In this second edition of Trading ETFS: Gaining an Edge with Technical Analysis (Bloomberg/Wiley, 2012) Deron Wagner describes a tried and true method for trading ETFs, at least when markets are behaving reasonably well.
Wagner uses a top-down strategy, first determining the direction of the broad market trend and then looking to buy relative strength in an uptrending market and short relative weakness in a downtrending market. He supplements this top-down strategy with some chart patterns and simple technical indicators.
Following chapters on entry and exit techniques, the author turns to examples of actual trades from the years 2005 to 2007—ten long and ten short, not all successful. He explains his rationale for taking each trade, his trade management plan, and how the trade worked out.
To get a feel for his approach, let’s look at a single successful trade, long PBW at $21.44 on September 18, 2007. Okay, I cherry picked this trade because, were an investor still holding onto PBW, he would be looking at a substantial loss. The PowerShares Clean Energy Fund closed last Friday at $6.20. Ouch!
Wagner entered the trade on a breakout above the convergence of both its 50-day moving average and intermediate-term downtrend line. The rationale for the entry was that “the more levels of resistance that converge in one point, the more powerful the breakout will be if it comes.” Moreover, the trading range had tightened up (within the context of a symmetrical triangle) and, as Wagner explains, “tight ranges during periods of consolidation increase the odds of a breakout ‘sticking,’ meaning the breakout holds above the prior level of resistance instead of drifting right back down.” Price moved rapidly, and Wagner decided to sell into strength, exiting just shy of a previous high. On a four-day hold the trade netted a quick 6.6% gain.
Wagner concludes Trading ETFs with ideas for custom-tailoring your approach and some additional pointers.
Veteran traders are unlikely to learn much from this book, except perhaps that outsized returns do not require overly complex systems. On the other hand, investors who want to be more active in managing their portfolios—that is, those who want to morph from being buy and hold investors into swing traders—would do well to read Wagner’s book. The strategies he lays out are relatively simple to follow and tend to outperform as long as markets are not range bound or erratic.
Monday, February 13, 2012
Wednesday, February 8, 2012
Kaplan, Frontiers of Modern Asset Allocation
Frontiers of Modern Asset Allocation (Wiley, 2012) could be subtitled “the collected essays and interviews of Paul D. Kaplan, quantitative research director for Morningstar Europe.” In 27 chapters, most previously published as journal articles in the last decade, Kaplan analyzes a range of issues that both academics and practitioners have found worthy of debate.
The book is divided into four parts: equities; fixed income, real estate, and alternatives; crashes and fat tails; and doing asset allocation. Some of the chapters, such as “Updating Monte Carlo Simulation for the Twenty-First Century” and “Markowitz 2.0” are technical and require quantitative skills. Others, such as those dealing with indexing, will be of interest primarily to academics and those who structure products. Still others are accessible to both financial professionals and investors with some background in statistics. The interviews with such noted figures as Roger Ibbotson, George Cooper, Benoit Mandelbrot, Harry Markowitz, and Sam Savage combine serious—mainly quantitative—discussion and debate with the occasional personal anecdote.
Let’s look very briefly at a 2000 paper written by Roger G. Ibbotson and Kaplan, “Does Asset-Allocation Policy Explain 40 Percent, 90 Percent, or 100 Percent of Performance?” for which the authors received a Graham and Dodd Award of Excellence. The authors raise three questions: “How much of the variability of return across time is explained by asset-allocation policy; how much of the variation among funds is explained by the policy; and what portion of the return level is explained by policy return?” (p. 257) They examined ten years of monthly returns of 94 U.S. balanced mutual funds and five years of quarterly returns of 58 pension funds. Fast forwarding to their conclusion: “asset allocation explains about 90 percent of the variability of a fund’s returns over time, but it explains only about 40 percent of the variation of returns among funds. Furthermore, on average across funds, asset-allocation policy explains a little more than 100 percent of the level of returns.” (p. 265)
Kaplan’s book will not appeal to the average individual investor. However, for those whose job it is to think seriously about asset allocation—whether theoretically or in practice—it offers a wealth of information.
