Posts filed under “Trading”

Method to the Madness: Alpha Chasing Beta

A reader asks:  "What is your investment strategy based on? Do you have a specific model?"

Fair question: Here’s the short answer:

My investment strategy is a "Macro-Vector" approach.

Its based on the belief that markets are neither random nor predictable, but rather, follow trends, which often respond to different combinations of factors in a way that may occassionally be predictible over the short term. 

Essentially, markets – all markets — only do 2 things: They Trend, and they Reverse. Most Macro models are designed to get you on the right on the right side of a trend, and keep to keep you there, and as far as that is concerned, mine is no different.

Where I diverge from most Trend traders is the process of determining when markets reverse. My framework uses 5 key elements — Sentiment, Market Internals (Technicals), Monetary Policy (Macro-Economics), Valuation and Cycles — to determine the potential of a market reversal at any given moment.

Note that each of these 5 elements works on different time horizons, and they are presented from the shortest term (Sentiment, and then Internals) to the longest (Valuation and then Cycles).

Even within a well defined Trend, these 5 elements help determine what the relative risk versus reward of the equity markets are, and assesses the most advantageous investment posture — Long, Neutral, or Short.

~ ~ ~

“There are very few markets (betas) or managers’
performance numbers (alphas) that are not dominated by changes in the
macro picture. That is because almost all pricing reflects expected
future conditions, so prices change as a function of changing

-Ray Dalio, founder of Bridgewater Associates, which manages $120 billion in institutional assets.

I believe my approach is very different — and a bit of a throwback — than what seems to have become the dominant investing approach over the past few years:  The undue emphasis of Alpha over Beta.

What does Alpha over Beta mean?

It’s a bit of a tongue in cheek phrase, but follow it to its conclusion: The recent surge is hedge funds assets is the result of investors “chasing Alpha.” Money has been flowing to managers who have shown the ability to eke out a profit arbitraging away some of the inefficiencies in the market.

Over the past decade, the move to chase Alpha — rather than Beta — was perceived as the less risky, smarter strategy. But for obvious reasons, it couldn’t last forever. The underperformance of the alternative investment community shows the net result: With over 8,000 hedge funds, alot the Alpha opportunities have been wrung out. Many of the inefficiencies which were the basis for the strategies hedge funds have been pursuing (Alpha) have run dry.

The great irony is that a decade ago, Alpha was actually a function of Beta. The great hedge fund managers, — from Robertson to Soros to Druckenmiller on down — were Alpha males engaging in Beta trading. They made big, bold bets on macro events: Currency, Rates, Commodities, Indices, Sectors, Stocks. They hardly engaged in the genteel strategy of ekeing out a percent a month or so. Instead, these swashbucklers developed the tools and skills to read the macro enviroment. The good ones were successful, the great ones, wildly so. 

And then the meteor came. Like the Dinosaurs before them, the Beta players got pushed aside. A combination of smaller faster mammals — new managers offering reduced risk — and the dot com bubble did what the Bank of England couldn’t: They ended the reign of the Dinosuars.

The environment today presents a fascinating void, a place in the food chain for those who know that for most of investing  history, Alpha has been a function of Beta. That’s the spot where large gains can be had.

That’s where I want to be . . .

Category: Investing, Markets, Trading

Will Rallying Oil Set a Bear Trap?

Category: Commodities, Markets, Psychology, Trading

Quote of the Day

Category: Psychology, Trading

On Line Trading: A Business Plan for the future

I originally wrote this about 6 months ago, but never got around to doing anything with it. Since then, we’ve seen E*Trade bid for Ameritrade (only to get rebuffed) while Ameritrade approached T.D. Waterhouse about a merger. I imagine others in the discount online brokerage space are engaged in similar manuevers.

Its all wasted energy.

Why? Think about Clorox, Kleenex, Post-its — these are commodity products that have differentiated themselves through branding from their competitors. Even specific brands of Premium gasoline are known to auto afficianados  (Amoco Ultimate and Sunuco 94 are the most liked).   

Even commodity products can distinguish themselves from the competition in a commodity field."

Competing on price doesn’t work; Your peers just engage in a price war. Bulking up doesn’t work; There’s still many competitors who will step in to fill the void. And while E*Trade spends almost $100 million per year on advertising, their competitors (collectively) spend even more.

There’s a better solution: Its called Differentiation. 

