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Archive for January, 2009

The human brain provides inspiration for artif...
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I love to surf around and discover articles by following Alice down the rabbit hole – meaning – start down a path and just keep going.  I was reading an excellent post by Woodshedder over at ibankcoin.com this morning on position sizing.  I think the post and Van Tharp articles (part 1 and part 2) it references are a good source for understanding position sizing and the effect on a given system.  In fact, I think they should be required reading for any aspiring trader.

The Woodshedder post referred me to a blog I was unaware of – Max Dama – a student/quant.  Max is obviously very, very smart (about 10x my brain power judging by his blog).  Max was profiled in a piece in Porfolio (also available via Wired) on the rise of quant-based strategies in the financial world.  That article referenced Legend Advisory – who offer a quantitative approach to asset allocation.  They use an artificial intelligence model for determining the asset allocations between different sectors and styles – think “should I be in financials?” or “will growth outperform value?”.

I did some more searching on Legend and came across an article in Allbusiness that detailed some of their predictions from December 2007.  Here’s what I find fascinating – for all their math and study, two of their predictions stood out to me as being so, so wrong (and they had others that were right) that it made me question their whole approach.  My comments are [in the brackets].

1. The financial sector should outperform in the second half of 2008. [My comment – wow – stunningly wrong].

2. Corporate earnings growth should continue to decline. [Interesting and correct – but what do you do with it?]

3. P/E multiple expansion will result from lower interest rates. [I don’t have the tools to look at this one to know if it right or wrong – my guess is that it is correct but again, what do I do with it?]

4. The US Dollar should continue to weaken throughout the year, but could reverse its course before the end of 2008. [Correct!]

5. After underperforming the broader markets for almost 6 years, healthcare should surprise investors (positively).  [Healthcare outperformed the general market, but still declined – I’ll give them half-right.]

6. The real US economic growth rate (GDP) will decline in 2008, below its historical trend. [Correct – but then how could you say that financial would do better given that the market is so dependent on the performance of financials?]

7. Growth stocks should outperform value stocks in 2008. [Value actually outperformed growth, at least in the small cap arena, for more than half of 2008]

8. The S&P 500 index should reach 1625 by mid year, 2008. [Stunningly wrong – the index was at 1504 on Dec 7th, the time of the writing of the article]

All of this isn’t to knock Legend specifically – most models (including my own) did not do well in the radically different market that 2008 gave us.  They also may be making some predictions here that didn’t make it into their client’s portfolios or were altered significantly during the year.

The point is this: don’t be too impressed by financial firms that throw a lot of whiz-bangy mathematical jargon out there.  Hell, I’m not that good at math, and, at first, I thought Legend’s approach sounded very interesting.  But in looking at their results, I’m reminded that you can throw all the math you want at the financial puzzle and still end up with a stinker.

It also reinforced, in me, the idea that everyone has to be responsible for their financial future.  You can’t put your financial future on autopilot with someone else and not be involved.  I am consistently surprised by the number of people, in surveys, that spend more time planning vacations than planning their finances.  I am also consistently depressed by the total lack of education prior to graduation from high school and college on these issues.

It sounds all well and good to let a computer model determine everything – but at the end of the day, much of what these firms put out there is mathematical masterbation.  Just remember that next time someone tells you they’ve got a model that can solve all your problems.

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I’m starting a new feature on the blog – I’ll be reviewing key sectors and the relative strength of each of them.  I’ll be posting this using a new proprietary tool I’ve developed.   This will be represented graphically by this new indicator over the prior 100 days.  I may end up doing 50 days as well if people are interested – let me know.

No shocker this week – we’ve got strength in Gold and Bonds.  We are seeing some relative strength in small cap stocks which, in my opinion, is key to the overall recovery of the market.

rel-str

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Geometrical interpretation of partial correlation
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I’ve updated the ETF correlation tracker tool today.  You can download from this post or go to the dedicated page under Strategies.  As usual, questions and comments welcome!

