February 2018 Performance Report

Industry Benchmark Performance

We would like to see futures profitable when the stock market drops, but that’s not yet the case. If equities keep moving lower, futures programs will short the equity index markets and, with leverage, produce enough profits to offset stock losses. That doesn’t happen at the start of a sell-off, and we have no reason to believe (yet) that the sell-off will continue.

Our commentary this month looks at the similarities between the 1987 crash and the current market performance, volatility, and a closer look at Bitcoin.

There is a large difference between the Hedge Fund Benchmarks and what we believe will be the final performance for February. When comparing the early reports in January, the hedge funds appeared to be up better than 5%. This report shows that they were only up 2%. We expect that the companies with better returns report early and the others are slow to post. We also expect that February will show larger losses than we see in the performance table below. Futures are different. The BTOP 50 reports daily, so the loss of 5.29% seems about right. Other CTA numbers are in-line with that. We’ve been here before and it’s early in the year. We remain optimistic.

Blogs and Recent Publications

Find this at the end of this report. We post new interviews and reference new articles each month.

February Performance in Brief

Please note that we have removed some of the ETF portfolios. While profitable, they were underperforming our expectations, and the portfolios were not focused on a particular sector. We are rethinking what would be more interesting for our investors.

We posted losses in nearly every portfolio, but hold onto gains for the Trend portfolios, both stocks and futures. Our net gains for January and February are well ahead of the S&P. Hopefully, that will give us a buffer in case of difficult times ahead.

Futures took the biggest losses, but after taking the biggest gains in January. Weekly futures are still ahead by 5% to 10% for 2018, while the daily program is up by about 3% to 7%.

Major Equity ETFs. All good things come to an end. After years of steady climbing, the equities market is nervous. A fast sell-off, a partial recovery and another sell-off. We look at this in this month’s In-Depth report, “Déjà vu,”  along with volatility and another swipe at Bitcoin.

IN-DEPTH: Déjà vu (all over again)

Most of you won’t remember October 1987. I do. Stock prices had been rising steadily and even though interest rates were declining from their high of 20% in 1980, the Fed decided to raise rates to head off a heated stock market and to prevent inflation. Does that sound familiar? Chart 1 shows the DJIA for 1987 and Chart 2 shows the interest rate increase highlighted in orange.

Chart 1. DJIA in 1987.

Chart 2. 3-Month T-Bill rates.

The stock market finally peaked on August 25, 1987 at 2722.42, sold off 8.4% by September 21, rallied to 2640 which it held for 3 days (October 1-5), then started its decline to 1766.74 on December 4. A total drop of 35%. Was the economy healthy? Yes.

The Fed seems more sophisticated now then in 1987. It could see the effect of its announcements and send a “clarification” that would ease the tension in the market. But the new Fed Chairman, Powell, did not start out that way and the market is reacting to what appears to be a more hawkish policy. The highlighted area in Figure 3 looks ominous. We’ll see if the Fed notices.

Chart 3. The DOW now looks similar to the DOW in 1987 before the crash.

The recent chaos in the Administration over a tariff on steel and aluminum (March 1) is inflationary, which feeds into higher interest rates by the Fed. That’s not a scenario that will help the stock market, except for the steel companies, and maybe not even them when the dust settles. Are they willing to gear up their operations and invest a large amount with the current uncertainty? It doesn’t seem likely.

Trading a Nervous Market

Any medium speed, or even macro trend trading strategy would have gotten you out of long positions in 1987 after a modest loss. It would have done the same in 2008. If you traded futures, you would have gone short and netted a profit when the move was over. That’s called “crisis alpha.” It’s when futures have large gains during periods when the stock market has large losses. It’s because you can go short with high leverage, so that the gains from a relatively small futures position will offset the losses of a large stock portfolio.

If we were trading a 60-day moving average of the DJIA in 1987, we would have exited the long and sold short on October 9 at 2482, 240 points below the high. We would have exited that short on January 14, 1988 at 1916 (after a low of 1766), for a gain of 566 points. Even with a lag of 30 days, a moving average would have netted a healthy profit while most investors lost somewhere closer to 35%.


Volatility will also tell you to exit. Instead of using the typical annualized volatility, we’ll use the average true range, which includes the highs and lows. In today’s market, the average true range shows that the trading range in points is nearly as large as the 2008 financial crisis (Chart 4), but in terms of percent, it is much smaller (Chart 5).

