Video Blog: Using and Understanding the Portfolio Relative Strength Application

May 27, 2010 in Backtest | Video

This video discusses some ideas related to our powerful new ETF Relative Strength Application. The key to understanding how it works is to understand its relationship with the ETF screener

Comments and feedback appreciated.



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Index ETF Focus: Gold (GLD)

May 07, 2010 in Backtest | Gold

We highlighted potential leadership developing in gold at month-end.  Last Friday, the Gold ETF triggered a buy vs SPY in the Relative Strength application.

 

 

As of Tuesdays close,GLD had then moved to the top of our screener relative strength list.   When volatility began surging in the equity markets, it should have become clear that US equities were going to drop in the screener rankings as high volatility is penalized in the model.  The logical asset to assume new leadership was Gold (GLD) as it had already been moving up the rankings, as highlighted in our May outlook and as also being supported by the RS ‘app.’   This is a good example of reading ‘market generated information.’   

 

 

While Gold (GLD) advanced this week, of course the best relative strength-based call was staying short international equities, particularly Europe.    Europe has some serious problems to deal with  and you can see the horrid relative performance of international stocks over the past few weeks.  This is an example of an opportunity that was available to globally focused investors and invisible to those with only a domestic focus.

 

Summary:  volatility has increased sharply in the equity markets, which makes equities LESS desirable to hold vs a fixed payment security like a short-term bond.   Meanwhile, the Gold ETF (GLD) is rising in price, which makes it more attractive as its volatility is justified by its improving relative strength.   

 

In a world of talking heads, rumors of computer errors and extreme emotion, it pays over the long-run to ground yourself with some strong reading of money flows that is statistically supported by backtested models.



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ETF’s --- The Mainstreaming Of Advanced ‘Basket-Trading’

May 01, 2010 in Backtest | Strategy

In a recent institutional research piece by Goldman Sachs targeted at European portfolio managers, they offer various ways to trade ‘the divergence theme in the Eurozone.’



In the note, they discuss the problems with domestic demand in Europe within the construct of strong global growth, led by the BRIC (Brazil, Russia, India, China) theme. This note was on April 28th and followed a similar note discussing a similar theme targeted at US portfolio managers.

The basic idea of the note is to “Go long international growth & short Eurozone domestic demand.” In both research pieces, they do a lengthy analysis of long lists of ‘basket trades’ that portfolio managers could do to implement this longer-term trend. The bottom line of these studies was to create a long basket of stocks (to be long) that has companies with high sales exposure to the strong parts of the world and create another basket with high sales exposure to mainstream Europe and go short that basket.

To execute this, you would submit a list of trades, with quantities of shares, to a firm like Goldman or Morgan Stanley or Merrill Lynch and say ‘buy(sell) this basket of 70 stocks on the market close today.’ Then, Goldmans quantitative ‘experts’ figure out how they are going to both ‘guarantee you closing price’ – and make money for themselves. They ultimately do some kind of elaborate combination of trades that hedges themselves --- and can use the liquidity in the futures market with a hedge ratio or whatever else they do to create a profit for themselves – and then they charge an extra fee to the buyside firm to do the program trade.

Now – enter ETFs. Think about what you can do now – you can buy any of 1000 pre-set trading baskets that were created by index construction experts at MSCI, S&P, Russell etc. In some cases, such as at Schwab or Fidelity, you can do this for zero transaction fee. Its like the world has aligned in favor of the small investor/advisor here. This is very powerful.

I should go on to note that in this most recent research piece by Goldman on ‘trading the divergence’ --- they spend nearly 1/3 of the report going into backtests of their newly created trading baskets.





Well, with ETF’s – the trading history total return chart of the ‘basket’ is known. You don’t have to simulate it with portfolio management software --- you can just run the total return chart on our site.

So this is the power in ETFs: 1) the index has been constructed for you by index experts already (the people at firms like MSCI are every bit as smart (I would say smarter) as the people at your typical large financial institution) – they know what they are doing. 2) the trading history of the ETF ‘basket’ is known and 3) you haven’t done any actual work yet and you are already analyzing the characteristics of the ‘ ETF basket’ (its volatility, out/underperformance, historical relationships etc).

The bottom line is that banks makes good money recommending these kinds of things for portfolio managers. The longer the list, the more the profits. Big portfolio managers with huge assets under management cannot buy most ETF’s – the ETF’s just aren’t big enough. But you – as the small advisor, small hedge fund or individual investor can -- and that is what our site is all about -- leveraging the inherent and underrated power that ETF’s bring to neutralize the investment landscape.

