New Daily DowHedge Program
Starting January 4, we will be adding a daily version of the DowHedge program to the Daily Trend group of systems. The weekly version will still be active.
This program trades the 10 best performing Dow stocks. In the weekly version, the Dow stocks are ranked weekly, and in the new version they are ranked daily. We have also found that the daily version will be more responsive to volatility and drawdowns. It will exit the entire portfolio when the risk is too high or there is a nasty downturn in prices.
A chart of the performance history can be found under the section, Daily and Weekly Trend Programs, further down in this report.
Industry Benchmark Performance
A good year for equity hedge funds, even though far below returns of the equity index ETFs. It’s good to see positive numbers everywhere. Long bias was clearly the best, with some stock sectors outperforming by a wide margin.
Blogs and Recent Publications
Thank you for the great reception of our new book, “Kaufman Constructs Trading System,” and for your very kind comments. You can find it on Amazon or on our website, www.kaufmansignals.com.
Find recent publications and seminars at the end of this report. We post new interviews and reference new articles each month.
Kaufman’s Fast Strike Systems on MetaStock
If you are interested in short-term trading, look at Kaufman’s Fast Strike strategies. Contact MetaStock at 800-882-3040 or go online to www.metastock.com/kaufmana.
December Performance in Brief
Another strong month added to an unexpected, but remarkably good year. It is not often that a stock program can return 50% or more, given there is no leverage. We recognize that some investors may not be able to trade 100% of their equity, or that entries on the open can vary. Many traders, like myself, will need to exit positions in order to free up funds to allow new positions to be bought. That can often work against the returns. However, everyone following the daily or weekly programs should be pleased.
We have no idea what performance will be next year, but our best guess is that we return to the average. The cause of this year’s returns is the Covid-19 pandemic. We would rather have an average return and no pandemic.
We at KaufmanSignals wish you all health and happiness in 2021!
Major Equity ETFs
If you only saw the chart below you would have no idea that the economy had collapsed and was trying to recover. And that airlines, hotels, and restaurants had lost 90% of their business, and that many of their workers were still waiting for their unemployment and relief payments.
The small caps, IWM, are gaining over SPY and DIA, an indication that investors are feeling more aggressive, at a time when we would expect them to be more cautious. It shows that you cannot predict the market. Just follow the trend!
CLOSE-UP: A Year Like No Other
It looks easy when you see it in retrospect. Every drawdown is followed by a strong recovery. In 2012 the analysts were saying “If you had held on in 2008 you would be ahead today!” But staying with your portfolio when it drops more than 50% is not easy. How do you know that it won’t drop more, as NASDAQ did in 2000 after the dot.com bubble? That cost some investors 90% of their equity.
Chart 1 Equity index ETFs from 2002.
Then we had a distressing sell-off at the end of 2019. It was easy to think that a collapse was here, after 10 years of a bull market. But the recovery was fast. It is hard to fault investors who got out or reduced their exposure. And diversification is not always the answer, as we saw in 2008, when all assets, stocks, art, and real estate followed the same path lower. It was the flow of money. Investors liquidated everything to cover losses. The only safe haven was bonds, which rallied (lower yields) significantly.
There are two approaches to investing. One is being long stocks and having faith that they will continue higher. That the government will somehow find a solution to any bad economic situation. Or you can diversify into bonds, which are at historically low yields, but safe.
As we wrote about last month, we at KaufmanSignals believe in the fat tail. That is, there are always stocks that do incredibly well. Those depend on the economy. Chart 2 shows our trend ranking of stocks. This is not a ranking of pure stock returns, but how well they performed on a trend system.
Of the stocks that we track, 50 of them have had returns of 40% or better during the past 6 months! That is an incredible result. It is not the result of a clever trend system because all trend systems work when prices trend. It is a matter of selecting those stocks that are driving the market. Chart 2 shows that the best was Advanced Micro Devices (AMD), then Sun Power (SPWR), Tesla (TSLA), and Zoom (ZM). But it is the breadth of winning stocks that is most amazing.
Chart 2 Ranking of stock performance using a trend system over the past 6 months.
This year it was stay-at-home stocks, next year it could be the airlines and hotels. They have a long way to recover, but the market tends to anticipate. Delta Airlines has already recovered half of its loss (Chart 3). Perhaps the most likely market to benefit is energy. More driving, more air traffic, more activity, all need energy. It could be the common denominator. A move away from fossil fuels – green energy — will happen, but probably not this year.
