Tax Day Trading System & Strategy

Tax Day Trading System & Strategy

Tax Day Trading System & Strategy is the tendency for the US stock market to go up on the day after tax day.

This edge was written about by Stephen Moffit who showed that if you had bought S&P 500 futures on the close of the tax day and exited the trade on the close one day later, you would have made an average gain per trade of 0.5% since 1980.

The explanation for this stock market anomaly is that many people wait until the very last minute to pay their taxes and there is then a simultaneous rush to get their money into an IRA on the final day. Brokers then end up overwhelmed and lodge a number of the trades on the next day open.

The interesting thing about this anomaly is that it doesn’t exist prior to 1980 when the rules regarding IRA contributions were changed.Tax Day Trading Strategy

Tax Day Trading System & Strategy:

You can go long S&P 500 futures on the close of tax day and hold for ONE full trading day.

Tax Day Trading System & Strategy

Buybacks And Equity Issue Trading System & Strategy

Buybacks And Equity Issue Trading System & Strategy suggests that companies that buy back (repurchase) more of their own shares tend to outperform.

In one study, researchers Amini and Singal looked at 15,106 buyback announcements between 1994 and 2015. They found that companies that repurchased shares shortly before an earnings release went on to show persistent positive raw returns of 3.31%.

The buyback anomaly also appears to make logical sense.

Company directors are best placed to know whether their company has had a good quarter therefore stock buybacks shortly before earnings releases may contain useful information for other investors to take advantage of.

The equity issuance anomaly is a similar effect and was discussed in the same paper mentioned above.

This time the researchers looked at 19,466 seasoned equity offerings (not IPOs) between 1970 – 2015 and found the opposite effect.

Shorting stocks that had recently issued new equity (SEO) prior to an earnings report was shown to produce a significant net profitable return.

The explanation is that equity issuance is a bearish signal often done to raise money in a flagging business and that this gives off information that predicts negative earnings.

The first chart below shows how returns improve in the days following earnings in stocks that have buybacks. The second chart shows how returns fall in stocks that initiate seasoned equity offerings:

Buybacks And Equity Issue Trading Strategy
According to Amini and Singal, stock buybacks before earnings leads to outperformance while equity issues has the opposite effect.

Buybacks And Equity Issue Trading System & Strategy:

You should go long stocks that announce share buybacks in the two days before earnings announcements and hold for up to 15 days.

You can short stocks that announce equity offerings two days before earnings announcements and hold for up to 30 days.

Tax Day Trading System & Strategy

The Accruals Trading System & Strategy

The Accruals Trading System & Strategy uses the non-cash component of company earnings and a company with low levels of accruals in their earnings has more real cash flow coming in and therefore more certain earnings.

A company with high levels of accruals, on the other hand, has less cash-related earnings and may therefore have less certain earnings.

The logic of the accrual anomaly is that most investors fail to account for the accrual component in earnings releases and therefore stocks with lower levels of accruals in their earnings become undervalued.

The Accruals anomaly is quite a robust anomaly with a lot of research behind it and it seems to make rational sense.

According to data from Quantpedia, the accrual anomaly can be used to pursue annual returns of around 7.5% more than the market and with lower volatility.

The following chart taken from a paper called Persistence of the Accruals Anomaly shows the abnormal returns associated with the anomaly going back to 1965:

The Accruals Trading Strategy

Src: Lev, Nissim, Columbia Business School.

As with many of the anomalies on this page, the accruals anomaly may also be combined with other factors such as momentum. It is also shown to be effective in international markets.

Research from the same paper mentioned above also shows that a larger number of stocks in the portfolio increases the statistical significance of the effect.  (In other words, you can increase the probability of success with this strategy by incorporating more stocks into the portfolio):The Accruals Trading Strategy 1

The Accruals Trading System & Strategy:

You can sort stocks into deciles and go long the stocks with the lowest accruals and short the stocks with the highest accruals. Alternatively, you can use accruals as just one factor in a multi-factor investing model.

Tax Day Trading System & Strategy

The Stock Split Trading System & Strategy

There is evidence that create a stock split outperform the market while those that undertake reverse stock splits under-perform. The Stock Split Trading System & Strategy works because company splits its stock it’s often because of strong share price performance.

Usually the company splits the stock to bring the share price down and make it more affordable for investors to purchase blocks of shares. Therefore, the stock split effect is tied in to the momentum anomaly.

There is also evidence from Kalay (2014) that stock splits cause analysts to revise earnings forecasts by around 2.2-2.5% which could be another component of the excess returns.

