Friday Mailbag

Teresa, May 9, 2008 @ 10:42AM ET | Link | RSS | Read via Email | 7 Comments  

Our client Daniel took the time to send in questions about a number of things people want to know, but were afraid to ask. ;-)

Daniel
I have a question to know if it is possible. If one wants to “catch” a peak although you would not recommend on it how would I know what the band would be on the upside. I mean I have the band on the lower side obviously because it would still be a long position, but what I have seen in the charts it does not seem simply a matter of reversing the difference from the Close or Open to the band.

Teresa
If you wish to ‘pick tops”, there are two types mentioned in The Ultimate Trading Course: the spike top (after a parabolic rise) and the test of top (Trader Vic 2B). These are anti-trend hit and run trade setups, and generally, the InVivo.Stops would still be UNDER the price action.

08-wynn.gif
WYNN was a particularly elegant Trader Vic 2B Test of Top

08-wm.gif
WM was a particularly elegant spike bottom


Daniel
Before asking these two questions I would like to say that all the material, either at your site or the Q&A at Kirk’s site has been a fresh welcome flood of information that I hope someday will translate into knowledge.

I have trouble at the blog distinguishing the links from the rest. The fact that they are not underlined and the red color is not much different from the black it makes it difficult for my tired eyes.

Teresa
Sorry about that. I have underlined the important links now.

Daniel
The RMI.Histogram it took me some time to understand that it related to indices, and so I guess that I should use the right EFS file for the right ticker. Might be obvious for you but for someone relatively new like me does not look so obvious.

Teresa
RMI = relative momentum. We are measuring X relative to Y, with Y being a benchmark index. That’s why we made four versions, one each for S&P 500, NASDAQ 100, Russell 2000 and DJ EuroStoxx 50. I’ve updated the instructions on the download page. Thanks for your suggestion. Pete and I also did an extensive podcast.

Daniel
I have a basic knowledge of your InVivo indicators. I came to them by change and tried to understand your concepts and even replicate them (I am honest). I have not done so completely, (and is not what I am seeking) but being able to understand the concept behind was (for me) a must so as to trust them.

What I do not understand is the Histogram (the concept behind). During the weekend my subconscious mind has been working and ended with something like this (please don’t laugh if I am completely off): RMI (Relative Momentum Indicator)
My mind thinks that what it does is measure the relative momentum (that should be some kind of relationship between the RoC of the Ticker with regards to the Index measured against) so as to be able to construct the Histogram. To be able to compare different RoC they should be normalized and for research I have made, I would say they should be also linear (which they are not, I mean the usual RoC).

Teresa
Yes, please continue. I am sure there are many ways to measure relative momentum. Calculating the differences of RoC between the ticker symbol and the benchmark index might be one way.

Daniel
I have been thinking of your InVivo Strategic Performance Portfolio. For a first timer, one should buy the portfolio with those weights at or before the start of the first Monday or maybe get in at better suitable times to each of the five constituents? I know (or now understand better the concept of rebalancing) I had something like this wandering in the back of my mind lately, so maybe the answer is get in and just rebalance, but I prefer to make a dumb question than a dumb movement after all, and after the ones I have made.

Teresa
Since the asset allocation is done dynamically in response to market conditions, you should rebalance as close to the opening price each week (or month if using the Conservative Retirement portfolio) as possible. Your can direct your efforts at market timing toward your trading endeavors.

Daniel
Also I would like to ask you if the Lehman 20+ Year Treasury Bond Fund (TLT) and the CurrencyShares Swiss Franc Trust (FXF) act as a I sometime heard “being in cash is a valid position” and also if it meant to hedge against inflation instead of being only in cash.

Teresa
You might wish to revisit the quotes from David Swensen in Part 4 of Build Your Own Portfolio. Treasury Bonds are deployed as a core asset class. I added currencies as an alternative asset class because it’s a good idea to have diversification there too.

“Being in cash is a valid position” is probably fine in the world of trading where marketing timing is presumably “the edge”. Cash in an investment portfolio, particularly if it is held in the same currency as all of your other investments, is not necessarily good, or even desirable:

Investors frequently divide fixed income assets into cash and bonds, with the former consisting of instruments maturing within one year and the latter including instruments with more than a year to maturity. For investors with short investment horizons, cash represents the riskless asset, as market participants know nominal and real returns with reasonable certainty. This certainty, however, comes with a high price: historical returns amount of 3.8 percent per annum for cash, which reduces to a paltry 0.7 percent per year after adjustment for inflation.

