Market Neutral Trading / Securities

Market Neutral Equity Trading

Since I visit http://www.hedgefundindex.com I am impressed of the risk reward ratio that Equity Market Neutral Trading seems to offer.

Performance in 9 years 159% with a max DD of 3,5% on a monthly basis. RR 45
This means yearly around 3:1.

More then the RR impress me the risk on a neutral portfolio. When I trade equity long short strategies as my journal here at Elitetrader I am 90% of the time to much overweight long or short in my portfolio. So I fear most events like 9/11 or something in the future that let the market gap extremely. May be there will be a day when they solve the world hunger problem over night and I am holding a full packed short portfolio.

When I am market neutral holding equal valued positions long and short I do not care extrem gaps as much as I do when trading weighted long short.

So there are many ways to trade neutral – pairs was discussed here a lot.
Trading securities in one direction only and hedging – bring the portfolio to neutral – with futures or warrants – is another one.
I like most the idea of going long strong stocks out of an index and shorting the weak ones.

I started testing the last mentioned and within 3 hours I came to incredible results. 1994 to yesterday, same timeframe as the numbers above from hedgefundindex.com, I’ve got 590% with -12,77% drawdown DAILY. This would be a ratio of 45 DAILY. If I am not confident with 12,77% drawdown I can put ¾ of the money into fixed income. Ok it’s before managed and performance fee but good numbers anyway.

Have I missed something? This sounds ones again like the holy grail
I would like to discuss here the pro and cons of neutral trading. Where is the real risk? I know that the shorted one can raise and the long one can fall but within the same index and widely diversified ????

Anyway would appreciate any thoughts on this topic? Is anybody out there trading this thing with real money?


Good trading all

 

I think man is your man for answering this question.

> I started testing the last mentioned and within 3 hours I came to incredible results. 1994 to yesterday, same timeframe as the numbers above from hedgefundindex.com, I’ve got 590% with -12,77% drawdown DAILY. This would be a ratio of 45 DAILY. If I am not confident with 12,77% drawdown I can put ¾ of the money into fixed income. Ok it’s before managed and performance fee but good numbers anyway. <


Could you show us the parameters for this test and the detailed
test report? Also the Index/Stocks would be interesting and necessary to discuss the theme.

 

NYSE,

I would have to agree that market neutal is a great approach...in fact I am trying to find a way to systematize this myself (have had much time to work on it lately). When you do mkt neutral your greatest risk becomes firm specific....so IMHO, keeping a very diverse portfolio is essential.

I have a friend who works at a low-net exposure hedge fund and their volatility is extremely low. Their equity curve looks like a steady path upwards. You're right, the contrast b/t equity mkt neutral and the other styles is very evident in terms of risk/reward. I would love to hear more of your thoughts.

MYD

 

I did some similar work on a market neutral strategy, both as a small percentage of account and on paper for larger view.

I took some positions in strong/weak stocks in the same sector and some general long/short positions in strong/weak stocks where there were not good counterplays in the same sector.

I used a capital neutral (equal dollar) basis. Perhaps shifting toward beta-neutral would have been better.

I followed it from Sep thru Mar, with the timeframe on individual holdings from several days to weeks.


What I found:

1) The method averaged around 3.0% return on equity per month, however, I know April would have brought this figure down.
2) The standard deviation of weekly returns was much higher than I thought (a whopping $3500)
3) When the market reverses up, as it did in first weeks of Jan and again in mid-Mar you get pounded. Your shorts do not holdup as well as your longs.
4) In a strong selloff, such as Dec and late-Jan/early Feb, you make decent returns, but not as much as you lose in the selloffs.
5) It's the mid-trend pullbacks, quieter days, topping days, etc. where you slowly pull in the money.

I started seeing in April that my strategy was flawed in several places. My timeframe was either too short (or too long) so I was a bit 'out of sync' with the market. My method for short selection needed improvement. I did not have a good exit strategy in place for either long or short. I would need to adjust my expectations to stomach such huge swings from week to week.

I put this aside for awhile to work on some other things.

