Spread Betting UK Shares Experiment
Updated: Mar 19
Valmo Trend Following System - Introduction
I know a lot of people who don't know where to start with investing. It's overwhelming, confusing and at times scary for the average person who isn't obsessed with trading, like me!
So I wanted to write a post to simplify it for people by giving them a system that frankly my cat could trade.
As an experiment I'll trade the same system, I'll divulge all my trades and openly track results over a number of years, and hope that those copying the system can join me in taking this approach.
Another thing that makes this experiment effective is that it improves accountability which mitigates one of the biggest factors behind why most traders fail - meddling! The best way to avoid meddling is to hold yourself accountable, and understand why you're trading the way you are so that you have faith in your decision making.
Every month I'll share my trade decisions and results. We can all share in the highs and lows of the markets together, and this will hopefully make it less daunting.
What's The Point of This?
Shorter answer: Making spread betting, trading and investment less scary and more accessible. And beat the 'buy and hold' approach
Aside from the aforementioned goal of making spread betting, trading and investment less scary and more accessible, the measure of this experiment's success will be in whether or not the chosen system can beat the 'buy and hold' approach that many pension funds and managed ISAs end up closely replicating for us.
If you're interested in what 'buy and hold' is and other ways to optimise your savings then check out this post I wrote on '3 Simple Trading Systems That Beat the 'Buy & Hold' Approach'.
How Much Money Do I Need to Start?
Shorter Answer: +/- £5,000
Normally when I answer this, I say £3,500 as a bare minimum. But ideally > £5,000. The reason I say £3,500 is because then if someone is straight-up buying shares for an ISA they can take 7 diversified stocks at £500 each, so it's doable. Any less and I'd say you just need to be a little patient and wait until you've saved a touch more - you need to be able to weather drawdowns!
I really wanted to make this experiment accessible and so I asked a few chums and I searched good old Google, where I found that the average savings for someone my age in the UK (as of 20 Dec, 2020) was just shy of £6,000. This also tallied with the median outcome of asking my friends. Consequently, I settled on a nice round £5,000.
So in order to make this relatable to as many people as possible I too will square off £5,000 into a new spread betting account on IG, just for the purpose of this share trading experiment.
How Does The System Work?
Shorter Answer: Hold when the price on daily charts closes the month over the 200d EMA. When it closes the month beneath then remain in cash.
We call the system the 200 Day End-of-Month (Long only) Strategy, catchy eh?
Popularised by legendary trader Paul Tudor Jones. It's the simplest strategy I know that beats buy and hold.
- Add a 200-day moving average to your charts (I choose to use the Exponential Moving Average).
- Only place a trade at the end of the month. One trade per month MAX.
- It's a long-only system where all you do is buy, and never short!
- At the end of the month, if the price closes above the 200-day moving average, then buy!
- Check at the end of each month, if it's still above the 200d MA then do nothing.
- Only close out the trade when at the end of the month the price is below the 200d MA.
- If the price moves under the 200d MA during the month then sit on your hands and do nothing until the end of the month. It's important to give the trend room to fluctuate up and down in its journey northwards. But if it's going to crash then it'll get you out of the market and mitigate any damage.
That's the mechanics of it.
If you can't spare 2 minutes a month then it's not for you. In fact, if you can't then I'm flattered you're reading this post at all.
Backtesting it To Understand Why it Works
Shorter Answer: 'Buy and Hold' over 16-year period = 125.2% return with 55.2% drawdown. Whereas 200d EOM Strategy over the same period returned 317.7% return with just 17.3% drawdown. (Tested on S&P 500 index).
I've previously shared this video before which covers the system and shares the backtesting results from Steve Burn's book '5 Moving Averages That Beat Buy & Hold'.
The system is tested from 2000-2016 and captures bull, sideways and bear markets (including crashes), it is tested on the world's most liquid index, the S&P 500.
For the purpose of this experiment we're only looking at the first system featured.