(by the way, our relative strength model pointed towards this weakness in Europe months before Goldman wrote research on this – just go into the ETF screener and move the date back to January and see for yourself)

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New Relative Strength Backtest 'App' Added To Site. Check it out.

Apr 26, 2010 in Backtest | Relative Strength

We have added an innovative new relative strength backtest application to the site.

Click Here: ETF Relative Strength Backtest App

 

 

For a video tutorial on this 'app' click here: Relative Strength Tutorial"

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Video: Find Relative Strength Ideas -- Then Integrate Ideas Into A Portfolio

Apr 20, 2010 in Backtest | Screener | Video

 

4 minute video going over a few recent examples:

 

 

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Moving Average Backtest Page Added To Site, Have A Look

Apr 13, 2010 in Backtest | moving average

New application added. This simple application generates a report for any ETF in our database based on the user-defined rules regarding a moving average cross.

 

 

Moving Average Backtest Page

Comments and feedback appreciated.

Thanks,

www.ETFreplay.com

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Global Asset Class Rotation

Mar 30, 2010 in Backtest | Relative Strength | Screener

This is to highlight some specific thoughts on the important topic of global money flows and its implications for investors.   ETF’s have caused a major shift as they allow cheap ways to access new markets.  It is our belief that this innovation will cause the discussion to increasingly become ‘which MARKETS should I own?’ – and less about ‘which stocks should I own?’

Below are some performances of a few of the major ETFs over the past three years.  I am starting at a very high level here and then working towards my ultimate point of coming up with a process for interpreting global money flows.  (Note that all returns posted here make the proper dividend and distribution adjustments as total return is absolutely essential in any professional discussion of performance)

The point of this slide is to simply highlight that even if trading long-only, a well-executed high-level rotational strategy could have produced strong, consistent returns.

The next image highlights how a combination of 80% bonds and 20% emerging markets has performed over the past 3 years.  Most investors think myopically about returns.   The discussion of returns, without the context of risk, is meaningless to professional investors.  

Note how despite a massive volatility spike in the overall marketplace, the standard deviation of daily returns for our 80/20% portfolio was quite low.   This assumes no rebalancing.  Value could have easily been added over this return with a relatively simple re-balancing rule.

This brings us to the Sharpe Ratio. The important aspect the Sharpe Ratio framework brings is to factor in ‘drawdown potential.’   If you own securities with higher relative volatility, the high to low moves will be larger and cumulative negative returns become increasingly difficult to overcome.  By thinking in terms of a sharpe ratio rather than returns-only, you will inherently adjust for the ever-present possibility of drawdown.  You cannot fully know the risk that awaits -- but you can at least think in terms of reward/risk.

To make this practical and to keep this from becoming a dissertation, I will just simply show one way to de-compose the Sharpe Ratio into a multi-factor model that allocates toward the segments of the market that show strong combinations of high relative strength and lower relative volatility.  This model uses two timeframes to calculate return and one part volatility.   It is considered a statistical model, a subset of the APT framework – and can more easily be thought of as ‘risk-adjusted relative strength.’

Below is an image of the model as it stood on June 30, 2007.  I can 'roll back' the model to any historical date through the calendar control in the top right corner.  Global asset classes are color-coded for ease of understanding what is showing strong relative strength.  International equities and select US equity segments were leading the market on a risk-adjusted basis during the middle of 2007.  Though not shown in the image, you can go to the site and view what was lagging (hint: housing and financial segments).

Fast-forward 1-year through setting the calendar control to June 30, 2008.  At this point, the screen is dominated with fixed-income ETFs. One way to interpret this is that global money is flowing INTO bonds.  These kinds of shifts are likely not whipsaws as you might find with the US-based Sector SPDRs --- which can have violent rotations even within a secular bull move.

This was one example of a global asset flow shift.  I could run this ETF Screener 50 times, run the results through our Backtest ETFs page and then post all of those images here.  But to truly understand this, it is better to interact with the data yourself.   It takes time to understand complex financial relationships and it is nearly impossible to see this in just one-dimensional snapshots in time through some images.   Change the model inputs, vary the timeframes.  This tool is meant to enable users to interact with each other at a fundamentally higher (risk-adjusted) level of conversation.

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