Saturday, May 7, 2011

Adventures in Being Wrong

I thought the video of Kathryn Schultz was well worth the time to watch. In a lot of ways it can be easily connected to our current toxic political environment, and the type of environment that leads to catastrophic errors in calculations by so called experts.



Tuesday, May 3, 2011

Good Article on Commodities

I came across this little report recently that reaffirms some of my long term views about the future. The single largest problem our world faces is population growth and the demand on resources this presents. Oil production is really the major factor that has allowed world populations to grow at the rate they have grown. The developments in seeds and fertilizers are also responsible. I think we are going to find that we will soon be, (if we haven't already) experiencing limits to oil and fertilizer production that simply cannot keep up with expanding population growth. China realizes this. They invest heavily in trying to maintain their future supplies of these resources. This is going to mean long term prices are going to be going up, and in my opinion probably a large drop in standard of living for the next generation.

Read the article. It's worth your time.

Link to article

Sunday, May 1, 2011

GB9A Relative Strength Portfolio

Here is a relative strength portfolio that I just started trading. I'll explain what it is and the rationale for using it.

The portfolio uses 9 asset classes. DBC (Commodities), EEM (Emerging Markets), EFA (EAFE index), IAU (Gold), SH (Short S&P), SPY (S&P 500), TIP (Inflation protected treasuries), TLT (15 year treasury), VNQ (real estate).


Why so few etfs? I've found that packing too many etfs into a relative strength portfolio doesn't add performance. It actually hinders it from rotating to the best performing sector. It's best to keep it simple and not over complicate it by adding similar asset classes with slightly different shades. Some people like to create separate portfolios for bonds, international stocks, and US stocks. That is typical asset allocation. However, I would like to point out that in a bull market your bond allocation will be in high yield bonds which don't provide you the traditional protection that treasury bonds add. Your asset allocation won't protect you in the same way a fixed asset allocation will. So in this light I'd rather go with one portfolio and let it rotate to the best asset class.

How many to hold? I'm selecting the top 2 asset classes from the list. Why? The top 2 provides a little more stability to the returns while still allowing the portfolio to completely exit an asset class. Using 3 etfs in such a small portfolio means you have to hold an under performing asset class. To hold more asset classes you need a larger portfolio.

How is the relative strength calculated? It is calculated using the 3 month price performance weighting this calculation at 70 percent. It also uses the 20 say volatility weighting this calculation at 30 percent.  I've back tested 6 month price performance the the draw downs are much higher. The 3 month catches the big trends but adapts fast enough to get you out of an asset class as it begins to lose favor. A smaller time frame can help you get out even sooner but you will get whipped around more and it doesn't seem to help overall returns. The volatility filter helps reduce draw downs and provides more stable returns. As the volatility of an etf increases it's rank will be pushed lower. Volatility eats into returns and is also a sign that an asset class is beginning to fail. It will hurt overall returns but will reduce risk and draw downs. I think I've found a good balance with this weighting.

How often do you update the portfolio? The portfolio is updated once per month. Updating more often doesn't increase returns, nor does it reduce risk. You only whipsaw yourself. No stops are used but I will start calculating an equity curve and see if that helps reduce draw down and risk.

What about risk management? That's up to you. You can use stops, and equity curve, puts, nothing or a combo. I'm going to let it run without stops and trust that the portfolio to rotate as it is designed into treasuries, or an S&P short if the market dives. I like using cheap out of the money puts to protect against major catastrophes in excess of 30 percent losses. Less than that I'll let the portfolio run and rotate me out into safety at the beginning of each month.

Important Notes About the Back Test
The max draw down on the performance graphs is calculated monthly. It is not your true max draw down. During the month the portfolio could draw down much greater than 15 percent. All the performance test is showing you is that from month to month it never exceeded 15 percent, but it could have drawn down 30 percent or more during the month. A couple of the etfs on the list did not exist before 2006 so the performance before 2006 would be impacted by this.

