APRIL 2015 Performance Report

RETURNS

IMPROVING YOUR ENTRY PRICE

As a systematic trader I have spent a lot of time discovering ways to get a better entry price, all of them based on clear rules. A lot depends on your trade holding period, that is, whether you’re a short-term trader in for only 1 to 3 days, or a long-term trend follower with positions lasting 2 to 3 months.

Early on, markets had much clearer trend. Eurodollars, short sterling, Euribor, and other short-term rates have the strongest trends of all futures markets. Because they reflect Central Bank policy closely, they would move steadily in one direction, with very little noise. Trying to finesse an entry by waiting for a better price was a lost cause. It just kept moving away from you. Even with noisier markets, as the S&P, you would be able to beat the system entry price 3 of 4 times, but they were for small amounts. On the fourth time the market ran away and you lost all of the profit and then some.

In today’s markets, it’s easier to improve fills for long-term trend following than for fast trading. It’s easier to improve fills for index markets than for individual stocks. For improving fills, noise is your friend, and equity index markets have far more noise than individual stocks. There are stocks that can be significantly improved by waiting for a better entry point, but not those that are running away to the upside (or downside), such as Apple.

DEFINING THE RULES

To decide if we can improve an entry price, we need to have a system. Because  a long-term trend will be a better example than a short-term strategy, we’ll use the following:

An 80-day moving average, representing a macro-trend system.
Buy signals occur when the average turns up; short sales when the average turns down.
Entries occur on close of the same day as the trend change, subject to conditions.
Exits are not subject to conditions, they always occur on the close of the same day as the trend change.
We’ll look at a number of tactics for improving the entry price:

The benchmark is to always enter on the close of the day that the trend changes.
Alternatively, on the day that the trend changes, close out the current position and place one of these orders:

Buy tomorrow at any price lower than today’s close (a “minimum” pullback).
Buy if tomorrow’s low is less than the prior n-day low (n = 1,2, or 3).
Buy if tomorrow’s low is less than the system entry price less a factor x 20-day ATR, where ATR is the average true range and the factor is 10%, 20%, or 50%. (The new entry varies with price volatility.)
Short sale signals are the opposite of the buy signals.
There are three simple but unique conditions resulting in seven combinations. We applied the trend strategy and the entry options to a number of individual stocks, equity index markets, and futures using 15 years of data.

SUMMARY OF RESULTS

Using SPY as an example, the first line shows that profits are all in the long positions. The Profit Factor is the gross profits divided by the gross losses and give you a reasonable reward/risk ratio. A value above 2.0 is very good.

When we enter on a “minimum” pullback the next day, total profits and ratio increase significantly, although the improvement is all because the short trades have a smaller loss. The three pullback tests (PB) show even more improvement, increasing the profits in longs and reducing the loss in shorts. The  percentage of the average true range, which is a volatility measure, improves the long trades and hurts the shorts. We can nearly double the returns of SPY long-short trend trading by waiting for a better entry price (the 3-day pullback). We can increase the returns of the long trades returns by 20%, which is a better choice because all the shorts are losses and we will favor trading the long side. In terms of return to risk, the 50% ATR is best.

Ex 1

For individual stocks we’ve used Apple and J C Penny as examples. Apple seems to be always going up while Penny has been going down. This is a case where, if you wait to buy Apple, it can run away from you. Not so with JCP, where as much profit has been made on the short sales as on the longs. In both tables, the green highlighting shows those tests that were better than the benchmark. For Apple that was only the minimum pullback and the 20% ATR. For JCP it was everything.

Ex 2

The best candidates for entry improvement are markets with high noise. Noise is the frequent backing and filling that allows you to find a better entry price. For that, equity index markets are going to be better than individual stocks.

