CAPE <> F-Score <> Quad Top Trading Strategy

Warren Buffet once said “Price Is What You Pay, Value Is What You Get”.

This simple statement clearly conveys the knowledge & experience he's acquired throughout his illustrious career.

I'll never hold a flame to the Oracle of Omaha, but luckily, he continuously writes and talks about his understanding of the markets, and from that we can all learn a thing or two.

Since my interest in financial markets began in high-school, I've grown a strong passion for trying to decipher the madness of markets in pursuit of unearthing valuable trading opportunities.

Some call this obsession a fools errand, some call it an passion, and others have had the good fortune of making it a career.

At times I've certainly agreed with the sentiment that it's a fools errand, but the long-held belief that one can systematically evaluate the future appreciation or depreciation of equity market prices has always intrigued me.

While learning about (and trying to make sense of) the markets over the years, I've come with aGlobal Macro Long/Short Equity Trading Strategy that I believe has some merit.

The strategy includes three primary components: 2 fundamental criteria for value discovery, & 1 technical criteria for assessing momentum and determining entry & exit. These components are:

1. Cyclically Adjusted Price-to-Earnings Ratio (CAPE): Utilizing an exponential moving average with calculation based on quarterly data for 8,9, or 10 year time-frame(s). Parameter depends on desired responsiveness

2. Piotroski F-Score: Calculation based on quarterly data - Indicator defined by aggregate signal measure, F-SCORE, is the sum of the nine binary signals - Buy/sell threshold determined somewhere in the 4 - 6 range, depending on how strict or loss the threshold parameters should be.

3. Triple-or-Quad-Top Breakout or Breakdown on P&F Charts: Triple or Quad top depends upon risk preference

Using the above criteria, you implement the strategy as follows:

1. Calculate the CAPE (EMA Q,10) of all stocks in an index and rank them in ascending order.
2. Calculate percentage ranking of all stocks according to CAPE.
3. Calculate the F-Score of each stock.
4. For the bottom 20% (0-20%) of all stocks according to CAPE, select all stocks that have an F-Score above 5. These are your long positions.
5. For the top 20% (100-80%) of all stocks according to CAPE, select all stocks that have an F-Score below 4.These are your short positions.
6. For selection of long positions, entry point is determined when price achieves triple-or-quad-top breakout on P&F chart, based on weekly or quarterly data (parameters depend on entry/exit risk preferences).
7. For selection of long positions, exit point is determined when price reaches 80th percentile of CAPE scores, or F-Score falls below 4.
8. For selection of short positions, entry point is determined when price achieves triple-or-quad-top breakdown on P&F chart, based on weekly or quarterly data (parameters depend on entry/exit risk preferences).
9. For selection of short positions, exit point is determined when price reaches 40th percentile of CAPE scores, or F-Score increases above 5.

Over the next several weeks, I'll post articles that dive into the implementation of this strategy that I've developed in python.

I warmly welcome any questions / comments / criticism about this trading strategy.

Thanks for reading!

DISCLAIMER: To be brutally honest, I do not know if this strategy can consistently generate abnormal risk-adjusted rates of return. I am simply sharing this idea so others can contest or explore its potential usefulness. The information in this post does not constitute investment advice. I will not accept liability for any loss or damage, including without limitation any loss of profit, which may arise directly or indirectly from use of or reliance on such information.