Industry Benchmark Performance
The Hedge Funds have been crawling back over the past two months, now only down 5% for the year. That’s good considering the drawdown of more than 30% that we’ve seen in the index markets. The systematic CTAs did the best, not higher by almost 3% for the year, an argument for diversification. But direct investment with CTAs have always returned more than a fund, given the fee structures.
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.
Blogs and Recent Publications
Find this at the end of this report. We post new interviews and reference new articles each month.
May Performance in Brief
After 6 weeks back in the market, performance has been very volatile, and not correlated to the S&P. For a few days, the market focuses on tech stocks, then healthcare, then internet companies, then none of them. Reports of opening the economy, likely vaccines, and outbreaks in Brazil drive prices up then down. At the end of May our benchmark 10-Stock portfolio was higher by 1.66%, with YTD +6.71. While SPY was up 3.69% in May, it is still down by -5.08%, an 11% difference.
The strongest index remains Nasdaq, +4.74% in May, and +9.10 for 2020. The small caps remain the hardest hit, still down -15.9% for the year. Futures were quiet in May, posting small losses but still nicely higher for the year.
The outstanding performance is the Timing Strategy, +3.76 in May and +32.6% for 2020. Buying oversold stocks in an uptrend seems to be the way to go.
Major Equity ETFs
Equity index ETFs keep creeping higher, anticipating a recovery, despite economic reports to the contrary. Investors continue to look for bargains, trying not to be left behind. The focus so far has been tech companies, and the QQQs are close to a new high. At the other end of the small caps, which tend to be avoided during difficult economic times. But even the Dow, that represents the largest and most stable companies, is still well off its highs.
To understand this rally, we need to look at individual stocks. Some can justifiably rally, while others, such as cruise ships, airplanes, and resorts, seem less likely. It is a case of stock-picking.
We have chosen a few stocks to review for those readers interested in unusual opportunities due to Covid-19. We cannot cover them all, but we feel that seeing a group of similar stocks will help make decisions easier.
The Race for a Vaccine
Moderna (MRNA) has gotten a lot of press based on a small study, which has also been questioned. That caused a sharp run-up followed by a 30% drop. Meanwhile, Regeneron (REGN) has moved higher steadily as they develop an antibody test. Gilead (GILD) has been quiet lately even though its drug, Remdesivir, has been approved by the FDA. Probably because it plans to give away a large amount, making its profitability questionable. Gilead and Regeneron are both in our stock portfolio.
Figure 1. Pharma research
Last month we said that healthcare providers will always find a way to make money. From their recovery to new highs, that seems to be true. Humana is in our stock portfolio.
Figure 2. Healthcare providers
Shopping at Home
We are all buying more online, some necessities, some impulse. The three companies benefiting from this are Amazon (AMZN), eBay (EBAY), and Etsy (ETSY), shown below. These companies declined with the rest of the market, but have all recovered to new highs, with (surprisingly) ETSY outperforming. Our stock portfolio held eBay but now holds ETSY.
Figure 3. Shopping at home.
We only look at the two biggest grocery and everyday shopping giants, Costco (COST) and Walmart (WMT). Both show the same 5% gain since the beginning of the year, and both had a volatile period before stabilizing, however, with very different patterns. Our stock portfolio is holding Kroger (KR).
Figure 4. Groceries plus.
Airlines represent one of the hardest hit sectors. For some reason, Southwest (LUV) has been noted as “doing better” than the other major carriers, but it is really difficult to see that in the chart. We can say that they all look as though they have seen their lows. We have no airlines stocks in our portfolio.
Figure 5. Airlines.
Anyone following the market news knows the crude oil prices went negative in April, disrupting the industry. The sharp drop in demand did not stop the flow of oil, natural gas, or shale being produced. Tankers were sitting outside ports in all cities and countries, with no place to offload their cargoes. Demand is still a problem, as seen in the chart below. Prices have not yet recovered half of their losses. The deferred deliveries never reflected the short-term glut and now seem to be back to manageable levels, even while demand remains low. We have no energy companies in our stock portfolio.
Figure 6. Energy.
CLOSE-UP: Waiting for a Pullback, Part 1
“Pullbacks” can be seen two ways: improving your entry by waiting a few minutes after the open, and as a system that, for example, enters on an oversold indicator during an uptrend, similar to our Timing strategy. The first is short-term tactic and the second is a strategic approach. This month we will look at improving an entry.
