Stock Exchange: Do Not Invest In Bitcoin, Trade It!

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 asked: Are Momentum Trades Better Than Dip Buying? If you missed it, a glance at your news feed will show that the key points remain relevant. One takeaway from last week’s Stock Exchange was that a particular trading style works great, until all of a sudden it doesn’t. Dr. Brett Steenbarger likens this phenomenon to a strong tree that may crack when it gets windy, versus a bamboo or willow that survives by bending with the wind. There is a distinct regime in the current market. And when the momentum trade finally cracks, will you bend like a willow or crack right along with it?

This Week: Do Not Invest In Bitcoin, Trade It!

If you have strong valuation skills, you’re probably a horrible trader. That’s the common knowledge among many successful trading circles. For example, Renaissance Technologies, one of the most successful systematic trading firms of all time, “avoids hiring anyone with even the slightest whiff of Wall Street bona fides” (i.e. they prefer to hire mathematicians, physicists, and statisticians, for example). Similarly, Steve Cohen’s Point72 likes to hire people with non-finance backgrounds such as history and music.

Image source

Professor Aswath Damodaran (from the Stern School of Business at NYU) offers some invaluable insight into why traditional backgrounds in valuation don’t necessarily lend themselves to trading, in this article on Bitcoin: The Bitcoin Boom: Asset, Currency, Commodity or Collectible? Professor Damodaran explains that Bitcoin is not an income-generating asset that can be valued, but rather Bitcoin has characteristics of a currency that can only be priced. And as shown in the following table from Professor Damodaran, pricing means everything to traders, whereas valuation is often irrelevant to them.

Sticking with the Bitcoin trading theme, trader JC Parets points out an amazing pattern to Bitcoin pricing in this article: Fibonacci Analysis On Bitcoin. Specifically, Parets notes Bitcoin pricing has been following the Fibonacci Sequence “so perfectly that it’s hard for some to believe that this is simply normal behavior.” The Fibonacci Sequence is a mathematical phenomenon that has nothing to do with valuation, but has historically demonstrated itself relevant for traders with regard to pricing.

And for those of you with a background in long-term investing, not trading, Blue Harbinger offers five current ideas on how to place trades that fit your style in this article (hint: they’re all income-generating put option sales on attractive stocks that he believes are trading below their long-term value, meaning you keep the premium income generated for selling the puts no matter what, and if the shares happen to get put to you then you’re happy to pick them up at an even lower price).

Expert Picks from the Models:

This week’s Stock Exchange is being edited by Blue Harbinger (aka Mark Hines). And this week, we’ve included Bitcoin in a couple of our momentum model rankings (e.g. Felix and Oscar) to see how the cryptocurrency matches up against other trading opportunities within a particular universe.

Holmes: This week I bought Sally Beauty Holdings (SBH). Are you familiar with this company?

Blue Harbinger: Well, I know Sally Beauty is a specialty retailer and distributor of professional beauty supplies, but I am not a customer. They do hair care and color, nails, skin, accessories.

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: Interesting pick Holmes. I have mixed feelings on this one. On one hand, Sally Beauty is a retailer located in shopping malls. People aren’t going to malls so much anymore because service stinks (in my opinion) and it’s easier to just buy stuff online. I believe comps have been mostly flat for Sally Beauty. But on the other hand, Sally Beauty still generates a lot of revenue and it’s consistently profitable. The contrarian in me likes to buy stocks that are out of favor. This stock’s price has essentially been cut in half since early 2016. For some fundamental perspective, here is a look at Chuck Carnevale’s very useful FastGraph.

Holmes: I am happy you’re considering the fundamentals, Blue Harbinger. But I am a trader, and my typical holding period is about 6-weeks, so I’ll be in and out of this one before the long-term valuation story plays out. I am attracted by the current price (i.e. it has upside).

BH: Tell us a little more about your trading style, Holmes.

Holmes: My style is based on dip buying and mean reversion. 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 too far.

BH: Like I mentioned, I see positives and negatives to this one. But I’ve been doing this Stock Exchange with you for several months now, and I see the success you’ve been having, even in our current momentum driven market. Let’s check back on this one in about 6-weeks (i.e. your typical holding period).

Holmes: Fine by me. How about you RoadRunner, what have you got this week?

RoadRunner: I like Netflix (NFLX) this week. As you know, 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 Netfix.

BH: In this momentum-driven market, I can see Netflix going higher, and I like your strategy of buying at the lower end of a rising channel. How long do you plan to hold Netflix?

RR: My typical holding period is about 4-weeks.

BH: Netflix recently posted another strong quarter of subscriber growth and revenues. Plus they plan to increase the price of subscriptions, and that may be a good sign (depending on how it works out) because according to Warren Buffett “the single most important decision in evaluating a business is pricing power.” Also, for your reference, here is a look at Netflix FastGraph.

RR: Thank you for sharing that fundamental information, but I am a trader. I’m most concerned with the current price versus where it will be in four weeks.

BH: I acknowledged I like your dip-buying within a rising channel strategy, but what are you going to do when the momentum trade stops working? Are you going to crack, or are you going to bend like a bamboo or a willow?

