Stock Exchange: Can Model-Based Trading Beat The Market?

The Stock Exchange is all about trading. Each week we do the following:

  • Discuss an important issue for traders;
  • Highlight several technical trading methods, including current ideas;
  • Feature advice from top traders and writers; and,
  • Provide a few (minority) reactions from fundamental analysts.

We also have some fun. We welcome comments, links, and ideas to help us improve this resource for traders. If you have some ideas, please join in!

Review

Our previous Stock Exchange discussed different methods for selecting stocks. Considering the many thousands of publicly traded securities, most traders have a preferred process to sift through the universe. If you missed it, a glance at your news will show that the key points remain relevant.

This Week: Can Model-Based Trading Beat The Market?

The advantages of model-based trading seem clear. For example, models are much more disciplined in their decisions than are humans. For example, we’ve written about this previously by describing the importance of disciplined entry and exit points for your trades, as well as using disciplined position sizing. Further, model-based trading eliminates emotion. For example, according to Dr. Brett Steenbarger, evidence shows that emotions can really screw up your trades (especially if you are a newbe), but they can also be used to help increase your focus if you know what you’re doing. And on that note, we’ve written previously about the importance of making sure your trading process fits your style.

And considering the wide accessibility of model resources (such as data and modeling applications as simple as Microsoft Excel), many of the things human traders seek can be accomplished easily with models. Further still, there should be plenty of incentive to build such models considering the profits that are available.

Please note: This week’s Stock Exchange is being edited by our frequent guest: Blue Harbinger. Blue Harbinger is a source for independent investment ideas focused on value and income opportunities. Please also note: this week our models have no new specific stock picks to share. Instead, we review our model scorecard.

Our Model Scorecard:

Not surprisingly, our models based on momentum (i.e. Felix and Athena) have been working the best lately, while our models based on mean reversion and dip buying (Holmes and RoadRunner) have performed less well. We say “not surprisingly” because momentum stocks (MTUM) have been performing very well recently (relative to the S&P 500) as shown in the following chart.

For more perspective on the recent strength of momentum, James Picerno provides a lot of details in this recent article: Momentum Continues To Lead US Equity Factor Strategies.

However, despite the strong performance by momentum, our other models have held their own. For example, over the last four months, our results (including commissions and fees) are approximately even for Holmes and RoadRunner and up approximately 20% for Felix and Athena. And if you had an equal weighted portfolio of these four models you’d have roughly doubled the S&P 500’s return during the time period. Obviously, short-term success of an approach varies a great deal. And in a few months, the results could be just the opposite (i.e. momentum could underperform). However, one strength of Holmes and RoadRunner is that they outperform over the long run with a low correlation to the market. This is important for volatility reduction purposes (i.e. risk management).

And for a little more color on momentum, here are the previous “Stock Exchange” series write-ups on a couple of Felix’s previous recommendations that have been doing quite well (Felix is our momentum model with an average holding period of 66 weeks):

Hertz (HTZ): Felix’s pick from the week of June 29th

Urban Outfitters (URBN): Felix’s pick from the week of July 20th

And if you are curious, here is a current list of some of the most attractive Russell 1000 stocks according to Felix:

Please note, the above list is very different than the list we’ve been showing readers in previous “Stock Exchange” articles. Also, as a reminder, readers are welcome to send us specific stock ideas that they’d like us to run through our various models, and we’ll happily share the results as we are able.

Conclusion:

At the moment, our models are doing well. And ultimately, extending our longer-term track record of success is most important. We cannot share all of our model picks in this forum, however we believe sharing our approach is interesting and worth discussion. We’re also able to share more information with a few of you that are interested in investing in our models. And also worth mentioning, we’re doing a webinar next Thursday covering our current market views. We hope you enjoy and evaluate our approach and ideas.

Stock Exchange Character Guide

Background on the Stock Exchange

Each week, Felix and Oscar host a poker game for some of their friends. Since they are all traders, they love to discuss their best current ideas before the game starts. They like to call this their “Stock Exchange.” (Check it out http://dashofinsight.com/background-stock-exchange/  for more background). Their methods are excellent, as you know if you have been following the series. Since the time frames and risk profiles differ, so do the stock ideas. You get to be a fly on the wall from my report. I am usually the only human present and the only one using any fundamental analysis.

The result? Several expert ideas each week from traders, and a brief comment on the fundamentals from the human investor. The models are named to make it easy to remember their trading personalities.