So in a nutshell here are the rules.

1) Buy the top 2 etfs in the portfolio according to the above ranking rules
2) Update the holdings once per month. If the etfs being held are no longer the top 2 performers they are sold and replaced by the new top 2 performers. If nothing has changed in the rankings then nothing is bought or sold that month.
3) Take the good and the bad. Sit tight and let the portfolio work. It will out perform at times, and also correct sooner or larger than the overall market at times.

I'm trading this portfolio and I'll keep updates on the 1st of the month on it's progress. I'll also post some more info on this portfolio and additional tests as I go along.

Thursday, April 28, 2011

This Credit Rating Agency Has it Right

I've wondered for quite some time how the United States with a 12+ trillion dollar debt, has maintained a credit rating higher than China, a country with a huge mega surplus of cash. It makes no sense. We all know about the S&P threats to lower the US credit rating but one credit agency has gone ahead and rated it the way it should be.  China should be ranked higher than the US in credit. The US takes it's rightful place with countries like Brazil and Japan. By the time we wake up and realize we have a problem it will be far too late. I'm glad my portfolio is very protected against inflation.

http://www.marketwatch.com/story/us-gets-c-credit-rating-lower-than-mexico-2011-04-28

Thursday, April 21, 2011

The Ivy Portfolio Review and Tests

The Ivy Portfolio by Mebane Faber is a great read and is a staple reference in my library.

Take a look at this chart:
 I'd say that's a pretty decent return on a strategy since 2008. + 36% return vs. -3.6% on the S&P 500.  The above is a simple back test of a strategy from the Ivy Portfolio that I did on etfreplay. It uses the 19 asset Ivy Portfolio which performed better on the moving average model than the portfolios with less asset classes. I want to point out  that this portfolio goes back only to 2008 where market timing clearly had a big advantage. Longer term numbers are decent but not like the above. You can expect to beat buy and hold with less draw down by about a percent per year but not destroy it like the above test may lead you to believe. Probably charts like the above have sparked interest in using moving averages to reduce risk in portfolios. Do they work on lengthier horizons? According to the Ivy Portfolio book the answer is yes. According to my own back testing results the answer is also yes.

There are two main investing ideas in the book - Diversity through asset allocation, and simple market timing to avoid bear markets. Faber goes into detail on how the endowments invest in various asset classes which helps bring more stable returns with less draw downs. (2008 was a bad year for the endowments because essentially all asset classes failed except treasuries. Asset allocation still helped but was much less effective)

The simplest allocation is us stocks, international stocks, real estate, and commodities. (Invest in etfs obviously not rip off mutual funds) The more complex portfolios essentially sub-divide those asset classes into finer cross sections. The discussion on these ideas is very good but of even more interest to me is the timing model Faber promotes in the book.

The timing model is incredibly simple but performs well.  When the asset class is above the 280 day moving average you buy that asset class. If it is below the 280 day moving average you sell that asset class and move into cash. Just the percentage of the portfolio dedicated to that asset class would be in cash. Larry Connors uses the 200 day moving average in virtually all of his swing trading strategies. He's found having the long term trend at your back helps reduce risk. I do want to point out though, that Connors is not a fan of moving cross over strategies. He questions the longer term results Link

Robert Colby's work in his book the Encyclopedia of Technical Market Indicators shows his back testing results on simple moving average systems like this with very positive results going very far back in time vs buy and hold.

Using these moving average systems seems to reduce risk but can be prone to whipsaw in sideways market. There appears to be a fairly simple solution to this problem.

In Faber's models he updates the portfolio once per month. Buys and sells are only done once per month regardless of any signals during the month. At first I thought this was just to make it easy to manage. After testing specifically if it made a difference I found it actually improved performance significantly. The reason is simple. You don't get whipsawed buying then selling the position around the moving average as it moves back and forth. I was surprised that simply buying on the same day each month improved performance so much. There might be even better ways to avoid whipsaw like waiting x amount of days after a cross over to make a position change to make sure the trend change is real but I have not tinkered with that. The monthly management method works well and is far easier to work with.

