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Tuesday, March 28, 2017

Volatility and Arbitrage

Posted by Robert on July 29, 2013

Sometimes, trading stocks is easy and fun. Sometimes, it’s difficult and painful. If I had to guess, I’d say that the market goes up about 1/2 of the time, goes down (by almost an equal amount) about 1/6 of the time, and the rest of the time it goes sideways. Looking back, we (in Canada) appear to have been stuck in “sideways” movement over the past two years. The market really hasn’t made any progress (or lost any value) over that time.

That’s not to say there haven’t been opportunities to make money. I don’t really advocate trying to time the market. Investing everything when the market is low, trying to sell at the top and buy back in at the bottom, is a fool’s game. Chances are very slim that anyone will make enough money that way to overcome the time, effort, stress and trading fees that it costs. But neither do I advocate buying and holding a group of stocks no matter what.

What makes sense to me is owning good stocks at a reasonable price. Companies (and their stock) have a “personality” that you can get to know. Some are seasonal, rising in the winter and falling in the summer (or along some other pattern). One example might be Gildan Activewear (GIL), the T-shirt maker. Some will rise (and fall) in spurts, as new products impress or disappoint. An example would be Apple (AAPL). Some companies will perform well (or poorly) according to the economic cycle. As an example, WalMart (WMT) has tended to rise as the economy fell and shoppers started seeking deals.

If you own and watch a number of companies that you are familiar with, where you are reasonably confident of their business prospects, you are likely to see opportunities arise. To use the examples above, you may own Gildan and Apple, but not Wal-Mart. The economy may begin to perform poorly, and you may see that Gildan and Apple are beginning to fall, but WalMart is beginning to rise. There is an opportunity to sell (some or all) your shares of Apple and Gildan and instead buy WalMart. I consider this to be a type of arbitrage. These companies all make up part of the market, and the market will continue to fall (or rise), but the shares you own and watch may move differently, compared to each other. When some go down and others go up, especially if there is no discernible reason, it may be an opportunity to sell high and buy low.

This works especially well for me when I invest in dividend paying stocks. Assume (for simplicity) that they all pay the same dividend. Then, after some time, some share prices fall and other rise, in response to supply and demand of the shares and no fundamental changes. I can sell the low yielding stocks (where the prices rose) and buy the higher yielding stocks (where the prices have fallen). ┬áThis helps me to sell high and buy low, as well as increasing my monthly income. This opportunity doesn’t arise often, but I watch for it and act on it when I can. Recently, I sold RPI.UN to buy RET.A. I’m now seeing RET.A rise in price, and so I’ve profited from that trade. It doesn’t always work, but when it does, it seems to be a lower risk way of profiting from the stock market.

How do you give yourself the best chance to buy low and sell high? Or do you have an entirely different investment strategy? How do you mitigate the risk?

Comments

One Response to “Volatility and Arbitrage”
  1. Elizabeth says:

    I just buy the index. I have neither the time, interest, or faith that I can time the market. (Come to think of it I am highly skeptical of anyone who thinks that they can accurately time stocks, and if they can chances are I can’t afford them!)

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