Industry Benchmark Performance
Yet another month of gains, this time spurred on by hopes of the Fed reducing rates. The ¼ point reduction on Wednesday did not satisfy the market, but no sooner than it was announced, traders are looking for another ¼ point. The three benchmark equity index markets are giving investors great returns for the year.
Hedge funds and futures are also positive for July but well below the returns of the index markets. Trend systems are outperforming and the Futures Industry, measured by the BTOP 50, is up 8.44%, a very respectable return for an alternative investment.
MetaStock Launches Kaufman’s Fast Strike Systems
For more information on these short-term trading systems, contact MetaStock at 800-882-3040 or go online to www.metastock.com/kaufmana.
Blogs and Recent Publications
Find this at the end of this report. We post new interviews and reference new articles each month.
JULY Performance in Brief
A good month for our Daily Trend portfolio but an excellent one for our Weekly Trend program, up 5% compared to SPY up 1.5%. The Dow Arbitrage program is also putting in a good year, up 18.6%. The 10-stock Divergence portfolio is doing the best, up over 20% for 2019, slightly ahead of SPY. On the other side of the ledger is the Timing portfolio which is now running at a small loss.
Daily futures posted another gain with the smallest $250K portfolio running far ahead of the more diversified portfolios, up 19%. The Futures Divergence program is a healthy 24% ahead. The Weekly Trend is lagging with the smallest portfolio the only one that is ahead for the year, and better than the CTA performance.
Major Equity ETFs. New highs for NASDAQ, SPY, and the DOW while the small caps lags far behind. We would normally attribute that to more conservative investors and some caution about the economy. But then NASDAQ is the strongest and usually the most volatile. It shows that trying to understand the investor is a difficult task.
CLOSE-UP: An Indicator Is Not a System, But It Could Be… With Just a Few Tweeks
I recently read an article by John Ehlers in Technical Analysis of Stocks & Commodities. It was about a new indicator, the Voss Predictive Filter, that tried to limit the lag in the indicator values. Ehlers is a rare talent, focusing on cycles, specifically signal processing, but offering very interesting and practical solutions. I particularly like his roofing filter that smooths out calculations such as a stochastic. But that’s for another time.
His latest offering is best seen as a plot along the bottom of S&P futures chart (Figure 1). The darker blue line is the Voss filter and the thinner red line is the signal line. But an indicator is not a trading system, it is intended for timing. Life would be simple if every indicator produced profitable trades.
Figure 1. S&P futures with the Voss indicator (blue) and signal line (red) at the bottom.
If we use the simplest rules, buy when the Voss filter crosses above the signal line and sell when it crosses below the signal line we get horrible results. We won’t even show them.
Creating a Strategy
Two elements are needed for a successful strategy: rules that recognize the intent of the strategy and identifying when volatility is good and bad in the context of this method.
Because this indicator is being treated as a mean reverting tool, selling high and buying low is fine. But even though the indicator seems to flow nicely from being overbought to being oversold, there is only about one swing per month, a bit long for a mean reversion system that profits due to price noise. Although it’s not always clear on the chart, there is no reason why the price needs to go from overbought to oversold and back again. The most we can ask is that it reverts to normal, which would be the zero line. Then our first rule would be:
Sell when the Voss filter crosses below the signal line and exit when the Voss filter crosses zero. Do the opposite for buy signals.
If you have confidence that the indicator will swing from top to bottom regularly, you are welcome to trade that way. I think exiting when it normalizes at zero is safer even if it seems to make less money.
Volatility is always important. You can see on the chart that there are two extended periods where the indicator swings are narrow, last August and September and again from February of this year. Small swings are not desirable. But this filter is not like a stochastic or RSI that are bounded by zero and 100. It can take on a wide range of values. However, we are only interest in removing the small swings and leaving the large ones alone.
With that in mind we filter out any trade in which the crossing of the indicator and the signal line occurs between +5 and -5 for the S&P. We get the signals shown in Figure 2. There is no trend filter, but the long trades produce nearly all the profits. The short trades are slightly profitable, which shows more robustness than if they netted a loss. Note that there are no trades when the filter is narrow.
Figure 2. S&P futures with trading signals based on the Voss filter.
Using 20 years of futures data, we get the following results:
Long trades were profitable about 65% of the time, and short sales about 50%. Not a bad result. The box below contains the TradeStation code if you would like to try it on your own. Remember that mean reversion trading is best using noisy markets, generally equity index but a few others as well.
// Ehlers Voss (Predictive) Filter
input: period(20), predict(3), exitlong(0.05), exitshort(-0.05), minentry(10);
vars: order(0), F1(0), G1(0), S1(0), bandwidth(0.25), count(0),
sumC(0), filt(0), voss(0), investment(25000), size(0);
if currentbar = 1 then begin
order = 3*predict;
F1 = cosine(360/period);
G1 = cosine(bandwidth*360/period);
S1 = 1/G1 – squareroot(1/(G1*G1) – 1);
// Position size
size = investment/(avgtruerange(20)*bigpointvalue);
// Band limit the input data with a wide band BandPass Filter
filt = 0.5*(1 – S1)*(close – close) + F1*(1 + S1)*filt – S1*filt;
if currentbar <= 5 then filt = 0;
// Compute Voss predictor
sumC = 0;
for count = 0 to order – 1 begin
sumC = sumC + ((count + 1)/order)*voss[order – count];
voss = ((3 + order)/2)*filt – sumC;
if marketposition > 0 and exitlong <> 0 and voss > exitlong then
sell all contracts next bar on open
else if marketposition < 0 and exitshort <> 0 and voss < exitshort then
buy to cover all contracts next bar on open;
// “filt” is the slower and “voss” is the fastest
if marketposition <= 0 and voss crosses above filt and
(minentry = 0 or voss < -minentry) then
buy size contracts next bar on open
else if marketposition >= 0 and voss crosses below filt and
(minentry = 0 or voss > minentry) then
sell short size contracts next bar on open;
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.
