IWF: #STFR

And one day later: #STFR. Quick hits are the best hits.

2018.07.06 IWF - STFR

I don’t put a lot of faith in support and resistance because the entire history of the stock market is one of breaking support resistance levels. However, it typically takes more time for price to grind through new highs instead of returning back to where new highs are a possibility.

So I made a quick buck and am hunting for the next trade.

IWF: #btfd

If you want to skip the entertainment below and get straight to the punchline: IWF has shown strength over the past X months and recently experienced a pullback. It looks like the drop has stabilized so I’m going to jump in and try to ride it back higher.

However, if you want to read on for what too often passes for trade analysis, feel free to keep going.

Obligatory Macro Environment Analysis

Trade war jitters probably caused the pullback. I’m thinking interest rate hikes might be another likely culprit. Of course, maybe you just had a bunch of people decide to take profits, which lead to a cascade of sell orders from algorithms and monkeys. Honestly who knows but we just experienced a risk-off period that created a buying opportunity for us.

Chart Analysis of Questionable Value

I could draw a bunch of random lines on the chart to pretend like they show support and resistance levels. News flash: they don’t. The classical interpretation or the price action on the chart is a rising wedge. Some technicians would have you wait until price breaks the upper line that represents overhead resistance, some would have you wait until price breaks the upper line and then “retests it,” while others would have you enter off support of the lower line. I’m a short-term mean-reversion trader so I’m doing the latter.

Just so we’re clear: I’m not actually using that “rising wedge” to guide my trade because you could also interpret the price action as a tiny dwarf wielding a really long whip that’s about to be cracked. I’m not sure what you do with that information, but there it is.

2018.07.05 IWF - BTFD

Since the randomly drawn lines above are not predictive we always use the pioneering work done by the Franciscan friar William of Ockham (of Occam’s Razor fame) to double check our assumption. It’s a 4 step process:

  1. Pour yourself a shot of your favorite liquor.
  2. Take the shot.
  3. Now squint at the chart for no more than 2 seconds. A real technical analysis pro will use his peripheral vision while squinting.
  4. Answer one question: did the blurry, squiggly line you thought you saw go from the bottom left of the chart to the top right?

If you answered “yes” to the fourth step above then you’re in luck! The trade has been confirmed. If you’re somehow not sure, then repeat steps 1 through 4 above until you have your answer.

Obligatory comment on what’s driving sector support

A lot of movement in markets is random noise. Narratives happen that get overblown, which leads to a sell-off. At some point that narrative goes quiet or gets replaced. Since the trade war rhetoric has simmered down and news is out that Europe is actively seeking a way to diffuse it the next narrative is likely to be the old narrative: the US economy is still growing, unemployment is really low, and inflation is still contained. So go buy growth.

on the need to do something

So much of investing is the avoidance of doing dumb stuff. If you’re not sure what “dumb stuff” entails in investing then let me provide you a very incomplete list:

  1. Selling a broad index fund after if dropped 20+ percent and going to cash.
  2. Putting more than 5 percent of your portfolio into a single stock.
  3. Frequently trading in and out of a stock based on its gyrations without a well-defined trading strategy.
  4. Buying individual stocks without reading 10Ks, 10Qs, or knowing how to perform at least a simple valuation based on fundamentals.
  5. Being sold an investment product instead of proactively researching the investment on your own.
  6. Paying a front-end sales load for a mutual fund.
  7. Buying most IPOs on the first day of public trading.
  8. Trading volatility or other structured products with too much leverage.

The one thing the above have in common is that they all reflect the need of an investor to “do something” to try to get better returns. The reality is that all of these actions are hazardous to an investor’s wealth.

There’s one simple trick to avoid all the bad behavior that hurts an investor: dry powder.

Dry powder can come in two forms:

  1. Periodic savings from your paycheck.
  2. Keeping a portion of your portfolio in cash until you find the “right” opportunity.

Every investor has heard about the benefits of dollar cost averaging. They’re not exaggerated and I won’t rehash them here. It’s one of the few free lunches in investing and the best use of the periodic savings from your paycheck.

But you probably didn’t come here to be told to dollar cost average your paycheck into a low-cost, tax-efficient portfolio. You came here to know what to do with the portion of your portfolio you’re now keeping in cash as dry powder so you can do potentially dumb stuff while keeping the bulk of your assets in a responsible, diversified portfolio.

