Being Reactive

We heard a podcast this week hosted by author Michael Covel that reminded us of some of the oldest and wisest perspective provided by the then CEO of Exxon, Lee Raymond when he was on CNBC in 1998 discussing the pending merger between Exxon and Mobil. The commentator asked him what direction he thought oil prices were headed in the near-term. He replied (paraphrased from memory), “We gave up trying to predict the direction of oil price moves a long time ago. Instead, we have detailed strategies that if the price moves up to some extent, we execute Plan A, and if it goes down to some similar extent, we execute Plan B.”

In the Covel podcast, he compared and contrasted technical analysis of the capital markets as either being predictive or reactive in design and gave a clear message that reactive was far better and that it’s impossible to predict the future based on analysis of past numbers. That’s the perspective for the trend-following approach we use which reacts to price moves in either direction and also the degree of volatility of the price moves. The price data is loaded into our math models each night which outputs a simple decision – buy, sell, or adjust the stop loss. We try to mentally approach the market each day with an objective mindset, with no substantive opinion about the short-term direction of the market either way (long-term, however, we believe the market will trend higher due to inflation and innovation). Regardless, we recognize that within the span of the next month or even next year – a substantial move in either direction is possible – so we trade accordingly.

Forte Strategy Update

We executed 6 trades last week for a net gain of 1.1% compared to a loss of 0.6% by the S&P 500. Our YTD net results equal a 4.7% gain compared to a 2.1% YTD gain for the S&P 500. Our YTD max drawdown is 9.5% versus 33.9% for the general market. The account correlation to the S&P 500 remains low at 0.156.

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.

Fridays are the Worst

We frequently review and revise our trading models to find ways to improve results based on sound reasoning and data-driven justifications.  However, it is important to not add too many parameters with precise settings to avoid curve-fitting of historic datasets.  One way to accomplish this is to compare model performance with out-of-sample data to expected in-sample results.  Sometimes this is as simple as optimizing the model parameters for a time period (e.g. 2015-2020), applying the same parameters to a prior time period (e.g. 2009- 2014) and then comparing the results for consistency.

This week we retrieved analysis performed for a presentation made to a medium-sized hedge fund in Chicago in September 2014 to see if recently observed patterns can be validated by prior time periods.  In this case, the sum of the Dow Jones 30 Index gains on Fridays so far this year are negative 2.3% versus a positive 5.5% for the other four days of the week.  The absolute ratio of these two numbers is 2.4 compared to the same ratio applied to the dataset below for a period of June 2000 through June 2014 of 2.9.  So, there are two independent datasets suggesting that the gains in the DJ30 during the first four days of the week are around 2.5 times in size as the losses that occur on Friday – on average and in general.

We rigorously tested this theory applied to our daily TQQQ 3X leveraged Nasdaq model and did find that it improved results by around 10% if we exited the position on Thursday at market close and then re-entered on Friday market close if the position would have otherwise been open at that time or provides a buy signal for the open on Monday.  However, we were not able to validate this theory for the UPRO 3X leveraged S&P500 ETF model, so we’ll leave that logic out which will provide some measure of diversification by time as one model will be active on Friday and apply new buy signals on Monday at open, and the other will be dormant on Friday and apply new buy signals on Friday at close.

It’s worth noting that the above excerpt from the 2014 PowerPoint presentation indicates that a simple strategy of holding the Dow 30 tracking ETF (DIA) from Friday close to Thursday close and then swapping this for the inverse ETF (DOG) on Thursday close to Friday close may provide results 2X the buy-and-hold DJ 30 strategy (more fodder for your next “you can’t beat the market with active trading methods” conversation).

Lastly, we concluded a multi-month study comparing models based on 15-min data updates versus models using daily data and found that there is not enough (if any) added benefit to using the more complex and time-consuming 15-min models, so these are retired for now.