The book is divided into four parts: equities; fixed income, real estate, and alternatives; crashes and fat tails; and doing asset allocation. Some of the chapters, such as “Updating Monte Carlo Simulation for the Twenty-First Century” and “Markowitz 2.0” are technical and require quantitative skills. Others, such as those dealing with indexing, will be of interest primarily to academics and those who structure products. Still others are accessible to both financial professionals and investors with some background in statistics. The interviews with such noted figures as Roger Ibbotson, George Cooper, Benoit Mandelbrot, Harry Markowitz, and Sam Savage combine serious—mainly quantitative—discussion and debate with the occasional personal anecdote.
Let’s look very briefly at a 2000 paper written by Roger G. Ibbotson and Kaplan, “Does Asset-Allocation Policy Explain 40 Percent, 90 Percent, or 100 Percent of Performance?” for which the authors received a Graham and Dodd Award of Excellence. The authors raise three questions: “How much of the variability of return across time is explained by asset-allocation policy; how much of the variation among funds is explained by the policy; and what portion of the return level is explained by policy return?” (p. 257) They examined ten years of monthly returns of 94 U.S. balanced mutual funds and five years of quarterly returns of 58 pension funds. Fast forwarding to their conclusion: “asset allocation explains about 90 percent of the variability of a fund’s returns over time, but it explains only about 40 percent of the variation of returns among funds. Furthermore, on average across funds, asset-allocation policy explains a little more than 100 percent of the level of returns.” (p. 265)
Kaplan’s book will not appeal to the average individual investor. However, for those whose job it is to think seriously about asset allocation—whether theoretically or in practice—it offers a wealth of information.
Monday, February 6, 2012
Brooks, Trading Price Action Trading Ranges
The second of Al Brooks’s three-volume magnum opus, Trading Price Action Trading Ranges: Technical Analysis of Price Charts Bar by Bar for the Serious Trader (Wiley, 2012), focuses on that area where markets spend the majority of their time—in trading ranges. He looks at trading ranges themselves, breakouts from ranges (transitions into new trends), and pullbacks (trends converting to trading ranges). The other two parts of the book deal with magnets (support and resistance) and orders and trade management.
In keeping with Brooks’s general style, the 600-page Trading Price Action Trading Ranges is a detailed and necessarily somewhat repetitive book. After all, if patterns didn’t repeat, technical analysis would be completely bogus.
I, on the other hand, don’t want to repeat myself. Since I reviewed the first volume in December, I’m going to take a different tack this time around and share a couple of points Brooks makes about trading ranges and trade management that I think might be of general interest.
First, on the relation between pullbacks and trading ranges. Brooks writes: “All pullbacks are small trading ranges on the chart that you are viewing, and all trading ranges are pullbacks on higher time frame charts. However, on the chart in front of you, most attempts to break out of a trading range fail, but most attempts to break out of a pullback succeed.” (p. 183)
Second, on so-called reversal patterns: double tops and bottoms and head and shoulders tops and bottoms. “Since trends are constantly creating reversal patterns and they all fail except the final one, it is misleading to think of these commonly discussed patterns as reversal patterns. It is far more accurate to think of them as continuation patterns that rarely fail but, when they do, the failure can lead to a reversal.” (p. 319)
And third, a description of trading ranges in terms of trends. “Every rally in a trading range is essentially a bear flag and every selloff is effectively a bull flag. Because of this, traders trade the top of the range the way they trade a bear flag in a bear trend. … They expect that attempts to break above the trading range will fail, that the bear flag breakouts will succeed, and that the market will soon reverse down and test the bottom of the range.” (p. 331)
Finally, just one of many thoughts on protective and trailing stops. “Traders can use wide stops when they are fading breakouts in stairs patterns or on trending trading range days. If the average range in the Emini is about 10 to 15 points and there is a breakout that runs about five points, a trader might fade the breakout and risk about five points to make five points, expecting a test of the breakout. In a typical situation, this trade has better than a 60 percent chance of success and therefore has a positive trader’s equation.” (p. 523)
Brooks, who believes that “trading is entirely about math,” (p. 437) offers examples of trades with a probability of success of 70%, 60%, 50%, 40% or less, and 40-60%. Naturally, he also describes the reward: risk ratio necessary to break even on each of these types of trades.
