New trading models: In the last issue you discussed your models for trading gold stock funds and real estate funds. Are you working on any new trading models that you expect will be available to clients in the not too distant future? As you probably have figured out, this question would not be here if the answer is no.
I am always on the lookout for way to improve the way I trade your accounts (and my personal accounts also since I believe in “eating my own cooking”). These efforts may be aimed at finding better methods for trading the instruments I currently use such as sector funds, broad based index funds, and stocks in the Dow. I also investigate what can be considered to be “alternative investments.” Those are funds that should be not highly correlated with the broad U.S. stock market as typified by the S&P 500 index. The models for trading gold stock mutual funds and real estate mutual funds that I developed and made available in the past few years are examples.
One that I am working on now applies to the Morgan Stanley Europe Asia Far East (EAFE) index. It is essentially an index for stocks in the developed economies not in North America. There are exchange traded funds (ETFs) that track this index, so it is practical to trade it with an effective method.
The index dates back to the beginning of 1970. I have monthly data since then and daily data, which I obtained fairly recently, dating back to mid-1994. I have done some preliminary development using the monthly data, and the results are promising. However, I prefer not to base trading decisions on the end of the month data alone. Given how fast things can move these days, it is critical to analyze daily data and develop a model that can buy or sell on any given day. That does not mean that I expect to trade frequently, and since there is a cost to trade an ETF—commissions and the bid/ask spread, I am searching for a method that has at most only a few round trips in a typical year.
Another important reason for analyzing daily data is to evaluate the risk levels associated with the trading methods. Conventional “wisdom” discussed above loves to point out that over sufficiently long periods of years, stocks always go up. While that is true, the drops during secular bear markets make it very difficult for many to stick with “buy and hope.” Also, some investors may not have a long enough investment horizon to wait for the always going up phase. While a model based on monthly data may have reasonable drawdowns based on monthly changes, if there are too frequent and severe declines during some months, sticking with and having confidence in the model may be questionable.
In recent years the stock markets in the developed economies have become increasingly correlated. That raises the question of whether trading the EAFE will add meaningful diversification to accounts such as those in the Tactical Asset Allocation program that trade funds that track the S&P 500. If one were essentially buying and holding the S&P and the EAFE, the additional diversification in recent years from adding the EAFE would have been minimal. However, my investigations so far show that the model based on monthly data for trading the EAFE has quite a low correlation with the model I use for trading the S&P. My thinking is that adding an EAFE model will provide additional profit opportunities without increasing the risk due to a widespread decline in global stock markets.
The models I use for trading gold stock funds and real estate funds are fairly simple, which is also true for the ones I use for broad based stock funds and bond funds. Any EAFE model I develop for use in managed accounts will also be fairly simple. While a more complex model may test out better, my experience is that the more complicated model is, the more likely it is to “stop working” in the future. While simple models sometimes “miss something” and can even “look silly,” over the course of a few years they usually work quite well.
I will keep you informed about hoped for progress developing an EAFE trading model. If you are interested in my applying it in your account, please get in touch with me.