The backtest results show that if we'd bought and held our investment in the S&P 500 in 2000 and sold our position in 2016 then our overall return over that 16-year period would have been 125.2% with a max drawdown of 55.2% (i.e. you'd have lost more than half your equity during one down turn). However, had we traded the 200d EOM System above, then we'd have seen an overall return of 317.7% with a max drawdown of just 17.3%
But in our system we want to take this approach and we want to give ourselves another edge. So how do we do that?
Finding An Edge in the Markets
In a previous blog post on 'The Biggest Edge in Spread Betting' I mentioned that these are prime examples of edges in trading:
Positive risk-reward ratio
Trading with the trend
Trading around areas of support and resistance where you can get the best RRR (Risk Reward Ratio)
Averaging into trades to maximise winners on pullbacks or breakouts.
Being long on equities
Being a robot to ensure consistency and never missing a profitable signal for your system.
So let's see which of these we're ticking off our list shall we?
Positive risk reward ratio - CHECK - We're going to cut our losers short and let our winners run.
Trading with the trend - CHECK - We're only taking long/buy trades when the price is trading above the 200 day exponential moving average, a popular way of ascertaining the trend direction.
Trading around support/resistance zones - NOPE - we're not doing that specifically on this system.
Averaging into trades - NOPE - we're not averaging in, it's a low maintenance system for beginner investors.
Being long on equities - CHECK - we're only going to buy stocks, we're never looking to short them. The UK and US markets tend to move up in the long term due to the rate of innovation.
Being a robot - CHECK - these rules are so simple, and we're all going to keep one another accountable in order to make sure that we don't do anything that isn't in the rule book, just like a robot!
So 4 out of 6 ain't a bad way to turn what is a 50/50 coin flip trade, into a well-informed trade plan that gives us better odds.
So what else could we be doing to tilt the tables in our favour?
How about use a filter for finding the stocks that are 'more likely than not' to go up over time?
Sure, sounds like a plan.
Stock Selection Process
Shorter Answer: Using a slightly edited Stockopedia screener.
There are literally millions of ways to find stocks to invest in or trade. In the past it was a more laborious process that would have put-off a lot of 'would-be investors' before they even got started. But today we are fortunate enough to have the internet, a vast treasure trove of instant data at our fingertips. Filterable in seconds and with full access to earnings reports, dividend yield data and even market/analyst sentiment meters.
So much so that now the thing that puts newbies off is actually data paralysis. Where the devil should you even begin with starting to shortlist stocks to buy or trade?
Well, I use Stockopedia, and I'd massively recommend it for anyone out there seriously considering getting into this game. However, for the purposes of this experiment I'm very generously sharing the shortlist of stocks that I get each quarter when we come to rebalance our portfolio. So you won't need a Stockopedia subscription if all you intend to do is follow along with me. However, if you do want to do your own thing then it's a dream tool for investors and an absolute necessity.
So onto what we're looking for in order for a stock to make our short list! Beware the name of this filter is incredibly sexy, please don protection...
Top ValMo Rank 200d MA Cross
This is a filter on Stockopedia that I have edited slightly to suit the entry requirements of our system.
It focuses on stocks which have already been given a blended rank based on both value and momentum scores.
Value and momentum are the two strongest forces in almost all markets (including currencies and commodities), together they make great bedfellows.
The beauty of finding a well balanced blend of these two characteristics is that when value stocks tend to 'zig', momentum stocks tend to 'zag' and therefore are complementary to one another and help to smooth your equity curve and naturally hedge.
Various versions of this watchlist strategy have been a core focus of Quants and Academics for many years.
Our tweaks to this stocks filter are the following:
- Their net debt must be less than 3x that of their operating profit over the past 12 months
- The price must be over the 200d moving average, but no more then 10%. This means our risk profile is better when we take the trade.
So with these properties at play sifting through thousands of UK stocks for us, we're only going to trade the ones that make the cut and pass our grueling interview process.
Currently on our list at the time of writing (14/03/2021) we have:
So the idea is that trading these sorts of stocks, with a system that limits drawdowns and keeps us in the good trends is going to give us a significant edge over standard buy and hold.
Using my Stockopedia filter these stocks will continually update as they enter and exit the range of our parameters.
How Many Stocks is Enough?