If investors operate with time horizons of several years, cash constitutes a risky asset. Holding-period returns become uncertain as investors roll over maturing cash instruments into new investments at then-market rates. In contrast, when employing a five-year investment horizon, the five-year zero coupon bond with its fixed nominal return represents the risk-free asset.

Because investors frequently employ one-year horizons when conducting portfolio analysis, cash naturally enters the matrix of capital market returns, causing many long-term investors to misidentify cash as a riskless asset. If investors conducted analysis over periods consistent with an appropriate investment horizon, cash would appear as a substantially riskier asset. — David F. Swensen, Pioneering Portfolio Management

My personal opinion is this: when a manager holds a lot of cash in the same currency as the rest of the investment portfolio, it usually translates to, “the market smacked us big time, so we sold a bunch of good stuff near the lows and raised cash to make a big bet on a couple of value plays. Fingers crossed.” Check out Eric Falkenstein’s comments at his blog.

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  1. Daniel on May 9th, 2008 4:14 PM

    Thanks Teresa,

    I read it and go through it in detail latter on. Right now I am “studying” The Ultimate Trading Course.

    Now I am the one who is behind :-) my reading material.

    Thanks once again,

    Daniel

  2. Daniel on May 9th, 2008 4:31 PM

    Teresa,

    Sometimes you give for granted things that are common for you for so many years. Like the comment on Trader Vic 2B. I had no idea who he was nor what he did. I Googled and found this for a start.

    Your site is not for dumbs nor for those that do not want to work hard to fully appreciate it, but sometimes I feel one arrives to it only after having learned a lot in the process even beforehand. This is not a criticisms, it’s more of a fact to me.

    I discovered your site by chance a few or more months ago. I liked (a lot) what you said, but at that time it was not enough to get me coming back and wanting to read more. Only when the Kirk Q&A appeared and saw some of your indicators in his graphs that I came back, even before the release of the Q&A in Kirk’s site.

    If it were a graph it would have been a double top!

    Thanks

    Daniel

    P.S. Example of things that you take for granted: in the book (I must confess I have not finished it yet) you apply concepts of divergence. Maybe someone that has never seen divergence might not get it as the powerful concept it is, and may just go through the pages not giving it the right value of your explanation or fully understanding it.

  3. Teresa on May 9th, 2008 10:45 PM

    I hear what you’re saying Daniel.

    The interesting thing is that almost everything an individual investor reads about trading is actually concerned with only directional trading. Most of it is unimportant.

    Directional trading is sort of like poker (except we choose our hand): the outcome is uncertain and subject to exogenous factors. The only thing the player controls is how much of the bankroll to bet on that hand, if he will ante up and when to fold. See comments by LeBeau and Eckhardt.

    When I started teaching online ten years ago, I thought everyone knew this, but I was wrong. It took almost a decade for me to learn that I have to focus on showing people that success depends much more on risk management and the graceful exit. That’s how the monkey beat Bill Miller.

    There is a saying in the brokerage business that it is better to be a good trader than analyst. I think there is a lot of truth to this, especially when the definition of a trader is “an expert on how much to bet and when to fold”.

  4. Daniel on May 10th, 2008 9:44 AM

    OK, I get the picture…

    One thing I have been wondering about graceful exits is whether you always stick to the In.Vivo.stops or if your indicators like the RMI are showing a negative bias you exit upon a retracement (so as to loose less) and don’t wait for the initial stop or the trailing stop to be hit.

    Thanks,

    P.S. (haven’t finished yet reading the book, just in case it is just there the answer).

  5. Teresa on May 10th, 2008 5:25 PM

    If there is a specific trade setup — most likely a scalp — then I would take my money at the predefined target. Most of the setups in The Ultimate Trading Course are like that.

    If an entry is based on a more “fuzzy” setup with no corresponding defined exit — you know: mid-trend, third party recommendation, “feel” trade, the neighbor, “I can’t stand it anymore” impulse or just plain throwing darts — then it would be best to follow the stops.

  6. Daniel on May 11th, 2008 9:33 PM

    Teresa,

    But what happens then to “let the profits run”. I understand what you mean but….This is the place where it gets more fuzzy and less exact science and where we would call it an art kind of…

    I thought for once that a strategy would (have been) to target a good entry and let the In.Vivo.Stops do the rest.

    Just talking out loud,

    Daniel

  7. Teresa on May 12th, 2008 10:40 AM

    If the trade setup is a “retracement” designed to enter a trend, then it makes sense to “let the profits” run. If one is trying to “pick” an obvious, anti-trend spike top or bottom, then I would be more inclined to scalp.