TRADING TECHNIQUES
One Rank To Trade With
A Mutual Fund Trading Method
by Norman J. Brown
Get better profits and reduce your risks by using the one-rank method to select mutual funds to trade.
There are many techniques and tools you can use to define turning points that generate trading signals. In this article I will discuss an approach that uses only very short-term persistence -- that is, from one day to the next. I refer to this one-day principle as "one rank" (OR). The trading rules are simple, and historical evidence from the last 13-plus years clearly shows that using OR to select mutual funds can help you gain substantial profits and reduce your risks.
BACKGROUND
The OR technique is critically dependent on the short-term persistence of the mutual fund you are trading. There are several mutual fund trading schemes that make use of the concept of "persistence of price" or "momentum." But what does "persistence" mean in this use?
Suppose you look at the performance of a mutual fund by flipping a coin. One toss would be made for each day (256 trading days per year) to represent whether the fund has a positive or negative return. If the coin is fair, there'll be an equal probability of a positive or negative return (bias = 0.5), and the distribution of streaks will be similar to that displayed in Figure 1.
Thus, in one year (256 days), a single six-day up streak as well as a six-day down streak is probable. Over a 16-year period -- roughly the period to be discussed for OR -- you could expect one 10-day up streak. On average, the total number of up streaks per year is 64, and the average streak length equals two days up and two days down. Now, if those streaks are lengthened, the net streaks will drop below 64, and the average streak length will be longer than two up days. This is persistence.
FIGURE 1: FAIR COIN-TOSSING METHOD. There will be an equal probability of a positive or negative return.
...Continued in the June 2003 issue of Technical Analysis of STOCKS & COMMODITIES
Excerpted from an article originally published in the June 2003 issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright 2003, Technical Analysis, Inc.
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