Trading Strategy for Bear Markets

Abstract

This paper aims to find a strategy that would work even during bear markets. Such approach should be profitable even when the equity markets are down and could be used as a hedge during those bad times. Common sense suggests that maybe some different asset classes could be used for such purpose. Therefore this paper examines the relationship between prices and skewness of commodities from the practitioner's point of view, where such idea is based on something similar in the world of equities, the Lottery effect in the stocks. Individual investors tend to prefer stocks with lottery-like payoffs in the search for the as high profits as it is possible, and they are willing to play the equity lottery. Unfortunately, in the lotteries, there is a small number of winners, a large number of losers, and one happy lottery ticket issuer that has profited from it. Studies have found out that stocks with lottery-like payoffs have negative abnormal returns if they are compared to the stocks with non-lottery-like payoffs. The same results are found in the world of commodities, where the lottery-like characteristics can be measured by skewness. Most importantly, such a strategy consisting of going long four commodities with the lowest skewness and shorting four commodities with the highest skewness is profitable and negatively correlated with the equity market. It also survives various trading assumptions and trading costs, while remaining profitable.

Keywords: trading strategy, skewness effect, commodities, bear markets, hedge, lottery effect