Nifty Gap-up Strategy

As a stock investor, it is hard to beat the market benchmark (Nifty 50, Sensex etc.) without an informational edge in these times through mutual funds. The active mutual fund manager tries hard to beat the benchmark, but given the impact of expense ratio, it is infrequent that one mutual fund has beaten the market consistently. Thus one has to take more risk to beat the market and expand their universe and go beyond the Nifty 50 stocks. Also, the nuanced investors do not know how to pick stocks in their portfolios. So from Jorge Bogle’s idea, it is an optimal strategy to buy a whole index (Nifty 50) by ETFs or Index funds to get the market return.

But here, we will discuss a simple strategy to outperform the market while reducing the drawdown of wealth.

(Note: For the Backtesting, We have taken the Nifty 50 Futures data from 26 October 2007 to 6 December 2021)

The above chart shows that the buy and hold strategy has faced a significant drawdown in the 2008 financial crisis and the 2020 Covid-19 crisis one has to see, wiping out 59.96% of the wealth during the 2008 financial crisis. While Nifty 50 has compounded 8.18% CAGR in these 14 years, that means if you had invested 100 rupees on 26 October 2007, it would have become 300.62 rupees.

Now let’s see the primary strategy of this article.

Strategy: Every day, buy a Nifty Futures at the market’s closing and sell it the next day at the market’s opening.

From the above chart, we can see that this strategy has beaten the market and compounded at the rate of 12.48%, and one has to face a 36.85% drawdown of their wealth in the 2008 financial crisis, which is far much better than buy and hold strategy. Using this strategy, if one had started with 100 rupees on 26 October 2007, It would have become 519.7 rupees.

We can also use one modification to reduce drawdown substantially using the 200 SMA filter.

Modified Strategy: Every day, buy a Nifty Futures at the market’s closing and sell this it the next day at the market’s opening if and only if the Nifty Futures is above its 200 SMA.

So with this modification, we can reduce drawdown very substantially to 10.46%. We can enjoy the CAGR of 13.08%. If one had invested 100 rupees on 20 August 2008, it would have become 494.13 rupees (Note: We started on 20 August because of drawing a 200 SMA line).

Summary: From the above study, we see that it pays to hold the position overnight rather than trading the active market.

By Kaushik Sanghani