Some solid options if you have the need to do something besides have patience while invested in diversified portfolios over long periods of time:

  1. Trade around a core position: every time one of your core diversified holdings drops by some threshold, whether it’s 10, 20, or 30 percent, use your cash to buy some more and then hold on until it appreciates back to the previous price level. Sell, then repeat.
  2. Trade around a core position but sell long-dated put options. Same as the above, but instead of buying the underlying asset you sell an at-the-money put option with a maturity date of 6 months from sale. Hold onto it until 90 percent of the time value (theta) disappears or it gets assigned to you. If it gets assigned to you then hold onto the underlying until it appreciates back to the original strike price. This strategy has the added benefits of some downside protection, timing the sale of insurance when it’s dear, and a dash of sophistication and sexiness because it involves options (even though it’s a dead-simple strategy).
  3. Speculate on companies you think will do really well, allocating no more than half a percent of your overall portfolio to any single position. There are lots of ways to do this – I don’t recommend it for most people but if you keep your position size very small for each stock you probably won’t do too much damage (plus it’s fun to say you bought shares of Tesla 8 years ago!).
  4. Use an active trading strategy, making sure you placed your stop loss where you’re only risking 0.25% of your portfolio on any single trade at least until you’ve mastered the art of trading. For most people this will be a waste of time and money, but at worse it’s a slow bleed with plenty of action.

The last two options typically lead investors astray; however, if you use the recommended position sizing you won’t do too much damage to your terminal wealth.

What’s your edge?

The best part about financial markets is the mythos that the amateur can compete or even outcompete the professional.

How many other ultra-competitive activities does that hold true? Would you step onto the field against an NFL team? Would you wager millions of dollars playing against a chess or golf pro?

Arrayed against you is an army of PhD-wielding mathematicians, economists, and artificial intelligence researchers, backed by another army of programmers that turn the first group’s insights and data into algorithms that get the best executions and take advantage of fleeting market opportunities in fractions of a second.

So why do you think you can outcompete a finance professional? And I mean a real one – a buy-side hedge fund like AQR or Renaissance Technologies or institutional asset managers like Blackrock or Goldman Sachs, not your typical “financial advisor” who is scrabbling for a ten or fifty thousand dollar 401k rollover.

How do you compete?

As an individual trader you have 3 edges:

  1. Smaller pools of capital: you can have tens of millions of dollars and still be a very small fish that with a little care doesn’t have to worry about moving most markets with your order flow. You can get in and out of investments faster than any institutional investor. While they may be faster than you on the execution of any single trade, you’ll almost always be faster when it comes to large-scale portfolio repositioning.
  2. Patient capital: if you trail your index by five years it’s not like you’ll have the capital you’re trading with yanked away from you; however, if an institutional investor trails their index by five years, whoever owns that capital might transfer it to another financial institution to manage. This allows you to be patient and let your investment or trading thesis play out without worrying about career suicide. Most portfolio managers can’t afford to do this.
  3. You don’t have to do something that appears complex or fancy to justify your fees to your clients. You can invest in simple index funds and beat 80%+ of active portfolio managers.

How does Signalee apply these edges?

  1. Signalee doesn’t have the infrastructure or knowledge to compete with high-frequency traders so we only play in areas where speed of execution doesn’t much matter.
  2. We ignore the traditional concept of risk that substitutes volatility for the permanent loss of capital.
  3. We use a trading strategy that accomplishes our goals – not someone else’s.

For the average investor, focusing on things they can control like investment expenses (including taxes), diversification, and their savings rate, if they’re still in the accumulation phase, is a much better use of their time than trying to find an edge in the market when the playing field is crowded with more capable competitors.

ECH: #STFR

I always love dumb luck. Sometimes mean-reversion trades take an extra day or two to find their footing and resume the prior trend. Sometimes they pop the next day. These trades don’t happen often and they’re certainly not due to skill: just luck.

2018.05.10 ECH - STFR

We hopped on, ECH popped, then we hopped off. Sure, it was dumb luck but a well-defined process helps you take advantage of it when it happens.

#BTFD: ECH

It’s always fun to speculate as to what is driving markets. Trump pulled us out of the Iran deal and the European Union is scrambling to keep it in place. Do they think the deal is effective or do they want to maintain the lucrative market access that lifting the sanctions gave them? Does Trump think he can get a better deal or is he just playing to his base of supporters and can give a rats about actually following through at the negotiation table?