As for risk management, he writes graphically: “If you are 60 percent confident that the market will go up, that means that in 40 percent of the cases it will instead go down, and you will lose if you take the trade. You should not ignore that 40 percent any more than you would dismiss someone 30 yards away who is shooting at you, but who has only a 40 percent chance of hitting you. Forty percent is very real and dangerous, so always respect the traders who believe the opposite of you.” (p. 442) Amen.
In keeping with Brooks’s general style, the 600-page Trading Price Action Trading Ranges is a detailed and necessarily somewhat repetitive book. After all, if patterns didn’t repeat, technical analysis would be completely bogus.
I, on the other hand, don’t want to repeat myself. Since I reviewed the first volume in December, I’m going to take a different tack this time around and share a couple of points Brooks makes about trading ranges and trade management that I think might be of general interest.
First, on the relation between pullbacks and trading ranges. Brooks writes: “All pullbacks are small trading ranges on the chart that you are viewing, and all trading ranges are pullbacks on higher time frame charts. However, on the chart in front of you, most attempts to break out of a trading range fail, but most attempts to break out of a pullback succeed.” (p. 183)
Second, on so-called reversal patterns: double tops and bottoms and head and shoulders tops and bottoms. “Since trends are constantly creating reversal patterns and they all fail except the final one, it is misleading to think of these commonly discussed patterns as reversal patterns. It is far more accurate to think of them as continuation patterns that rarely fail but, when they do, the failure can lead to a reversal.” (p. 319)
And third, a description of trading ranges in terms of trends. “Every rally in a trading range is essentially a bear flag and every selloff is effectively a bull flag. Because of this, traders trade the top of the range the way they trade a bear flag in a bear trend. … They expect that attempts to break above the trading range will fail, that the bear flag breakouts will succeed, and that the market will soon reverse down and test the bottom of the range.” (p. 331)
Finally, just one of many thoughts on protective and trailing stops. “Traders can use wide stops when they are fading breakouts in stairs patterns or on trending trading range days. If the average range in the Emini is about 10 to 15 points and there is a breakout that runs about five points, a trader might fade the breakout and risk about five points to make five points, expecting a test of the breakout. In a typical situation, this trade has better than a 60 percent chance of success and therefore has a positive trader’s equation.” (p. 523)
Brooks, who believes that “trading is entirely about math,” (p. 437) offers examples of trades with a probability of success of 70%, 60%, 50%, 40% or less, and 40-60%. Naturally, he also describes the reward: risk ratio necessary to break even on each of these types of trades.
As for risk management, he writes graphically: “If you are 60 percent confident that the market will go up, that means that in 40 percent of the cases it will instead go down, and you will lose if you take the trade. You should not ignore that 40 percent any more than you would dismiss someone 30 yards away who is shooting at you, but who has only a 40 percent chance of hitting you. Forty percent is very real and dangerous, so always respect the traders who believe the opposite of you.” (p. 442) Amen.
Friday, February 3, 2012
Williams, Long-Term Secrets to Short-Term Trading
Larry Williams is a legendary commodity trader, author, and educator, probably best known for his blow-out performance (a 11,000% return in 12 months) in the 1987 Robbins World Cup trading contest. In this long overdue second edition of Long-Term Secrets to Short-Term Trading (Wiley, 2012; the first edition appeared in 1999) Williams incorporates some of his more recent reflections on trading.
First, what this book is not: it is not a day-trading manual. In fact, contrary to the title of the book, Williams writes that “You will never make big money until you learn to hold on to your winners, and the longer you hold, the more potential you have for making a profit. … Thus short-term traders, by their very definition, are limiting their opportunities.” (pp. 60-61)
Second, what this new edition doesn’t and does do: it doesn’t update any of the backtests of Williams’ trading “secrets” from the first edition. Fair enough, because as Williams readily admits, systems “work for a while, work really well and then fall apart.” (p. 86) In the second edition he offers some new ideas coupled with “a little common sense and testing.” (p. 95) Nonetheless, traders who are looking for the latest and greatest money-making systems will be disappointed in this book. The systems have (think the music industry) a vinyl quality—regarded by aficionados, largely cast aside by the mainstream and the cutting edge. For better or worse, most quants are pursuing a different path and Williams’ systems seem a bit dated. Then again, as he writes, “you’ll catch more fish with worms and hoppers on a bent pin than any fly ever tied.” (p. 245)
To my mind, the real strength of this book lies in Williams’ thoughts on what it takes to be a successful trader (which is very different from being a trading contest winner—think money management). He writes about fear and greed (and why “there is a lot more to fear than fear itself”). He illustrates how stop placement is critical to a system’s results. And he explains why even successful traders who have no additional income stream may not be able to pay their bills month in and month out.