EQUITY INDEX MARKETS

We also found that different entry options could be very good on one index but not on all. In some cases it improved returns by 100%. But we want robustness in our selection, so a rule needs to work on a large number of markets to be acceptable. The rule that was most consistent was simply the minimum pullback. A summary of the index markets that we looked at shows that everyone had an improvement in the “All” profit factor, and in the absolute profits, showing that it improved returns more than it increased risk.

Ex 3

To see the results better, we’ve shown the percentage improve in the ratios for all the equity index markets as a percentage of the benchmark case. The improvement in the long trades varies from one case of -3% to +20%, but for the short trades it was consistently strong. We can explain that due to the difference between the long and short trade profiles.

Ex 4

Long trades are held much longer than short trades. Longs develop slowly. On the other hand, shorts tend to be highly volatile and stop quickly. It is difficult  for a  trend system to profit from a short trade because it is late getting in and late getting out, giving up too much of the potential gain. Of course, there are exceptions. By waiting for an upwards pullback after a short sale entry signal, we enter at a much better price. In some cases the trend might reverse quickly and no trade was entered. That would be even better.

The robustness of the entry rule that waits for a minimum pullback is seen in the consistency improvement in both long and short trades. But remember, this is for entries only, not exits. Finessing an exit can get you into trouble.

Trend Strength Index

One measure of market strength is our Trend Strength Index. Our Trend strategy is a composite of many trends, medium term to slow applied to about 250 stocks. When combined, these determine the position size of the current trade. If the faster trends are down but the slower one up, then the position size might be zero. The appearance is that trend positions scale in and out based on the strength of the trend. The Trend Strength Index appears at the bottom of the Trend Stocks All Signals report each day. We’ve tracked it from the beginning of 2014, and the chart below compares it with the SPY. TSI is the Trend Strength Index and SPY is the SPDR ETF. TSI values about zero indicate a positive trend. The range of the TSI is +1 to -1.

Ex 5

Reduced volatility and marginally higher prices in the SPY continues to show the same lethargic advance. The Trend Strength Index remains in a sideways pattern, but positive, reflecting the very weak upwards trend.  During this period of uncertainty, beginning last December, the SPY has gained about 5%. We still expect delays in Fed interest rate hikes due to low inflation, tepid growth, and the strength in the dollar. If the Fed were to raise rates, money would flow to the dollar, bringing it to levels that we believe would be undesirable by the Fed and severely dampening exports. Given the conflicting data, we see more of the same in the next months, although with higher volatility.

We offer this Index for those investors who select their own trades rather than following our sample portfolios. Daily Index values are available to subscribers.

April Overview

A poor return for the Equity Trend program, which was hit with losses in Biotech and Health Care in the last few days of the month. Our Trend stock portfolio turned negative for the year while the ETF portfolios are still positive and competitive, even with holdings in both BIB and CURE. It seems that the Biotechs have been very volatile for the past few months. The chart of Biomarin, one of our frequent portfolio components, shows the sharp retracement after a very strong year. We benefitted from the rally, but discipline dictates that we wait for a reversal before removing that stock. This time, the downturn was more volatile than usual.

Ex 7

The Divergence and Timing Programs fared better, with only small losses, holding on to gains for the year in the stock portfolios, and modest losses in the ETF portfolios.

When it rains it pours, and the Futures program took losses as well this month, also turning most portfolios negative for the year. The Divergence program was particularly hard hit due to few positions and higher leverage. Again, what has served us well in the past can also present risk. This month we seem to be in a major change of trend for the energy markets, a stabilization of the dollar rally, and uncertainty in bonds. As these sort themselves out, the programs should be back on track.

We can see in the chart of the major equity index ETFs (below) that, since February, we’ve had a sideways, increasingly volatile period.  The end of April posted strong declines for both QQQ and IWM, after making marginal highs in all the major equity index markets. Given that systematic trading programs need to take defensive action, these patterns are not conducive to easy profits.

