The Psychological Barrier

In a recent article referencing technical analysis and its impact on market psychology, the Wall Street Journal this week tipped its hat to Robert Edwards and John Magee, two renowned market technicians who have long touted the predictive power of charts and statistical indicators. For the WSJ, which most commonly speaks to the most prevalent investor audience, the fundamentalist, this is noteworthy. After all, fundamental analysis is what is taught in nearly every business school while technical analysis, on the other hand, had for years been largely stigmatized by academics and relegated to the witch doctors and tea leaf readers. But in the words of Bob Dylan, the times they are a-changin’. Well, in regards to investment analysis, times have actually been changing for several years now.

Investopedia says “Fundamental analysis is a method of evaluating securities by attempting to measure the intrinsic value of a stock. Technical analysis differs from fundamental analysis in that the stock’s price and volume are the only inputs.” Although both methods of investment analysis are used to help predict future trends, the former relies on macroeconomic data and individual company financial statements whereas the latter has been referred to as chartology, and math modeling which focuses on price action relative to key moving averages, support/resistance levels, supply/demand and volatility to list a few common parameters.. While Goldman Sachs and a lot of other large global investment banks have stacked their talent decks for decades with Ivy League MBAs who are pros at pouring over balance sheets and income statements, these same Wall Street firms have more recently added market technicians, mathematicians and computer engineers. . Adding technical analysis into the trading and investment equation provides a critically important balance. We’ve often said that fundamental analysis is used to determine “what” to buy and sell; technical analysis helps decide “when”. It’s relatively easy to say, “buy AAPL”, “buy AMZN”, or “sell the Russell 2000”. But when is the optimal time to do so to maximize your profit potential?

Taking advantage of pullbacks to key support levels, paying close attention to increasing or decreasing volume, and, as the WSJ highlighted, having keen awareness of psychological levels in the overall indexes are just a few historically-proven ways to increase your overall returns. So as we (and now some astute WSJ readers) watch the S&P 500 bounce off of the psychological 3000-level barrier (or to us technicians, support), which, by the way, happens to be right at the 200-day moving average (no coincidence), our Forte (ETF) and Forte Futures strategies are systematically adjusting to these levels to produce above-average returns.

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Forte Strategy Update

We executed 9 trades using the Nasdaq 3X leveraged ETF (TQQQ) and the TVIX ETF (2X leveraged VIX futures) for a net loss of 1.7% compared to a loss of 2.9% by the S&P 500. Our YTD net results so far equal a 3.4% loss compared to a 6.9% YTD loss for the S&P 500. Our YTD max drawdown is 9.5% compared to 33.9% for the SP500.

More details about our trading activity can be found by registering on the Collective2 website and searching for Forte Strategy. A running list of these email blogs and general information about Maestro Capital Research can be found at maestrocapitalresearch.com.

How We Manage Risk

It’s been a year where risk management is a major topic. As we addressed in prior email blogs, in terms of volatility and drawdowns, 2020 is in line with Black Monday 1987 and the Great Financial Crisis of 2008. Having watched our TVIX holding gyrate by as much as 40% earlier this week, we thought it would make sense to outline our strategy for managing risk as a key component for meeting our four overriding goals:

1) Preserve capital

2) Avoid a drawdown greater than 20%

3) Earn a return above average benchmarks such as the S&P 500

4) Be uncorrelated to the general stock market and economy

As a general rule, we’ll never put more than 2% of the account at risk for any given trade. Before we enter a trade, we know the buy price and the stop loss price (the price at which we would sell the position if the price were to fall below a certain level). For instance, if we get a buy signal and the current price is $100 and the stop loss is calculated at $90, we know the maximum price drop risk is $10. If an account has $100,000 and our max risk is 2%, or $2,000, then the investment size would be $2,000 / $100 = 20 shares. So, we would size the investment based on the 2% max-loss constraint and the price spread between the current price and the stop loss.

Also, based on our historical models, our trading strategies are in cash around 40-70% of the time, so the risk exposure is also proportionally reduced by these percentages. The sell signals are either driven by the stop loss value or by rapid changes in price volatility. As shown in prior analysis, there is a strong correlation between market sell-offs and sizable increases in price fluctuations. Lastly, we trade symbols that are somewhat uncorrelated to provide a measure of diversification.

Forte Strategy Update

The equity markets finally dropped to a level where all models are active. We executed nine trades using the Nasdaq 3X leveraged ETF (TQQQ) and the TVIX ETF (2X leveraged VIX futures) for a net gain of 0.8% (based on closing out any open positions from last week and any open positions at the end of this week). Our YTD net results so far equal a 1.5% loss compared to a 4.1% YTD loss for the S&P 500. Our YTD maximum drawdown is 9.5% versus 33.9% for the S&P 500.

More details about our trading activity can be found by registering on the Collective2 website and searching for Forte Strategy. A running list of these email blogs and general information about Maestro Capital Research can be found at maestrocapitalresearch.com.

