Dow Maximum Drop Investment Concept

A forum contributor in Channel News Asia Market Forum by the nickname of Puntfast has suggested the following:

• Buy when DOW drops 20%
• Exit when DOW rebound 30% from entry price or
• Exit after 3 years in the trade

I have modified the rules slightly so that it can be tested based on historical data from yahoo. Data is from Feb 2 1940 to Feb 9 2008.

The rules are:

Entry

1. Compute the highest price for the past 60 days. Lets call this H1
2. Note the lowest price today. Lets cal this L1
3. Compute D1 = (H1-L1)/H1.
4. If D1 > 0.20 and there is no buy signal for the past 20 trading days, buy at the opening price on the next trading day
   

Exit

1. If position is showing a gain of 30%, close the trade
2. If position has been open for 765 trading days (assuming 255 trading days per year), close the trade
   

The trading result is shown below:

The draw down in this case ranges from 0 to -29%. There were 14 cases where the 30% profit target was reached before the end of the 3 year holding period.

If you were to apply this simple concept to an exchange traded fund that tracks the DOW Jones Industrial Average, you would have made on average 26% (before expenses) with average holding period of 1.5 years.

I still like the method based on FED rate cut because the range of the draw down swing (from 7% to 9%) is much lesser.

The probability of win is 100% for this case. I think that is why people always say that if you can hold on to your investment and time is on your side, the chances of making money is very high if you invest in equities.