Ex 8

Strongest and Most Undervalued Sectors

There are two ways to view sector rotation, trade the strongest expecting them to stay strong, or trade the weakest expecting the business cycle to rotate them to the top. We have both. The Trend Rotation trades the strongest and the Timing Rotation trades the weakest. The Trend program may hold positions for a long time, so it’s possible for two ETFs to be in both programs. For example, XOP (Oil and Gas) can be in a long-term uptrend, but a short-term oversold situation.

Strongest

The Trend Sector ETF program buys the 6 strongest sectors of the SPDRs. This month started with

Preferred stocks (PFF), Heathcare (XLV), Consumer Discretionary (XLY), and Retail (XRT), Industrials (XLI), Technology (XLK)

We removed Healthcare (XLV), Retail (XRT), and industrials (XLI) and added (not surprisingly) Oil & Gas Equipment (XES) and Energy (XLE), in addition to Material (XLB). Current positions are:

Preferred stocks (PFF), Consumer Discretionary (XLY), Technology (XLK), Oil & Gas Equip (XES), Energy (XLE), Materials (XLB)

Undervalued

The Timing Rotation program (buy low) removed the hedge in the SPY and QQQ as those markets reversed losses from April. What has been discarded by the Trend (strength) program is being picked up by the Timing (undervalued) program as having fallen too far. This program exited Materials (XLB), Consumer Staples (XLP), and Utilities (XLU), and replaced them with Preferred stocks (PFF), Healthcare (XLV), Consumer Discretionary (XLY), and Retail (XRT); therefore, it is now long one additional ETF, but still only 75% exposed.. As of the end of the month it is now holding:

Preferred stocks (PFF), Vanguard Reits (VNQ), Industrials (XLI), Healthcare (XLV), Consumer Discretionary (XLY), and Retail (XRT)

When an ETF appears in both the Trend and Timing programs, it means that market is very strong but is in a short-term retracement.

A Standing Note on Short Sales

Note that the “All Signals” reports show short sales in stocks and ETFs, even though short positions are not executed in the portfolios. Our review of using inverse ETFs to hedge stocks during a decline showed that downturns in the stock market are most often short-lived and it is difficult to capture those moves with trend systems. This confirms our approach to the Timing systems, which hedges up to 50% of the long stock risk using multiple trends. In the long run, returns from the hedges are net losses; however, during 2008 the gains were welcomed and reduced losses.  In any correction we prefer paying for risk insurance, even without the expectation of a net gain.

Portfolio Methodology in Brief

All of the programs, stocks, ETFs, and futures, use the same basic portfolio technology. They all exploit the persistence of performance, that is, they seek those markets with good long-term and short-term returns, rank them, then choose the best, subject to liquidity, an existing current signal, with limitations on how many can be chosen from each sector. If there are not enough stocks or futures markets that satisfy all the conditions, then the portfolio holds fewer assets. In general, these portfolios are high beta, showing higher returns and higher risk, but have had a history of consistently out-performing the broad market index in all traditional measures.

 

PEFORMANCE BY GROUP

NOTE that the charts show below represent performance “tracking,” that is, the oldest results are simulated but the newer returns are the systematic daily performance added day by day. Any changes to the strategies do not affect the past performance, unless noted.

Groups DE1 and WE1: Daily and Weekly Trend Program for Stocks and ETFs

The Trend program seeks long-term directional changes in markets and the portfolios choose stocks and ETFs that have realized profitable performance over many years combined with good short-term returns.

Even with larger losses in the stock programs this month, the overall equity picture continues to look good. The smaller 10 stock portfolio has been sideways for most of year but is still near the highs of its longer term NAV. The larger 30 stock portfolio appears to continue its modest uptrend. While losses are inevitable, they are not out of character.

The 10 and 20 ETF programs also show continued strength. The ETF sector program (buy strength) has flattened out near its highs.

Ex 9

The Weekly Stock programs also posted losses this month, but the overall picture looks healthy. All of the program show an upwards trend in NAVs.