Shorter Answer: 10-15
I think that 10 is a good amount personally, with a max limit of 15 if you have the account balance to safely extend to more stocks. But I wouldn't go any higher.
You don't want to have so many stocks that you may as well end up trading the FTSE 100 or 250. That's not the purpose here.
Sure you might make good money trading this system on the index alone. But we want to find the premium stocks that are perfect for our system to enter with! Too few and you're exposed to more swings that could magnify results (both good and bad), but that isn't in our playbook.
The idea is that everything we do gives us an edge, but is kept simple and easy to follow. If we can reduce uncertainty within our trading then we'll make better decisions and will find it easy to stick to our system.
So we'll start out by entering all the stocks that are currently showing in the Stockopedia filter (and available to spread bet on IG), and as and when new ones pop-up on Stockopedia in our ValMo screener I'll add those in, up to a maximum of 15 stocks eventually, but 10 provisionally to begin with.
If at the end of the month we have to close a couple of positions then those positions can be filled with our next favourite new ones that are available on our screener. We can prioritise which stock is next by 'Stockopedia Stock Rank', followed by levels of net debt, followed by whichever has the coolest name, followed by geographically closest to my house ;-)
No need for any complicated rebalancing or hedging tactics. As Stanley Druckenmiller has said many times in interviews, and I paraphrase slightly here:
"I don't like to hedge. If you're actively hedging then it means you think one of your trades is wrong. I prefer to put all my eggs in one basket and then watch that basket carefully" - Stanley Druckenmiller
Shorter Answer: No stop loss, just using the 200-day exponential moving average to dictate when we're in or out of the market at the end of each month.
So with this system, it's not like your usual trading system where you have close stops and and fixed risk/reward parameters. Instead we're refraining from meddling as much as possible, it's buy and hold, but with a once a month permitted exit if the trade has closed beneath the 200d EMA.
So right now we don't need to know how to use stop losses, our stop loss is when we see the price has closed below that moving average at the end of the last trading day of the month.
Looking at the largest market crashes between 1980 and 2017 we can see illustrated in red (see image below) the total market drawdown in each crash, then in yellow we can see how much you'd have lost by getting out once price crossed beneath the 200 day SMA (note this is 'simple moving average', with 'exponential moving averages' the EMA reacts quicker to the more recent price action and as such you'd have got out even sooner than this data depicts). On average across all the major crashes the average drawdown you'd have experiences using a 200d moving average was just 6% versus a very painful 35% average if you were to just buy and hold.
How to get setup
Shorter Answer: Open a spread bet account at a brokerage like IG for UK traders.
First you'll need to open a spread betting account with a regulated/certified UK broker. I use IG Index as I find that their web platform and mobile apps are by far and away the best user experience available. Their spreads are tight and execution has usually been the most reliable of all the brokers that I've tried. If you want to setup your IG account then sign up here. NB: Be sure to setup a spread betting account, as opposed to CFDs, that way you're not liable to pay any CGT (Capital Gains Tax) in the UK*
Once you've setup your brokerage account, you'll need to make your deposit and search for all the stocks that we're planning to open first.
You may want to also create a watchlist and add these stocks to said list. How you display your own trading screen is entirely up to you, so I won't even try to tell you how to do it, it's a personal thing.
Now that you've got your system, trade playbook, brokerage and funding all sorted, all that remains is to place your first spread bets.
Placing Your First Trades
Remember that we're going to start by allowing for up to a maximum of 10 trades at any one time with our lower account size.
Additionally, in this system we are allowing for zero discretionary input. In other words, your opinion matters not!
We follow the entry and exit rules (because historically, according to the data they kick ass), we only trade the stocks that our filter has shortlisted, because these companies have a greater chance of going up. We can't predict the future, nobody can, so with that in mind, let's apportion equal weighting to each position.
When trading with leverage we always want to ensure that we have plenty of margin. This is critical, because if you overdo your position sizing then as soon as the market moves against you, you'll be getting emails, push notifications and calls from the broker insisting that you put more capital up to cover your margin otherwise they'll close out your account positions and your money will have gone!
Margin calls are there for your protection, and in all honesty you should never get one because if you are, you're definitely over-trading in one way or another.
