ProfitAverage Profit %Average Bars HeldMaximum Consecutive Winning Trades
321 (61.14%)$2,875,406.00$8,957.655.89%113
Losing TradesGross LossAverage LossAverage Loss %Average Bars HeldMaximum Consecutive Losing Trades
204 (38.86%)($1,281,862.38)($6,283.64)–4.07%0.9714
Maximum DrawdownMaximum Drawdown $Maximum Drawdown DateRecovery FactorProfit FactorPayoff RatioRisk Reward RatioSharpe Ratio of Trades
–8.26%($168,763.75)9/6/20019.442.241.443.376.59
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26.6026.4026.2026.0025.8025.6025.4025.2025.0024.8024.6024.4024.2024.0023.9923.8023.6023.4023.2023.00
Volume
150M125M100M75.00M50.00M25.00M
FIGURE 1.4
QQQs on July 11, 2002.
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14.8014.6014.4014.2014.0013.8013.6013.5813.4013.2013.0012.8012.6012.4012.2012.0011.8011.6011.4011.20
Volume30.00M20.00M10.00M
FIGURE 1.5
YHOO on July 11, 2002.
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FIGURE 1.6
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Portfolio equity curve.
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FIGURE 1.7
Annual returns.
The Bread and But