Forte Strategy Update

We executed 4 trades last week for a net gain of 0.6% compared to a loss of 0.6% by the S&P 500. Our YTD net results equal a 3.6% gain compared to a 2.7% YTD gain for the S&P 500. Our YTD max drawdown is 9.5% versus 33.9% for the general market.

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.

50% More Gains with Half the Risk

As committed to in our July 4 and August 15 email blogs, we are following up with a defined trading system to take advantage of the next spike in volatility.  As we shared before, we believed that there was a way to construct a trading system by exiting a long market position when volatility spikes and then re-enter the position as volatility declines and there is some measure of confidence that the violating peak (market bottom) event had occurred.   We’ve proven this now as a sound theory and that serves well for a mechanical system structure that provides strong results as stated in the headline – 50% more gains with half the risk.

The trading system closely follows our prior analysis by exiting a long market Dow Jones 30 (using the DIA index tracking ETF) position when volatility (defined as the a simple standard deviation calculation of the last 10 days Open-High-Low-Close prices divided by today’s close price) spikes 1.75 times greater than the long-term average (9.4 years in this study) and then re-enters the position when the volatility falls by 50% compared to the maximum value of the prior 50 trading days.

The graph below shows the total gains of this trading system versus a buy-and-hold strategy with the performance statistics summarized in the table beneath the graph.

This model was developed using a simple Excel spreadsheet and round parameter settings (10-Day StDev moving, 1.75X peak,  and 0.50x drop) for illustrative purposes.  The results can likely be improved by using the more volatile NASDAQ-100 index, optimizing the parameters with more robust software (like TradeStation), using a leveraged ETF like DDM or UDOW, and, for some with higher risk tolerance, also short the market when volatility spikes above 1.75 times the long-term average.

As of Friday’s market close, the StDev of the last 10 days is 1.69 times greater than the long-term average – so the model is still long in the market now but will likely exist soon with another day or two of high volatility.

Lastly, we hope this helps in some way – at a minimum, to equip you with hard facts for your next cocktail hour conversation when a boorish market expert tries to convince you that it is impossible to beat the market with a mechanical method or timing.   Here’s one simple example to do that by at least 50% and with half the risk.   The graph even shows that it beat the market within 90 days and then held and extended the gains for the following 9 years.

Forte Strategy Update

We executed 9 trades last week for a net loss of 1.0% compared to a loss of 2.5% by the S&P 500. Our YTD net results equal a 2.9% gain compared to a 3.4% YTD gain for the S&P 500. Our YTD max drawdown is 9.5% versus 33.9% for the general market. 

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.

September Swoon?

Anyone who has followed the markets for even a handful of years knows that the month of September is on average the worst performing month of the year.  September 2020 is starting off to be no different.  Beyond the crazy high multiples of big tech and the overall equity markets, the volatility (or fear) index (VIX), which typically remains low during more placid (and GDP-correlated) upward moves in the markets, has been running up in tandem with stocks ahead of this recent selloff.  Furthermore, a recent CNN Business article pointed out that the VIX relative to new S&P 500 highs are at levels comparable to the tech bubble:

With historically bad vibes in September combined with the upcoming elections, investors may want to fasten their seatbelts (and take some profits).  It will likely be a bumpy ride.

Forte Strategy Update

We executed 11 trades last week for a net gain of 2.0% compared to a loss of 2.3% by the S&P 500. Our YTD net results equal a 4.5% gain compared to a 6.1% YTD gain for the S&P 500. Our YTD max drawdown is 9.5% versus 33.9% for the general market.  Overall, we are pleased with the performance of the models leading up to and during the sell-off.   The VIX ETF models triggered early and served as both a hedge to open long trades and profit generators as the market sold off.   And, the sudden increase in volatility shut down the TQQQ ETF to help avoid losing whipsaw trades.   The net profits for the week came from both the long market trades and the VIX hedging trades – as planned and hoped.  The math models ended the week 100% in cash.

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.