Goal: Purchase a stock (or mutual fund, etc.) more cheaply than a regular trade.
Strategy: At market open, note the opening price. Immediately set a limit buy at X% discount from the opening price, which expires at end of trading day. Repeat until bankroll is spent.
Assumptions: You have unlimited free limit orders. You can calculate a Y% chance of the order executing based on past performance. From that, you can figure out what discount you want and how frequently it will execute. For your initial bankroll, you can calculate the amount to buy each time so you will probably finish by a certain time.
Questions:
How does this compare to dollar cost averaging? Or other strategies?
Do you do any better if you set a limit order that expires in 60 days? (i.e. longer time interval)
What exactly do you hope to accomplish with this strategy? If you have a clear goal in mind, there is probably a better investing strategy for achieving it.
I think this is not dissimilar to trading strategies referred to collectively by the technical term: Picking Up Pennies In Front of a Steamroller
Usually you will gain a little extra profit. Sometimes you’ll be sorry.
To see this most simply, let’s assume only three things can happen:
[ul][li] the stock you want to buy fluctuates.[/li][li] the stock starts falling and never goes back up.[/li][li] the stock starts rising and never comes back down.[/li][/ul]
With your strategy you will fail to buy the stock in just one of these three cases. Which one?
I have a customer who has a few stocks picked out that tend to wander in a fairly narrow range +/- $1 or so over a few days (bastard wont tell me which ones )
He basically does kinda what you do, it drops a few % points below average, he buys a bunch, goes over by a few percentage points, he sells it. He claims this is his only source of income and he obviously isn’t starving but I dont know if hes jerking my chain.
It’s possible to do this. You look for the floor of support and the ceiling of resistance. Here’s some good reading to get started: Support and Resistance Basics
The trick is to identify these trends while they’re happening. Any idiot can draw lines on a graph after the fact, but that’s not going to help them make money.
[QUOTE=drachillix]
I have a customer who has a few stocks picked out that tend to wander in a fairly narrow range +/- $1 or so over a few days (bastard wont tell me which ones )
He basically does kinda what you do, it drops a few % points below average, he buys a bunch, goes over by a few percentage points, he sells it. He claims this is his only source of income and he obviously isn’t starving but I dont know if hes jerking my chain.
[/QUOTE]
As noted by septimus, that kind of thing may work fine. Until it doesn’t.
There are a number of investment strategies that involve making a modest amount of money 99% of the time and losing a large amount of money 1% of the time.
You’re assigning some kind of special significance to the opening price that isn’t real. You’re anchoring on that price, which blinds you to the fact that you’re not actually gaining anything via this method.
Yes, this mechanism will result in you buying stocks when they are cheaper than the opening price, but so what? At the time you buy the stocks, you’re still buying at market price. The stock can go anywhere from there. It’s sort of natural to think of the opening price as the “true” price, and by waiting for the price to fall a bit, you can get in at a discount and wait for the price to return to its proper place. But that’s not the way the market works. All market prices are equally true. If the stock is trading at X this morning and Y this afternoon, then X was the market’s best guess of the real value in the morning, and Y was its best guess this afternoon. There’s no reason to think that the stock, priced at Y, will have any bias towards returning toward X.
The problem with this strategy is that the market generally trends upwards. Because of this you are not likely to immediately hit your ‘buy’ criteria, and the longer you have to wait, the longer you are sitting on your pile of cash which is earning no return.
This is also why dollar-cost averaging is a silly strategy - spreading out your initial investments will generally buy you less and less as time goes on
Hmm interesting. I guess my thinking is with a broad market index, the first thing would be more likely to happen.
It’s true that the broad market index tends to go up over time. It’s also true that certain stocks could either free-fall or become runaway successes.
But let’s slow down for a second and compare what happens with this strategy versus a “buy-once” strategy.
Case 1. The price fluctuates, but stays near the original price on average. If you buy once, you get the starting price and no discount. With this strategy you’ll have an X% discount. My strategy wins.
Case 2. The price falls and never goes back up. If you buy once, you get the maximum loss. With this strategy, the loss is reduced. You also paid less, with the X% discount factored in.
Case 3. The price rises and never goes back down. Well, this is probably not likely to happen with a broad market index like the S&P 500. It usually fluctuates more, but to go with your example, the S&P 500 index becomes a strictly step-wise increasing function. You’ll never buy in. So yes, in this exaggerated example, you lose out.
The problem with this comparison is that you’re only comparing the performance of your strategy vs. having purchased the stock or index at the beginning of the day your trade actually executes. Realistically, by simply buying the stock or index in the first place, you’d be earning some implicit (or explicit via dividends) yield during the days or weeks that your strategy would leave money sitting on the sidelines.
And as others have pointed out, your strategy is essentially one that bets against momentum in the stock market (since you’re hoping the dip will reverse itself). Historically this has not been a winning strategy.
You bring up a good point, but you have to compare the value of the implicit yield against the discount of my strategy and the benefit of dollar cost averaging. So there’s really three strategies to compare:
A. Buy once at the start with the entire bankroll
B. Dollar cost average
C. Use limit orders to get a discount on strategy B
There is a tangible benefit with strategy B that comes from buying more at lower prices and less at higher prices. As you said, there is a benefit with strategy A in implicit yield where you earn more the longer you are invested.
But I am wondering if strategy C is better than either one since it has the additional discount from the limit orders. The loss from implicit yield within a single day is nothing, so at the very least it seems C is always better than B.
Any method which attempts to beat the index is simply a method of gambling, with an expected value less than the index. This is inherent in how the index is defined in the first place. If that’s really what you want, then you’re probably better off just buying an index fund and sitting on it, and then taking the dividends to Vegas: That way, you at least know precisely how much below the index you’re taking, and you get free drinks served by pretty ladies to boot.
You’re not going to arrive at the right answer with such qualitative concepts of probability. There’s reams of price data from the past. You can easily back-test this theory and get good hard numbers (which will show that you’re wrong).
Yes, this is exactly what I’m talking about. Limit orders on EFT index mutual funds.
If you look at the past history of any market index, it has never performed as a step-wise increasing function. How exactly does the past price data show that I’m wrong? Enlighten me please.
I think you’re just being dismissive without really saying anything. It’s a cop out to say my strategy is “gambling”. Unless you can explain why there’s no discount, it’s just your intuition against mine.
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