The Stock Split Trading Strategy

On the flip-side, reverse stock splits are more associated with negative returns.

In a sample of 143 reverse stock splits in US micro cap stocks between 2008-2016 I found an average return of -5% over the 50 days after the reverse split.

Here, the explanation is that reverse stock splits are typically implemented in poorly performing stocks.

Such companies typically implement the reverse split not as a sign of quality but because they need to trade over a certain price level to maintain exchange listing requirements.

The Stock Split Trading System & Strategy:

You can implement a portfolio that consists of going long stocks after stock splits and going short stocks after reverse stock splits. Short trades must be managed closely but long trades can be held for up to 50 days.

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God Bless America’s Founders

God Bless America’s Founders as they were brilliant God fearing men married to amazing women. They took it upon themselves vast sacrifice to found the greatest country ever to exists on the face of this earth. Thousands have fought and many have died defending this country. A country based on a constitution that respects the individual and one that has helped spread liberty and prosperity to every corner of the world.

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As the child of two amazing immigrant parents, I have been fortunate to have been born, raised, and educated in the USA. I am blessed and just completed a prayer of thanks to God for allowing me to live at a time of rapidly expanding global freedom and prosperity. More importantly, I am thankful to be able to share our algorithmic trade signals with our friends around the world.

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Tax Day Trading System & Strategy

The Distressed Company Trading System & Strategy

The Distressed Company Trading System & Strategy involves a bet that a company experiencing severe financial difficulties is essentially not as distressed as the market believes. When a company undergoes severe hardship and becomes distressed, many investors react by selling shares and this can drive the stock price below fundamental levels.

Distressed companies can therefore be attractive to opportunistic traders looking for a bargain.

Furthermore, there are different forms of bankruptcy which can help the distressed investor.

Chapter 7 bankruptcy will involve liquidation of assets which means investors could still get a payout.

Meanwhile, under a Chapter 11 bankruptcy, the company is given permission to continue trading and reorganise which could lead to significant improvement down the road.

The following chart from Barclay Hedge shows how the Edhec Distressed Securities Index has outperformed the S&P 500 since 2000:

The Distressed Company Trading Strategy
Out-performance from funds specializing in distressed securities. src: barclayhedge.com

The Distressed Company Trading System & Strategy:

The distressed securities anomaly holds that some distressed securities become undervalued through forced selling and investor psychology.

To really succeed you need to understand balance sheets and the logistics of distressed companies.

Ideally, you should have experience of picking companies that could offer a return after liquidation of assets or after a company reorganization.

Tax Day Trading System & Strategy

The IPO Trading System & Strategy

The The IPO Trading System & Strategy has baffled academics for several decades and is the result of three unusual price patterns that are typically associated with new public stock offerings:

  1. The first day of trading for new IPOs sees abnormal returns
  2. IPOs typically under perform over the longer term
  3. IPO under performance moves in cycles

According to Mahjoub, by the end of the first day of trading, US IPOs between 1990-2007 traded on average 18.9% above their offer price at which the company sold them.

This pattern of under-pricing also held strongly in the 1960s (21.2%), 70s (9%) and 80s (8.2%).

But it reached its peak in the Internet bubble of 1999-2000 where an estimated $66.63 billion was left on the table based on the starting price of US IPOs in that time period.

Meanwhile, separate research from Jenkinson and Ritter seems to illustrate that this anomaly is a global phenomenon:

The IPO Trading Strategy

The abnormal returns for IPOs on the first day of trading is another rejection of the efficient market hypothesis and a number of explanations have been put forward for its existence.

Some authors argue that issuers voluntarily leave money on the table in order to create a nice start and good feeling among new investors in the stock and therefore allowing issuers to have more successful Seasoned Equity Offerings in the future.

Others argue that IPO under-pricing can act as risk compensation for the underwriter. One other study found that banks can lose IPO market share if they under-price or overprice too much (Dunbar).

To go alongside this anomaly, there is also evidence that IPOs go on to perform worse than the market overall. So it seems IPOs typically return above average returns on the first day of trading but then go on to under-perform.

In analysis of US IPOs between 1970-2010 Ritter found that equal weighted returns for IPOs were -4.8% in the first year, -8.1% in the second year and -3.3% over five years. This is well under benchmark returns.

Whatever the explanations, there do seem to be anomalies persistent in IPOs that could be available for the average investor to take advantage of.

