Portfolios Explained

Kaufman Signals currently publishes 5 Portfolios.
( DE1 / DE2 / DE3 / DF1 / WE1 )

Please click on any of the buttons for a full explanation of each Portfolio.

DE1: Daily Trend Equities

» Macro Trend
» Income Focus

» Dow Hedge

Macro Trend

The macrotrend program takes advantage of long-term price moves. These trends are most often generated by interest rate policy, which comes from the Fed and other central banks. These trends can last for years and tend to develop slowly. Interest rate policy directly affects currency, where money flows to the country with the highest interest rate net of inflation. It may also be a safe haven during a crisis. Most often, money has moved into the U.S. dollar, U.S. bonds, and the U.S. stock market.

This program has multiple trend signals and a unique portfolio selection process. Using our strategy, it ranks the stock performance according to how well it performs, then automatically picks the best ones to trade. We can exit a stock if the trend turns down or if it drops in the ranking, that is if other stocks are performing better. It does not need to wait for the trend to end, when it tends to give part of the gains; therefore, it holds the positions for less time than a typical macrotrend program.

How Often Does It Trade?

The program usually has 4 to 8 trades per week, and trades are held for an average of 28 days. It has fewer trades when prices are moving our way and more when the market is uncertain. The positions are long only.

The daily stock program has the advantage of being able to respond quickly to changes in market sentiment. Yes, as with other trend programs, there can be a risk when all stocks turn down at the same time. Stocks such as Apple or Tesla, which have had significant gains, may still be in the portfolio for a few days after prices reverse. The program may hold a position through a volatile period in order to net a profit at the end.

Because the portfolio selects highly profitable stocks, it tends to have a high “beta.” That is, it will have higher returns than the broad market on good days and may have lower returns on bad days.

Exiting a Bear Market

Trend programs benefit investors during a bear market simply because they will exit stocks that are trending down. While everyone recognizes a bear market, most investors are not willing to close out their positions, hoping for a quick reversal to the upside. It's easy to understand why. The downturns and retracements in the stock market are usually short-lived. The market seems to turn back up as soon as you sell your position. But that's not a good reason to stay long. The internet bubble of 2000 and the financial crisis of 2008 prove that.

Extreme Risk Exit

The program monitors the risk of individual stocks as well as the entire portfolio. When an individual stock exceeds the high-risk threshold, the program exits all positions in that stock and is blocked from taking a new position until volatility drops below the threshold.

The volatility of the entire portfolio is also monitored daily. When a combination of high volatility and portfolio losses occurs, we exit the entire portfolio. We reenter when volatility falls below our threshold, and the portfolio again shows profits.

The volatility threshold for individual stocks is understandably higher than the portfolio threshold. The stock threshold is in the neighborhood of 50% while the portfolio threshold is 32%, the same that is considered “high” for VIX, the volatility index.

High beta

The portfolios generated by KaufmanSignals are expected to outperform the overall market by choosing stocks that have

  • Higher volatility
  • Greater activity
  • A history of successful performance using this strategy

By eliminating many stocks that barely move and others that are not “trending,” we can construct a portfolio with returns better than the broad market index. But a high-beta portfolio will also have a higher risk. We count on recognizing when the trend of a stock has turned down or the trend of the stock is weaker relative to other stocks, then remove it from the portfolio. Using our special algorithm, we rotate out when a stock is underperforming in favor of those that are stronger. If the entire stock market turns down or the overall market becomes extremely volatile, the program would eventually close out all positions. While rare, this has prevented unnecessary losses.

» Income Focus

The Income Focus program benefits from interest income to offset much of the downturns in performance. It trades only three ETFs: municipal bonds (MUB), high-yield stocks (JNK), and preferred stocks (PFF).

The strategy has positions in all three ETFs, in equal risk amounts when all trends are up. If only two of the ETFs are trending up, we allocate the full investment to those markets. If only one is trending higher, it gets the full investment. If all three ETFs are trending down, the investment goes into 3-month Treasury bills.

See the Performance Report for a history of returns and a current chart of performance.

Daily DowHedge Program

Using the same concept that the best-performing stocks will continue to perform well, we trade the best 10 stocks in the Dow. These are ranked for performance daily and will change when one stock is doing better than another.

We also monitor the volatility and risk of the portfolio returns and may exit the entire portfolio when the risk exceeds our upper threshold combined with losses in performance. This is similar to the risk rule in the Macrotrend program.

Get Daily Trend Equities – DE1

DE2: Daily Equity Divergence

Divergence is a well-known concept that recognizes when two related markets are moving away from each other. We often see this in the major index markets, the S&P, and Utilities, or in two related stocks, such as Micron and Intel.

Our method is called technical divergence, and it occurs when the price moves higher, but a momentum indicator moves lower or when the opposite pattern happens. “Momentum falling” means that prices are moving higher at a slower rate, which most often predicts change.

We use a stochastic indicator modified by John Ehler's Roofing Filter to smooth out the pattern. This tells us when the stock is relatively overbought or oversold. Because we only take long positions, we are looking at oversold conditions in an uptrend.