While SPY has made new highs, the Trend Strength Index is now at a resistance point, a level it has seen many times. Even though it shows an underlying lack of strength in the market, it is difficult to fight new highs. We would still recommend caution.
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 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.
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.
The Weekly Equity Trend program finally looks as though it’s recovering from the sell-off at the end of last year. Sometimes it takes the program more time than we would like to get back into the right portfolio. The Daily program also looks better and is closer to the old equity highs.
Income Focus and Sector Rotation
Now that the Fed has lowered rates by ¼ point, the rate markets are looking to see another ¼ point at the next meeting and possibly another cut after that. Performance of the Income Focus program reflects larger than normal gains, now at the level for 2019 that would normally be the return for the entire year.
While experts talk about Sector Rotation as a strategy of the past, this program gained 2.5% in July and is now higher by 6.8% for the year. It generally tracks returns of about the same as the broad market, but with less risk. This year it’s lagging far behind, but then we are never able to predict what will happen next.
Another good month for the Dow Program, up 3.35% and now 18.6% for 2019. While slightly behind the S&P, this program has a much smaller drawdown while returning more than the S&P.
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.
Another gain of 1.4% and 2.5% for the Divergence portfolios puts the 10-stock portfolio higher by 20.2% for 2019. At the same time, it offers remarkable diversification because it holds trades only during the when the trend is sideways or turning.
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 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 buys undervalued stocks and hedges with one of the major equity ETFs when prices turn down. This year it hasn’t gained any traction and remains flat. It has spend a good deal of time hedged during the steep downtrend, then kept a partial hedge position while the market regained its upward movement. Still, it sits near its highs.
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.”
Gains of 9.24% for the 250K Daily Futures Portfolio brings the 2019 returns to 18%. The more diversified portfolios gained from 4% to 5% and are still nicely ahead for the year. Because bonds seem to be driving the performance and the smaller portfolios have a larger proportion of bonds, they are outperforming.
The Daily Futures Trend program is well ahead of the Weekly Program this year. Moderate gains in the Daily program brings the 250K portfolio to19.2% while the other two portfolios sit just above 8% for 2019, still better than the industry. The Weekly program is having a difficult time finding a trend, or just having bad timing if the trend direction changes mid-week. It is modestly ahead for the year with the exception of the largest portfolio which is marginally lower.
Group DF2: Daily Divergence Portfolio for Futures
With modest gains in July, this program is ahead from 18.5% to 25.2%, an excellent year so far. It remains in a pattern of large equity swings which can be unsettling. In combination with another program of lower volatility, this would work as excellent diversification.
Blogs and Recent Publications (for the past 12 months)
MetaStock has launched the Kaufman Fast Strike add-on. It 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
“A Simple Way to Trade Seasonality” will be published in the September issue Technical Analysis of Stocks & Commodities.
Mr. Kaufman appears as a chapter in Mario Singh’s new book, Secret Conversations with Trading Tycoons, published by FXI International.
A second part of the interview with Caroline Stepan at TalkingTrading.com was just posted.
Mr. Kaufman was interviewed by Caroline Stephen at TalkingTrading.com. It covered a wide range of topics. It has not yet been posted but should be available soon.
We thought the article in ProActive Advisor Magazine would be in March, but it should appear any day in April. It is “Let’s Be Realistic About Drawdowns.” Most traders don’t pay enough attention to the drawdown history of their trading, or of any system trading. Large drawdowns are infrequent but can be ugly. This article shows how to assess them and some ideas on reducing drawdowns.
Technical Analysis of Stocks & Commodities will publish “Volatility: What They Don’t Teach You In Grad School,” in the January edition.
An article appeared in ProActive Advisor Magazine looking at all calendar patterns, including the Santa Rally, the Presidential Cycle for 2019, the January and May effect, and seasonal patterns in ETFs.
In January Technical Analysis of Stocks & Commodities will publish an article showing the real relationship between price and volatility, which will surprise you. It should change the way you size your positions.
Mr. Kaufman spoke in Tokyo and Osaka to the Japanese association of Technical Analysts on various techniques for trading Japanese markets. You can contact the organization for a copy of the presentation. Mr. Kaufman was presented with a Japanese translation of his newest book, A Guide to Developing a Successful Trading Strategy.
He also spoke about “Making Volatility Work for You” at the 2018 IFTA conference in Kuala Lumpur. It was an excellent conference with many good speakers. You may be able to get a copy of the presentation by contacting MATA, the Malaysian Association of Technical Analysts.
“In Search of the Best Trend” will appear in Technical Analysis of Stocks & Commodities this month.
A new article on “Defense is Your Best Defense” will appear in ProActive Advisor Magazine this week.
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, and Michael Covel’s website, TrendFollowing.com.
Mr. Kaufman has been a keynote speaker at a number of IFTA conferences, the most recent this year in Kuala Lumpur, and the previous year in Milan. You can find his presentations on their website.
© July 2019, KaufmanSignals. All Rights Reserved.