Profit Making Mantras:- Day Trading

A lot has been said about Efficient Market Hypothesis. According to most academics, markets are almost Strongly Efficient, and it is impossible to make any profit based on past stock performance, or fundamental analysis.
Though there have been many arguments for and against market's efficiency, most practitioners believe that markets are not efficient. Though hold only money managers and investment funds have not been able to do better than market, a lot of hedge funds which use a mix of different strategies have been able to show strong results over long periods.

I will like to talk about a strategy that seems to work a lot number of times. I have been using this since last week of December and it has worked on most days.

Short and Cover - Strategy


The basic principle behind this strategy is that in the short term, investors overreact to a lot information. Thus, a positive earning guidance may shoot up the stock price of a company much beyond the actual material potential of the news (earning guidance in this example). Similarly, a bad news in the market may lead investors to pull out a particular stock holding.
In general, I believe that investors react more towards a positive news than towards a negative news. This may be particularly true in the trading period that is associated with my research and results (Dec'09 to Jan'10). As US and rest of the world was considered to be coming out a long recession, and with companies 4th quarter earning numbers expected to beat analyst estimate, the reaction to news was probably way beyond their material impact on the stock's intrinsic value.

Based on this insight, I started testing this trading strategy:-

1. Screen stocks with a one-day return of over 10%
2. Research the news associated with these stock movements
3. If material was considered non-material, then short that stock
4. Look for covering that position close to the end of day, or next day morning.

Now this strategy involves a lot of risk, specially the risks involved with Shorting stocks. Liquidity is one of the primary issue that one should be aware of when using such strategies. In my portfolio, I looked at stock with market cap of $80M+, and average daily volume of 50,000+.


A snapshot of this portfolio is given here:-