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Bulkowski’s IRS Test Portfolio

Written and copyright © 2008 by Thomas N. Bulkowski. All rights reserved.

This page shows a test portfolio based on industry relative strength. You can find background information on the method here. I strongly suggest you read the information in the link, including results 2.

Portfolio Construction Rules

I used the following guidelines to construct and maintain the portfolio.

• Securities selected for inclusion in the portfolio come from a database of approximately 550 stocks.
• All trades are in round lots (no fractional shares) of at least 100 shares each.
• Commissions are $10 per trade ($10 for a buy and $10 for a sale).
• SEC fee is applied to all sales (not buys) at the current rate (as of May 2008) of $11/$1,000,000 of value.
• No slippage is factored into the trades.
• All trades occur at the opening price the next trading day after a signal.
• Concurrent (multiple) open positions in the same stock are not allowed.
• The portfolio can hold an unlimited number of stocks.
• Stocks priced less than $5 per share are excluded.
• Commissions and SEC fee are applied to the S&P 500 index as if it were a stock.
• Dividends are not included nor interest on cash balances, taxes, ECN fees and so on.
• Margin is not allowed.
• Each buy is for no more than $30,000, including commissions.
• For a buy, pick from the top performing industry over the past 6 months. This was originally set for the top 3 industries but too many whipsaws occurred (selling one day and buying it back the next day). The changed boosted performance for the year while cutting the maximum potential loss.
• Do not buy if the previous trade in the same stock was a loss and it occurred within 31 days (the wash sale rule).
• Select the top 3 best performing stocks in that industry, based on the price change for each stock over the past 6 months (stock relative strength).
• Sell all of the stocks in an industry if the rank drops to or below 5.

Trading Strategy

This portfolio uses two methods for selecting stocks: industry relative strength and stock relative strength. Both methods look at today’s close versus a close 6 months ago.

I set the parameters to buy at rank 1, 3 stocks per industry, and sell at rank 45. That tested best for profits. However, since only 48 industries were represented, waiting for the sell rank to hit 45 suggested a buy and hold mentality with the potential of giving back too much profit. I redid the spreadsheet to include an average of the maximum loss. I define the maximum loss as the largest decline below the buy price while the stock is owned. This is not the same as the draw down.

Having found the maximum loss per stock, I just averaged the results to get the largest average decline. I did this to help smooth over the large declines caused by dead-cat bounces. Those make the losses look far worse than they actually are.

I combined the average maximum loss and the average gain and sorted the results. The spreadsheet shows the order. Using the new information, I determined that buying when the rank climbed to 3 or higher, using 3 stocks, and selling when the rank dropped to 5 gave the best profit, smallest loss, and did not concentrate the portfolio in any one industry.

Tracking the portfolio in real time showed that several stocks were sold on one day and rebought the next. So, I changed the buy signal to only select stocks from the top performing industry (a rank of 1). A rank of 2 did not cure the whipsaw problem. The change boosted the performance for the year while cutting the maximum potential loss slightly and substantially cutting the number of trades. All of that is a win-win setup.

The Portfolio

In the table, the Buy/Sell columns show the dates when shares were purchased/sold at the opening price. The Net Change column is the profit or loss of the trade, expressed as a percentage (shares x sell price - commission - SEC fee) - (shares x buy price + commission). If the trade is still open, the closing price as of the date the list was created is used as the sale price. The S&P Change column is the change in the S&P 500 index between the Buy and Sell dates, using the same Net Change calculation as for the stock. The Max Loss column shows the largest drop below the buy price during the time the stock was held. This is not the same as a draw down but it is a potential loss. If you owned the stock and panicked, you could have sold at such a loss. However, the system does not work that way, so the actual loss is not as severe (but you have to hold the stock until told to sell).