Getting Updates

We have a (free) service for subscribers of our Felix/Oscar update list. You can suggest three favorite stocks and sectors. Sign up with email to “etf at newarc dot com”. We keep a running list of all securities our readers recommend. The “favorite fifteen” are top ranking positions according to each respective model. Within that list, green is a “buy,” yellow a “hold,” and red a “sell.” Suggestions and comments are welcome. Please remember that these are responses to reader requests, not necessarily stocks and sectors that we own. Sign up now to vote your favorite stock or sector onto the list!

Stock Exchange: 3,811 US Stocks, How Do You Pick Yours?

The Stock Exchange is all about trading. Each week we do the following:

  • Discuss an important issue for traders;
  • Highlight several technical trading methods, including current ideas;
  • Feature advice from top traders and writers; and,
  • Provide a few (minority) reactions from fundamental analysts.

We also have some fun. We welcome comments, links, and ideas to help us improve this resource for traders. If you have some ideas, please join in!

Review

Our previous Stock Exchange compared the difference between patience and complacency. They can appear the same, but the results can be very different. If you missed it, a glance at your news will show that the key points remain relevant.

This Week: Thousands of US Stocks, How Do You Pick Yours?

There are 3,811 stocks included in the S&P Total Market Index (including large-, mid-, small-, and micro-cap stocks). If you’re going to pick your favorites via detailed fundamental analysis, you’re going to need a lot of time.

Alternatively, you may choose to follow Eugene Fama’s efficient market hypothesis thereby owning the entire market (or perhaps some well-diversified, low-cost, passive ETFs like those offered by Jack Bogle’s Vanguard).

However, most active investors and traders have some disciplined process in place to help systematically sift through the universe thereby focusing their efforts on a much smaller subset. For example, the good folks over at Bespoke have a knack for sifting through the universe and presenting subsets of data in very interesting ways such as this table showing the most volatile stocks on earnings announcements (apparently, Netflix (NFLX) has been the most volatile large cap stock—they announce on October 16th).

Or another interesting table from Quantifiableedges shows what has happened historically when the S&P 500 (SPY) closes the month at its highest closing price of the month.

Further still, Charlie Bilello from Pension Partners offers an interesting Twitter feed chock-full of interesting data points and metrics, such as the recent highly unusual statistic that micro-cap stocks have only been down 3 times in the last 33 trading days, which he calls a “ramp for the ages.”

 

But as an investor and/or trader, how do you use this data to pick stocks? Our strategies use a variety of models that we have developed over the years to sift through the data and select highly attractive trading opportunities. We’ve named our models to help differentiate their styles as described in the following table.

Expert Picks from the Models

This week’s Stock Exchange is being edited by our frequent guest: Blue Harbinger. Blue Harbinger is a source for independent investment ideas focused on value and income opportunities.

Holmes: This week I bought Molson Coors Brewing Co (TAP). Are you familiar with this company?

Blue Harbinger: Yes. They brew beer, Holmes. Why did you purchase the stock?

Holmes: Well the stock’s dip over the last month is the sort of set up I like to see. From the chart below you can see it is below its 50-day and 200-day moving averages. And it has attractive upside over the next six weeks.

BH: I appreciate that you’re able to sift through an entire universe of stocks to quickly identify the ones that are most attractive to you. However, I would never buy a stock simply based on its recent price performance alone without first understanding the fundamental situation of the company. For example, here is a look at Chuck Carnevale’s FastGraphs data for TAP. You might want to consider it—it’s very highly regarded.

Holmes: Thanks for the information, but as you know, my style is based on dip buying and mean reversion. I’m also really into protecting assets, as well. My process drastically reduces vulnerability to drawdowns while attempting to stay invested for the longest possible period of time. I use a mix of advanced trading techniques (including profit taking, stops, and trailing stops) and technical analysis to help protect if the stock price starts to fall.

BH: That’s interesting, Holmes. However, I am a long-term investor. How long do you usually hold your positions?

Holmes: I usually hold my picks for about six weeks at a time. And I have a growing track record of very profitable success.

BH: I really do appreciate your track record of success, but our investment time frames are very different. Nonetheless, I can relate to your mean reversion and dip buying style. In fact, as you can see in the following table from my recent article titled “Tectonic Market Shift Coming” the entire Consumer Staples sector to which TAP belongs has performed relatively poorly over the last 1- and 3-months. Like you, I pay attention to mean reversion and dip-buying opportunities.

Holmes: Thanks for the data, but I’ll stick to my process. It’s been working quite well. Anyway, how about you, RoadRunner, what have you got this week?

