Analysis: Should we await a pull back before investing?

We are trying to further optimize the returns of the portfolio of the best performing S&P stock identified in the previous article.

Using the simulator, we are verifying the hypothesis that holding off investing awaiting for a pull-back in the stock price leads to greater returns and reduced risk.

We test the returns if each of the portfolio stocks is not bought right away at time 0 but is only invested into when there's a pull-back of 7%, 15% and 40% from the all-time-high of the stock price.

We are simulating across all 3Y periods within the last 20Y (like in the previous article).

Simulation results: buying right away

Read the 10th percentile results as follows:
- in 90% of the 3Y periods the stock generated 16% annualized return or better
- in 90% of the 3Y periods the total value of the portfolio experienced the maximum intermediate loss of -19% of better .

Note:
- for the maximum drawdown we are evaluating the loss of the total value (both cash and stock) relative to the value at time 0

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Simulation results: waiting for 7% pull-back

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Simulation results: waiting for 15% pull-back

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Simulation results: waiting for 40% pull-back

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Conclusions

Based on the results above, we conclude that it makes NO sense holding off the investment for the stocks in the portfolio.

Namely, we see that waiting and investing on a pull-back reduces the typical returns (compare the 50th percentile of returns across the charts above).

The consistency of return also gets worse(compare the 10th percentile of returns).

This is explained by the following:

- We are loosing the upside the stock gains while we are waiting for a pull-back
The stock being close to the all-time-high actually means the market conditions are favorable and significant gains are likely. These gains are likely to be bigger that the pull-back we are expecting.

- The stocks in our portfolio are insufficiently volatile
In fact, the consistency of returns was one of the reasons we selected them.

Quite surprisingly, awaiting a pull-back also does NOT improve the safety of investment for the stocks in the portfolio (compare the Max draw-down across the charts).

By investing on a pull-back you are investing during the period of inferior market conditions that haven't yet reached the bottom. So, you are likely get to see significant losses shortly after buying the stock.

This is opposite to the right-away purchase of stocks when you are investing during the better times.
This way if the stock gains 15% and drops 10% you will still be in the positive territory (+5%) no money is lost relative to time zero. Note that we are calculating max draw-down relative to T0.