Here's what I advise:
Imagine that you only have 25% of the equity available to open new positions with.
We know that eventually we'll have 10 positions, so divide 25% by 10. So you have 2.5% max margin commited per trade. (NB: If the min stake means you're over this by 20% then that's fine, it's just a guide to keep our exposure in control)
On the stock you're looking to trade, choose the direction you're taking (Buy/Long). This isn't placing a trade on IG, it's just planning your position.
Ignore the limit, our system isn't using one. We're following the trend until it ends.
Underneath all this in the 'Deal' window you'll now see the projected 'margin' of your proposed position size. Adjust your position size in the top field until your margin/equity used matches 2.5% of your overall account equity.
Once that is all done, hit 'Place deal'
Now you're in the markets.
Do the same for the other shortlisted stocks, and check back in on the last trading day of every month before the markets close to find out if you're remaining in your positions, or closing them out and moving to cash.
Keep an eye on this blog and I'll advise you when we've got new stocks appear on our screener that we're adding to our portfolio. We'll add these whenever we have less than 25% equity used on our account, up to a max of 15 positions. With a lower account balance, like the one we're starting this experiment with, it's likely that (depending on the stocks) we'll have to start with fewer positions, otherwise we won't be able to place the trades on stocks with larger margin requirements.
You will notice that when you've placed your first trades, that they're all in the red (making a loss), don't panic, that is normal. you're spread betting, so rather than paying a flat commission fee for every open/close of a trade, instead you buy at a higher level than the true market price, and sell at a lower level than the true market price. This is how the brokers take their cut, and ultimately, as soon as the price moves up a little bit you'll be back in profit. The lower the spread (difference between the 'buy' and 'sell' prices, the better, as your trade has to move less before it's in profit!
Shorter Answer: Sign up and follow along. Connect with me on social media too! I'll update the blog as and when new stocks enter our radar.
In the blog I will dedicate a category to this experiment and if you subscribe to receive emails then I'll keep you posted. Check back in regularly for updates, or alternatively sign up to Stockopedia and keep yourself informed independently.
I will publish ALL my trades in this experiment whether winners or losers, and I hope that in doing so it will provide a realistic view to beginners of what trading looks like.
I've never traded this system before. I'm in no way promising profits, or performance that is consistent with historical data. I'm doing this as an experiment for you to follow along with at your own discretion. The premise is to show how easy it is to start spread betting stocks and beat 'Buy and Hold'.
This is how beginner traders/investors all start to become profitable traders, by having a system that provides an edge on the market, and consistently sticking to it. It's much easier to stick to it when you share your results with others, so please do feel free to share your results as and when you join in.
Different people will start at different times, sometimes you may have a moment of madness or weakness and close out of a trade when you shouldn't. Or you may add too much size. Whatever it is, share it with me and others in the experiment and allow yourself to be open about it, as this really does help breed better habits in everyone.
I hold myself to these same rules.
So what do you say? It's not a guarantee of riches for life. But I hope you'll agree that it's a solid plan that on paper should beat the standard investors approach of 'buy and hold'... 'hit and hope'. Let me know in the comments or via Twitter if you're going to get involved!
*Always read the label, may contain nuts, always seek the advice of a qualified/certified professional accountant to assess your own personal circumstances. But although 'terms and conditions' may apply, this is the case in the UK because you're not buying the underlying asset, you're simply betting on which way it goes. So it's technically a gamble which HMRC would find it hard to tax, because if they did they'd also need to take into account all the losses to offset against income, and do you know how many retail traders lose money in spread betting? It's a lot! Over 90% most years. So it's likely to remain the case that spread betting is tax-free in the UK for residents for the foreseeable future.
**DISCLAIMER: Please be aware that I am not a certified professional trader/investor or educator. Trading, especially with leveraged products such a derivatives carries enormous risk and you can in fact lose more than you deposit if you don't manage your risk carefully. I am sharing my own thoughts, opinions and trades on this site for the purpose of discussion, interest value and above all...fun. I do not accept any responsibility for losses you may incur as a result of following my advice or actions. I'll take credit for your profits though ;-) Please trade responsibly and enjoy the markets.