Who knows.

The reality is that the global economy is still chugging along. While the rest of the world may be slowing down a little, the US is showing few signs of taking a breather. There is some rumblings that China has shut down port offices and are not issuing new certificates cargo ships to import various products into China. I’m assuming it’s targeted at US farmers although a lot of other industries are finding themselves caught up as collateral damage.

There are so many storylines out there to try to guess where the market is going to go. Or if you prefer: to guess where other people will guess where the market is going to go.

Instead, stick with a repeatable process: look for uptrends, wait for the pullback, buy once it looks like it is stabilizing, sell when it mean-reverts.

Which brings us to ECH.

2018.05.09 ECH

ECH has been in a strong uptrend for the past couple of years but has spent most of 2018 in a trading range. Trading ranges work for us too. Regardless, price pulled back to the bottom of the range, looked like it caught a bid around $51 and moved up again today. The fun thing to note on today’s price range: it looks like someone forgot to use a limit order and got taken advantage of.

Entered at $51.67. Stop loss is at $48.75.

Fiduciary Standard & Radical Transparency

The best part about only managing your own money is that you’re incentivized to always do the right thing because it’s your own money. My goal is to maximize wealth within the context of a risk management framework. I don’t have a boss that’s constantly pushing me to gather new assets or maximize revenue. So the debate on the fiduciary standard doesn’t really affect me.

But it doesn’t mean I don’t have an opinion.

Fifth Circuit v Fiduciary Rule

The Fifth Circuit recently ruled against the DOL. It is now widely assumed that the SEC’s proposed rules will replace the DOL’s fiduciary rule. The SEC rules require brokers to look out for clients’ best interest but it stops short of imposing a fiduciary standard on brokers. The end result is that brokers can keep their kickbacks as long as they disclose them to clients.

Ask yourself how small the print will be when the brokers “disclose” those kickbacks to their clients.

A More Perfect World

In a perfect world, every financial advisor would already be providing each and every one of their clients the lowest cost, most effective financial products that align perfectly with their goals.

This doesn’t happen in the real world.

The easiest way to improve outcomes in the real world is to ask your financial advisor how he gets paid for each product he has you invested in. If you have an honest advisor he’ll show you the percentage you’re paying for the ongoing management fee of the mutual fund, the fee you paid to get into the mutual fund in the first place (although it’s crazy to pay an upfront fee to buy a mutual fund in this day and age – if you’re paying upfront mutual fund fees you probably have an advisor who isn’t looking out for your best interests), and whatever account wrapper fee he charges on top of all of this for his “advice”. You’ll likely get this number in percentage form. Do yourself a favor and convert it to dollars. Ask him who else is paying him so you can figure out if you’re actually the client or the product being sold.

Then think hard as to whether the advice you’re getting is worth that sum. You might decide your advisor is worth it, but it’s easier to understand the true cost when it’s in dollar form because you can more easily compare that number to a list of alternatives. Like a vacation, a bass boat, or a wine cellar.

A less than honest or incompetent advisor will give you incomplete numbers, or even worse, not be able to give you the numbers because he has you in a bunch of annuity products whose fees are opaque as a pint of Guinness.

If you don’t have a family office looking out for you, show your financial statements to a financial advisor from Vanguard, Fidelity, or an honest-to-God fiduciary RIA like RWM. They’ll be able to quickly tell you how much you’re paying in fees, mostly becuase they use it as a selling point to win new business.

Don’t get me wrong – the lowest cost option isn’t necessarily the best choice. The true value of financial advisors for most people is to keep them from doing dumb stuff when they’re panicking in a bear market. But there are a lot of good financial advisors that combine good advice with reasonably low costs.

Radical Transparency

My solution for financial advisors to meet the fiduciary standard is to make every financial management firm present you a quarterly or monthly invoice for every fee they charge. This invoice must be paid by a check you write to them. Don’t allow them to automatically deduct a tiny percentage from your account every day, which is their current practice, and is so small that you don’t notice it but whose effect over decades¬†totals hundreds of thousands if not millions of dollars.

You know how much your mortgage costs you every month. Why shouldn’t it be just as easy to know the total cost of asset management every month? And if you’re wondering why Vanguard, Fidelity, and Blackrock dominate the asset management business: they’re not screwing their customers with high fees.