ETF Correlation Tracker – 10 day (CSV)

ETF Correlation Tracker – 10 day (HTML)

ETF Correlation Tracker – 50 day (CSV)

ETF Correlation Tracker – 50 day (HTML)

ETF Correlation Tracker – 120 day (CSV)

ETF Correlation Tracker – 120 day (HTML)

ETF Correlation Tracker – 260 day (CSV)

ETF Correlation Tracker – 260 day (HTML)

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The Skills Dat Pay Da Bills album cover
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Wow – that was quick.  The Skills Index strikes again on the sell of the market.

I’ve been thinking about something else in relationship to the index which is probably obvious to everyone else out there looking at any index that runs from 0 to 100% where zero is oversold and 100% is overbought: that your position size can/should be determined by, as Dorsey Wright would say, your relative field position.  So when the Skills Index was in positive territory but at or above 70%, then, if you do enter long, you should probably be thinking about doing it at a small size.

Now, I didn’t get a chance to take much advantage of the sell in this case – my new boy Max has been taking up my time (and that is a great thing) – but another interesting aspect of the Skills Index is that when you are in a bear market, you want to play, immediately (not wait for a retracement) to the short side.  The same would be true of a bull market – take the signal with a half position immediately, and then add to the position on confirmation.  And you should wait for a retracement for entry on the long side when the bear market is on, and wait for a retracement to the long side when you’re in a bull market.  Man, that’s confusing.

Anyway, enough of the diatribe – I’m just happy the index is keeping me on the right side of the market.

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I’ll be writing more about what I’m seeing in the market but I wanted to do a quick update on the Skills Index.  We now have a sell signal after the index quickly climbed to over 70.  Two interesting points about the performance:

  1. It rose very quickly to 70 – probably too quickly in my mind.  As a result, I was hesistant to put money to work on the long side while it was that high.
  2. The performance of the index in bear markets is consistent with what we’ve seen in past bear markets.  Meaning, we have a quick, large bear-market rally and then a swift retracement.  I’m thinking a lot about how to model for this in a system.

Here’s the index:

skills-index-01-14-09

Now – similar to the way we trade the index on the upside, we don’t enter immediate but will, rather, wait for a retracement of this down move to look to enter on the short side.  More to come.

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My damn day job….

I don’t talk a lot about my day job – mainly because I don’t think it is relevant to the topics of this blog, but I feel the need to write a bit about it today.  The reason I don’t trade full time at the moment is because I work for a great company – so I have nothing to complain about with my day job – it is interesting and I get to work with some very cool people.

Today was unique – we were invited down to ring the closing bell at the Nasdaq with one of the members of our media library – Jeffrey Hayzlett – Chief Marketing Officer of Eastman Kodak (he’s the really tall guy in the photo below).  Jeff was nice enough to come down and ring the bell with us, and he is also a tremendously nice guy.  Interesting facts about Jeff – he is obsessed with Twitter – he has 1000 followers on Twitter and was twitting away on his way to the event.  You can see his twitter blog here.  He’s also on Facebook – interesting to meet a senior executive so “down” with the new media.

mc_011209_hires

That’s me to the left of Jeff holding the green book.  If you happened to be watching CNBC, Bloomberg or Fox at 4pm you would have seen us clapping like fools in the background…..I’m fully confident no one noticed!

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Geometrical interpretation of partial correlation
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I’ve updated the ETF correlation tracker tool today.  I’m moving this to a dedicated page under Strategies from now on – I’ll continue to let everyone know when it is updated – the goal is weekly.  Questions comments welcome.

ETF Correlation Tracker – 10 day (CSV)

ETF Correlation Tracker – 10 day (HTML)

ETF Correlation Tracker – 50 day (CSV)

ETF Correlation Tracker – 50 day (HTML)

ETF Correlation Tracker – 120 day (CSV)

ETF Correlation Tracker – 120 day (HTML)

ETF Correlation Tracker – 260 day (CSV)

ETF Correlation Tracker – 260 day (HTML)

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