The The IPO Trading System & Strategy:

More research may be needed but the general strategy is to go long IPO stocks on their first trading day. You can also short IPO stocks to capture under performance in subsequent years.

Tax Day Trading System & Strategy

Post Earnings Announcement Drift Trading System & Strategy

Post Earnings Announcement Drift Trading System & Strategy (PEAD) is another one of the most significant stock market anomalies to have been discovered. The idea is that when a stock releases earnings that are a big surprise to the market, the stock tends to drift in the direction of that surprise  for up to 60 days after the announcement.

Since the efficient market hypothesis postulates that new information is almost instantaneously incorporated into a stock price, the observance of Post Earnings Announcement Drift Trading Strategy suggests that the market is not perfectly efficient.

According to a paper by Brandt and Kishore, PEAD is capable of abnormal returns (in excess of the market) of about 12.5% annually.

Explanation

The most popular explanation for Post Earnings Announcement Drift Trading System & Strategy is that investors typically under-react to earnings surprises and it takes time for the new information to filter through and get priced into the market.

The following chart from Mr. Damodaran shows the effect very clearly:

Post Earnings Announcement Drift Trading Strategy
Trading System & Strategy:

The way to trade PEAD is to buy stocks with the strongest positive earnings surprises and short stocks with the strongest negative earnings surprises. Trades can be held from 1 to 60 days after the announcement to capture the drift.

Tax Day Trading System & Strategy

P/E Ratio Trading System & Strategy

P/E Ratio Trading System & Strategy illustrates that low P/E stocks produce higher risk-adjusted returns than high P/E stocks. This is another classic value investing anomaly that has been supported by value investors such as Warren Buffett, Joel Greenblatt and Howard Marks and written about by researchers including Basu and Shiller.

A key insight concerning the P/E ratio is how it encapsulates investor sentiment.

If a stock has a high P/E ratio, its price is high relative to recent earnings. Investors are therefore expecting that stock to grow quicker and produce higher earnings in the future.

A stock with a low P/E ratio, meanwhile, is less expensive relative to recent earnings and investors are therefore less optimistic on growth.

Low expectations are more easily overcome and this is why a low P/E ratio can indicate an undervalued company and a good investment opportunity.

The P/E ratio is a noisy signal but there has been lots of research into its effectiveness.

Professor Shiller produced one of the most well known studies into the P/E ratio and showed a clear correlation between low P/E and forward returns. In the following chart you can clearly see the relationship:Low P/E Trading Strategy

P/E Ratio Trading System & Strategy:

According to this anomaly Trading Strategy, you should prefer low P/E stocks when constructing your portfolio in order to benefit from this value premium.

Tax Day Trading System & Strategy

Book-to-Market Value Trading System & Strategy

Book-to-Market Value Trading System & Strategy is commonly referred to as the book-to-market effect and dates back to famed value investor Benjamin Graham and showed a difference of 7.6% average returns between high and low book-to-market stocks and that value stocks outperformed growth stocks in 12 out of 13 major indices.

What is book-to-market?

The book-to-market anomaly compares the book value of a company to its market price. Therefore, the larger the book-to-market ratio, the cheaper the company is on a pure fundamental basis.

For example, if a stock has $100 million in real assets but is valued with a market cap of only $80 million, the B/M ratio is 1.25 (100 / 80).

You can therefore say that the stock is trading below its book value and is fundamentally cheap.

If you were to strip the company and liquidate all the assets you would end up with more cash than the current market value (that is assuming the assets are valued correctly).

The book-to-market effect is one of those anomalies that makes logical sense and has a good history of out-performance which contradicts the efficient market hypothesis.

Book To Market Value Trading System & Strategy Explanation

Explanations of this anomaly are mostly behavioral based.

For example, one explanation is that investors overpay for growth stocks with compelling narratives and so value stocks get overlooked and undervalued. Investors overweight past performance into their investing decisions.

Another explanation is that high book-to-market stocks are often distressed companies and therefore entail higher investment risk.

An obvious drawback of the book-to-market anomaly is that it only takes into account one variable.

Famed value investors such as Warren Buffett would say that it’s best to look at the book-to-market ratio as simply one piece of a much larger puzzle.

The following chart from Slide-hare (apparently with data from Ken French) shows an illustration of the book-to-market effect with data from 1927 – 2007:Book-to-Market Value Trading Strategy

Book-to-Market Value Trading System & Strategy:

You can calculate the book-to-market ratio using the total book value of the stock divided by the market capitalization of the shares. You can then scan for stocks with high book-to-market values and use these as a basis for further investigation.

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