Long-Term Secrets to Short-Term Trading should be required reading for every new, and even not so new, trader. It imparts the wisdom of the battle tested.
First, what this book is not: it is not a day-trading manual. In fact, contrary to the title of the book, Williams writes that “You will never make big money until you learn to hold on to your winners, and the longer you hold, the more potential you have for making a profit. … Thus short-term traders, by their very definition, are limiting their opportunities.” (pp. 60-61)
Second, what this new edition doesn’t and does do: it doesn’t update any of the backtests of Williams’ trading “secrets” from the first edition. Fair enough, because as Williams readily admits, systems “work for a while, work really well and then fall apart.” (p. 86) In the second edition he offers some new ideas coupled with “a little common sense and testing.” (p. 95) Nonetheless, traders who are looking for the latest and greatest money-making systems will be disappointed in this book. The systems have (think the music industry) a vinyl quality—regarded by aficionados, largely cast aside by the mainstream and the cutting edge. For better or worse, most quants are pursuing a different path and Williams’ systems seem a bit dated. Then again, as he writes, “you’ll catch more fish with worms and hoppers on a bent pin than any fly ever tied.” (p. 245)
To my mind, the real strength of this book lies in Williams’ thoughts on what it takes to be a successful trader (which is very different from being a trading contest winner—think money management). He writes about fear and greed (and why “there is a lot more to fear than fear itself”). He illustrates how stop placement is critical to a system’s results. And he explains why even successful traders who have no additional income stream may not be able to pay their bills month in and month out.
Long-Term Secrets to Short-Term Trading should be required reading for every new, and even not so new, trader. It imparts the wisdom of the battle tested.
Wednesday, February 1, 2012
Mysak, Encyclopedia of Municipal Bonds
Never having invested in municipal bonds, I had only a passing acquaintance with their structure and history. And, I confess, when I requested a review copy of Joe Mysak’s Encyclopedia of Municipal Bonds: A Reference Guide to Market Events, Structures, Dynamics, and Investment Knowledge (Bloomberg/Wiley, 2012) I anticipated a slow, dull read. How wrong I was!
Joe Mysak is a journalist who has covered the muni market for thirty years—and he knows how to tell a good story. In this so-called encyclopedia he both defines terms and recounts some high and even more low points in municipal bond history. The result is a surprisingly compelling, informative read.
The definitions in this book are not the one-liners we are accustomed to. Consider, for instance, “All bonds go to heaven.” Mysak writes that “This is an old market axiom describing how municipal bonds are bought and held, and rarely trade, after they are sold in the new-issue market.” Mysack provides data to support this axiom. Moreover, he writes, “This also helps explain why prices on outstanding municipal bonds rarely react to news in the way stock prices do.” (p.3)
Or, to take another example, this time from the law, the term ‘ultra vires’ “meaning ‘beyond the power of men’ is used to describe bonds that have been invalidly issued. Municipalities often used such claims to repudiate debt in the nineteenth century, particularly in the Reconstruction South and in the railroad-mad West, which led to the growth of the bond counsel business. In modern times, the Washington Public Power Supply System default in 1983 was caused by a judge ruling that a majority of the participants in the system had entered into contracts without the specific authority to do so, thus invalidating the bond payments and causing the largest default, $2.25 billion, in the history of the municipal market.” (p. 197)
The three-page entry on ‘tourist attractions’ begins “No, no, no, no, no, no, and no. Aquariums, theme parks, glorified rest stops, and zoos have a checkered history in the municipal market, and have left behind a trail of defaults and heartbroken investors.” (p. 191) The lead sentence for ‘Convention centers’ is “Stop the madness!” (p. 36)
Naturally, Orange County, California, rates a lengthy entry, but so does the concept of escrowed to maturity. We read about bid rigging, Chapter 9, garbage, bond insurance, pay-to-play, the 11 Deadly Sins, and Jefferson County, Alabama.