 Here are some of my own testing results below:

The first chart takes all signals on any day of the month on the $spx index. If the price closes below the 280 day moving average it is sold, and if it crosses above the 280 day moving average the market is bought.

You can't buy shares of the pure index so the dollar amounts are more about comparing the two results than actual returns.
 You can see some evidence of whipsaw eating into profits on the chart. The back test goes too far back to get it all in on this chart though.
 Here is the once a months management method. Performance is much better.

Less whipsaw and fake outs.

Overall I think this is a good system to be using. I'm using it in conjunction with the relative strength models I often post about. You can actually combine the two models but I run them as separate portfolios. 

I want to point out that I've done tests using a 120 day exponential moving average and got good results. It might be worth looking at that time frame as well. 

If you don't have the book, here is link to Faber's paper on market timing relative strength model. link

Sunday, April 17, 2011

Inflation

If you look at the government numbers we have minimal inflation. Remember back when gas was hitting $4.50 - $5.00 a gallon in some places and food and health care costs were also going up just as fast? The government reported next to no inflation. It was a joke.

The government has been slowly devaluing your currency for ages and they changed the way they report inflation to keep you in the dark. I came across this article today which looks at the way the government used to report inflation, and if they still did it this way today inflation would be over 10 percent, which seems in line with what I'm seeing in my day to day expenses. article

Peter Schiff talks about how the government reports inflation quite a lot in his book Crash Proof. I've been a big fan of Peter Schiff, though I find it sad someone who saw the stock market crash coming couldn't make a profit from it, but I digress...

Another piece of evidence for inflation if through the permanent portfolio. The permanent portfolio divides assets into 5 categories and equal weights them. Precious metals, commodities, growth stocks, treasuries, and swiss franc assets. The ticker is prpfx. It's a mutual fund based on the Harry Browne  concept of the permanent portfolio.


This fund is designed to beat inflation by a couple of percentage points. Why has it been on fire the past decade? It's because inflation has been a lot higher than people want to believe in my opinion. It's done it's job staying ahead of inflation by a couple of percentage points. Sure the chart looks like the fund is kicking @#$ and taking number but not so much when real inflation is taken into account. It probably demonstrates that people are afraid of the prospect of their long term savings losing value. 

 We are becoming poorer every year without realizing it. The sad thing is that when the government is forced to stop printing money things are going to get ugly because we will face the implosion of our service economy. It's a no win situation. 

Relative Strength Investing Weekly Update April 17th

In the Smarter Investing Relative Strength Portfolio I'm running, I had 2 stop outs. One was in IYE, and the other was in IWR.

New buys to be placed for Monday are:

Asset Allocation Portfolio - IAU - I cringe a little at this one but the rules say buy so I buy.

Sector Allocation Portfolio - IYE - Just got stopped out but it's the number one rank. The whipsaw is a little costly since I missed the rally in it on Friday.

I am torn about using stops with this portfolio for a number of reasons. Whipsaw is the primary one.   I decided I would try to follow the plan that Michael Carr put forth in his book Smarter Investing in Any Economy which uses stops. I will keep to this plan and see how it works moving forward. The portfolio should beat the market regardless and will have a much lower draw down than other relative strength investors are probably used to.

I have , however, been doing some more research and put together a method which would not be using stops has a less frequent updating time and is easier to implement. The testing results look good and I'm about ready to go forward with it soon. I plan to put out a post with my test results. I'll also at some point put together some more systematic way to track results. The nice thing is that I can run an unlimited number of portfolios in foliofn and run them independently all free of commission during their trade windows.

The method for calculating relative strength used in this portfolio is the ratio of multiple moving averages. Carr's back testing goes further back than historical etfs since he used mutual fund data and I'm confident in his testing methods. I wish I could duplicate them, but my trading / back testing software cannot make relative strength comparisons between different markets. Check older posts for more details on this method.

