An alternative way to trade or invest in popular stocks.
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Hi Everyone. Today we look at Fang stocks.
The term Fang is an acronym given by Jim Cramer from CNBC. Originally based on four ‘next generation’ technology stocks, but later extended to cover five stocks, including the names of Facebook, Apple, Amazon, Netflix, and Google.
These stocks make up approximately 15% of the S and P 500 index, a considerable portion for just five companies.
We can see the performance of the Fang stocks since 2010 here.
The chart shows the relative returns against the S and P index which languished behind with an overall return of 215%.
The combined return of the five Fang stocks over the same period equated to over 2300%, a huge improvement on the index.
The focus of this video however is to demonstrate how we can improve upon these results, with particular focus on reducing the risks often associated with such stocks.
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Let us first look at one of the five Fang stocks in isolation, in this example we use Netflix.
Since 2010 the stock has risen considerably from approximately $8 to $486 per share, resulting in a $10,000 investment turning into almost $600,000, a staggering return of 6000%.
The concern I have however, is that a buy and hold strategy such as this would have seen periods of significant drawdown.
At one point the buy and hold investor would have seen an 81% drawdown, imagine how you would have felt with a $100,000 balance dropping to just $19000 in 4 months, and watching it languish there for over a year.
Other notable drawdowns were seen throughout the holding period, coupled with periods of stagnation.
This is simply not an approach that suits my personality, I don’t like large drawdowns or lengthy periods of stagnation where my money could be working for me elsewhere.
For those in my group, or those who have watched some of my videos, you will know my philosophy is all about minimising risk and maximising reward, unlike the Netflix position where we would have been exposed to maximum risk.
Let’s put this philosophy and simplistic version of my strategy onto Netflix and see how the strategies compare.
First we revisit the monthly chart. We know the Netflix stock lost 81% in late 2011, reaching $44 before dropping to $8.
There is however a simple method which would have limited the loss to just 18%. Regular viewers would be unsurprised to hear that the method used, is the mack dee indicator, using the weekly chart.
Here we see the peak price of $44, and here the low of $8, which provides the 81% drawdown.
The key to limiting such drawdown lies within the method I personally include, which is the cross down of the weekly mack dee. The next step is for a stop loss to be placed under the wick of the closing weekly candle. In this example the stop loss is just over $36.
The following week the price continued its downward path, and we were closed out of the position. By doing so we not only missed out on 16 weeks of decline, but we also avoided considerable opportunity cost, a metric often unconsidered by many.
This exit strategy was applied to Netflix throughout the eleven years, avoiding further buy and hold drawdowns. The 45% drawdown was reduced to 14%, the 41% drawdown reduced to 12%, and a few months later replacing a 35% drawdown with a 10% loss.
The exit strategy clearly saves us from considerable drawdown, but how did we enter and re-enter our long Netflix positions during this same 11-year period…
Let’s first look at the positional returns.
We made 17 trades in total, 7 were losing trades and 10 were winning trades, providing a win rate of 58.8%.
The average loss was 9.4% and the average win was 61%.
So let’s look at the entry criteria enabling us to achieve such reward with very reasonable risk.
We once again look at the mack dee indicator on the weekly chart.
There are two quite simple entry criteria.
The 1st trigger for an entry is when the blue mack dee line crosses above the red signal line. Although in this strategy we must also ensure the blue mack dee line is above zero, shown here on the histogram.
We ignore the noise of price action above, and simply follow the mack dee line until it crosses down over the signal line, just as we did in the earlier example to avoid large drawdowns.
We place a stop loss under the wick of the closing weekly candle, thereby locking in profits, and protecting us from any downside risk, often associated with a change of momentum.
We await the upward crossing of the mack dee to re-enter our long position, and repeat the cycle.
The second entry rule is considered only when the blue mack dee line is below zero on the histogram.
This chart provides an example of such a scenario through 2012.
Here we have the zero histogram line.
Notice how the mack dee crossed above the signal line, which often triggers a buy signal, however in this example the mack dee line is below the zero histogram line, in which case it does not meet our criteria.
Our trigger to re-enter a trade is when the blue mack dee line crosses the zero histogram line, not the signal line. We therefore place a buy order here, at the point the mack dee crosses up.
Adding such criteria often reduces false signals.
Using this strategy against the Netflix stock from 2010, we achieved a compounded return of 2281%, turning a $10,000 investment into over $228,000. Providing a compounded annual growth rate of 380%. This considers that we were only invested in Netflix for a total of 2191 days, equivalent to 6 years.
Next we use the same strategy for the Fang stock Amazon, and again analyse the results.
But before we do can I please ask you to hit the like button, it really does help the channel.
Using the same time horizon of 2010 until today, we look at the monthly Amazon chart to see the buy and hold performance.
In January 2010, the price of Amazon stock was $132, and as of today the price has risen to $3200, an increase of 2350%. A $10,000 investment would have therefore turned into $235000.
As great as this performance is, we are still met with several considerable drawdowns along the way.
Also not forgetting, a buy and hold strategy suggests you hold onto all the downside risk, meaning that at any point the stock could collapse and tie up our capital for years.
Now let’s apply the same mack dee strategy as we did before.
Here we have the weekly Amazon chart from mid 2013 to the end of 2015, we use this as a reminder of the strategy before looking at the 11-year results.
We would have made a re-entry here at the mack dee crossover, and approximately 20 weeks later at the mack dee cross down, we would have placed our stop, again underneath the wick of the closing candle.
The trade would have returned 14% over 133 days which equates to an annualised 39%.
Next we see a number of crossovers, but the blue mack dee line is below the zero histogram line, we therefore avoid the trades and await the blue mack dee to cross above zero.
We see the mack dee line cross above zero here, and we re-enter with a long trade.
This trade returned a 70% profit over 343 days which equated to 75% annualised.
The most important lesson from this example however, is not the returns, but the opportunity cost and the avoidance of a continued drawdown.
We can see here price not only dropped a further 20% from our exit, but it languished for a total of 50 weeks, tying up our capital in the process. Not forgetting, the buy and hold investors also held onto any further downside risk.
Now let’s look at the 11-year results of following the strategy against the Amazon stock.
We had 14 trades in total, 5 of them were losing trades, the worst being just under a 15% loss, and two at just 1%.
We had 9 winning trades, providing us with a 64% win rate.
Our average loss equated to 6.5% and our average win equated to 32%, providing a near 5 to 1 risk reward ratio.
Just like the Netflix trade we were only invested for 2331 days, which is just over 6 years out of the 11. This gave a compounded annual growth rate of 122%, again a great performance considering we had limited risk.
So what have we learnt so far from this video?
We know that if you want to hold some of your favourite stocks for the long term, you don’t necessarily need to hold all the risk, and neither do you need to tie up your capital during long periods of consolidation.
By focusing on the risk, you provide the platform for significant reward.
Take away the psychological pain of drawdown, and possibility of complete loss.
Stay in positive momentum only.
Time limited we can’t go through all the Fang stocks today, but we can see by applying a simple mack dee theory, we can protect our account from drawdown whilst benefiting from much of the upside.
I apply some of this theory to my personal strategy which I share in our group, why not consider joining….
As always, thanks for listening.