A Numbers Update & Turning Abstract Letters into Investment Strategies
Bridging the Gap Between Theory and Practice
A warm hello to all new readers! I’m glad you are on board.
New here? I’m Michael and on a mission to make beating the stock market as easy for you as choosing your favorite ice cream. I write an algorithm that does exactly that.
How it all started. The journey so far.
“Mathematics is the most beautiful and most powerful creation of the human spirit.
- Stefan Banach
For me, math and its equations used to be just letters that you push around on paper. They seemed disconnected from reality. Like a baby trying to ride a bike.
But then came a project during university that changed everything. And as always in life, reality hits hard.
In a practical project, we were tackling a vibration problem. My approach? The good old-fashioned way—trial and error. I confidently declared, "We need a damper!"
My friend Dennis, also still just a mechanic and fellow student at the time, looked at me as if I had just suggested repairing a rocket with duct tape. "Or," he said with his calm voice, "we could just increase 'm'—you know, the mass—to decrease the frequency."
I blinked at him. "How do you know that? Why not just use a damper and we are done?"
He looked at me, grabbed a piece of paper, and scribbled down the math equation. "Look," pointing at the paper, "if we increase m, the frequency decreases because the denominator gets bigger. It’s right here in the math."
That was one of my "aha" moments in life. Suddenly, those dry letters and cryptic symbols made sense. They weren’t just abstract concepts anymore—they suddenly had practical, tangible use. I realized that math was just another language that explained how the world worked. I finally understood how powerful it is – if you read and understand the equations and don’t just see them as abstract letters.
Why am I telling you all this? Math might feel dry sometimes and it has its limits, but trust me, it’s like the hidden wiring in a machine. It makes things work.
This article is all about numbers, but I will do my best to make it as easy to consume as possible.
We will talk about the returns the algorithm produced in my backtests and what they mean in real life.
Shall we start?
The Progress
Short and sweet.
I’ve picked the three most promising strategies, and I must say, that the numbers below look quite impressive. I’m sure you notice the blue areas. As a longtime reader, you already know that all algorithms will have some luck as they do the work. No matter how optimized they are, chance—some call it luck—always plays a role in our world, no matter how digitalized it is, or becomes. Therefore, we should keep in mind that numbers can become bloated just by chance.
So, here's takeaway number one: every algorithm has a bit of makeup on.
Now, onto takeaway number two: the good news is that math can help us bring these results down to earth. It can adjust the numbers to a conservative level, making them more realistic. So, takeaway number two is that the numbers below are naturally inflated by default called luck but are then deflated by our friend math.
Specifically, we deflate the Sharpe ratio (here is an old article for more context).
TLDR; the Sharpe ratio measures how much return we get for each unit of risk.
How much do we have to deflate? In a minute, you will know.
Here are the inflated returns the algorithm produced.
TheValueVantage.com - Strategy 1
Strategy Mean Returns (without Dividends): 19.68%
CAGR of Strategy (with Dividends): 17.77%
Beta: 0.61
Standard Deviation: 21.91
Sharpe Ratio: 0.9
Expected Excess Returns Ratio: 19.63%
Sortino Ratio: 3.28
Deflated Sharpe Ratio: 0.72
Strategy was: 18 times out of 26 times better than the SP500
The strategy was 69.23% of the time better than the SP500
The strategy was: 18 times out of 26 times better than the Dow Jones
The strategy was 69.23% of the time better than the Dow Jones
TheValueVantage.com - Strategy 2
Strategy Mean Returns (without Dividends): 20.19%
CAGR of Strategy (with Dividends): 18.12%
Beta: 0.64
Standard Deviation: 22.81
Sharpe Ratio: 0.88
Expected Excess Returns Ratio: 20.14%
Sortino Ratio: 2.83
Deflated Sharpe Ratio: 0.715
The strategy was: 20 times out of 26 times better than the SP500
The strategy was 76.92% of the time better than the SP500
The strategy was: 19 times out of 26 times better than the Dow Jones
The strategy was 73.08% of the time better than the Dow Jones
TheValueVantage.com - Strategy 3
Strategy Mean Returns (without Dividends): 20.46%
CAGR of Strategy (with Dividends): 18.36%
Beta: 0.76
Standard Deviation: 22.85
Sharpe Ratio: 0.89
Expected Excess Returns Ratio: 20.41%
Sortino Ratio: 2.71
Deflated Sharpe Ratio: 0.72
The strategy was: 20 times out of 26 times better than the SP500
The strategy was 76.92% of the time better than the SP500
The strategy was: 19 times out of 26 times better than the Dow Jones
The strategy was 69.23% of the time better than the Dow Jones
For Context
Risk-free Return Rate: 5.0%
SP500 TR
Mean Return Rate SP500 : 9.94%
Compounded $ Amount S&P500: 794,756
CAGR: 8.3%
Dow Jones
Mean Return Rate Dow Jones : 7.24%
Compounded $ Amount Dow Jones: 476,166
CAGR: 6.19%
As we can see, the deflated Sharpe ratio is roughly 20% reduced than the calculated one. This is good, because now we can deflate the returns for each year by this number, and we get the returns below.