The column for the relative strength multiple moving average is the center one that starts with RS.


Friday, April 15, 2011

Spy Inverse Head and Shoulders

I've been watching this form over the past week. It looks bullish but do we have enough gas left in the tank to push through the neckline? We need better earnings news to do it, but at least gas prices have come back enough to allow the possibility. I can't predict this. All I can do is wait and see if we get a break or not.

 If we do break above the H&S pattern and get a small run, it's probably the last hurrah before a larger correction, at least according to the timing Terry Laundry's T-Theory. There are many cycle predictions coming together for a late May / June intermediate top. Terry sees April 27th as a possible peak date as well. I don't follow much technical analysis because most people simply use it to provide evidence for their own beliefs. T-Theory is something I do pay attention to. It has helped me identify when the risk outweighs the reward on a longer term horizon. You can check out his T-theory observations if you hit the link on my side bar or just do a google search for it.

Thursday, April 7, 2011

A Back Test On a Larry Connors Strategy

This is just a simple back test on a simple but effective strategy from Larry Connors.

This test is on the S&P 500 stocks.
The rules are buy at the next market open on a limit order if the 2 period rsi is below 2 and the stock is above the 200 day moving average.
All trades are taken in the test and no stops are used.
Exit when the stock closes above the 9 day moving average.
This test is for long only.
 No transaction costs are figured.
The strategy buys 100 shares per trade. However to make this worth it, you would need to trade a minimum of 200 shares. (The average profit per trade is only $27 on 100 shares.



A couple of things to point out.
The average profit per trade is low so it requires a decent position size.
The draw downs were very small and it has a nice 45 degree angle equity curve.
You probably can't take every trade on big pullbacks when there are many opportunities to pick.
No stops are used in this test but I will likely create another similar test with a stop and see how much of an effect it has.

The stop will have to be a rather wide stop as more of a catastrophic protection. Only protective puts protect from overnight exposure and those could be used in conjunction with the strategy.

I buy the S&P stocks when they hit 5 on the 2 period rsi, but I plan for a maximum of 4 buy ins as the stock drops. This above method figures only 1 buy in at a lower 2 period rsi level.

Monday, April 4, 2011

These are not good odds :)

Wow, this is interesting. 2 major forex brokers reported that 70 percent of all accounts lost money each of the last 4 quarters, according to the following LA Times article. Are you kidding???

I knew the odds were stacked against all but the best players but those are pretty abysmal stats for those that play forex. Random betting with a risk management system would have to do better than that I would think. But then again you have to beat the spread and the quirky things that happen in the forex market that don't happen in the futures market.

I've got some of my own stories of experiences in the futures and forex markets that a few people thinking about getting into the game might like to read but that's another day.

Anyway here's the link to the article.

http://www.latimes.com/business/la-fi-amateur-currency-trading-20110403,0,588787.story

2 Period RSI pullback stock buys

xlnx bought at 31.74 first 10 percent of position

dell bought at 14.17 first 10 percent of position

Both buys were through the folio fn trade window which worked out very well since both stocks moved down at the open.

Buying the next 20 percent of the position if either stock drops 1 percent or more +- a few ticks from the buy in price on the trade window.

Smarter Investing Relative Strength Ranks

Here are the current relative strength rankings for the Smarter Investing relative strength model as if Sunday April 4th. If you were to begin using this model you would buy the single highest ranked etf in each category. The ranking numbers are the column marked RS multiple MA 1. Most of these etfs are overbought and it might be wise to wait for a small pullback before getting in. The formula for the relative strength calculation is the 8 period weekly moving average / 15 period weekly moving average. It's a shorter time frame for calculations than I believe many people use. My portfolio is already long so I only hold one of the top ranks. The others have dropped down a bit. They will be sold when they either get stopped out, or drop down to the midpoint on the list.





