Industry Benchmark Performance
We only have the first day of returns for equity funds, but they are in line with the index returns. CTAs have done better as a group, although the SG reporting always seems to lag. It’s a new year, so we are optimistic that results will be good.
Blogs and Recent Publications
Don’t forget our new book, “Kaufman Constructs Trading System,” . 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.
January Performance in Brief
A good month for many of our portfolios. The benchmark 10-stock Trend program gained over 7%, continuing its run from last year. There is a scattering of negative results, but the outstanding performer was the Weekly 10-Stock Trend, up 37%, which benefited from the soaring price of Sun Power (SPWR), reflecting the new administrations push towards green energy.
Even though all the major equity ETFs finished slightly mixed, they were about 4% off their highs for the month. It looks as though it might be the start of a sell-off, but we have been there before than prices recover. Our own trend program exited all positions mid-week, based on our “extreme risk” measure, so we might see more of a drawdown.
We should expect significant rotation in the market, with stay-at-home stocks losing ground to recovery stocks, such as restaurants and (hopefully) airlines. The companies producing the Covid vaccines seem to be performing erratically.
Some say the Robinhood effect is hurting the market, but it seems to be affecting such a small set of stocks that its impact on the S&P cannot be strong. We will wait to see if it gathers strength.
CLOSE-UP: Running Amok
After 2020, anything could happen, and it has. Social media has mobilized stay-at-home traders to wage war on institutional short sellers. This may turn out to be the fortunes of war, or something illegal. We are only interested in looking at this as a trading challenge. Can we make money in these bizarre moves without risking our entire investment?
We start with Bitcoin (BTC-USA), which has had a history of extreme volatility. Can we find a simple system that has consistent profits?
Consider the volatility first. You do not want to sit with a trade when the prices are moving 5% or 10% each day. For those trades that are “risk seekers” it may be fine, but the rest of us just want a profit without that much aggravation.
The key to trading an erratic, volatile market is to take advantage of the noise and exit on a windfall profit. When volatility drops, we can try again. Figure 1 shows the annualized volatility of BTC from 2014. We use the formula,
Annualized vol (AVOL) = STDEV(20-day returns) x sqrt(252)
That is the same as the formula for implied volatility and the one used by most financial analysts. The reason values go above 1.0, which is clearly impossible in real life, is simply because we are projecting the 20-day volatility to be annualized. As long as we are consistent, this works.
Figure 1. Annualized volatility of Bitcoin (BTC-USA)
Our system is going to be a 20-day breakout (buy when today’s close is greater than the close of the previous 20 days), and exit when the volatility goes over 0.60. Entering a trade when the volatility is high exposes you to extreme risk. As you can see, volatility changes quickly.
We use a breakout rather than a moving average because it does not have a lag – when prices make a new high, we are in. Figure 2 shows the performance of a 20-day breakout with and without a volatility exit.
Figure 2. Our breakout strategy with and without a volatility exit.
The price moves are so fast that staying with the 20-day breakout (in blue) gives back all the gains. By exiting when the volatility is high, we can produce steady profits, even large profits.
But that’s BTC. How can we use that to trade Gamestop (GME) and AMC (AMC)? Figure 3 shows the volatility of GME. It has some spikes above 1.0 before this latest run. If we have been trading it as we would trade BTC, we would have exited when the volatility reached 0.90, my normal extreme volatility exit. You would have had 4 or 5 good trades, but then you would have missed the big move last week and taken a modest gain when you could have been rich.
Figure 3 GME annualized volatility.
Do you really think you could have anticipated this move in GME? Figure 4 shows the moves for last week. Without knowing what would happen, and if you were lucky enough to trade GME, you exit on the first jump up. Not bad. Volatility stays high so you do not reenter. The approach of buying a breakout and exiting on high volatility will do a good job of controlling risk. If you are wrong, prices will reverse, and you will lose that unrealized gain. That is the reality of trading.
Figure 4. GME price moves for the past week.
What about AMC, another target of the anti-short sellers? Figure 5 shows its volatility pattern. Again, had we been trading it, which is unlikely, we would have liked our volatility exit at 2.0 and taken two profits before the recent move. By the way, we removed the last two days of annualized volatility because the numbers were so large (in the millions) they could not be displayed.
Figure 5. Annualized volatility of AMC without the last two days.
It is not likely that you would have traded these markets in advance of the rally unless you were networking with the anti-short sellers. But the principle of buying a breakout and exiting on high volatility has worked for me. We exited Tesla (TSLA) and a few other markets when volatility reached 0.90. We leave a small amount of profit on the table but reduce our risk by a lot. We expect to keep doing that.
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 since are simulated but the returns from 2013 are the systematic daily performance added day by day. Any changes to the strategies do not affect the past performance, unless noted. The system assumes 100% investment and stocks are executed on the open, futures on the close of the trading day following the signals.
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.
While we thought a 50% gain for 2020 was remarkable and unexpected, January posted a 37% gain in the Weekly Trend Program, entirely the result of a giant move in Sun Power (SPWR). Prices moved from 24.74 on January 5th to 54.01 at the end of January, up 118%. The 7% gain in the Daily Program looks anemic in comparison.
The Trend Programs, both daily and weekly exited all positions mid-week due to “extreme volatility.” That is a combination of drawdown and high portfolio volatility. Previous similar situations have followed with either a sharp stock decline or a decline and rebound. In some cases our program avoided a loss, in other cases it broke even. In both cases it avoided considerable risk.
Income Focus and Sector Rotation
Both daily and weekly Income Focus portfolios posted losses of between 1% and 2%. The daily program is holding its pattern of slow gains and small losses, while the weekly program needs to recover from its recent drawdown. We expect rising interest rates, as the U.S. recovers from the pandemic, will put these programs back on track.
After a good December, this program gave back more than 4% in January. It still remains near its old highs and may be showing some signs of life!
We have added a new Daily DowHedge program while keeping the Weekly program. Our objective is to offer more responsive trading signals and additional risk controls. You can see in the charts below that the daily program was able to control the losses during the 2008 financial crisis. It also had a smaller drawdown at the end of 2019. In exchange, the annualized returns are lower, about 14.4% instead 20%. You will need to decide on your risk preference.
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 loss to start the year, but the program remains in an equity uptrend with the smaller 10 stock portfolio outpacing the larger portfolio.
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.
After an incredible performance in 2020, the Timing program gained fractionally in January. This program buys stocks that are undervalued relative to its benchmark. We are anxiously watching how this year develops.
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.”
Mixed results, with the 250K and 1M portfolios posting gains of better than 4% and 2%, while the 500K portfolio had a fractional loss. All portfolios look good on the chart below.
Group DF2: Daily Divergence Portfolio for Futures
Similar gains of 4% in all Divergence portfolios continues the ratcheting up pattern in the chart below. Returns are now at highs and another month higher would then give way to a drawdown. It is a strange but consistent pattern so far.
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 email@example.com.
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.
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