Chart 3 Delta Airlines from 2019
The most remarkable single price move of 2020 was the collapse of crude oil prices in April. No one was driving, no one was flying, no one was taking trips of any kind. No one wanted oil. Oil tankers had no place to unload. All storage was full. Prices fell to nearly ‒$40/barrel on the day of delivery of the April futures contract (Chart 4). The exchanges were not prepared for a negative price in a commodity. It was a mess.
Chart 4 Cash prices of crude oil, 2020.
But the creeping recovery in the last two months of the year reflects optimism about 2021 and a vaccine. We expect crude prices to move well above $60, probably to at least $80 because demand will come all at once.
Our best advice is to have a plan and stay with it. Do not overinvest and be prepared to ride out reasonable risks. The market does not like to be predicted. A “normal” return this year would be very acceptable.
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 equity portfolios. Our work over the years shows that downturns in the stock market are most often short-lived and it is difficult to capture with a longer-term trend. The upwards bias also works against shorter-term systems unless using futures, which allows leverage. Our decision has been to take only long positions in equities and control the risk by exiting many of the portfolios when there is extreme volatility and/or an indication of a severe downturn.
Portfolio Methodology in Brief
Both equity and futures programs 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 on the specific system, 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 outperforming the broad market index in all traditional measures.
PERFORMANCE 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, including Sector Rotation, Income Focus, and Dow Arbitrage
The Trend program seeks long-term directional changes in markets and the portfolios choose stocks that have realized profitable performance over many years combined with good short-term returns. It will hold fewer stocks when they do not meet our conditions, and exit the entire portfolio when there is extreme risk or a likely drawdown.
How do you explain at gain of more than 50% in stocks? We could never expect it and should not expect it to continue. We do expect a “normal” year in 2021. That means somewhere above 10%, which could be disappointing after this year. But the market always surprises. We will just try our best to control the risk and let the profits take care of themselves.
Income Focus and Sector Rotation
The Daily Income Focus program came in slightly below the long-term annualize returns, and with very low volatility, just like the doctor ordered. The Weekly portfolio was the only one of our programs that lost this year, finishing down 2.65% after a gain of 1.70% in December. We believe that the extreme volatility early in 2019 did not let the weekly program change positions quickly enough. While that is unusual, weekly programs cannot react to fast, sustained changes in price.
A good December let this program finish with a small gain for 2020, and near the highs of its equity, as seen in the chart below. This program is based on a classic concept of rotation in stocks, using the SPDR ETFs to define the sectors. It has had good periods of steady gains but has been struggling for the past year.
(The New) Daily DowHedge Program
We are adding a daily version of the DowHedge program as of Monday, January 4. The strategy is the same as the weekly program, trading the 10 best Dow components. But this program will rebalance daily and add some risk controls similar to the Trend programs for stocks. We feel that the volatility of the overall market may cause risks that can be handled better with a daily program.
The returns of this daily version are not as high as the weekly strategy, but we expect that the future risks will be controlled better. There is always a trade-off between return and risk.
Weekly DowHedge Program
A gain of 4.1% in December puts this program up by 36.6% for 2020, near the highest performance. While this program has performed extremely well, we are introducing a daily version. We feel that the volatility of the market could make it more difficult for a weekly program to control risk. We will continue following this program and see how it does compared to the daily version.
Group DE2: Divergence Program for Stocks
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.
A good month for the Divergence program puts the final yearly results at +48% and +37% for the 10 and 30 stock portfolios. The 10-stock portfolio, as with most other smaller portfolios, has higher returns and higher risk. This program holds trades for about 8 days and offers good diversification with other programs.
Group DE3: Timing Program for Stocks
The Timing program is a relative-value arbitrage, taking advantage of undervalued stocks relative to its index. Its primary advantage is that it does not depend on market direction for profits, although these portfolios are long-only because the upwards bias in stocks and that they are most often used in retirement accounts.
There is a market for every strategy and this year it was our Timing program. This strategy looks for technically undervalued stocks relative to their most correlated benchmark. Even with marginal gains in December, the Timing strategy finished + 59% and +74% for the 10 and 20 stock portfolios. Those are the best of all our portfolios in 2020.
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 down 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.
Please read the report describing our revised portfolio allocation methodology. It can be found in the drop-down menu under “Articles.”
Another month of steady gains for all portfolios ends the year higher by 19% to 29%, above the long-term expectations. We have had good moves higher in the equity index markets, lower in the dollar, higher in gold, and higher in bonds. It helps to have trends. Not all years are this good.