Ex 10

Group DE2: Divergence Program for Stocks and ETFs

The Divergence program looks for patterns where price and momentum diverge, then takes a position in anticipation of the pattern resolving itself in a predictable direction, often the way prices had moved before the period of uncertainty.

With the Divergence Program posting small losses for April, it continues to have a slight drift lower. Looking for oversold or sideways markets that should rally is more difficult when the overall markets are flailing about. The larger 30 stock and the 8 ETF portfolios seem to be in much the same state, biding time until the price patterns improve.

Ex 11

Group DE3: Timing Program for Stocks and ETF Rotation

The Timing program is a relative-value arbitrage, taking advantage of undervalued stocks relative to its index. Its primary advantage is that it doesn’t depend on market direction for profits, although these portfolios are long-only because they are most often used in retirement accounts. When the broad market index turns down this program hedges part of the portfolio risk. The ETF Rotation program buys undervalued sectors, expecting them to outperform the other sectors over the short-term.

The Timing Program buys undervalued stocks so that it will buy the weakest even in a declining market until that stock shows that it is not expected to rally. Risk is protected with an absolute stop of 15% and also by hedging the broad index.

The Timing program posted marginal losses this month, holding on to year-to-date profits in both stock portfolios, and a fractional loss in the ETF portfolio. While the downturn in all programs may have stopped, we would all be happy to see undervalued stocks and sectors rally.

Ex 12

Futures Programs

Larger losses in both Futures strategies can be seen in the sector returns below. All sectors posted losses, although the Trend Program still holds year-to-date gains in interest rates, energy, and agricultural products. Not so for the Divergence program, which now shows all sectors at a loss. Note that these charts show only 2015 performance. The longer-term returns would be significantly positive everywhere.

Ex 13

Groups DF1 and WF1: Daily and Weekly Trend Programs for Futures

Futures allow both high leverage and true diversification. The larger portfolios, such as $1million, are diversified into both commodities and world index and interest rate markets, in addition to foreign exchange. Its performance is not expected to track the U.S. stock market and is a hedge in every sense because it is uncorrelated. As the portfolio becomes more diversified its returns are more stable.

The leverage available in futures markets allows us to manage the risk in the portfolio, something not possible to the same degree with stocks. This portfolio targets 14% volatility. Investors interested in lower leverage can simply scale all positions equally in proportion to their volatility preference. Note that these portfolios do not trade Asian futures, which we believe are more difficult for U.S. investors to execute.

Using the same strategy and portfolio logic, the Weekly Trend Program for Futures has the added smoothing resulting from looking only at Friday prices. While it will show a larger loss when the trend actually turns, most price moves are varying degrees of noise which this method can overlook.

Please read the new report describing our revised portfolio allocation methodology. It can be found in the drop-down menu under “Articles.”

In April, the CTA industry also posted losses in both Trend and Short-Term trading categories, although 2015 performance is now ahead of our program.  The main reason for this divergence is that the Industry tends to be highly diversified, while we favor a smaller portfolio based on ranking. That has served us well when, during 2011 through 2013, the CTA performance was been flat to negative, and we were highly profitable. In this case broad diversification served to reduce April’s losses for many CTAs.

Ex 14

We should always expect a reversal in profits after an unprecedented run to the upside; however, we never know when that will happen. Even on the charts below, the reversal doesn’t look significant, while it may make a dent in our real equity. Is this the end of the “big move?” We can’t predict what will happen, but energy seems to hold the greatest potential for a rally, with crude having already come off the lows by nearly 50% (from about $40 to $60). Meanwhile, expect both programs to automatically deleverage until volatility drops.

Ex 15

Group DF2: Daily Divergence Portfolio for Futures

Larger losses in the Divergence program hurt the smallest $250K portfolio the most, dropping equity back to its 2014 support level. The larger portfolios are faring better, although the past 6 months shows much higher volatility than we’ve seen in the past. Note that the larger portfolios are more diversified, which accounts for their steadier uptrend.

Ex 16

 

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