Believe it or not, but the most liquid traded asset in U.S. stock markets is not a large cap stock.
No, it’s not Microsoft or Amazon, not even close.
The most widely traded asset is the SPY ETF.
The SPY was the very first exchange traded fund listed in the United States.With average daily volume of over 100 million shares, it crushes the competition.
If you’re not familiar with SPY, it seeks to provide investment results that correspond to the price and performance of the S&P 500 index. It’s like buying a basket of stocks from all the major industries, without paying commission multiple times.
In a nutshell - if you want to trade the overall stock market in one shot - SPY is your number one choice.
Let’s Look At Some Numbers.
If you purchased SPY on January 1, 2000 and held it till March 15, 2018, your annual average return would amount to exactly 3.50 percent. That’s 87.31 percent over the entire testing period. For every $100.00 you invested into the overall stock market, you’d end up with $187.00, over the entire 18-year time period.
While it’s not too impressive, you do have to remember that the overall stock market experienced several brutal corrections over that stretch.
According to our data – SPY’s worst loss from peak to bottom was 57 percent. If you’d held it for the full drop - your portfolio would have shrunk by nearly two thirds before even starting to make a comeback.
Now the Good News.
As it turns out, you could easily double your returns by adding one simple rule to buy and hold. More importantly you could reduce your risk roughly three-fold.
(Click to enlarge)
Let’s look at the numbers.
Instead of a 3.5 percent annual return, we hit 7.22 percent. Your biggest drawdown would plunge from 57 percent all the way down to 19.76 percent.That increases your gains from 87.31 percent to a whopping 254.62 percent over the 18 year period we looked at.
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That means every $100 dollars that you invest over 18 years grows to $354.62 instead of a paltry $187.31.
Consider this: you could buy the triple leveraged SPY ETF (SPXL). Your returns would have multiplied roughly three fold. Your worst drawdown in 18 years would have been 59.58 percent. That’s just 2.58 percent higher than buy and hold with SPY at 57 percent.
That means you could have generated average annual returns of 21.60 percent instead of 7.20 percent, while maintaining nearly identical drawdown risk.
Imagine turning every $100 into $863.86…during the exact same time period – all with a risk profile of slightly over 2 percent over the original buy and hold S&P 500 baseline example that we started with. Related: U.S. IPOs See Booming First Quarter
That means, instead of walking away with 87.31 percent return on your money in 18 years… you make 763.86 percent instead.
No Computer Science Degree Needed.
Sometimes the best results come from simplicity.
Moreover, when back testing performance, the fewer conditions involved, the higher the odds of the test working out in reality. It’s super important to keep things simple.
- No fancy indicators.
- No complex formulas.
- No degree in science needed.
All you need to do is understand the basics of market sentiment. Specifically, the sentiment of stocks that drive the SP 500 or the SPY ETF.
By now, you probably guessed that the SP 500 holds a total of 500 different stocks.
While most indicators focus on price action, we go one step deeper and focus on what really makes the index tick. We look at the percentage of companies that are soaring. We then look at the percentage of companies that are declining sharply in value.
How do we measure all of this?
We look at a very simple gauge. One that measures the percentage of stocks in the SP 500 that are trading above as well as below the 200-day simple moving average.
You can see what it looks like in the graph below.
I don’t expect you to calculate this yourself. The vast majority of technical analysis programs, both online and offline, include this simple sentiment indicator.
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The chart above demonstrates over 2 years of data. You can see exactly what percentage of stocks within the S&P 500 are trading either above or below the 200-day moving average.
Let’s Get Into The Rules Of The Strategy.
You buy the SPY when the percentage of stocks is trading above the 200-day moving average moves to 80 percent. Similarly, you liquidate the SPY when the percentage of stocks trading above the 200-day line moves down below 20 percent.
It’s that simple.
Essentially, what this does is eliminate every major market crash, correction or congestion that the overall market experienced over the past 18 years.
The stock market cannot create any sustainable buying pressure when over 80 percent of stocks in the SP 500 are trading below the 200 day moving average.
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Therefore, it’s simply best to avoid holding a position when over 80 percent of stocks are trading below the 200-day line.
Keep In Mind
The test results I’m showing you go back almost 2 decades. Furthermore, they are based on very simple common-sense principles. If over 400 out of 500 stocks in the SP 500 are trading below the 200 day price level, why in the world would you want to be long the stock market?
Related: 5 Stocks That Can Weather The Global Trade War
Essentially, this simple filter keeps you out of trouble and on the right side of the market over time.
Let’s Review
The SPY is the most liquid and most tradable ETF in the world. The majority of investment advisors and fund managers have their performance compared against the S&P 500 annual returns. Over the past 18 years, the S&P 500 gained an annual average return of 3.50 percent or a 87.31 percent total gain. The biggest correction during this period resulted in a 57 percent drop in price.
By using a simple sentiment indicator that measures the percentage of stocks trading above the 200 day simple moving average, investors can avoid the large windows of time that stocks are declining or trading sideways. Moreover, by avoiding bearish market periods, the gains increase from 3.50 percent to 7.22 percent on average over the 18-year time period.
The drawdown, or correction period declines from a whopping 57 percent to only 19.76 percent during the exact same time period.
That means you can risk substantially less of your hard-earned money.
Or instead, you could have used a triple leveraged SPY ETF and increased your average annual gains from 7.22 to 21.66 percent over the 18-year period.
Over the period I analyzed - you’d have earned 3 times the profits, while incurring just a tad more risk versus simply holding the SPY ETF.
By Roger Scott
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