Chart 4 DJIA average true range from 1998

Chart 5 DJIA average true range as a percentage of price

Volatility is not a friend to the trend trader, or position trader. It gives very little profit but adds a large amount of risk. Volatility below 15% seems to be the comfort level for the Dow. Chart 6 shows the annualized volatility for the DIA (ETF) for 2018. Volatility crossed over 15% on February 5 when the price was 242.65. Since then, volatility has remained near 30% even though prices are not lower. Avoiding risk is an important part of trading. This trade has yet to finish.

Chart 6. Annualized volatility of DIA during 2018.

Bitcoin 2018

While we are discussing risk, nothing represents volatility more than Bitcoin. In Chart 7 we see the price of BTC-USD from 2017 along with the annualized volatility. While volatility usually runs from 10% to 20% for many markets, BTC has held over 100% for most of 2018. Investors didn’t seem to mind the volatility when prices were going up, but it’s another story when prices drop. From its peak on December 16 at 19,345 to its recent low of 7,592 on February 7, BTC dropped more than 60%. We haven’t seen that since the Nasdaq drop when the internet bubble burst in 2000.

Chart 7. Bitcoin prices and annualized volatility from January 2018.

What is the charisma of Bitcoin? It’s advertised as an alternative currency, but are investors thinking of that when they buy? Most of us know that investors chase profits. We all do. Investing in something that is losing money is only for specialists. Most of us buy a stock or futures market when it’s doing well and count on that performance continuing.

How do we control the risk? Just as with the DOW, had used something as simple as a 40-day moving average, we would have gotten out of our long position on January 15th, a month late (a 40-day average lags by 20 days) and gone short at 13631. We would have taken a loss of 29.5% and gone short with an open profit of 31.9%.

What Is Bitcoin?

The creators of Bitcoin argue that we need a new currency. The one we have, and that refers to all countries, is manipulated by the Central Bank and possibly other government powers. Currencies fluctuate based mostly on trade. If someone in another country wants to buy U.S. wheat, they must buy U.S. dollars for the transaction. The more a country exports, the stronger their currency. Well, usually. The value of a currency is reduced by higher inflation. If an investor buys a U.S. stock and the stock remains at the same price, but inflation causes the U.S. dollar to decline, when that investor repatriates his or her investment, the money they get back will be less than they invested. That’s also true of political instability, which will cause a currency to lose value. The interaction of these factors is complex, but the net is the current value of the U.S. dollar and other currencies.

But what about Bitcoin? Shouldn’t it track the U.S. dollar? Perhaps the creators of Bitcoin don’t think it should because the U.S. dollar is manipulated. If we look at a chart of BTC from January 2018 and compare it to the major U.S. equity index markets (Chart 8), we see that the pattern is similar to the stock market. While BTC may have days when it does not move in the same direction as the stock market, it generally does.

Chart 8. Bitcoin compared to the major U.S. equity benchmarks.

If we find the correlations of BTC against those benchmarks, we get:

It shows that there is a modest, but real, positive correlation. Then investors are buying and selling BTC in much the same way they buy and sell other stocks. Just to be sure, BTC and the euro currency are shown in Chart 9.  The table above show that there is a zero correlation between BTC and the euro currency, which means that the price moves of BTC have no relationship to the moves in the U.S. dollar. But they are related to the moves in the stock market. We must conclude that BTC is not acting as if it was a currency, just another stock. And a risky one, at that.

Chart 9. BTC-USD compared to the euro currency (EURUSD).

If you combine the exceptional volatility with the legal and regulatory issues of Bitcoin, then add in the ability to hack into the system to steal investor money, it’s not clear why anyone would trade it. Oh, yes, there is. The Bitcoin price started at 0.04951 and went to 19,345. That’s unprecedented. But then the volume was 5 shares. Someone was very smart, unless they sold it the next day. It traded over 1 million shares on 8/8/2011 at a price of 9.99. Still a good place to buy, in retrospect. We wish we had bought, but we didn’t.

That was then. Is it a good place to buy now? The trend is still down, but what are you buying? It’s not a currency. It has no intrinsic value. It’s supported by others who think the price will now go from $10,000 to $1,000,000. Does that remind you of anything? You’ll need to decide if that’s a scenario you want to buy into.

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 275 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.

The Trend Strength Index reflects the internal strength (momentum) of all the stocks that we track, about 275. These stocks tend to have a stronger trend than the typical stock. It is also a mix of stocks from the S&P and Nasdaq, with a few smaller caps, but none trading fewer than an average of 1 million shares per day.