RoadRunner: This week I like ABIOMED, Inc (ABMD). It’s a $7.7 billion market cap medical device company. It provides mechanical circulatory support devices to aid heart recovery for heart failure patients.

BH: You literally picked that stock two weeks ago, RoadRunner. Granted, you’ve had a lot of success with it considering the price has gone from $157.34 to $172.37, for a 9.6% gain in two weeks. However, you always say you like to pick stocks that are at the lower end of a rising channel. How can it be in the lower end of a rising channel after a nearly 10% gain?

RR: Have a look at the following chart. It’s at the lower end of a rising channel.

BH: You just redrew the lines to fit your narrative. Do you really expect me to believe you?

RR: I’m a computer model, not a human. My picks are based on objective data. After sifting through my entire universe of stocks, ABMD ranks highly again this week.

BH: Well, as we discussed two weeks ago, the CFO recently resigned, and the FDA approved their Impella heart pump after five years of research. Plus, analysts at SunTrust initiated coverage of ABMD last week with a BUY rating and a price target of $195. Also, here is a look at Chuck Carnevale’s FastGraphs data—again, you might want to consider it.

RR: Thanks for the info, but as you mentioned, I have my own data-driven process to sift through the universe in order to identify the opportunities that are most attractive to me. How about you Athena, what have you got this week?

Athena: I don’t have any trades this week, and I’m not going to force anything.

Felix: Same here. No trades stood out for me this week, and I’m not going to force anything either.

BH: Thanks Athena and Felix. How about you, Oscar, what have you got?

Oscar: I like the China Consumer ETF (CHIQ). Emerging markets have been performing very well this year, China in particular. Plus, the consumer segment of China is increasingly strong.

BH: You’ve also picked this ETF a couple times recently (once on September 1st and again on September 22nd), and you’ve been doing well. I know you are a momentum trader, so it makes sense you’d like this ETF.

Oscar: That is correct, despite the strong gains so far this year, and the increasing volume of fearful investors, I’ve been happy to hold shares as this ETF climbs higher.

BH: This particular ETF includes some individual stocks with amazing momentum. For example, it holds some JD.com (JD) (the online direct sales company) and Alibaba (BABA) (the online mobile commerce company). If you think US names like Amazon (AMZN) have been hot this year (+30.8%), it is boring compared to JD.com (+53.9%) and Alibaba (+103.6%).

Oscar: I invest in momentum, my holding period is only six weeks on average, I rotate to something better when I’m ready to exit, and I use stops to control risks. And CHIQ is attractive right now.

BH: I respect your approach and your track record of success, but have you considered the potential volatility? When these types of stocks fall, they can fall hard.

Oscar: That’s why I’m invested in a basket of stocks through this ETF instead of individual names. CHIQ holds 39 stocks. Plus, as I mentioned, I use stops to manage risk, and I’ll rotate to something else when it’s time to exit.

BH: Well – I like the idea of having some exposure to emerging markets, and this is certainly one way to do that.

Conclusion

There are literally thousands of stocks to choose from. And unless you have an army of researchers, it’s not realistic to do a deep dive analysis of every single one. Further, mistakes are often made depending on the varying levels of objectivity versus subjectivity of the individual researchers within your army. That’s why many traders use computer programs and screening models to objectively sift the universe and narrow their focus. We’ve developed our models to focus on the opportunities that are most attractive to us, and we’ve been having a lot of success with them. Nonetheless, we acknowledge there are a wide variety of attractive methodologies to sift the universe depending on your individual style and preference.

Background on the Stock Exchange

Each week, Felix and Oscar host a poker game for some of their friends. Since they are all traders, they love to discuss their best current ideas before the game starts. They like to call this their “Stock Exchange.” (Check it out http://dashofinsight.com/background-stock-exchange/  for more background). Their methods are excellent, as you know if you have been following the series. Since the time frames and risk profiles differ, so do the stock ideas. You get to be a fly on the wall from my report. I am usually the only human present and the only one using any fundamental analysis.

The result? Several expert ideas each week from traders, and a brief comment on the fundamentals from the human investor. The models are named to make it easy to remember their trading personalities.

Getting Updates

We have a (free) service for subscribers of our Felix/Oscar update list. You can suggest three favorite stocks and sectors. Sign up with email to “etf at newarc dot com”. We keep a running list of all securities our readers recommend. The “favorite fifteen” are top ranking positions according to each respective model. Within that list, green is a “buy,” yellow a “hold,” and red a “sell.” Suggestions and comments are welcome. Please remember that these are responses to reader requests, not necessarily stocks and sectors that we own. Sign up now to vote your favorite stock or sector onto the list!