Systematic traders, our selves included, want to beat the system entry price. For our stock systems, that is the opening price. The choices are:
- Place an order to “buy (or sell) on the open”
- Buy or sell in the premarket
- Wait for a reversal after the open, lower for a buy, higher for a short sale
Systematic traders have it easier than discretionary traders. If they are confident in the long-term success of their system, then they only need to beat the system price. That will be the posted opening price. Doing better than the opening price, or even getting the opening price, will assure that they are matching the returns of their system. What is the best way of doing that?
“At the Market”
The opening price of a stock posted on data services should be the first trade, but unless you request it, it is the price at which the maximum volume is transacted as determined by matching orders received ahead of the open. It is also called the equilibrium price. When you buy on the open you are more likely to get the high of the bid-asked spread, not usually as low as the posted open. On the other hand, you can place your order in advance and not spend any time trying to beat the system. And the system will use the equilibrium price as its fill.
Use the Premarket
The more active stocks will start trading in the evening, but volume will be very light and the direction , higher or lower, is not indicative of what will happen the next morning, even when earning are released after the close. Prices get pushed around on low volume.
About 1 hour before the official open, prices become more realistic and there is enough volume to execute a reasonable size order. Most major economic reports are released one hour before the stock market opens. Following those reports, prices are likely to make their biggest move.
If SPY is called higher, it does not mean that your stock will be higher, although it increases the chances. If you are a trend follower and just got a buy signal, it means that there is a stronger tendency for your stock to go higher. Using the index as a guide should help. Remember that the index is composed of many stocks, some going down even when the index is up. You need the confirmation of a buy signal to know that your stock is one of those that should be going up. There may be other systems giving a buy signal in your stock, so buying ahead of the open might get a better price.
Buying on a Pullback
Many of us will try to improve the price by waiting until the stock, ETF, or futures market opens. I have done some studies on gap openings and found that there is a good chance of a 30% to 40% pullback and a likely close at or above the gap opening price. But a lot of the data reflects the long bull market that started in 2008, so we should tone down our expectations.
In my opinion, the ability to get a better price after the open has to do with the amount of noise in the market. Most of you have heard me say this before. Markets that have a lot of noise will give you a chance it get in at a better price; those will less noise should be bought right away because they are more likely to continue the way they opened.
Which markets are they? Figure 1 shows a sample of individual stocks. The ones on the left have the most trend and the ones on the right the least trend. We can wait for a better fill from those on the right (XOM, AXP, WMT) and need to enter quickly for those on the left (TWTR, NFLX, GOOGL). The ones in the middle are not as clear.
Figure 1. Ranking the noise of individual stocks. More trend is on the left.
Figure 2 looks at the popular ETFs, many having the characteristics of an index, and spanning a wide range of industries and products. Bonds, on the far left, have the most trend. After that, the level of noise increases significantly. On the right, with the least trend, are the ETFs representing the Japanese Nikkei and sector EFTs. The S&P (SPY) is in the middle.
Figure 2. ETFs ranked by noise. More trend is on the left.
I find futures the most informative because they represent broader groups of products, are highly liquid, and are all driven by fundamentals, rather than earnings and corporate personalities. Short-term interest rates are clearly on the left, showing more trend. Index and foreign exchange are on the right, with more noise, less trend.
Figure 3. Futures ranked by noise. More trend is on the left.
When you are looking for a better price, use the extremes of these three charts to make decisions. Markets on the left should be entered quickly, and you can wait for a pullback if the market is on the right.
A Closer Look at SPY
SPY is one of the most popular ETFs, representing the S&P 500. We know that S&P futures were fifth from the right in Figure 3, indicating high noise. We looked at how long you would need to wait after the open to get a better fill based on a new trend signal from a 20-day moving average system.
We chose a 20-day trend in order to get more trading signals, and we looked at the last 5 years, which includes the end of the bull market through Friday, the last trading day in May. The intraday data had 30-minute bars.
Figure 4. SPY shows that if you wait from 30 min to 3 ½ hours you will get a fill better than the open, but not by much.
On the left of Figure 2, the “0” indicates the profits from entering on the open. After that, each bar is 30 minutes, so bars 1 through 7, where there are the best returns, represents waiting 30 minutes to 3½ hours, with the best returns at 2 hours. But this is only in order to beat the opening price by any amount, essentially avoiding slippage.