You might also notice on these charts the Genesis Relative rankings in the middle column. This is another method for ranking the etfs which I use for another relative strength portfolio. I'm running that portfolio as well and seeing how they perform going forward. More on that in another future post. You can see significant differences in the rankings though. 

Sunday, April 3, 2011

Smarter Investing Relative Strength Portfolio

Here are the positions in my Smarter Investing Relative Strength Portfolio

Stops are the highest close since entry - (3* the average true range of a 10 bar period)
Relative Strength calculation uses a ratio of multiple moving averages. I'll give detail on this calculation in another post.

International Allocation -EWI
 stop set at 17.89
Current rank of EWI on the international allocation list is 2 out of  17 etfs. If the rank drops below 8 on the weekend evaluation it will be sold and replaced by the current #1 ranked international etf.

Asset collocation - IYR
stop set at 106.42
Current rank of IYR on the asset allocation portion of the portfolio is #3

Sector Allocation- IYE
stop set at 43.74
Current rank of IYE in the sector etf allocation is #1.

Smarter Investing in Any Economy The Definitive Guide to Relative Strength Investing Review



One of the etf investing strategies I am currently using is Relative Strength. Basically relative strength investing invests in the strongest performing etfs or stocks. The idea is that those sectors that have been performing the strongest in the past will continue to perform strong in the current year.

The book Smarter Investing in Any Economy The Definitive Guide to Relative Strength Investing,  by Michael Carr,is a comprehensive study of this method with thorough back testing and results to support it. If you are interested in this subject, this book is a must read. 

The book begins by discussing why relative strength investing works. People tend to pile into markets that have performed well creating trends. Carr provides many references to studies on trend following and the results which support relative strength investing.

Carr then proceeds to explore and test 9 methods in detail for calculating relative strength. Carr gives the formulas and back testing results for each method. This research alone would be worth the price of the book since back testing relative strength strategies is very difficult to do. All 9 methods for calculating relative strength out performed the S&P 500 which supports the robustness of this strategy. 

Carr then selects the strategy he felt had the best risk reward. He works on optimizing this strategy, but is very careful and aware of data mining and over optimization. You can be confident his optimization work is reliable as his results provide a wide range of profitability and selecting a range of inputs will still beat the S&P 500. 

One of the qualities that sets this book apart from most is the risk analysis, and the extra steps Carr takes to reduce risk in the relative strength method. The problem with relative strength investing is that, though it out performs when the market is going well, it can decline much steeper than the overall market when it begins to fail. You can give back all of your precious gains very quickly if you do not have risk management in your system. The method will rotate you out of the under performing sectors but without risk management you can suffer significant draw downs in a relative strength strategy. Carr advocates the uses of trailing stops which do reduce profits, but they reduce draw downs. Another area of risk reduction is diversity by using etfs, and a balance of asset classes. He provides 3 sets of etf groups and runs the strategy on these 3 etf groups which helps reduce the overall risk. He also uses an equity curve. The overall result is a significant reduction in draw down with a fairly minimal impact on profits. 

This book covers all of the bases on relative strength investing and is simply a must read on this strategy. I haven't come across many books that were so easy to read yet  packed with so much information. 

Saturday, April 2, 2011

Day of the Month Investing

Amazingly one of the most consistently profitable trading methods I've found is a system designed to go long on the first trading day of the month. It's absurdly simple, and has tested well even in bear market. It's also an uncomfortable system to trade since I want an indicator or some confirmation to go long. It just makes me feel better about the trade than just blindly going long on the first trading day of the month.

Anyway here are the results of my testing. You should always verify results on your own and keep in mind I'm not recommending this system. I'm using it but it's only one of many strategies I use during the month. It only gives you one trade per month but it has captured most of the gains in the market for such a short exposure.

Okay let's take a look at the following example.