Stock Exchange: Are You Patient or Complacent?

The Stock Exchange is all about trading. Each week we do the following:

  • Discuss an important issue for traders;
  • Highlight several technical trading methods, including current ideas;
  • Feature advice from top traders and writers; and,
  • Provide a few (minority) reactions from fundamental analysts.

We also have some fun. We welcome comments, links, and ideas to help us improve this resource for traders. If you have some ideas, please join in!

Review

Our previous Stock Exchange reviewed the “less than smooth” ride during the multi-year bull-run, and how the bumps in the road create opportunity. If you missed it, a glance at your news will show that the key points remain relevant.

This Week: Are You a Patient or Complacent Trader?

It seems counterintuitive to make changes when things are going well, but that’s often the right course of action whether you are an investor or a trader. As an investor, you may be enjoying the sun that continues to shine brightly as the market regularly makes new highs with very little volatility. But let’s not forget the old saying “the best time to fix the roof is when it is sunny.” And from a trading perspective, it often makes sense to sell on the way up (before your profits are gone), and conversely enter your positions on a cloudy pullback.

Trading in and out of positions is not for everyone. It requires doing a lot of work and watching the market closely. Before you even think about entering a trade, make sure you have the patience to see it through and not the complacency to let it fail.

According to Brian Portnoy, a contributor at Forbes:

“there is a fine but important line that divides patience from complacency. The rub is that the two are outwardly indistinguishable. They both appear to involve doing nothing.”

His article from last week, describes “The Good and Bad of Doing Nothing,” and it’s worth a read if you’re starting to feel perhaps a little too confident about this market.

In the same vein, Wayne Thorp offers some sage advice in this article on when to nail down your trading profits (hint: “while you still have them”). And conversely, Aleksey Tatsitov describes his favorite tactic for identifying trading entry points in this article about “pullback trading.” Aleksey runs through specific examples of pullback trades describing the strengths and weaknesses of the strategy.

And The While Coat Investor (Jim Dahle, board-certified emergency physician) reminds us all (in this article) that trading is a job that requires watching the market closely. It’s certainly not for everyone, especially if there are other things you’d rather be doing.

Expert Picks from the Models

This week’s Stock Exchange is being edited by our frequent guest: Blue Harbinger (also known as Mark D. Hines). Blue Harbinger is a source for independent investment ideas focused on value and income opportunities.

Holmes: This week I bought Alliance Data Systems (ADS). Are you familiar with this company?

Blue Harbinger: Yes. It’s basically private label credit cards. They take shopper data and create marketing and loyalty programs. For example, the company’s Canadian Air Miles program is a popular one.

Holmes: Well the stock’s dip over the last month is the sort of set up I like to see. From the chart below you can see it is below its 50-day and 200-day moving averages. And it has attractive upside over the next six weeks.

BH: From a fundamentals standpoint, this stock looks like it has some upside too, but that is assuming the company’s strong credit performance won’t slide. For example, I saw some recent data that says deliquencies have ticked up at ADS. However the steadily climbing EPS and the share price pullback is interesting. Here is a look at the FastGraph.

Holmes: As you know, my style is based on dip buying and mean reversion. However, you may not be aware that I’m really into protecting assets too. My process drastically reduces vulnerability to drawdowns while attempting to stay invested for the longest possible period of time. I use a mix of advanced trading techniques (including profit taking, stops, and trailing stops) and technical analysis to help protect if the stock price starts to fall from, for example, an uptick in delinquencies, as you described.

BH: From what I’ve been reading, ADS continues to sign new deals with additional retailers, and that’s a good sign. The forward P/E is near the lower end of its range this year which is also a good sign, but I know part of the reason is because of the risks (e.g. rising delinquencies, the potential for more competition).

Holmes: I’m only looking to hold this position for about six weeks. And during that time period I suspect ADS will rise despite your concerns.

BH: Thanks. I’ll watch this one closely. And honestly, I think this is a decent pick, however I prefer to hold my positions for longer than six weeks. How about you RoadRunner—what have you got this week?

RoadRunner: I like Take Two Interactive (TTWO) again. As you know, I’ve been having success with this one in recent months. I like to buy stocks that are at the bottom of a rising channel, and if you look at the chart below you can see why I like TTWO again this week.

BH: Well our theme this week is to know the difference between patience and complacency. You don’t seem to be complacent considering this is your third TTWO trade since May. And you’ve been very successful with these trades, I might add. But have you considered using a little more patience such as simply buying and holding TTWO? Considering this rising channel you keep bragging about, you’d have don’t pretty well with a buy and hold strategy, don’t you think?