Unlike other divergence strategies that consider divergence a sign of directional change, we look at it as a pause in a trend. When resolved, the program expects prices to continue in the trend direction.

Our Divergence strategy will trade the reaction that follows the divergence pattern.

Performance Characteristics.

  • This is a short-term strategy, holding a position for an average of 5 to 8 days.
  • It has a low correlation to trend-following because it is taking positions either opposite to the direction of the trend or at a time when prices are moving sideways.
  • It has a high likelihood of success on individual trades.
  • Profits per trade are smaller than trend-following because trades are held for less time.
  • It works for stocks, ETFs, and futures using the same rules and specifications.

We believe that this program will capture profits during periods when the trend is uncertain and can add important diversification to most investment portfolios.

Get Daily Equity Divergence – DE2

DE3: Daily Equity Timing

The Timing Program uses a strategy based on pairs trading logic, also called relative value arbitrage, as written in Mr. Kaufman's book, Alpha Trading (Wiley, 2010). Opportunities in pairs are based on identifying when two related stocks are moving apart, entering at extreme divergence and exiting when they return to near normal, all based on using the Stress Indicator.

The Stress Indicator, developed by Mr. Kaufman, measures the difference between the stochastics of the two different markets. When one is high, and one is low, we have an opportunity to enter a trade.

The key difference in this program is that, instead of matching two stocks, we match a stock with a correlated stock index. When the stock declines to a relatively oversold position compared to the index, we can buy that stock. There is no trade if there is no correlation between the stock and any of the major indices. Because stocks have a high degree of “noise,” erratic up-and-down price moves, this has proved to be a successful strategy.

A number of issues make pairs trading difficult for most investors.

  • There are a large number of stocks that have to be scanned to look for opportunities.
  • It is necessary to sell one stock short against another. Short sales may not be possible in every stock. They require “borrowing” the stock and paying the dividend as well as interest on the cost of the stock, reducing the potential gain.
  • The arbitrage between two similar stocks yields frequent but often very small profits.

To avoid these issues and make the strategy more profitable, our Timing program:

  1. Only buys the undervalued stock when a combination of a Stress signal (found in the book, Alpha Trading) and minimum correlation threshold occur (see #3). It does not sell any stock short.
  2. It measures all stock signals against the SPY, QQQ, or IWM, rather than another stock, opening up a broader set of opportunities.
  3. It chooses the equity index that is most correlated and decides if the stock is oversold relative to that index. If there is no valid correlation, there is no trade possible.
  4. It only buys the stock. It does not sell the index. We found that selling the index reduces the profits to a very small return, yet the long stock position in itself has a good return.
  5. It exits when the oversold condition is satisfied or the correlation disappears.

In that sense, we can call this strategy a “pseudo-arbitrage.” We believe that this program will add significant diversification to most investment portfolios.

Get Daily Trend Equities – DE3

DF1: Daily Futures Trend

This is a macrotrend program that tries to capture the long-term price trends that relate to economic policy or structural shifts in supply/demand. The concept is the basis for most of the hedge funds and managed account programs and has been a stabilizing and profitable component for over 40 years.

I can personally say that I both love and hate trend-following, and both at the same time. No doubt trend-following works, but it also can have large drawdowns when the major trend turns, especially using leveraged futures. Because of that, our strategy has a portfolio selection process that can remove a poorly performing market before the trend changes direction.

Unlike many large hedge funds with very broad diversification, we believe that fewer futures markets chosen for performance can drastically improve results.

Trend programs in the futures markets can take advantage of a bear market because it can take short positions in a downturn or a financial crisis. Smaller gains are possible because of the intrinsic leverage of futures. There are no short-sale restrictions.

Returns, Discipline, and Insurance

Using a trend system needs to be viewed as insurance, but insurance with a very good payout. Experts have called the use of futures “crisis alpha.” While it can be profitable in many market situations, it has been very profitable during major stock market declines — the bear markets. In 2008, trend systems in Futures gained from 20% to 70%, while most stock funds lost 40% to 50% because they could not sell short, act quickly or apply leverage.

The need for disciplined trading cannot be over-emphasized. There are brilliant discretionary traders, but that requires exceptional talent and huge amounts of time and money. You don't make profits by luck. Discretionary traders are usually “systematic.” They don't use a computer to produce trading signals but have a routine and look for special set-ups. No one survives without discipline.

Not All Trend Following Is the Same and Not All Systems Work for All Markets

There are similarities and differences in trend-following strategies. All of them must capture the largest part of the trend, but some do it by trading in and out of smaller moves, while others try to hold the same position for as long as possible. The unique features of our macrotrend program are

  • It scales in and out of positions as the trend increases in strength and changes direction.
  • All positions sizes are risk-adjusted (also called risk parity) for increased diversification.
  • Multiple trends are used based on a range of non-linear calculation periods to avoid a program that is biased toward faster or slower choices.
  • Multiple confirmations are used so that we add to the position as the trend solidifies.

