Industry Benchmark Performance
Erratic prices led to small losses for most equity programs, buy year-to-date is still better than most years. Commodity funds are doing well this year, even though prices seem to have quieted down in most sectors.
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. This link is now working!
As of September 30th our system tracking had the following results for a sample of futures markets and Equity Index ETFs, and you can choose your own markets to trade.
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.
September Performance in Brief
Given the erratic behavior of the markets, all programs except the 10-Stock Equity Trend have done well. We can only say that the program moved to tech stocks when they appeared to be recovering, then made a U-turn and headed lower. It will eventually settle on the best markets, but we admit it is frustrating.
On the other hand, the Timing, Trend Futures, and Weekly Trend programs are doing very well. That makes this market move even stranger. Perhaps it argues for system diversification.
Major Equity ETFs
The S&P fell below its 50-day moving average a week ago and the 100-day moving average yesterday, not a good sign. The stalemate over infrastructure and the 3.5T social safety net seems to be the problem. Fighting over raising the debt limit is serious but it is more likely to be posturing than obstruction. It’s about paying for last years debts, not those to come. But the market has built in optimism about infrastructure and it is telling the Administration to get it passed.
CLOSE-UP: Living Off Profits
I know a young woman who trades full-time, but she needs to generate enough profits to live on. That bothers me because withdrawals constantly drain the account and makes it impossible to compound the returns, which is the key to accumulating wealth. I’m sure she’s not the only trader with that problem. The question that needs to be asked is, “how much can you withdraw and still keep trading?”
Let’s take a simple example, using the SPY ETF from inception. It’s had three great bull markets, the last part of the 90s, 2003-2007, and starting after the financial crisis of 2008. From 1993, the annualized return has been 10.3%, from 1999 it is 5.53% and from 2010 it is 12.6%. Those differences reflect some extreme ups and downs.
Fixed Withdrawal Amounts
As our benchmark, we start with $1 million on February 1, 1993, the inception of SPY. If we need $50,000 to live on each year, we will withdraw $4,166.66 at the end of each month. That reduces the amount of capital we can invest the following month. Each month we apply the SPY percentage returns to the previous month’s ending asset value and subtract the monthly withdrawal. We calculate the new monthly return and compound that in the usual way to get the NAV shown in Chart 1, marked “W/D 50K”, and shown in orange.
Chart 1 Monthly withdrawals of fixed dollar amounts, from a passive SPY account, based on an annual amount.
The impact of a $4,166 monthly withdrawal is not too bad. If our trader could live on that (hypothetically, of course), the equity still grows. But she really wants to withdraw $100K each year, or $8,333.33 per month. That gives us the gray line in Chart 1, essentially removing all profits and always keeping about the same as the starting investment. That leaves little room for error.
What if she needed even more? As you can see by the yellow line in Chart 1, withdrawing $150K each year ($12,500 monthly) takes about one half the time to consume all the investment, even going negative in the middle of the 2003-2007 bull market.
The market has been good to many investors, but there is a limit to what it can produce. You might think that withdrawing a percentage each month would be better, but then the amount you take out will vary considerably. Let’s look at what happens.
Chart 2 shows the buy-and-hold SPY investment (in blue), along with the equity given monthly withdrawals based on annual amounts of 5%, 10%, and 15%. It appears that we have basically the same pattern as the fixed dollar withdrawals. The 5% option allows the account to grow, 10% removes all gains, and 15% leaves you with nothing, albeit slower than the withdrawal of $150,000 each year.
Chart 2 Monthly withdrawals of percentage amounts, from a passive SPY account, based on an annual amount.
The benefit of percentage withdrawals can be seen in the monthly cash flow. A monthly dollar withdrawal of 5% is $4,166. If instead, you withdraw 5%, or 0.4166% monthly, you end up with more money to spend, shown in Chart 3. The reason is that, when the SPY is in a drawdown, you withdraw less, so when the market recovers, you have a larger investment. Over the period from 1993 you would have withdrawn an average of $7,509 each month instead of $4,166.
But that picture can be deceptive. It is based on beginning these calculations just ahead of a bull market scenario.
Chart 3 Monthly income flow, based on percentage withdrawals, starting January 1993.
Starting at the Wrong Time
Those who traded in the 1990s should remember the remarkable bull run that ended at the beginning of 2000. What if you had started at the worst possible time, instead of the best time? Taking a 5% annualized withdrawal (monthly) would still have survived the two devastating bear markets that have occurred since 2000. But more than 5% reduces your equity significantly, as seen in Chart 4.
Chart 4 Net equity after percentage withdrawals, starting in January 2000.
