We track hundreds of different economic, fundamental, technical, sentiment, and cycle indicators. Some are stand alone and only help us discern particular situations while others are full blown timing models that we use to get in and out of the market. Some are very complex with ten and even twenty inputs ranging from jobless claims, to put call ratios, to nickel, to the advance decline line. Essentially anything that we test that helps to give us an edge we use to some degree or other. As global macro traders we of course have several models for every market that we trade, as well as models that only point us to markets showing abnormal movement.
As of a few days ago we had one of our longer term SP500 timing models trigger a buy signal. This timing model is very simple and only uses the NYSE Advance Decline line and the SP500 closing price. This models esge is not huge but it is solid and historically you are risking about 1:1 meaning that the historical return is almost the same as the worst historical drawdown.
In our macrotrader.com/members/signup.php?product_id=1″title=”Macro Trader Newsletter” >newsletter and in our own trading we rarely use a model as an automatic buy or sell signal but we do use them to tell us which dorection to trade. Right now this extremely simple model is showing that the advance delcine line has finally been able to have a sustained run and break above its long term trend, in this case the 150-day moving average. Again we don’t, and don’t recommend, trading directly off of these signals as almost every model we track can be improved upon by selecting better entry and exit points but they do helo us tremendously in our trading.
SP500-NYSE Advance Decline Line
As you can guess we are becoming increasingly bullish after being bearish for the better part of two years. Who knows if this rally will continue as there are a ton, and maybe a trillion tons, of harsh economic realities and hardships, but for now the trend is up and we are starting to lean to the long side.
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CNBC has 50 guests a day coming out and saying that this is “THE” bottom, Kass comes out and calls it a “Generational Bottom”, and investors that are flat or short are wondering if they are missing the boat.
In times like these it helps to put things into perspective. One of the ways we do this is to compare our current situation with similar times in history. As you will see in the following charts there is a good chance that you aren’t missing much at all.
This chart is of the current situation. We have marked each move of 20% or more. As you can see we have already had three rallies that were up 20% or more in a matter of weeks, or even days. If you had bought the top of the first 20% rally hoping to not “miss out” you would be down over 20%.
SPY-SP500 ETF
As you can guess this is not the first time that this has happened. Every extended bear market in history has had multiple 20% moves that have only sucked in the desperate traders only to burn them with a long fast fall back to new low. If you look at this chart of the 2000-2002 bear market we had four rallies of 20% or more before finally bottoming out and starting the 2002-2007 bull market.
SPY-SP500 2000-2002
Going back farther here is the 1962-82 bear market. Here we are using the Dow and the 20%+ swings are shown in the bottom pane where a reading of 1 means that there was a rally of 20% or more and a reading of -1 means that it fell by at least 20%.
Dow 1962-72
And finally we have the Great Depression. Looking at the lower pane we can see that there were several different 20% or greater swings.
Dow Jones 1928-1940
The market loves to fake us out. Bear markets are always more volatile than bull markets and this one is no different. While this could be THE BOTTOM we tend to think that it is A BOTTOM and we are currently short.
So you may be asking what would need to happen for us to change our minds? The simple answer is higher highs and higher lows, also known as an uptrend. Other bullish signs would be economic indicators that actually improved instead of worsened, improved and sustained breadth, and some actual leadership. By the way, banks will not be the new leaders.
This week The Macro Trader equity risk index climbed from 11.11% to 22.22%. As great as a jump like this looks it is still quite bearish as the index goes from 0% which is very bearish to 100% which is very bullish. In a regular bull market it will usually be in the 65-85% range. As you can see in the chart below during an insane bear market it tends to hang out in the 30% and below range.
As this is being posted Tuesday afternoon you have likely seen the huge rally we had today with the SP500 up over 6% in one day. While this will likely have everyone on bubblevision (CNBC) calling a bottom and telling us to be buying up everything we can, we take the view that in a bear market rallies are made to be shorted. In our weekly newsletter The Macro Trader we have taken a few very small long positions but are expecting a multi-day rally that will likely give us several good shorting opportunities. We are in a bear market, the domestic economy is in a recession, and the global economy is in a recession. Until we see evidence to the contrary the primary trend is down and that is where investors should be spending most of their efforts.
Our equity risk index remained at the same 11.11% reading that we got last week. Essentially our models are bearish and see very little reason for the market to go up. Valuations have improved but that is it. Breadth is horrible, the trend is down, and the economy sucks. The sad thing is that the United States is in better shape then Europe. Yeah there is light at the end of the tunnel but we aren’t close enough to the entrance yet to see any of it.
We offer our proprietary equity, fixed income, and precious metals risk indexes each weekend in our weekly macrotrader.com/members/signup.php?product_id=1″title=”Macro Trader Newsletter” >newsletter. We offer the equity risk index on the site a few days delayed each week.
This week we had a slight rise in the risk index. This was once again due to the fact that Treasury bonds have been so volatile lately which has caused a few of our models to have a bit of a whipsaw.