Everyone who invests in municipal bonds should read this book. I would highly recommend it as well to those who simply want to broaden their knowledge of the financial markets. I personally learned a great deal and had fun doing it.
Joe Mysak is a journalist who has covered the muni market for thirty years—and he knows how to tell a good story. In this so-called encyclopedia he both defines terms and recounts some high and even more low points in municipal bond history. The result is a surprisingly compelling, informative read.
The definitions in this book are not the one-liners we are accustomed to. Consider, for instance, “All bonds go to heaven.” Mysak writes that “This is an old market axiom describing how municipal bonds are bought and held, and rarely trade, after they are sold in the new-issue market.” Mysack provides data to support this axiom. Moreover, he writes, “This also helps explain why prices on outstanding municipal bonds rarely react to news in the way stock prices do.” (p.3)
Or, to take another example, this time from the law, the term ‘ultra vires’ “meaning ‘beyond the power of men’ is used to describe bonds that have been invalidly issued. Municipalities often used such claims to repudiate debt in the nineteenth century, particularly in the Reconstruction South and in the railroad-mad West, which led to the growth of the bond counsel business. In modern times, the Washington Public Power Supply System default in 1983 was caused by a judge ruling that a majority of the participants in the system had entered into contracts without the specific authority to do so, thus invalidating the bond payments and causing the largest default, $2.25 billion, in the history of the municipal market.” (p. 197)
The three-page entry on ‘tourist attractions’ begins “No, no, no, no, no, no, and no. Aquariums, theme parks, glorified rest stops, and zoos have a checkered history in the municipal market, and have left behind a trail of defaults and heartbroken investors.” (p. 191) The lead sentence for ‘Convention centers’ is “Stop the madness!” (p. 36)
Naturally, Orange County, California, rates a lengthy entry, but so does the concept of escrowed to maturity. We read about bid rigging, Chapter 9, garbage, bond insurance, pay-to-play, the 11 Deadly Sins, and Jefferson County, Alabama.
Everyone who invests in municipal bonds should read this book. I would highly recommend it as well to those who simply want to broaden their knowledge of the financial markets. I personally learned a great deal and had fun doing it.
Monday, January 30, 2012
Oxley, Extreme Weather and Financial Markets
Living in Connecticut, I rarely experience extreme weather. Last year was an outlier. The winter was brutal, then came the remnants of Hurricane Irene (not in itself extreme but nonetheless a week-long power outage), and finally the freak Halloween snow storm (and, yes, another week without electricity). Although there was undoubtedly a spike in generator sales, let’s face it: no investor is going to make much money betting on Connecticut weather.
In Extreme Weather and Financial Markets: Opportunities in Commodities and Futures (Wiley, 2012) Lawrence J. Oxley takes us to where weather is genuinely extreme and where real money can be made. Wending his way through the various commodities and ways to trade them, he focuses on five potential global climate shocks: excess snow and ice; flooding mines; farmland droughts, floods, and frost; hurricanes and tornadoes; and timberland fires.
Let’s take a look at a single commodity, which the author says “may well be [his] favorite weather-based investment”—platinum. Platinum enjoys strong global demand, the supply side is highly concentrated geographically (South Africa accounts for 76% of total platinum mine production), and these geographies have the potential for politically rooted supply shocks.
Assume there is a flood in South Africa. Who are the biggest winners? First, platinum futures, followed by ETFs and the stocks J. Matthey and Stillwater. If the flood is in Montana, the biggest winners are still platinum futures and ETFs. The same holds true if the flood is in Russia. “At this point you might be wondering why ‘platinum futures’ and exchange-traded funds (ETFs) in platinum are ranked higher than all of the publicly traded stock winners. The futures market and the ETF market do not care where the global climate event occurs. All they care about is the price of platinum. It makes life a bit easier if you do not have to worry about which names in the stock market are the winners and losers, but instead simply focus on the extreme weather events and the price of platinum.” (pp. 71, 75)
Oxley does not, however, confine his analysis to trading commodity futures. He gives examples of pairs trading in equities and explores opportunities in the bond and forex markets.