The gray bar shows the returns if you wanted to improve the fill by 2 big points. Your profits dropped significantly because you missed many of the trades.
Then waiting for a better price can improve your returns by 25%, a healthy amount, but not if you want more than just a minimum improvement from the open.
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.
After 6 weeks back in the market we have little to show for it, but still hold on to good gains for 2020 without having taken a large loss. Both daily and weekly portfolios are more than 11% ahead of the S&P this year. Our selection of stocks for the portfolio has been limited to those that have performed well over the past few months. Because that still includes a good part of the Covid-19 decline, stocks are only new becoming available to the system. As of Friday we had 9 of 10 stocks in the daily portfolio.
Income Focus and Sector Rotation
We pointed out last month that a weekly program cannot react quickly to unexpected news. This month, the Weekly Income Focus gained 3.24% while the Daily program gained 0.71%. It may be on the road to recovery. We can see from the 2008 history that the Weekly program suffered a similar setback but then recovered nicely. Markets do that and we expect it will happen here.
The Sector Rotation program took the biggest loss of all of our portfolios, down 19% for the year. In May it was marginally higher. There has been no consistency in the returns of the major sectors and this program reflects that problem
One of the best features of the Dow Hedge program is that it recovers quickly from a drawdown. It is now near all-time highs, up 5.96% in May and ahead by 6.2% for the year. Granted, we don’t like taking a loss, but a fast recovery is a good scenario.
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.
Both 10- and 30-Stock Portfolios posted similar 3.3% gains in May, making them profitable for the year. The 10-stock program has been gaining steadily over the larger portfolio, usually with somewhat greater risk. They did not suffer any large drawdowns during the worst of the stock market declines, but we’ll need to see how they now handle a recovery.
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.
Every system has its moment, and this seems to be the one for the Equity Timing Portfolio. This program was up another 3.7% and 8.8% for the 10- and 20-stock portfolios, now up 32% and 38% for the year. What is interesting is that the 20-stock portfolio is outperforming the 10 stock. Normally, more diversification dampens returns. The only explanation for these good returns is that those stock beaten down more are now recovering fastest – at least some of them – and clearly the ones in the Timing portfolio.
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.”
This Trend Strategy is another case where the Weekly Portfolios cannot react quickly enough to changing market conditions. The Daily Futures Portfolios were all lower by slightly more than 1%, but the smallest $250K portfolio remains higher by 10% this year. The $500K is down slightly and the $1 million is up by 4.5%. The particular markets are resulting is large differences in the daily program.
The Weekly Futures Trend program has been very erratic. While there were small losses in most portfolios in May, they all remain lower for the 2020.
Group DF2: Daily Divergence Portfolio for Futures
While it may be difficult to see on the chart, the Futures Divergence program has maintained its pattern by gaining 8% to 12% in all portfolios in May. That brings them back to mostly unchanged for 2020. Another good month an we’ll be back at the highs.
Blogs and Recent Publications
Trading Systems and Methods, Sixth Edition
The sixth edition of Trading Systems and Methods was released the last week of October 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 be presenting at Jake Bernstein’s seminar over the week of June 22nd. Presentations will be at 4 and 5 pm each day. Check online for the specific dates and speakers.
The June issue of Technical Analysis of Stocks & Commodities will publish 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.
A new article “Essential Math For Traders” will be published in the Bonus 2020 issue of Technical Analysis of Stocks & Commodities.
ProActive Advisor Magazine (on-line) published “Controlling risk that doesn’t go away,” posted on January 15.
Both of these articles are important for understanding your investment risk.
Technical Analysis of Stocks & Commodities published an interview with Mr Kaufman in the December issue.
MetaStock Seminar held in Sunnyvale
Mr. Kaufman was a keynote speaker at the MetaStock conference in Sunnyvale, November 3. You can hear this presentation by going to the MetaStock website.
Technical Analysis of Stocks & Commodities published “Running for Cover,” an article by Mr Kaufman that looks at whether buying bonds after a sudden drop in the S&P can still be profitable.
“A Simple Way to Trade Seasonality” was published in the September issue Technical Analysis of Stocks & Commodities. Seasonal trades and filters can be a big asset to market timing and put you on the right side of a price move.
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.
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 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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