The Scammer Investment Strategy: A Cautionary Case Study

Understanding the Pitfalls of Unvalidated Backtesting and Illiquid Stocks

Introduction

The "Scammer" Investment Strategy of the SimFin user Howard, despite its audacious name, serves as an important example of the pitfalls of relying solely on backtesting without proper validation through paper trading.

The user Howard provides an eye-opening demonstration of how apparent high-performance (126% CAGR!?) in backtesting could be misleading when the strategy invests in illiquid penny stocks. The strategy seemingly offers high growth potential, but the lack of volume makes execution of trades unrealistic, thus presenting a false picture of profitability.

Our Chosen Stock Filters

EV/EBITDA: It filters for companies whose EV/EBITDA ratios are above 0 but below the 90th percentile of all companies.

Closing Price Growth Rate: Companies that have a 1-week closing price growth rate lower than the 10th percentile of all companies are targeted.

Trading Volume: It ensures that the trading volume of selected stocks is higher than their 1-week simple moving average.

Return on Equity: The portfolio rules emphasize firms with a trailing twelve-months Return on Equity higher than the third quantile of all companies.

Trading Volume Average: It only considers companies with a 1-year simple moving average trading volume higher than 500,000.

Snapshot of Listed Stocks

This is a list of the 11 matching stocks in the portfolio that fit the aforementioned filters (14/06/2023).

Strategy Intent

According to Howard, the Scammer Strategy primarily serves as a cautionary example, highlighting the dangers of relying on backtesting without proper validation. Its original design of investing in illiquid penny stocks led to inflated backtest results that could not be practically realized due to low trading volumes. With the updated filters, it now aims for more realistic performance based on a balanced blend of value and growth factors in companies with adequate trading volumes.

Opportunities

While the Scammer strategy initially serves as a cautionary tale, the updated version with added volume filters presents a realistic opportunity for steady growth with a CAGR of 28% since July 2011.

Risks

The original design of the Scammer Strategy emphasizes the significant risks of investing in illiquid stocks, including the difficulty in buying and selling at desired prices and potential losses due to price volatility.

Backtest Result Presentation

The backtesting of the modified Scammer Strategy, from July 2011 to present, resulted in a respectable 28% CAGR. However, it's crucial to note that the original design, despite showing an inflated $1.7 million in backtesting, is practically unachievable due to its reliance on illiquid penny stocks.

Summary

The Scammer Investment Strategy is a valuable learning tool from SimFin user Howard, illustrating the importance of validating backtest results with real-world trading conditions. The updated strategy, with volume filters, seeks to offer realistic and consistent returns, emphasizing the necessity of thorough investment strategy evaluation.

Link to original portfolio "Scammer" of user Howard: https://app.simfin.com/portfolio/649089fb4aee6943a1dd5cfc

Disclaimer: Investing in stocks always involves a risk of loss. Past performance does not guarantee future returns. Please consider your financial situation and consult a financial advisor before making any investment. This strategy should serve as a cautionary example, emphasizing the importance of validating backtesting with realistic trading conditions.