A clear sell-off, but nothing yet as strong as previous retracements. The Trend Strength Index sits a little over 20, still showing a mild uptrend. At zero it is neutral, which would be the first target. Going below zero would be negative for all stocks and a harbinger of a bear market. Let’s hope we don’t go there.

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.

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.


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.

The reversal in February doesn’t look very important on the long-term chart, but it is worrisome. If it continues, the Trend program will reduce it exposure because it won’t find stocks with recent gains that qualify for the portfolio. Meanwhile, these portfolios are all holding on to net gains for 2018.

Income Focus and Sector Rotation

The daily Income Focus program netted a gain for February, while the weekly program had fractional losses. This program benefits from income from interest rate investments, but mostly when interest rates are stable or yields are falling. Given the economic situation, the program is performing well.

A 3.58% loss in February still leaves the Sector Rotation program with a 2.72% gain for 2018 and holds onto its upwards trend. That’s all we can expect at the moment.

 DOW Arbitrage

February shows the first setback since 2008, but the year-to-date is still ahead by 3.37%. We’re in a wait-and-see mode.



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.

Fractional losses in the 10-stock portfolio and a larger 4.5% loss in the larger portfolio for February. That leaves the smaller portfolio higher for 2018 but the larger on marginally lower.


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.

This program took the largest losses because it buys undervalued stocks. But it will also hedge its positions by selling any of the index ETFs to protect against larger declines. At the end, it should perform best in a declining stock market by having the least exposure.


Futures Programs

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

Large losses in February but that followed even larger gains in January. The Weekly Trend Futures remains higher by 5% to 11% for 2018 and the Daily program by 3% to 7%. If equity markets continue to fall, this program will go short and offset losses in traditional stock portfolios. It would be better if it didn’t come to that.

Group DF2: Daily Divergence Portfolio for Futures

This program also took a loss of 5% to 6% but that fits with its long-term pattern of volatility.

Blogs and Recent Publications

A new interview with Mr Kaufman has been posted on the FXCM website (Forex Capital Markets) as of a few days ago.

Mr. Kaufman spoke at the Trader’s Expo in New York on Monday, February 26th. His presentation was on ways to reduce risk that traders forget to use.

Mr. Kaufman has a presentation in Jack Schwager’s FundSeeder webinar, which should now be available online.

The 3-day seminar in Chicago on developing a successful trading strategy, sponsored by the Chicago Institute of Investing has been changed from early March to late-April to avoid conflicts with the Chinese New Year. It will be in English and Chinese. For more information contact Katie.Tian@chicagoii.com.

There is an interview on YouTube conducted by Alex Gerchik for his Russian audience. We think you will find it enjoyable and helpful. The link is:


Technical Analysis of Stocks & Commodities published Part 1 of a two-part article on profit-taking and resets, in their January issue.  The first part looks at trend following and the second at short-term trading. Part 2 is scheduled for the February issue. Before that, they published “Optimization – Doing It Right,” in the September issue.

Mr. Kaufman was a Keynote Speaker at the IFTA annual conference, hosted by the Swiss technical analyst’s association (SIAT) held in Milan, Italy, in October 12-16, 2017. A video of the presentation has been posted on the IFTA website.

“Portfolio Risk in Uncertain Times” was just posted on Seeking Alpha. It shows a better way to structure your portfolio. Prior to this, you will find “Living Off Profits,” which shows how much you can safely withdraw from your account without seeing spiral down out of control. Before that Seeking Alpha published “What Are the Odds?” a look at how to assess the risk of loss for any investment.

Modern Trader published “Dogging the Dow in the current edition, and a new article “Trading Opening Gaps” in stocks, scheduled for January 2018.

The IFTA Journal published an interview with Mr Kaufman in the most recent quarterly issue.

The broker FXCM will post a live interview with Mr Kaufman, taped on October 30.

ProActive Investor Magazine published Keeping Risk Under Control on June 22. Check their website. It will be publishing other articles later this year.

Andrew Swanscott at BetterSystemTrader.com (a good source for trading systems) has put up an edited version of an older presentation of Mr. Kaufman’s. It’s all about price noise and the Efficiency Ratio.

Look for past articles by Mr. Kaufman on Seeking Alpha (www.seekingalpha.com), Forbes (https://www.forbes.com/sites/perrykaufman). www.equities.com, Modern Trader, Technical Analysis of Stocks & Commodities, and Proactive Advisor Magazine. You will also find many articles posted under Articles on our website, www.kaufmansignals.com. You can address any questions to perry@kaufmansignals.com.


©Copyright February 2018, Kaufman Signals. All Rights Reserved.

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