They are lower and still impressive.
Ok, now the final step. Or the last question.
What’s the blue stuff?
Maybe you remember the liquidity topic. Liquidity refers to how easily you can sell an asset. For example, if you want to sell a stock, you need a buyer. If there's no buyer, the market is illiquid. Everybody who tries to sell a house knows the housing market, is quite illiquid because it takes a while until the deal is done. On the other hand, if you want to sell Apple stock it is sold in seconds.
So, we need a minimum level of liquidity to make our strategy work in the real world. In addition, if we're the only ones buying or selling stocks, we become market makers/movers, which can significantly impact the market—something we want to avoid at all costs.
How much liquidity do we need?
And how much is needed to avoid becoming a market maker/movers?
That's up to you, but here's what I did: I asked my friends logic and math, and they said.
Stay under the radar and hide in a big enough crowd.
Great.
What does that mean in real life?
Literature suggests staying 5% below the daily market volume of a stock to achieve this. I've calculated the numbers for daily liquidity of at least $500k and $2 million per stock, and the results are quite similar.
With an investment of $100k per stock, we stay under the 5% threshold. This means we can move a portfolio of 25 stocks up to $2.5 million annually without significantly impacting the market. Notice, the blue areas start around this threshold, showing that these three strategies remain effective for a long time. With a starting investment of $100k, which breaks down to $4000 per stock initially, this strategy could be used for roughly 20 years, keeping us on the safe side for a very long time. And since we put more money into larger companies than smaller ones, in reality even longer.
I'll still calculate larger liquidity pools to see how they impact returns further down the road.
The Results
So I guess it’s safe to say that the algorithm produced a deflated CAGR of 14.7% and that the strategy has a mean return of 16.5%.
From my perspective, we have pretty solid results for now.
So, what's next?
The Plan
These results are calculated for a fixed 12-month interval, from the end of one year to the next. But what if you want to start on March 1st or May 17th?
That's the final step.
After calculating bigger daily liquidity pools, I'll apply these three strategies over a full year to see their day-to-day performance.
The code is already written; I just need to update a few pieces, and we'll be good to go.
If you find errors in my logic, feel free to hit me up.
What’s on my head
Great progress. Even though the last weeks have felt messy, the results are satisfying.
Nuggets
I’ve added a Cheat Sheet site to my profile where you can find concept breakdowns and other things to keep in mind. Just click or tab here.
I will add more with time.
So that’s a wrap for today Stock Star!
Hit that heart if you love progress!
Michael
Hit that heart if you love moving forward in your life!
Michael
Recommend The Economy Rocket to your readers and friends
I share my stock investment story without sugarcoating – you get the good, the bad, and those tricky ego trips. I'm developing a service with a mix of smart code and proven investment strategies, making stock analysis a thing of the past if you wish. Why? Because life offers so much more beyond the confines of stock analysis.
Disclaimer:
The information in this article is my personal opinion. I’m not a certified investment professional. It is not consulting, nor does it constitute investment recommendations.
I do my research carefully and follow my personal investment strategy.
The stock market is a complex building with its own rules. There are no rules set in stone, like the rules of physics.
Therefore, use the contents of this newsletter at your own risk and do your own research as well. Investing in the stock market can lead to a total loss of the capital invested.