Long / short: blending stat and fundamentals

Research review: Percent accruals (2010)

A subscriber to our premium research newsletter and owner of our software commented that he was surprised by the depth of fundamental analysis we applied to our selections.

This is particularly the case where the anticipated trade horizon demands it. That is, it is frequently a good idea to identify the stronger half of your pair and trade with it rather than against it – especially for longer trade durations. Over time pricing is more likely to reflect fundamentals than not.

This approach is in keeping with the notion of “filters” we have written about several times in our research to clients: the stat tells one story; technical indicators another; sentiment yet another; and the accounting one more (and so on). The sweet-spot where these filters overlap represents a validation of one’s primary methodology.

To underline this point have a read of this older but still valid paper that is accounting-focussed. The core, entirely reasonable notion is that cash trumps accruals – and the large data set presented demonstrates the payoff. The authors are positing that a single indicator allows traders to select both a long and a short and expect a significant reward (in the aggregate) over the following accounting exercise.

These types of indicators are useful secondary triggers that help validate a trade’s thesis. But limitations remain and it would be a misguided trader who sought to apply it (i) in isolation; and (ii) for very short-term trades.

 

*This is an abridged version of an excerpt from our research service. Try it free.