Macro Trading Using Relative Strength

Since the start of our newsletter we have been using a relative strength table that looked at Fidelity Select Sector Funds to show what industry groups are leading and which groups are lagging. The relative strength calculation is similar to the style used by Bill Oneil and IBD but is slightly shorter term in nature. We used the Fido Funds due the their price history and breadth of different groups. Now that there are not only enough different industry group ETF’s, but also the needed price history we have revamped the model to use ETF’s instead.

We publish one list for United States industry groups and one that is focused on global ETF’s with several country and a few sector specific ETF’s. These tables are valuable in a few ways. One is that we have developed a trading model based upon them that uses the rankings along with buy, sell, and money management rules. Over time this model has beaten the market with far less risk. The other way that these tables are useful is that they show you what is strong and what is weak.

While this concept is not rocket science we are consistently surprised how little attention it is given by other traders. By using relative strength we can see what is really working and where investors are going. Many times the supposed “hot sector” is not really that hot. By looking at the tables we can see what is really working and what is not. For instance looking at the Global RS Ranking table below you can see the leaders and the laggards. While it is no surprise that Brazil is at the top when was the last time you saw someone on CNBC telling you to buy Indonesia or Turkey? Yeah we missed that segment as well. (click on table twice to enlarge)

Global RS Rankings


Right now this table is confirming to us that for the most part developed nations are weak and should be sold and that emerging markets are strong and should be bought. No, this is not the first or the only tool that told us this same thing but it is one way in which we can systematically be long the best areas of the world and short the worst areas of the world. It also gives us a road map of where investors are putting their money and where they are withdrawing it.

Another point worth noting is that while we are starting to run this as a “standalone system,” the system represents only a part of our portfolio. In our trading and our newsletter model portfolio we use several different methods in order to build a less correlated portfolio trading across asset classes.

Happy Trading,

Disclaimer-We are long EWZ-Brazil, EWT-Taiwan, and EWM-Malaysia

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Title: Macro Trading Using Relative Stength

Our Basic Approach To Finding Investment Ideas

As you probably know Macro-Traders typically take a top-down approach when looking for potential investment ideas. Specifically we look for the best risk to reward opportunities we can across all asset classes, countries, and trading strategies. So we basically trade anything anywhere that we can find an edge.

Our investment approach takes a multi-step process to generate investments for our portfolios.

This is a flowchart showing our basic process.


Macro Flowchart

What follows is an explanation of each step.

We have two ways to come up with investment ideas. We have our quantitative methods and our traditional research. Our quantitative methods vary from all out trading models that give actual buy and sell signals to scanners that look for favorable conditions in different asset classes, to a few tools we have that just look for unusual activity. One of the best things about using quantitative tools is that we miss fewer opportunities due to a computer being able to scan more asset classes in more markets than we could ever do.

As much as technology helps us to catch things we wouldn’t otherwise find. We also rely heavily on traditional research. We are always reading magazines, newspapers, books, trade publications, research reports, etc. We read anything that might help us find new investment opportunities or more information for our current positions and themes. We also try to listen to smart people and watch news and other television that might help us find anything helpful. Basically we are information junkies.

Our next step after getting some investment ideas is to research them further to validate them. Most of the time we hit dead ends, but occasionally we come across something good. If we decide that it makes sense we start looking to see if there is a past model that goes with it. For instance as of this writing we are bullish emerging market telecom and have been for some time. When we first came across this theme we liked the idea because it was logical. So looking for a model we found VIP and MBT both Russian telecoms. They both had outstanding growth rates and the stocks were definitely outperforming the market. Well since then we have traded them and have found several other good telecoms riding that theme like TKC, TMX, TEF, and ETF.

After deciding that what we have found is a solid theme that works out fundamentally, we look at the risks and rewards. Risk management is the most important part of what we do. We look at risk on several levels. At the individual security level we look to see what the best instrument to trade, usually with security for m&A virtual data room are used by advisers and investors to set up a deal room for their clients quickly and allow them to remain in control of the documents they wish to share.. For instance if we are bullish on a country do we play it using equities, debt, or currency? We then look to see if we can cut off risk by using options. We like options for their flexibility. Many times we will find an idea that we like but due to the risk profile we can’t get in using the typical security, but we are able to manage the risk by using options. Another risk we really look at is portfolio risk. How does it correlate to our other positions, how does it correlate to the overall portfolio, are we actually just playing another version of a theme we already have on? We look at geographic, political, and any other type of risk we can. The final thing we look at is at what point do we admit that we are wrong? Or in other words where do we place our stop. Our stops are based off of the chart, volatility, potential reward, and size of our position. With risk there are not too many absolute rules. But one that we do always abide by is to never risk more than 2% of the portfolio on any position. Many times we will risk less but we will never risk more. So we size our positions accordingly.

Once all of this has been done we can finally add it to our portfolio. In future posts we will go into more depth on each part of this process. But this should give you an idea as to what we do and how we go about doing it.

Happy Trading,
The Macro Trader

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