RR: Buy and hold is not my style. I typically hold my positions for about four weeks. Besides, I have a track record of doing a lot better by buying low and selling high within the rising channel, even after taxes and trading costs.

BH: Well I’ve said it before, and I’ll say it again, Take Two seems fairly risky to me. I agree the price has been rising steadily, but the company’s earnings are volatile, and the entire franchise is heavily dependent on the success of one video game, Grand Theft Auto. Any missteps with the next release of that game could spell disaster for Take Two. Plus its price-to-(forward)-earnings ratio is already rich, and it has an earnings announcement expected on approximately October 31st that could add to volatility. Here is a look at the Fast Graph.

RR: I am aware of all the things you mentioned, but I mainly like this stock over the next 4 weeks based on its location within its rising channel. I’ll be in and out before that earnings announcement you mention. Plus, I have certain risk management procedures in place if anything goes wrong (e.g. I limit my position size, and I only trade highly liquid stocks).

BH: I prefer to have a little more patience with my picks, but your strategy seems to be working well for you, RoadRunner. How about you Athena, what have you got this week?

Athena: I don’t have any trades this week, and I’m not going to force anything.

Felix: Same here. No trades stood out for me this week, and I’m not going to force anything either. However, for your reference, here is a look at my rankings this week.

BH: Thanks Athena and Felix. How about you, Oscar, what have you got?

Oscar: I still like the iShares Semiconductor ETF (SOXX)

BH: You also picked this ETF a couple times already this year, first in March and then again in early September. I know you like to hold these for only about six weeks at a time, and 6 weeks after your March 24th pick the shares were up big. And so far you’re doing great on your September 8th pick, as well.

Oscar: My style is momentum, and I like to rotate to another sector after about six-weeks. And of course I use stops to control for the risks.

BH: Well I like your pick, but I don’t like your style. How can you possibly know where this stock’s price is going to be in six weeks? I have a pretty good idea that the semiconductor industry will be much higher in six years considering the growing uses and complexity of semiconductors in everything from cell phones, to data centers, to self-driving vehicles, and eventually the arrival of 5G networks. But six weeks from now? Come on Oscar, don’t you think you need a little more patience?

Oscar: You‘ve already acknowledged I’ve done very well with my two previous SOXX recommendations, and I have a track record of success across all of my picks, for that matter. I don’t get them all right, but my winners are bigger than my misses. Plus, buying and holding something for six years like you suggest seems a little complacent, in my view.

BH: Interesting, Oscar. I wouldn’t buy the entire semiconductor industry anyway. There will be clear winners and losers in this space. Some of the smaller semiconductors included in this ETF don’t have the sophistication to keep up with evolving technologies, and their shrinking margins are already showing that.

Oscar: If you’re curious, here’s a snapshot of my rankings for this week:

Conclusion

Holmes and RoadRunner both use an element of “dip buying” to enter their trades, and they don’t get complacent considering they generally hold their positions for no more than four to six weeks before they take their profits. Oscar tends to be more purely momentum-driven, but he also knows not to get complacent and looks to take his profits after about six weeks. No matter what your style, there is an element of patience involved with participating in the market. However, too much patience can become complacency, and that can become detrimental to your financial health.

Stock Exchange Character Guide

Background on the Stock Exchange

Each week, Felix and Oscar host a poker game for some of their friends. Since they are all traders, they love to discuss their best current ideas before the game starts. They like to call this their “Stock Exchange.” (Check it out http://dashofinsight.com/background-stock-exchange/  for more background). Their methods are excellent, as you know if you have been following the series. Since the time frames and risk profiles differ, so do the stock ideas. You get to be a fly on the wall from my report. I am usually the only human present and the only one using any fundamental analysis.

The result? Several expert ideas each week from traders, and a brief comment on the fundamentals from the human investor. The models are named to make it easy to remember their trading personalities.

Getting Updates

We have a (free) service for subscribers of our Felix/Oscar update list. You can suggest three favorite stocks and sectors. Sign up with email to “etf at newarc dot com”. We keep a running list of all securities our readers recommend. The “favorite fifteen” are top ranking positions according to each respective model. Within that list, green is a “buy,” yellow a “hold,” and red a “sell.” Suggestions and comments are welcome. Please remember that these are responses to reader requests, not necessarily stocks and sectors that we own. Sign up now to vote your favorite stock or sector onto the list!