2016 Revised Process

Investment Philosophy: Employing a Top-Down Technical Approach to create a portfolio of non-correlated assets with largely asymmetric risk/reward potential.

Below Is a More In Depth Look at My Approach:

Summary: 

First off, as a technician, my investment process does not involve any fundamental information about the underlying security. I focus on the price action of the security being analyzed and the behavior of the market itself. At the end of the day, it does not matter what a security should or shouldn’t do, but what it is actually doing in the market. Technical analysis introduces risk management into the picture by outlining levels where my analysis is wrong. As a market participant, I expect to be wrong the majority of the time, which is why I look for high risk/reward scenarios to add to the portfolio. The goal of my process is to construct a portfolio of non-correlated assets that currently have a risk/reward profile that is dramatically skewed in my favor. I work from a Top-Down Approach in that I try to identify broader themes present in various markets around the world and then drill down into individual securities to identify how best to take advantage of that theme while managing risk within the portfolio. By applying a technical approach to markets I can analyze and participate in any market whether it be equities, commodities, currencies, fixed income, etc… The factors that are important for my analysis are; absolute and relative performance, momentum, sentiment and seasonality. How these factors are quantified, measured, and utilized differ based on the asset class being looked at, which will be discussed further below.

Absolute Performance: 

An important part of my process is to analyze securities utilizing multiple time-frames: a weekly, daily, and intraday (65 / 60 minute). The weekly chart provides insight into the structural trend, while the daily and intraday charts provide a more tactical view that can help with the risk management process.

Indicators Used for Weekly and Daily Charts:

  1. 14 period RSI.
  2. 14 period ATR.
  3. 200 period simple moving average.
  4. Correlation labels (monthly, quarterly, yearly).

Relative Performance:

Relative performance is an important part of my analysis because I want to be involved in assets where relative performance is either trending or at pivotal turning points where my risk/reward is clearly defined. I can also participate in ratio (long/short) trades when the risk/reward on a relative basis is better than on an absolute basis.

  1. Ratio charts: When analyzing a security I’ll look at how it is performing relative to the broader market, its sector, an industry proxy or individual names in its peer group. This helps to identify the levels on which this particular security is showing relative strength or weakness.
  2. Ratio charts with trendlines and indicators: Once I’ve identified how a ratio looks from a structural perspective, I’ll add trendlines and indicators to identify areas of support and resistance while watching for traditional chart patterns to develop.

Momentum:

Momentum, as measured by the 14 period relative strength index, is a leading indicator that can offer helpful clues into the health of a price trend. I want to see momentum confirming price at new highs and lows and if it’s not, I can use this information to identify possible trend reversals.

  1. Divergences: Positive and negative divergences in momentum are often clues into a possible price reversal. If I am trying to identify a trend reversal or put on a counter trend trade, I need to see these divergences present in momentum. If I am trying to trade in the direction of the trend, I want momentum to confirm these new highs or lows.
  2. Bullish and Bearish Ranges: If a stock is trending higher, I want to see momentum stay in the top of its range > 30, and if it is trending lower, I want to see momentum stay in the bottom part of its range. < 70. Also, changes in bull/bear ranges occur when overbought/oversold conditions are hit.
  3. RSI can be applied to both absolute price charts and ratio charts.

Sentiment: 

Sentiment is important because consensus can be right for a long time but are often wrong at extremes. I look at a few different indicators to gauge sentiment depending on what type of asset I am looking at. Given that this data is usually very volatile and noisey in the short term, I use historical averages as a measure to gauge whether or not current readings are significant.

Sentimentrader Data: Sentimentrader.com is a paid service that has great sentiment and seasonality data created by combining various options and futures data, surveys, etc… into a few aggregate values. I look for multi-year highs or lows in levels of optimism or pessimism before taking this data too seriously, as I said before that the data can be noisey. I can also look to see if sentiment is confirming or diverging from current price action.

Short Interest: Short interest is the amount of shares sold short as a % of the float. I will look at this to identify situations where concensus may be overly bearish on a particular asset. This supplementary information allows me to identify areas where a short squeeze may occur.

Days to Cover: Days to cover is calculated by taking the number of shares short and dividing it by the 10 day average volume for the stock. This helps to quantify the amount of demand there could be for the stock if a short squeeze was to insue.