The rules were buy 100 shares of spy at the market close on the last trading day of the month, and sell on the market open on the 2nd trading day of the month. No other rules were used. (The trading day is not the same as the day of the month. For example the 1st day of the month might be a Saturday so the first trading day of the month would be the 3rd day of the month. )


Here is the equity curve:


This is impressive considering that buying 100 shares of spy back in 1988 and selling it on the same date as this test would have given you $10760. This strategy of being in the market only a couple days per month collected almost all of the gains in the market without the massive draw downs of buy and hold.

I've run other tests and perhaps I'll add the results on to this post later. Day trading this method works as well. Simply buying the open on the 1st trading day of the month and selling on the close of that day did very well also.

I'm not suggesting you run out and do this strategy immediately. Do your own homework. I find it very impressive that most of the overall market performance in the S&P 500 is on the 1st few trading days of the month.

Larry Connors in his book Short Term Strategies that Work also looks at this property of the markets. He, however found significant out performance toward the end of the month. He found an up bias toward the end of the month which I did as well in my testing.

Also in Robert Colby's book The Encyclopedia of Technical Market Indicators, he found significant out performance of a buy and hold strategy on the Dow by buying on the 26th of the month, and selling by the 6th of the next month.

And finally here is another blog entry that did a similar test: http://www.crossingwallstreet.com/archives/2011/04/investing-on-the-first-day-of-the-month-2.html

Using Foliofn Trade Window for Short Term Trading

Foliofn is an online broker that allows commission free trades during 2 daily trade windows. One window is at 11:00 and the other at 2:00.

I have found these window very useful for keeping transaction fees in check in conjunction with a swing trading system. I'm using a 2 period RSI pullback system that is discussed in Larry Connors Short Term Trading Strategies that work. I'll give the details on how I'm using this in another post. You can open many positions, add to them in multiple steps all for zero transaction costs. Doing this without a window would require a very substantial account to overcome the transaction costs since you may hold 15+ open positions each of which can be added to 4 times before they are sold.

This is how I use the trade window. I check my stock and etf screens nightly. I make a list of the potential buys I would like to make and put them on my watch list. I enter the trades on foliofn that night. If the stocks or etfs are trading below the previous day's close or no more than .25 percent higher I will allow the trades to be executed in the window. Any stocks that moved higher than .25 percent of the previous day's close I will cancel that order.

Trades will be exited according to rules on the next day's trade window. If I have been in a trade for more than one day the 2:00 window can be used to exit a profitable trade. This is useful since the trade window is at 11:00 not at the market open. I will sometimes exit a trade at the 2:00 window.

You cannot use stops with foliofn trade windows. The Larry Connors system does not use stops which opens your position to risk against unusual events.

There are 3 ways to deal with this risk. As you know stops do not protect you from overnight events that drive the stock market down. Therefore stops do not offer full protection. The only way to get full protection is to buy out of the money puts to protect against those rare events. The other way to protect your portfolio is set a mental stop for execution in the next trade window should the stock close below that "mental stop". This requires considerable discipline and since the orders are not executed instantly you are open to more risk than a standard stop. The 3rd way is to attach a stop after the window order has executed. You won't be able to attach the stop until the end of the trade window so there is a brief period of time you will be exposed with no stop and it requires you to put the stop in during the day which may not be possible.

Monday April 4th Short Term Long Trades

Orders I'll place  Monday April 4th.
Short term 2 period RSI stock pullback longs

Dell - I will be buying Dell through Foliofn trade window at 11:00 Monday April 4th if the stock is trading in the area of Friday's close of 14.34 prior to the trade window. A limit order the open for 14.34 is another way to get into this position.

I will be buying my 1st buy in which is 10 percent of final position.

Xlnx -
limit order long 32.15. Buy 1st 10 percent of position. Execute trade during Foliofn trade window or a limit order from 32.15 at the open.

I will  monitor these positions nightly. Exits will be placed for the next trading day open or Foliofn trade window.

The above listings are for informational purposes only are are not investing advice.