While the readings have changed a bit, rising from 22.22% to 33.33%, the levels are still fairly bearish. Remember that the risk index goes from 0-100% with 100% being the most bullish and 0% the most bearish so a reading of 33.33% is still pretty bad.
We could be at a short term bottom or maybe we have already hit “the bottom” but until the market internals improve considerably we won’t be putting on any large trades to the long side. In fact right now we are focusing a lot more on the short side.
There is not a lot to say about the index this week. Last week we dropped hard and this week the reading is the same at 22.22%. The equity risk index goes from 0-100% so a reading of 22% is pretty bad. When it is climbing we start to look harder for bullish trades but when it is at these levels we tend to lean towards shorting rallies more then buying them.
For the week ending 1/9/09 our Equity Risk Index made a 6 month high of 38.89%. Last week crushed it and brought it all the way back to the readings we saw in November of 22.22%. When the market fell apart breadth fell apart and T-Bond relative strength picked up as money left stocks and went into bonds.
So what will get the risk index climbing again? Consistent breadth, a real uptrend, and a decline in Treasuries would be a start. But what should be no surprise to our regular readers, we are not expecting that anytime soon.
While updating our models this weekend we thought it would be useful to show an example of one of our trading models. As we have stated previously we use a very systematic process to find trading opportunities. Half of our research time is spent building technical and valuation models that help guide us into and out of different asset classes. The other half of our research is spent reading and talking to people looking for ideas.
One market that has been fairly good to us lately has been junk bonds. We have a few different models that we follow to help tell us when the market is good and when it is bad. This particular model looks at the price action in junk bonds as well as the yield spread to Treasuries to tell us when conditions are favorable and when they are not.
When we trade junk bonds we typically use the HYG IBOXX High Yield EFT which has good daily trading volume. In the chart below you can see how our model did versus buy and hold. While HYG fell by 37.2% from its peak our models worst drawdown was 5.48%, and while HYG is currently down over 24% from its highs the model is just a few percent from its recent high.
As you can see, using models can help you find and manage good investment opportunities. In a year in which most investors lost 30-50% of their wealth we were able to stay slightly positive with very low volatility.
If you are interested in learning more about what global macro trading is and what we look at then you may be interested in subscribing to our weekly newsletter. If you would like to learn more about what global macro is then sign up for our FREE Macro Trading 101 course.
This list is based on conversations we have had with different traders over the course of 2008. Most of the items on the list are timeless trading principles. So, in no particular order, here are 10 things you can do to improve your trading results in 2009.
1. Focus on Risk Management — If you didn’t learn this principle back in the 2000-02 bear market, then it’s hard to feel bad for you now. Once again, the events of the past year have brought risk management to the front of most investors’ minds. This time, make sure it stays at the front. Your risk management process should include a position sizing model and a strict selling discipline. While there may be some exceptions, most successful traders make money by cutting their losers and letting their winners run. We’ve all heard this before . . . because it works.
2. Pay Attention toProcess rather than Outcome — As you exercise proper risk management, you should also be focusing on your process. Most successful traders agree that you will have a lot of little losers and a lot of little winners, but that the bulk of your profits will come from a few trades each year. In our weekly newsletter that we send to clients, we see similar results: a lot of small winners and small losers and a few pretty big winners. For example, early in the year we did really well catching the bulk of the move up in gold. In March we caught the breakouts in most currencies against the dollar, and then at the end of October we caught the majority of the breakdown in the Euro. And the past few weeks we have caught the move in corporate bonds. Aside from those trades we had several small winners and losers. In fact over the summer we had a streak of 8 losing trades in a row. By applying risk management to those trades, we made sure that all of the losses were small. And by focusing on the process, we were able to catch some strong winners as well. Remember, in a vacuum, any trade is irrelevant, meaning that one trade does not affect the next trade. You must have a systematic process and apply it over and over. Yes, you will have losing streaks, but over time, process will allow you to generate strong consistent gains and miss fewer trades.
3. BeConsistent — This goes hand-in-hand with Process. It’s critical that you have a consistent, systematic process to look at and track your ideas. How many times have you had an idea, forgotten about it, then looked at a chart a few months later and noticed that you missed a 50% move? If you’re like most traders, that happens fairly regularly. By having a systematic process that you look at consistently and that you apply every day or week or even every month-consistently-you’ll be able to capitalize on your ideas in a timely manner.
4. Accept Imperfection (in other words, leave your ego at the door) — Anyone who says he never has a losing trade is either a liar or doesn’t trade. As traders and investors, we must accept the fact that we are dealing with imperfect knowledge; therefore, we will not have perfect results. If you can’t handle that, you are in the wrong business. Investors who are not able to admit when they are wrong may get lucky for a while, but they will inevitably blow up. Ego might be useful in some fields, but it is absolutely destructive to your trading account. The worst investors are the ones who can’t admit when they are wrong. On the other hand, many of the best traders in the world are only right about half the time, and they’re not shy about admitting their failures. They make money by focusing on risk management and by making sure that they are in good risk-to-reward situations, and they always have a predetermined point at which they will get out if they are wrong. Spend more time following their example and less time pretending you never make mistakes.