Sell Side Buys as a % of Coverage: By looking at the amount of sell side analysts that rate the security as a buy compared to the total number of analysts covering the security, I can gague how negative concensus is toward the security. If too many market participants are on the same side of the trade, eventually everyone who wants to buy/sell has already bought/sold and that may present a situation in which the risk/reward is skewed to the short/long side.

Commitment of Traders Data: Commercial hedgers are referred to as “the smart money” which is why it is important to pay attention to their positioning by analyzing the commitment of traders data that comes out weekly. I’ll look for instances where these types of market participants are aggressively hedging or not hedging at all. Again, as with all sentiment data, there can be a lot of noise in the middle of these readings, but they can be important at extremes.

Seasonality:

Average Returns and Volatility: I look at monthly seasonal patterns within performance and volatility across all asset classes and securities I am interested in. This can be important from a portfolio management perpsective because this data may assist in market timing. For example, August and September tend to be weak months for the major US equity indices and there is normally a pickup in volatility during those months as well. Knowing that information allows me to make changes to the portfolio in an attempt to minimize my exposure to the weakness and volatility that historically occurs during this period. If a market diverges from historical tendencies, it can indicate that larger forces are at work and that may be important as well.

By combining the five above factors I am able to identify high risk/reward set ups and actively manage positions within the portfolio to maintain the goal of having a near zero correlation to the major asset classes. 

Timeframe:

My analysis primarily looks for setups over the short (0-2 months) and intermediate (3-6 months) term. If the facts change I’ll adjust the position as needed, but I primarily look for trades in that are expected to perform within those timeframes. If there is an event like an earnings announcement where I can’t define my risk then I’ll adjust the position to reduce risk into that event.

Entry and Exit Rules:

  1. All entries and exits outlined in the trade thesis will occur within the last hour of trading. This will ensure that I am not whipsawed in or out of a position on an intraday basis and prevent emotional decisions from being made based on intraday action. Position size will have to be adjusted down by 20% to account for the additional risk associated with entering and exiting positions at the close and not intraday.
  2. Half a position will be taken on the initial entry and the second half will be added to as the market confirms the trade thesis.

Position Sizing and Risk Management: 

  1. Every position in the portfolio will risk a maximum .8% of the total portfolio value.
  2. The initial position size will risk .4% of the portfolio and the additional .4% of risk will be added once the market confirms the trade thesis.
  3. Maximum overnight risk will be calculated using 2x the 14 period ATR for each of the positions in the portfolio.

Trade Preparation:

Weekends: Each weekend I go through a process of analyzing markets and identifying opportunities for the week ahead.

  1. Analyze bar charts of my universe of securities (300+ of equities, fixed income, commodities, currencies) on multiple time-frames (weekly, daily, 65 / 60 minute) with no studies to get a clear indication of what pure price action is indicating.
  2. Analyze candlestick charts of the same universe on multiple timeframes with studies (14-period RSI, 200 period moving average, relative strength (ratio chart), correlation labels) to get a more in depth understanding of the asset’s trend, momentum, strength / weakness on an absolute and relative basis.
  3. Write and post “Weekend Thoughts” which outlines my research conclusions, themes for the upcoming week, and trade opportunities that I’ll use as a guide throughout the week.
  4. Set alerts in Thinkorswim that will go off throughout the week to alert me when something is changing about a particular market, such as a breakout / breakdown occurring.

Weekdays: Each weekday between 3pm and 5pm I review the market’s action, make any portfolio adjustments as necessary, and review current events.

  1. Check my market summary excel sheet to see what occurred during the day for all the asset classes within my universe and go through some charts.
  2. Check the portfolio to identify if any trades need to be executed, then execute them.
  3. Update the portfolio spreadsheet with any changes.
  4. Post chart of the day and read to keep up with current events and on top of market action.

Things I Must Know When Entering a Trade:

  1. Security specific risks.
  2. Stop placement.
  3. Price targets.
  4. Acceptable entry prices.
  5. Position size.
  6. Impact on portfolio.

Conclusion:

  1. Analyze all liquid global asset classes.
  2. Identify broader themes.
  3. Determine best investment vehicles to play a theme.
  4. Portfolio management.
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