Event-based trading is notoriously difficult because everybody is responding to the same information. Think, for instance, of the recent run-up in orange juice after a cold snap threatened Florida’s crop, the FDA detained shipments of oranges imported from Brazil in which they found traces of an illegal fungicide, and Mexico’s crop faced damage from drought. Even with this perfect storm trading was still not easy. For instance, on January 10, when news of Brazil fungicide fears broke, orange juice surged 11%. The next day, as investors awaited more news from the FDA, orange juice futures fell 9.5%. Here’s the 30-day chart.
Oxley offers some tips for event-based trading, including when to sit on your hands. For example, if sugar spikes—which means that soda and chocolate are negatively affected, he recommends avoiding (not shorting) Hershey and Coca-Cola stock. And he cautions not to “buy excessively in the municipal bond market in hurricane regions during hurricane season.” (p. 179)
Oxley’s book is a worthwhile read for commodity investors, novices as well as the more experienced, who are in search of opportunities. It is also a cautionary tale for those who want to protect their portfolios. No one should trade commodities without understanding the impact extreme weather can have.
In Extreme Weather and Financial Markets: Opportunities in Commodities and Futures (Wiley, 2012) Lawrence J. Oxley takes us to where weather is genuinely extreme and where real money can be made. Wending his way through the various commodities and ways to trade them, he focuses on five potential global climate shocks: excess snow and ice; flooding mines; farmland droughts, floods, and frost; hurricanes and tornadoes; and timberland fires.
Let’s take a look at a single commodity, which the author says “may well be [his] favorite weather-based investment”—platinum. Platinum enjoys strong global demand, the supply side is highly concentrated geographically (South Africa accounts for 76% of total platinum mine production), and these geographies have the potential for politically rooted supply shocks.
Assume there is a flood in South Africa. Who are the biggest winners? First, platinum futures, followed by ETFs and the stocks J. Matthey and Stillwater. If the flood is in Montana, the biggest winners are still platinum futures and ETFs. The same holds true if the flood is in Russia. “At this point you might be wondering why ‘platinum futures’ and exchange-traded funds (ETFs) in platinum are ranked higher than all of the publicly traded stock winners. The futures market and the ETF market do not care where the global climate event occurs. All they care about is the price of platinum. It makes life a bit easier if you do not have to worry about which names in the stock market are the winners and losers, but instead simply focus on the extreme weather events and the price of platinum.” (pp. 71, 75)
Oxley does not, however, confine his analysis to trading commodity futures. He gives examples of pairs trading in equities and explores opportunities in the bond and forex markets.
Event-based trading is notoriously difficult because everybody is responding to the same information. Think, for instance, of the recent run-up in orange juice after a cold snap threatened Florida’s crop, the FDA detained shipments of oranges imported from Brazil in which they found traces of an illegal fungicide, and Mexico’s crop faced damage from drought. Even with this perfect storm trading was still not easy. For instance, on January 10, when news of Brazil fungicide fears broke, orange juice surged 11%. The next day, as investors awaited more news from the FDA, orange juice futures fell 9.5%. Here’s the 30-day chart.
Oxley offers some tips for event-based trading, including when to sit on your hands. For example, if sugar spikes—which means that soda and chocolate are negatively affected, he recommends avoiding (not shorting) Hershey and Coca-Cola stock. And he cautions not to “buy excessively in the municipal bond market in hurricane regions during hurricane season.” (p. 179)
Oxley’s book is a worthwhile read for commodity investors, novices as well as the more experienced, who are in search of opportunities. It is also a cautionary tale for those who want to protect their portfolios. No one should trade commodities without understanding the impact extreme weather can have.