5. Search for the Best Risk-to-Reward Ideas – As you may have noticed, we focus a lot on an investment’s potential downside. At times, this will cause us to skip a good trade or be small when we wish we were big, but more often than not, paying attention to risk-to-reward saves us from otherwise large losses. We only take trades where the return significantly outweighs the risk involved. Looking for good risk-to-reward scenarios also enables you to be wrong more often and still make money. For example, if you have $10 and lose $1 four times in a row, then make $10 once, you have only been right once or 20% of the time and yet you are up 60%. By focusing on the relationship between risk and reward, you are better able to make outsized returns.
6. Make Your Research More Efficient — If you are like most traders, you fall into the trap of trading the same things over and over. While sometimes this works, a lot of times you trade that way because you can’t find any other good trading ideas. You can avoid this by finding services that you trust to give you a virtually endless supply of potential trades that fit your criteria. Because we offer a weekly newsletter with trading ideas in several asset classes, you may be saying “aren’t you just trying to get me to buy your product?” Yes, we are, but we are also sincere in wanting to help you find good trades so that you can generate positive and consistent returns. Many people look at newsletters and other research providers as marketing services just trying to take their money. While there are no doubt some unscrupulous firms out there, there are many firms like ours that do a lot of work to provide you with useful, actionable, and real trading ideas. Some traders balk at paying for research. Our answer to that is that you can make up the cost of our service with one good trade. Think about it for a minute. If you spend $395 a year for a research service and are able to get a few good ideas a year from it, you will recoup the cost several times over. Most active investors should subscribe to 1-5 services that fit their style or that fill gaps in their style.
7. Invest in Some Technology — Technology can take a few different forms. You can spend a lot of money on new computers, software, etc. Or you can invest time to learn how to best use your current tools. Most investors do not need a new system; instead they need to take the time to learn how to use what they have. If you already have a good computer, a charting platform/data provider, and Excel, you can do tons of analysis if you learn how to use them. Go take a spreadsheet class or buy a book. You will find that a lot of trade tracking and model building can be done in a piece of software that you already have. If you are already well versed in the use of spreadsheets but require more analytics, it might be a good idea to finally get that back testing, option analytics, or other software or data provider that you need to do further analysis. Basically, investing in technology means looking at what you are doing that is taking up your time and deciding what you can do to make it more efficient. The less time you need to spend scanning, updating, etc. the more time you can spend researching new ideas, the more time you’ll have to spend with your family-now there’s a great investment.
8. Research, Research, and a Bit More Research — This is fairly self explanatory: Most of the best investors in the world are voracious readers. They read about trading, security analysis, risk management, economics, general business, science, manufacturing, philosophy, math, etc. Essentially they read about everything. You would be surprised how many good trade ideas were born in a book or magazine that had almost no direct relationship to the idea itself. Of course the other benefit is that you also get a lot of ideas that are directly related to a potential trade. Continuing education is one of the best things that you can do to enhance your trading results. Research is just another name for continuing education.
9. Be healthy — Some people may balk at this idea, but the healthier you are the better you are able to focus and think. The better you focus and think, the better you can function. The better functioning you are, the more you can get done and the better you can trade. Aside from better functioning, you will also live a longer and more enjoyable life. Health has countless benefits. Invest in your health.
10. Be a Critical Thinker — Critical thinking is not the same as pessimistic thinking. Critical thinking is a mental process of discernment, analysis, and evaluation. Critical thinking allows you to find out the pros and the cons of an investment. It allows you to be objective and make more of the right decisions and less of the bad ones. Critical thinkers look behind the news, the PR, the spin, the figures. Critical thinkers look for bias, conflicts of interest, puffing, and spin. If all you see is the potential money you can make in an investment, then you need to start thinking critically. Doing otherwise will simply take money away from you and give it to someone else.
We could talk about each of these for hours. We could also make this list 100,000 items long instead of 10, but that would be a waste of your time and ours. Trust us, following these 10 points will help 99% of the investors and traders we know, and they will help you.
This week we added a new indicator to our Equity and Fixed Income Risk Indexes. Because of this the percent value has changed but the chart looks the same. For stocks we actually dropped from being 31.25% bullish to 27.78% bullish.
The new timing indicator that we added to the model is based on the relative strength between stocks and bonds. In future issues of The Macro Tradernewsletter we will be sharing our research findings with our subscribers.
Some of the bullish factors are that valuations are decent, breadth has been improving, sentiment is fairly bullish, and rates are low. On the bear side we have horrid economic data, declining earnings, and the biggest one is that the long term trend is still down. As the market tries to figure out what it is doing we are managing our risk with position sizing and stops.
Happy Trading, The Macro Trader
P.S. If you would like to learn more about our risk indexes for US equities, fixed income, and precious metals as well as have access to our research on US Equities, Fixed Income, Precious Metals, Foreign Equities, and Currencies then request a free trial to The Macro Trader. Simply e-mail us at Editor@TheMacroTrader.com and put trial in the subject line.
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