Volatility Second Wave

The market volatility increased significantly this week with the large sell-off on Thursday of 5.9% for the S&P 500. We thought it would be an appropriate time to provide an update on our prior historic market volatility analysis for the two events of the same scale as the COVID19 pandemic – the Black Monday crash of 1987 and the 2008 financial crisis. Recall that we focused our analysis on events that had a volatility spike that is 7X greater than the total average volatility of the Dow Jones 30 for a period from 1985 to the present. We used a simple definition of volatility as the 10-day moving average of the standard deviation of open-high-low-close prices divided by today’s closing price.

The graph below has been updated to show the data for the past two weeks. It’s interesting that all of the volatility levels peaked at about the same time 37 days after numbers elevated 10% above the historical average (this is an arbitrary cut-off we used to mark the beginning and end of the lines and definition of the volatility event). And now the lines are converging to about the same level 90 days into the volatility event. You can also see that the COVID19 green line had the lowest level of volatility for an extended period 65 -85 days after the start of the cycle but is now in-line with the prior two events. Both the 1987 Black Monday and Financial Crisis had at least two follow-up cycles of minor volatility spikes between 60 – 120 days into the event. This appears to now be underway for the market reaction to the COVID19 pandemic.

20200612_graph1

Here’s an excerpt from our blog email a couple of weeks ago as the market volatility was slowly increasing: “So, what does this analysis suggest for today’s market? We believe that, given the scale of the March volatility spike and striking similarities of the patterns compared to Black Monday and the Financial Crisis, we’ll see a second down-leg sell-off in the market…”. The Dow Jones 30 graph has been updated for the week showing the current sell-off underway.

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Forte Strategy Update

The equity markets remained at elevated levels of volatility for the week which left these trading models inactive. We executed two trades in gold which were essentially break-even. We completed our R&D work and started trading TVIX which is a high volume 2X leveraged ETF that tracks the S&P 500 VIX short-term futures index. This trade, which is still active, was a gain of 1.1% for the week. Our full-year net results so far equal a 1.1% loss compared to a 4.8% year-to-date loss for the S&P 500. Our YTD maximum drawdown is 9.5% versus 33.9% for the SP500.

More details about our trading activity can be found by registering on the Collective2 website and searching for Forte Strategy. A running list of these email blogs and general information about Maestro Capital Research can be found at maestrocapitalresearch.com.

Where do we go from here?

There continues to be many conflicting economic data points which are contributing to a wide array of “expert” opinions on where the economy and markets are headed. V-, U-, W-, WW-, L-, J-shaped…it’s an alphabet soup of recovery profiles in a world of complex global uncertainties. We recall very few early forecasts that called for the strong V-shaped recovery we are seeing unfold so far. On one hand, you’ll read that government intervention (fostered by Keynesian economics troupes) and extreme negative consumer sentiment is bullish; on the other hand, others will say the debasement of global currencies, which creates increasingly extreme asset volatility, destruction of purchasing power and a dangerously uncertain debt vacuum, is bearish. And the press headlines broadcast dismal economic metrics for the most part. Yes, we have our opinions too (as you may have read in our previous blogs), but it’s important to understand that our trading strategies are designed to be unbiased, mechanical and math-driven as it pertains to buy and sell decisions. We’ll continue to follow our models regardless of our own opinions, the headlines, or economic data reports. And, of course, as always, we tirelessly work on ways to improve the performance results.

New Forte Futures Strategy

Since its February 2018 inception, our Forte Strategy has been an example of this approach. Using primarily ETFs, Forte continues uncorrelated to the S&P 500 with a fraction of the drawdown experienced by the buy-and-hold index investor. Within the last month, we’ve also launched a second strategy called “Forte Futures”. This new futures version of our flagship Forte strategy uses a balanced selection of low-correlated contracts including the NASDAQ 100, gold, currency futures, and crude oil along with the Volatility Index (VX) futures during peak volatility periods. Forte Futures also includes a few other new components to allow for direct short positions and alternate time periods. Having just gone “live” in May, there is only a limited amount of performance history, so stay tuned as the performance scorecard is established over the coming months.

Forte Strategy Update

A few days ago the volatility level for the equity markets declined to a point where the Nasdaq model became active again consistent with the oil and gold markets in prior weeks. We entered our first trade using the 3X leveraged Nasdaq ETF (TQQQ) after a 14 week pause due to the COVID19 volatility excursion. We executed five trades in the Nasdaq, gold, and oil which were net break-even for the week. Our full year net results so far equal a 1.9% loss compared to a 1.1% year-to-date loss for the S&P 500.
More details about our trading activity can be found by registering on the Collective2 website and searching for Forte Strategy. A running list of these email blogs and general information about Maestro Capital Research can be found at maestrocapitalresearch.com.