Thursday, January 26, 2012
Palicka, Fusion Analysis
Fusion Analysis: Merging Fundamental, Technical, Behavioral, and Quantitative Analysis for Risk-Adjusted Excess Returns (McGraw-Hill, 2012) is based on a course V. John Palicka offered at the New York Institute for Finance. As the subtitle indicates, the book advocates a multi-pronged or, perhaps better put, a blended approach to investing.
Palicka’s general approach is not new. Many stock screeners and investment services score stocks using a variety of inputs. For the investor who wants to do it himself, however, it’s not always obvious what kinds of inputs make the most sense—and potentially the most dollars. It’s also not intuitive what the theoretical underpinnings of the various approaches are. For instance, in a somewhat philosophically muddled chapter that touches on faith, physics, and time travel the author argues that determinism (here most frequently contrasted with free will) is the basis for technical analysis.
Palicka throws a lot at the reader in this book. He blends Elliott Wave analysis with the fundamentals of real estate within the context of determinism. He studies gold trading and business cycles, describes buy and sell decisions using Gann analysis, outlines measures for risk-adjusted excess returns (Sharpe, Treynor, Jensen Alpha, and the Information Ratio), and explains how to use swaps for market timing.
Fortunately Palicka provides a case study (Steve Madden—SHOO) to illustrate how the fusion process works. He uses a scoring system to determine a rating but cautions that “my actual and proprietary system may differ from that illustrated for confidentiality reasons.” (p. 374) In his illustration he incorporates five categories—short-term return, price/book, expected P/E divided by the expected P/E on the S&P 500, price/cash flow, and technical (a weighted average of MA, support/resistance, MACD, OBV, market relative strength, and Fibonacci). The categories are weighted—in this case between 10% and 35%--and each category gets a rating. So, to determine the total rating you simply take each individual rating times its weight and sum the products. Then you compare the summed rating to a table which correlates ratings (buy, buy/hold, hold, sell/hold, sell) with points. If, for instance, in this example the total rating is under 1.5, the stock gets a buy rating.
Of course, in the investing world nothing is cut and dried, and Palicka’s book makes that patently obvious. Backtesting helps, numbers are critical, but ultimately fusion analysis relies on market experience, the integration of disparate fields of study, and the touch of an artist. Even though I doubt that the author would find this an apt description of his method, I intend it as a compliment.
Palicka’s general approach is not new. Many stock screeners and investment services score stocks using a variety of inputs. For the investor who wants to do it himself, however, it’s not always obvious what kinds of inputs make the most sense—and potentially the most dollars. It’s also not intuitive what the theoretical underpinnings of the various approaches are. For instance, in a somewhat philosophically muddled chapter that touches on faith, physics, and time travel the author argues that determinism (here most frequently contrasted with free will) is the basis for technical analysis.
Palicka throws a lot at the reader in this book. He blends Elliott Wave analysis with the fundamentals of real estate within the context of determinism. He studies gold trading and business cycles, describes buy and sell decisions using Gann analysis, outlines measures for risk-adjusted excess returns (Sharpe, Treynor, Jensen Alpha, and the Information Ratio), and explains how to use swaps for market timing.
Fortunately Palicka provides a case study (Steve Madden—SHOO) to illustrate how the fusion process works. He uses a scoring system to determine a rating but cautions that “my actual and proprietary system may differ from that illustrated for confidentiality reasons.” (p. 374) In his illustration he incorporates five categories—short-term return, price/book, expected P/E divided by the expected P/E on the S&P 500, price/cash flow, and technical (a weighted average of MA, support/resistance, MACD, OBV, market relative strength, and Fibonacci). The categories are weighted—in this case between 10% and 35%--and each category gets a rating. So, to determine the total rating you simply take each individual rating times its weight and sum the products. Then you compare the summed rating to a table which correlates ratings (buy, buy/hold, hold, sell/hold, sell) with points. If, for instance, in this example the total rating is under 1.5, the stock gets a buy rating.
Of course, in the investing world nothing is cut and dried, and Palicka’s book makes that patently obvious. Backtesting helps, numbers are critical, but ultimately fusion analysis relies on market experience, the integration of disparate fields of study, and the touch of an artist. Even though I doubt that the author would find this an apt description of his method, I intend it as a compliment.
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