Unlike the Dogs of the Dow, which is a strategy buying the 10 Dow stocks with the highest dividend yield at the beginning of the year, then dumping the "dogs" at the end of the year and selecting new ones, the "Free Lunch" trade is a very different strategy executed in mid December and shorter in duration. It attempts to take advantage of several year end phenomena such as index re-blalancing, tax selling, Santa Claus Rally, January effect, etc. and lasts until February.
According to MrTopStep:
Research has shown that NYSE stocks making new 52-week week lows in mid-December, primarily due to year end tax-loss selling, tend to outperform the NYSE through mid-February. These stocks are selected ahead of the Santa Claus Rally and approximately near the start of the January Effect.
Many of the stocks selected for the “Free Lunch” trade are down for good reason. Declining revenue and shrinking profits are most common amongst these names while others may have run into legal or accounting trouble. Once a name pops, profits should be taken and conversely if a name continues lower it should be cut loose quickly.
I think it's important to stress here to research just "why" these stocks are hitting a new 52-week low and take this into consideration when making your list of potential candidates. Clearly many of the big losers this year were in the energy sector and your certainly do not want to necessarily select a name at random. The above tickers (click to enlarge) have sold off over 60% from their high, offer good liquidity (1mil+) and are still projecting higher EPS in 2015 so they may be worth a look.
As an example, stocktradersalmanac 2013 free lunch trade (utilizing trailing stops) yielded beautiful results:
Since the close on December 20, our “Free Lunch” basket of bargain stocks has gained an average of 24% through the close on January 17 compared to a NYSE gain of 1.4%.
I myself recommended buying the Russia ETF, RSX on it's heavy sell off (see post on Blood in the Streets) as well as Russian internet name YNDX. You may come up with your own screen or just go with stocks making new 52-week lows but this is certainly an interesting strategy. If MrTopStep likes it, why not you?
Edited 9:53 am to add stocktradersalmanac link
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Jeff Hirsch @ Stocktradersalmanac posted on his 2014 Free Lunch trades:
Some rather tasty morsels were served up in the list of stocks hitting new 52-week lows last Friday. From the initial batch of about 78 stocks on the NYSE, AMEX and NASDAQ that made a new 52-week low we boiled it down to 17 choice selections for our 2014 FREE Lunch Menu of Bargain Stocks. After we eliminated preferred stocks, funds, splits, special high dividends and new issues we cut stocks trading below $1.00. The remaining stocks had to average at least 25,000 shares per day over the last three months and have a market cap of at least $20 million. Finally, any stock that was not down 30% or more from its 52-week high to the 52-week low reached on Friday were also eliminated.
Unlike previous years, we suggested specific buy limits and stop losses for each stock included and the trades will be tracked in the Almanac Investor Stock Portfolios. It turned out to be a surprisingly diversified group of companies and several receive high marks from rating agencies. The market’s rally off last Tuesday’s low and the rebound in the energy stocks reduced the number of oil-related shares making new lows on Friday. Though there are two Oil & Gas Royalty Trusts on the list. The biggest group representing is three from the big winner of the year yet recently beleaguered biotech sector.
The remaining dozen: International Restaurants, Israeli Cellphone Services, Apparel Manufacturing, Metallurgical Coal Miner, Specialty Steel Manufacturing, Online Dating, Chinese Internet, Travel, Solar, 3D printer, HVAC & Compressor Manufacturing and Medical Products. We were able to get a position at our suggested buy limits or better in all but three stocks so far. Hanwha SolarOne (HSOL), Spark Networks (LOV) and Tecumseh Products (TECU) all ran up and never traded at or below our buy limits. Amazingly, TECU was up 87% at one point today – 130% more than Friday’s close. But you can’t get them all.
Please remember, this “Free Lunch” strategy is not for the faint at heart. It is a quick, short-term strategy for sophisticated nimble traders. Folks tend to get rid of their losers near yearend for tax-loss purposes, often driving these stocks down to bargain levels. Over the years we have shown (STA 2015, page 112) that NYSE stocks trading at a new 52-week low on or about December 15 will usually outperform the market by February 15 in the following year. In the past 15 years we have added stocks from AMEX and NASDAQ and found that the most opportune time to compile our list is on the Friday of December triple witching which often further depresses already distressed equities and leaves plenty of time to capitalize on the Santa Claus Rally and January Effect.
If you buy these stocks, please note the following:
1. Consider selling them as soon as you have a significant gain and utilizing stop losses.
2. The stocks all behave differently and there is no automatic trigger point to sell at.
3. Standard trading rules from the Almanac Investor Stock & ETF Portfolios do not apply for these stocks.
4. We think you should be out of all of these stocks between the middle of January and the middle of February.
5. Also, be careful not to chase these stocks if they have already run away.
DISCLOSURE NOTE: At press time officers of the Hirsch Organization or the accounts they control, held positions in ARCO, BIND, CCIH, CEL, EPAX, IMGN, OGXI, OXM, SJT, SSYS, TNDM, WHX, WLT, and WOR.