I’ve thought about this for some time now. I’ve always followed E*Trade closely, because that’s how I got into this business. Well over a decade ago, a friend was running a branch office of E*Trade in NY — they were a proprietary trading house before they rolled out on-line trading. He brought me into the biz as a trader (hence my focus on capital preservation and technicals/internals).

We know there’s a price war, and that discount on-line trading is merely a commodity business. There’s significant customer churn. To break out from the back requires something significantly distinguishing from the other firms. Size isn’t what’s required, a better business model is. Something that is value-added for the customer, gives them a reason to pick you versus the other guy.

Here’s a way for an online trading house to distinguish themselves:

Since they popularized online trading, E*Trade has built tremendous brand recognition. But its come at a cost: Spending north of $86+ million in advertising over the past fiscal year, one must ask if the company is truly maximizing their return on advertising dollars.

It has become a crowded marketplace, but the firm that differentiates itself from the rest of the online brokers — Schwab, Ameritrade, Brown, ScottTrade, etc. — garners a huge advantage.

Of the full list, I believe Schwab and E*Trade are best positioned to put such a plan into full effect, with Ameritrade a close third.

After considerable thought (and using what little expertise and experience I posses), I have put together a series of ideas as to how an online broker can do this. When discussing this with a colleague, he made the astute observation that the ideas were alphabetical: A-B-C-D-E-F.   (Talk about pattern recognition!)

This was purely coincidental, but because of it, I present the list — not in priority form — but in alphabetical order:

A)   Advertising (pundit)
B)   Blog
C)   Commentary
D)   Database
E)   Education
F)   Fund

Here are the details of each:

A.  Advertising

Given the astounding amount of money each of these players spend on advertising (E*Trade’s $86M is an example), I do not think the companies are getting as much for their money as they could. An editorial presence in print, radio, internet and, of course, TV would extend the advertising dollars and dramatically improve ROI.

In my own work, I garner millions of dollars in PR for my firm — TV, Radio and Print. My motivation are not PR — I do it because I enjoy participating and furthering the debate — but that is surely the main reason my firm pays me a salary (btw guys, I want a raise).

Where is E*Trade’s talking head? Its astounding to me they dont have one — Schwab and Ameritrade do. It would extend and further the huge advertising outlay they make. The platform alone guarantees at least moderate coverage.

I figure for about a million a year (plus or  minus) — the Chief Investment Strategist position, staff, office, research, etc — they could add close to a 50% increased return on their massive ad outlay.

That’s the first layer; consider each of the following topics (B – F) as supporting the PR/Branding/Marketing aspect of the firm:

B.  Blog (Web logging)

Blogging is a great way to provide a readership with an overview of topical issues related to current media. By frequently posting short, interesting blurbs related to a given topic — i.e., the macro-economy, market moves, releases, etc. — a readership develops, drives traffic, and stays within a given website.

I’ve maintained a weblog in various forms — most recently The Big Picture — since  after 9/11. Since moving it to Typepad, readership and traffic have grown nicely. According to one traffic ranking site, The Big Picture consistently ranks in the top 100 web blogs. This is out of millions of blogs, with no advertising budget, staff, or research dollars.

There are a few examples of where a business’s website added a known blogger and drove their own traffic and reader retention much higher. The best example I know of is Washington Monthly, which integrated Kevin Drum’s CalPundit blog into their front page. But other companies have been using them for a variety: see  Jupiter Research and Microsoft as examples of different applications of Blogging to a corporate need.

E*Trade needs to hire a talking head, start a blog (with some editorial assistance and a small blogger crew), make their site stickier and actually be useful for their clients. Further, you
can use it to attract new clients who are not reached thru newspapers or TV ads.

On a ROI basis, I’ll bet a good blog utterly kicks TV advertising’s ass.

On-line brokers need a stickier site, a reason for customer and non-customers alike to hang around their — perhaps even open an account.

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Category: Markets, Trading

Apprenticed Investor: The Zen of Trading

Category: Investing, Psychology, Rules, Trading

How to Short a House

Category: Real Estate, Trading

Short term Frothiness could lead to an Intermediate Top

Category: Markets, Trading

Looking for the Next Catalysts

Category: Markets, Trading

John Murphy’s Ten Laws of Technical Trading’s Chief Technical Analyst, John Murphy, has created another set of trading rules:   “Ten Laws of Technical Trading:” “Which way is the market moving? How far up or down will it go? And when will it go the other way? These are the basic concerns of the technical analyst. Behind the charts and graphs and…Read More

Category: Rules, Technical Analysis, Trading

Weekend Wrap Up

Category: Economy, Markets, Trading