Group DF2: Daily Divergence Portfolio for Futures
Gains of 2% to 3% in December allowed this program to finish higher for the year. It continues it’s back-and-forth pattern but offers good diversification and a shorter holding period.
Blogs and Recent Publications
Kaufman Constructs Trading Systems
You will find both an ebook and a print version of Perry’s new book, Kaufman Constructs Trading Systems, published on Amazon. It is a complement to Trading Systems and Methods. It takes you step-by-step through the process of developing a trading system, with many examples. Order it through our website, www.kaufmansignals.com or directly on Amazon.
Trading Systems and Methods, Sixth Edition
The sixth edition of Trading Systems and Methods was released at the end of 2019 by John Wiley. It is completely updated and contains more systems and analyses.
MetaStock issued an upgrade to the Kaufman Fast Strike add-on in late January. This add-on has three short-term trading systems, holding positions for one to three days in two of the programs, and about one week in the third program. They trade noisy markets, including most major index ETFs and futures, plus one program trades the VIX. You can see a description of the programs and a record of past performance on MetaStock. Anyone interested should contact MetaStock at 800-882-3040 or go online to www.metastock.com/kaufmana
Mr. Kaufman will present to the technical students at the Universidad Politecnica de Madrid on February 3, 11 am CST. He will discuss risk and offer advice that comes from years of trading.
Technical Analysis of Stocks & Commodities published an article on Short-Term Patterns, with lots of computer code so that you could do it yourself.
November 1, he taped a session with Andrew Swanscott’s BetterSystemTrader.com
November 18, he presented a webinar on trading to the Italian bank, Fineco, this time in English.
November 27, he presented another webinar to Fineco subscribers in Italian.
Mr. Kaufman had a full schedule in October and November. You can find videos and recording of the following sessions:
On October 3 he addressed 1,000 members at the Indian Technical Analysis group You can find more at https://www.algoconvention.com/schedule
On October 10 he recorded a session on volatility and risk for TopTradersUnplugged.com
On October 22 he addressed another large group for the Italian bank Fineco (in Italian).
“Fools Rush In,” an analysis of the best time to buy an IPO, will be published in the September issue of Technical Analysis of Stocks & Commodities. There is also a full description of Kaufman Constructs Trading Systems in the “Books for Traders” section.
Mr. Kaufman gave a presentation at Jake Bernstein’s “Cycle” seminar. Anyone interested in a copy of the presentation should send a request to firstname.lastname@example.org.
The June issue of Technical Analysis of Stocks & Commodities published the article “Crashes and Recoveries.” It will help you figure out how the Covid-19 pandemic will play out. It will also have the TradeStation code for the “2nd Cross” strategy, requested by readers.
There are some comments in the April issue and on the current stock market drawdown and a correction to Mr. Kaufman’s article in the March issue of Technical Analysis of Stocks & Commodities
“The 1st and 2nd Cross” was published in Technical Analysis of Stocks & Commodities in the March issue. It is based on an idea of Linda Raschke and captures small but reliable pieces of a trending move.
Mr. Kaufman appears as a chapter in Mario Singh’s book, Secret Conversations with Trading Tycoons, published by FXI International.
Older Items of Interest
For older articles please scan the websites for Technical Analysis of Stocks & Commodities, Modern Trader, Seeking Alpha, ProActive Advisor Magazine, and Forbes. You will also find recorded presentations given by Mr. Kaufman at BetterSystemTrader.com, TalkingTrading.com, FXCM.com, systemtrade.pl, the website for Alex Gerchik, Michael Covel’s website, TrendFollowing.com, and Talking Trading.com.
Mr. Kaufman spoke in Tokyo and Osaka to the Japanese association of Technical and was a keynote speaker at the 2018 IFTA conference in Kuala Lumpur, both last October. You should be able to get a copy of the presentations by MATA, the Malaysian Association of Technical Analysts.
“In Search of the Best Trend” was published in Technical Analysis of Stocks & Commodities in July 2019. An article on “Defense is Your Best Defense” will appear in ProActive Advisor Magazine also appeared in July 2019.
Mr. Kaufman was a keynote speaker at a number of IFTA conferences, the most recent in 2018 in Kuala Lumpur, and Milan in 2017. You can find his presentations on their website.
© December 2020, Etna Publishing, LLC. All Rights Reserved.