 

thanks for all your input

ufo12

Yea man seems to be the expert - hope he will respond to this thread.
I've already read all his posts but they where mostly on pairs.

I've done many tests on many portfolios. The one I showed above is on the Dow 30 Stocks and a few big caps more.
For stability test I've done tests on SP 100, Nas 100, Semicon aso
but like moste the Dow stocks.....

I have tested this with wealth lab - to get sure that this numbers are correct I have to do it with MFC or VB. So long I do not want to discuss specific parameters for the test as I not know if statements I make will be correct.

My interest is most and basicly on neutral trading in general. Looks to good to be true


MYDemaray

Thanks for input. Yes a wide diversification into more stocks would be helpfull for firm specific risk.

I am very interested in your friend hedgefunds performance too. May be you can give me a link for his website. You can PM me if you do not want to post it here.


AmbushHillbilly

Thanks for you personal experience. Do you trade on fundamentals, technical indicators or a mix of both? Systematic or with discretion?

3% a month is amazing.

Interesting your experience on up and downs of the market appreciate it.


good trading all

 

"Market neutral" is a very dangerous term.

Strategies which, on their surface, appear to offer something for nothing invariably have, ticking within them, time bombs, of which even their practitioners may be unaware.

Remember LTCM....

There is an old stock market adage that seems a propos:
"The bulls make money and the bears make money but the pigs go broke."

 

MarathonTrading

Thanks good point.
But I currently trading other equity long short strategies and when I compare equity market neutral to my strategies from the risk standpoint it sounds far better.

LTCM
There were a lot of problems with LTCM outsinde of the usual market neutral trading that hit them so hard.

1st They were extremely leveraged. 28:1 at the end

2nd they were good hedged but nobody could expect that russia changes his policy that much.

3rd the had millions of dollars to go in and out in mostly illiquid markets.

But I like this example. Let's do a similar stress test on equities MN (no bonds swaps currencies).

Lets say I go 5 - 10 stocks out of the S&P 100 short and the same ammount of dollar capital long. What have to happen that I go bankrupt ????

Let say banks are week and technology strong. Banks has to fall to 0 and in the same timeframe technology stocks has to doubble the shareprice. In the case of no leverage.

What is the worst case????

I know LTCM has done stress tests like this and very clever people came to the conclusion that they never can lose more then 10%.

I like creative ideas thinks that might sound stupid or impossible.

 

Do short positions gain when long lose money?

As correlation calculation shows +0,8 because both strategies on its own are profitable I did a few simple calculation to find this out.

Caclulation on Daily Equity Curve.
1185 days when the long positions gains compare to yesterdays close.
1258 days when the short positions gains compare to yesterdays close.
425 days when long and short positions gains compare to yesterdays close.
331 days when long and short positions lost compare to yesterdays close.

so on an average
every 7 days both long and short lose money
every 5,5 days both long and short make money

both long and short loosing or winning in a series of 3 days is very unusual.

 

LTCM is a special story and none of the comments here about it seems well researched IMO. Both on the neutrality subject and the use of leverage.

market neutrality is definitely not a holy gral, but an investment technique first used 54 years ago and well documented for decades.

NYSE
I think you are using RR (Risk Reward?) in a confusing way if you just divide overall return by Max DD. Take annual return and you have something better. This is a concept used by MAR ratio. Even better use standard deviation of daily returns, annualise them and divide your annual return by that. This is the modified sharpe ratio. If you subtract risk free rate from the annual return you get the original sharpe ratio. If your strategy is biased upwards, thus you have more volatility to the upside than tu the downside you might want to calculate semideviations and use these to divide the annual return with.

market neutrality. big portfolios. high frequency trading are the basic drivers of sharpe ratio IMO.

thanks for being invited here.


peace

 

Of course, I know that LTCM was a special story and that most of their trades could not be defined as "market neutral". Indeed, it's not because you enter a spread trade that your trade can be defined as market neutral.
If you are short 10yr us notes and long 10 yr danish bonds, you are not market neutral.
If you are short 10 yr us notes and long 9.5yr us notes, your trade can in my view be seen as market neutral.

For those interested in the LTCM story:
http://risk.ifci.ch/146480.htm