We recognize that not all markets work for all systems. A trend system requires markets that have significant periods of trend. They also favor markets with less noise. Both of those conditions are measured when markets are selected for the portfolio.

More On Futures Portfolios — High beta

The portfolios generated by KaufmanSignals expect to outperform the overall market by choosing markets that have

  • Higher volatility
  • Greater activity
  • A better history of successful performance using this strategy

By eliminating markets that barely move and others that are not “trending,” we are able to construct a portfolio that should have returned better than the broad index. But a high-beta portfolio will also have a higher risk. We count on recognizing when the trend has turned down or the trend is weaker relative to other markets, then remove them from the portfolio. Using our special algorithm, we rotate out when they begin to underperform in favor of those that are moving directionally. When the market turns, we can take either a long or short position.

Futures offer true diversification, spanning a wide range of financial and commodity products. Futures portfolios cannot be dynamically allocated by the individual market performance because there would be a tendency to concentrate in markets from the best sector, interest rates one year, equity index the next, and crude oil in another. Choosing too many similar markets will greatly increase the risk. Instead, we force a minimum amount of diversification to keep risk as low as possible. Markets are equally weighted by risk. This assures diversification, liquidity, and stability.

Target Volatility and Volatility Stabilization

Portfolios in futures allow us to set target volatility. The target volatility is defined as 1 standard deviation of the daily returns. We use 14% measured over the past 20 days. That means there is a 16% chance of losing 14% over some long period of time and a 2.5% chance of losing 28%. Investors who feel that risk is too high can scale down the risk by trading smaller positions across all markets. Always reduce all positions by the same percentage to maintain diversification.

The program will automatically scale up or down the position size when the current portfolio volatility drifts 20% from our target. This essentially takes profits during periods of higher volatility and adds exposure when markets are quiet.

We offer futures portfolios of $250,000 (U.S. markets only), $250,000 (U.S.-European markets), $500,000, and $1 million, each using margin of about 40% of the total investment when targeting a volatility of 14%. The actual leverage is about 12:1. Results of these portfolios can be found by clicking on the Performance tab in the ribbon.

Get Daily Futures Trend – DF1


WE1:  Weekly Equity Trend +

» Trend
» Income Focus
» Dow Arbitrage
» Sector Rotation 2

A weekly trading program is not a lazy alternative but a viable strategy in itself, with some advantages over the Daily Trend program.

Weekly Trend Program

  • Weekly data is smoother than daily data. It reflects the trends better; therefore, it can be more reliable.
  • It requires a smaller investment in trading time and is more practical for many investors.
  • Long-term performance, both returns and information ratio, is similar to the Daily Trend program.

Its obvious disadvantage is that it may take longer to exit a trade because orders are only placed once each week, on Monday's open. However, the program may still exit on a weekday in extreme-risk situations.

The Weekly Trend

The Weekly Trend Program uses the same rules as the Daily Trend Program but has 2 or 4 trades per week based on Friday's closing prices. Trades are generally held for four weeks. The positions are long only.

An important feature of the Weekly program is that it will exit all positions during the week if portfolio volatility exceeds our risk threshold. Waiting until the end of the week is not responsive enough when the risk is high. The program will also reenter during the week when volatility falls below the threshold. Traders are notified when these events happen.

Weekly Income Focus

The Weekly Income Focus program also uses the same rules as the daily program and benefits from interest income to offset much of the downturns in performance. It trades only three ETFs: municipal bonds (MUB), high-yield stocks (JNK), and preferred stocks (PFF). The strategy has positions in all three ETFs in equal risk amounts when all trends are up. If only two of the ETFs are trending up, we allocate the full investment to those markets. If only one is trending higher, it gets the full investment. If all three ETFs are trending down, the investment goes into 3-month Treasury bills. See the performance report for a history of returns and a current chart of performance.

DOW Arbitrage

This program is long the ten best-performing DOW stocks, which also tend to be the stocks making the biggest moves.

When volatility gets to an extreme, as measured by SPY options volatility, the program sells one-half of all positions and sells short the ten worst-performing Dow stocks.

It resets the full position size when volatility returns to normal.

Rather than selling short, investors can hedge the portfolio by buying the triple-leveraged Dow ETF (SDOW) when the system triggers that signal.

Sector Rotation 2

On January 2, 2023, we introduced a new “Sector Rotation 2” program. While we use the classic approach of looking at past returns over the last few months, we rank those returns and select the best 3. Previously we had used a larger set of sector ETFs; we have now reduced that set to 10 Sector SPDRs: XLY, XLF, XLB, XLP, XLV, XLU, XLT, XLK, XLE, and IYR.

This is our own version using these 10 SPDR sector ETFs, ranking the returns, then choosing the best performers. We count on persistence to generate steady returns. The results are a significant improvement over the original version and can be traded with a small investment. We recommend starting with $30,000 and scaling up. Smaller amounts may be affected by transaction fees.

Get Weekly Trend Equities – WE1

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