The real problem comes in the cash flow. Instead of accumulating profits in the late 1990s that allows you to withdraw funds for the next 20 years, you start on a downturn. At no point can you withdraw the 5% that you need. In fact, for most of the time, you can only withdraw half that amount, and the average over all the years from 2000 is $2,943 each month (see Chart 5), rather than the $4,166 you are looking for.
Chart 5 Monthly income flow based on a percentage withdrawal, started in January 2000.
In theory, we should be able to withdraw something just short of the long-term annualized returns of our investment portfolio. If we start at a good time, when the portfolio returns perform better than average, we can accumulate extra reserves that will carry us forward for a long time. If our timing is bad and we begin ahead of a bear market, both the equity and the withdrawals work against us and we end up with much less than we wanted.
There is really no way to know what the market will do. Statistically, you have a better chance of a bull market than a bear market. Perhaps the best way is to withdraw a smaller amount, say 5%, until you build equity, then increase the size of the withdrawals. It will assure longevity.
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. From time to time we make logic changes to the strategies and show how the new model performs.
Groups DE1 and WE1: Daily and Weekly Trend Program for Stocks, including Sector Rotation, Income Focus, and DowHedge
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.
Quite a different picture for the Daily and Weekly Equity Trend programs. It is unusual to see them diverge this much. In addition, the 30-stock portfolios are benefiting from diversification, so the downturn in tech stocks does not have the same impact. Drawdowns are part of reaching for higher profits. History shows that we will come out of this gloomy period with new highs.
Income Focus and Sector Rotation
Continued fractional losses still keeps this program slightly down for the year. Given that the trend has been to higher yields, the income flow is holding returns steady. It may not give the returns of the stock market for now, but it will keep producing in the long-run with low risk.
Nothing is immune from a downturn in the whole market. This program lost 3.75% in September but remains 15% ahead for the year.
Smaller losses compared to other equity program puts the chart in a modest sideways pattern. Both daily and weekly program are ahead for the year by 3% and 8%.
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.
Modest losses this month but still profitable for the year. Both 10-stock and 30-stock portfolios lost about 3%, but the 30-stock remains higher by 10% this year.
Group DE3: Timing Program for Stocks
The Timing program is a relative-value arbitrage, taking advantage of undervalued stocks relative to its index. It first finds the index that correlates best with a stock, then waits for an oversold indicator within an upwards trend. It exits when the stock price normalizes relative to the index, or the trend turns down. These portfolios are long-only because the upwards bias in stocks and that they are most often used in retirement accounts.
We were looking forward to another leg up in this program. Instead it exited all positions flat for the month and has remained out of the market. The program looks for a pullback in an uptrend but the trends have now turned down. Sometimes it is best to be out.
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.”
Perhaps this is another year of “Crisis Alpha” where futures offset losses in stocks. We never know when that will happen or we would all be rich. This month all Trend Futures program were profitable, and the gains for the year are 30%, 24%, and 23% in order of smallest portfolio. The more diversification, the lower the return. Of course, less diversification also means more risk. You can’t have both!
Group DF2: Daily Divergence Portfolio for Futures
A second month of mixed returns for the Divergence program with the smaller portfolio profitable and the two larger ones with fractional losses. For the year, all portfolios are ahead by 8% to 12%.
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.
TradeView Australia in November
Mr. Kaufman will now be doing a virtual seminar for TradeView in Melbourne. On-again, off-again Covid restrictions make it impossible to plan an in-person meeting. On the other hand, it will now be available to a much broader audience. It is schedule for about November 27, but check their website for exact times and speakers.
FinecoBank (Milan) in November
Mr Kaufman will present twice for FinecoBank, Milan, in the last week of November. One presentation will be simultaneous translation (for Italian clients) and the other in the U.K. for their English customers. Check their website for exact dates and times.
For those practicing their Spanish, Mr Kaufman has an article being published in Hispatrading, an on-line Spanish technical analysis magazine. It is about how to execute a trend-following strategy.
There are two pending articles to be published in Technical Analysis of Stocks & Commodities. The first, “50 Years On,” is a recap of the most important lessons learned by Mr. Kaufman. The other article, “Trading a Moving Average,” looks at two key moving average rules as well as how to time an entry. We have no dates yet for the publication.
“Playing It Safe with Cryptos” appeared in Technical Analysis of Stocks & Commodities. It’s a challenge trying to trade these markets given their extreme volatility.
Mr. Kaufman gave a 30-minute presentation, “Lagged Trends,” for The Money Show on Tuesday, May 11. You can see it using the following link:
There are new articles being published in Technical Analysis of Stock & Commodities. The next one is “Better Entries,” scheduled to appear in the May issue.
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 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.
“The 1st and 2nd Cross” has been very popular with readers. It was published in Technical Analysis of Stocks & Commodities in the March 2020 issue. It is based on an idea of Linda Raschke and captures small but reliable pieces of a trending move. You can find it online.
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