RR: I don’t let your touchy-feely fear tactics scare me. I have discipline, and I stick to my strategy. Besides, when combined with the strategies of some of the other traders (Holmes, for example), we deliver strong returns with a lower correlation to the market, so the big market shift you keep warning about is interesting, but we are ready.

BH: If you say so RoadRunner. Your approach has been performing extremely well lately, and I appreciate that. How about you, Felix, what have you got this week?

Felix: I’ve got a real treat for you this week. The following list is my top ranked Nasdaq 100 stocks, and I’ve added the Bitcoin Investment Trust (GBTC) to the universe because I heard you talking about it earlier. And compared to the most attractive Nasdaq 100 stocks, Bitcoin is even more attractive!

BH: Now that is interesting, Felix. I see you have some semiconductor stocks like Nvidia (NVDA), Micron (MU) and even Broadcom (AVGO) on your list of top ranked Nasdaq 100 stocks, but you like Bitcoin even more. Remind us, what is your process?

Felix: I am a momentum trader, as you might have guessed because my top ranked ideas have all been performing very well lately. I hold things longer than the other traders, 66 weeks on average. I exit when my price target is reached, and I control risk by monitoring macro factors and using stops.

BH: Honestly, I don’t know a lot about the cryptocurrency, Felix. Except that the talking heads and media pundits won’t shut up about it. Based on the price performance chart we shared earlier, I can say that Bitcoin is scary. And I have no idea how to value it because it doesn’t pay dividends or even produce any income.

Felix: You don’t “invest” in Bitcoin, you trade it! Didn’t you learn anything from Professor Damodaran’s table earlier in this report?

BH: Great, thanks Felix. How about you Oscar, did you look at Bitcoin this week?

Oscar: I did look at Bitcoin. I added it to my universe of US and emerging market ETFs, and as you can see in the following ranking, Bitcoin ranks at the very top (i.e. it’s very attractive).

BH: And what is your selection process Oscar?

Oscar: I am also a momentum trader, but my average holding period is typically about 6-weeks. I rotate into another sector when it’s time to exit, and I also use stops to conrol risk.

BH: I do find it interesting that Bitcoin ranks so highly in both you and Felix’s models, but I suppose I shouldn’t be surprised considering the current momentum-based market envirnment.

Conclusion:

Momentum trades continue to work very well. One such example is the Bitcoin Investment Trust as discussed in this article. However, it’s important to recognize that Bitcoin is not an income-producing investment asset that can be valued. It’s a cryptocurrency that can be traded based on its price. And Bitcoin’s dramatically climbing price is not inconsistent with the favorable momentum trading envirnoment we are currently in. However, market conditions can persist for a long time, but then suddenly change with the wind. And when the wind blows, will your trading profits crack like a strong tree, or will you be ready to bend with the wind like a bamboo or a willow?

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: Are Momentum Trades Better Than Dip Buying?

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!

This Week: Are Momentum Trades Better Than Dip Buying?

The answer to that question depends, of course, on a variety of factors including your trading personality, your timeframe, how you manage risk, and market conditions, to name a few. Our models (as shown in the following table) have been developed to take advantage of opportunities depending on all of the above factors. And we’re having continued success, but more data and evidence is never disparaged. After all, trading style can work well; until they don’t.

As the above table shows, some of our trading models utilize momentum strategies (Felix, Oscar and Athena) while others use some form of dip buying (Holmes and RoadRunner). For some perspective on how momentum stocks have been performing recently, here is a look at the iShares momentum index (MTUM) versus the S&P 500 (SPY), year-to-date.

As the chart shows, the momentum trade is basically lapping the strong performance of the S&P 500 this year. And regarding our models, momentum strategies (Felix, Oscar and Athena) have been outperforming dip buying models (Holmes and RoadRunner), which is not surprising considering the strong performance of MTUM. However, our dip buying models have been holding their own. And when the models are combined, they’ve been outperforming the market, with a low correlation to the market (a very attractive quality). However, as mentioned previously, more data and evidence is needed.

When implementing our models, we generally allow them to do their thing with limited human interaction—after all, we designed them to avoid many of the common mistakes that human traders often make, such as complacency, data overload, fear, unrealistic expectations, disciplined entry and exit points, and position sizing, to name a few.

And with regards to models working well—until they don’t; one of the biggest factors that could cause a shift from momentum and possibly to dip buying is a business cycle peak. Alternatively, one of the biggest upside chances from the market could come from a market-friendly policy environment, which could provide a healthy foundation for stocks with plenty of upside. In fact, we covered these topics (and more) in our recent webinar presentation: The Most Important Year-End Questions for Investors. You may have to take a moment to “sign up” before accessing the webinar, however we believe there is a lot of good information worth reviewing.

(webinar link)

Without further ado, here are this week’s model picks…

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 Vipshop Holdings (VIPS). Are you familiar with this company?

Blue Harbinger: Yes. It’s a Chinese company and it’s an ADR. It’s basically an online discount retailer for brand names. They have flash sales where they have a limited amount of brand name products to sell.

