Don’t Fight the Tape strategy was created by Ned Davis. Davis follows the stock market action (the tape itself) to create his buy and sell signals. Davis observed that market strength leads to greater strength and vice versa. Hence the saying: the trend is your friend.
Don’t Fight the Tape method
The market trend allows the investor to see general price directions. Davis uses the Value Line Index to measure the market action. The Value Line Index is comprised of approximately 1700 stocks. Its value is published daily in suitable financial papers and websites. Davis uses the weekly close price for his buy and sell signals. These readings are published in Barron’s and Sunday’s New York Times.
Davis believes that a 4% change in the Value Line Index signals the trend change. During the 20 years of his market analysis (1966 -1985), Davis observed 42 buy points and 42 sell points. 20 buy points (48%) resulted in an average profit of 15.3% and 22 sell points (52%) resulted in art average loss of 3.9%. Investments were held at an average of 94 days bringing an annual return on 17.9%.
22 sell points (52%) turned profitable and 20 (48%) produced losses. The average profit amounted to 8.9% and the average loss was 3.6%. Investments (short positions) were held an average of 70 days, bringing an annual return of 16.4%.
A 4% rise in the Value Line Index signals a buy point and a 4% decline signals a sell point. Let’s assume that the Value Line Index closed at 200 on Friday (weekly close). If the index rises to 208 a buy point would be signaled.
Let’s assume that within two weeks the index rose to 209. The investor buys stocks and holds them until the index drops by 4%.
Let’s further assume that after a buy signal the index continues to rise to 240 and after reaching this level it starts to decline. Investors would sell their portfolio of stocks and go short if, and only if, the index declines to 230.40.
The advantage of this strategy is the ease of watching the market, and a guarantee of staying invested on the right side of the market. Its disadvantage is the multitude of transactions.
According to Ned Davis, market history suggests that most dips (declines of 5%) in the Dow Jones Industrial Average don’t turn into anything serious. But once the Dow Industrials are down 10%, there is an almost even chance the total damage will be 15% or more.