Trade idea: exploit the autocorrelation of all-time highs
The US is growing, unemployment is back to 2008 level and confidence has increased. Stocks followed through and set an all-time high.
The situation we are in puts many investors out of their comfort zone. Many seek to get back into stocks, attracted by the appealing breeze of greed pervading the newspapers. Others instead, find more attractive the green number that their position is showing after the recent surge.
To cope with the current setup, we studied the paper by BlackStar Funds (2009) that runs a backtest on stocks breaking all-time highs (for the interested reader I have uploaded the .pdf file to my public Dropbox directory: https://www.dropbox.com/s/h0xtsek7blatycb/Doestrendfollowingworkonstocks.pdf). According to their research, trend-following in this kind of environment is profitable, but the average loss can be quite harming.
Based on that, we recommend buying a midcap strengthening stock, only if it breaks this week’s highs. At the same time a short on weak bigcap should offer protection and add convexity to the portfolio. We pick as candidates respectively Tyler Technologies, specialized in government software and Intel. The trade should only be implemented only if highs are broken.
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