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: This company’s revenue has been growing rapidly in recent years. From the FastGraph below you can also see the earnings per share has been growing too, so that is a good sign. Do you know what this company’s total addressable market is?

Holmes: Total addressable market is difficult to quantify. However, my typical holding period is about 6-weeks, so I’ll be in and out of this one long-before total addressable market becomes an issue. Besides, China is big.

BH: Remind us Holmes, what exactly is your style?

Holmes: My style is based on dip buying and mean reversion. 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.

BH: Well listen, Holmes. This stock has pulled back significantly since the summer (the dip-buying opportunity you’re talking about), and it’s not just random noise. Vipshop just had a disappointing earnings announcement last quarter. Plus there is a lot of competition in the Chinese online marketplace.

Holmes: There may be a lot of online competition in China, but as you already mentioned, Vipshop’s revenues and EPS continue to grow. Talk to me in about six weeks, and we’ll see how this pick has done.

BH: Deal. How about you, RoadRunner. What have you got this week?

RoadRunner: I like Hertz (HTZ) this week. As you know, 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 Hertz this week.

BH: Interesting pick, RoadRunner. If you recall, Athena picked this stock back in early August, and considering she typically holds for about one month, it looks like she nailed it.

RR: I’m happy for Athena, but she could have let this winner run for about four more weeks—that’s my typical holding period.

BH: RoadRunner, Hertz looks like a disaster to me. Not only is the price down, but the earnings are way down (they’re actually negative), the short-interest remains extremely high (around 31.2%), and I just don’t see how they’re going to turn things around anytime soon considering the company is working so hard to reduce its car rental fleet size (i.e. they’ve got more cars than customers). I suppose you could say Hertz has been “Ubered” or perhaps “Lyfted” considering those ride sharing services have really decreased the demand for car rentals. For your reference, here is a look at the FastGraph from Chuck Carnevale. Chuck’s tools are the best, however that appears NOT to be the case for Hertz.

RR: You’re not thinking like a trader, Blue Harbinger. My holding period is typically about four weeks, not four years. I’ve been having a lot of success buying stocks in the lower end of a rising channel. It’s a mean reversion trade within a broader momentum theme.

BH: Interesting, RoadRunner, did you also know that Felix picked Hertz back in late June, but considering he usually holds for about 66 weeks, the jury is still out on his trade.

Felix: Hertz is still interesting, and we could actually see one heckuva short squeeze at some point. Especially, if those ride sharing services you were talking about start facilitating significant purchases from Hertz’s fleet for their drivers. However, this week I have something else for you.

BH: Oh yeah, what’s that?

Felix: This week, I’ve run all 30 of the Dow Jones stocks through my model, and you can see how they ranked below:

BH: That is interesting, Felix. Based on your ranking, it’s pretty clear you are in fact a momentum trader. You’ve ranked many of the best performing Dow Jones stocks at the top your list, and many of the worst at the bottom. For your reference, here is the recent performance for all 30 Dow Jones stocks.

Felix: My strategy is based on momentum. As you already mentioned, I typically hold things for about 66 weeks. I exit when my price target is achieved, and I use macro factors and stops to control risks.

BH: Well, I suppose you and I are more similar than some of the other models because your average holding period is over 1-year. That is sort of long-term, I guess. However, we disagree on methodologies. For example, you have Caterpillar ranked near the top of your list, and I actually just recently sold my Caterpillar shares for a big profit after holding them for about 19 months.

Felix: You need to learn to let your winners run, Blue Harbinger. How about you, Athena. Do you have anything this week?

Athena: I don’t have any specific stock picks this week because I don’t like to force anything when the opportunities are not right. However, since you ran the 30 Dow Jones stocks through your model, Felix, I did the same. Here you go.

BH: Interesting, Athena. I can see you too are a momentum trader considering you’ve ranked Boeing (the best performing Dow stock this year) at the top of your list and General Electric (the worst performing Dow stock this year) at the bottom of your list.

Athena: There is a lot more to the rankings than simply performance. Plus, my trading process uses price targets, I only hold positions for about one-month, and I manage risks with stop orders. And I have a growing track record of success.

BH: Regarding your bottom ranked stock, General Electric (GE), we could see some fireworks from them over the coming few weeks considering all the expedited leadership changes lately, earnings announcement today, and big investor presentation from the new CEO John Flannery scheduled for November 13th. I actually wrote about this company just this week: GE: How to Play the Dividend Cut Fear.

Athena: I’ve heard about all the things you mentioned, but they’re not my biggest concern considering there are plenty of Dow Jones (and non Dow Jones) stocks I like more than GE.

Conclusion

With regards to momentum and dip buying, one is not necessarily better than the other, but there are times (market conditions) when one works better than the other. Depending on individual investor needs, we find that using a mix of both trading styles can improve results by delivering strong, often market beating returns, with significantly low correlation to the broader market. We don’t apply our strategies by buying all the stocks in a specific universe like an index or and ETF would. Rather, we use our models to select attractive individual stocks, and we continue to have growing success.

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: 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!