Testing our models
We can use our inputs to create simple stop-and-reverse trading systems. Our systems also will allow us to further analyze the predictive nature of our inputs, as well as analyze how given inputs interact with one another.
Consider the following set of rules:
These simple rules (which have been optimized) create a model that beats buy and hold. Tested from Jan. 2, 1978 through May 23, 2013, our trades are 75.68% profitable with an average win of $507.02 and an average loss of $258.19. Our maximum intraday drawdown is $485.62, and the profit factor is a whopping 5.32. The total net profit over the period is $2,401.49. The system makes money on both the long and short sides of the market. The implication of these results, even though they are not walk-forward, is that earnings momentum is predictive of future S&P 500 price movement.
This variant is based on dividends:
It does not do as well as the earnings momentum version, but it still beats buy and hold. We make $1,427.80 on the long side with an open trade of $508.80. We also made $369.31 on the short side. This shows that dividend momentum is indeed predictive as well.