Man OM-IP 3 Eclipse

This is a hedge fund investment I am considering. The kind of thing that is not available to individual investors in the US but is available here in Australia. UK-based Man Group is probably the largest managed futures manager. This product is a structured investment that consists of four elements:

1. An 80%+ investment exposure in AHL, Man's main managed futures program. This is a system trading one hundred plus global futures markets. In the last 10 years it has returned 16.1% per annum (5 years, 12.3%, 1 year, 20.6% as at October 2007 - the MSCI returned: 8.8%, 20.2%, and 24.8% respectively - Moom: 10.8%, 26.1%, and 34.6%). So it outperforms stocks in bear markets and underperforms in bull markets. Examination of periods of drawdown in the Australian stock market, show that the program always made money in those periods.

2. A 20%+ investment exposure to the RMF Commodity Strategies program. This program invests with 30 hedge fund managers investing in commodities via futures and stocks. In the last three years it returned 18.4% p.a. (MSCI: 20.7%, Moom: 20.6%) and in the last year 13.2% as at October 2007.

3. A 20%+ investment exposure (yes there is moderate leverage in the scheme) to the RMF Asian Opportunities fund of managers. This program invests with 14 hedge fund managers specializing in Asian investments. In the last three years it returned 16.4% p.a. and in the last year 24.3% as at October 2007.

Though all three of these programs have quite high month to month volatility, their maximum drawdowns are lower than the stock market - they have a smoother equity curve in the long-run, year to year. Of course, this being a hedge fund, the fees are sky-high: 2% and 20% for AHL and 1.5% and 10% for RMF, plus brokerage of 3% per year plus an initial load of 5% (CommSec will rebate 80% of the 4% sales commission they will receive), plus another 0.5% overall to Man, plus 0.25% to Commonwealth Bank p.a and some other small fees. But all the returns quoted above are after fees (not the 5% load presumably).

4. A capital guarantee provided by Commonwealth Bank of Australia. When the investment matures in eight years they promise to pay back at least $A1.00 per initial $A1.00 investment. The most you can lose, therefore, is the interest on your money (assuming positive real interest rates) - which is quite a bit over eight years of course. They will also lock in each year half of any new net profits into the guarantee. So say the fund makes 10% in the first year. Then the guarantee will rise to $A1.05 per share and so forth.

Advantages Opportunity to invest in a high alpha (relative to the stock market) diversifying investment of a type that retail investors usually have limited access to. The managers are high quality.

Disadvantages The investment is relatively illiquid. Prices are quoted once a month and shares can be redeemed monthly. Until 2011 there is a 2% fee for exiting the fund. The capital guarantee only applies for shares redeemed in 2016 at maturity. Taxation is not so favorable either - according to the prospectus the long-term capital gains tax rate will apply to the capital guarantee but all gains above that will be taxed as an unfranked dividend - i.e. at ordinary income tax rates. There is also the potential for Australia's draconian foreign investment funds (FIF) legislation to apply. These rules require you to pay tax on unrealized gains in foreign investment funds annually - there are lots of exceptions but this isn't one of them. But if you have less than $A50,000 invested in such funds you are also exempt. So I think, from my reading of the rules, I should be exempt.

What do you think? Would you invest in this?

P.S.

How would this investment be funded? It can be funded using a Commonwealth Securities margin loan with a 70% lending ratio. After all my recent purchases I only have $5515 in cash available on my margin loan. But I could easily invest $10,000 in this fund and still have a buffer before I'd get a margin call as the 70% loan ratio means the cash available will only be reduced to $2515. Though that is beginning to cut things close. But, on 13th March I should receive $A16,400 from Primary Health Care for my Symbion shares. So there isn't going to be any problem in funding either $10k or $20k for this investment. Longer term I want to reduce the size of my margin loan as margin interest is expensive compared to other sources of leverage. We'll have to wait for some of my recent trades to payoff first though.

Symbion, Allco, and Clime

Seems that the Symbion (SYB.AX) takeover story finally comes to an end today. Primary Healthcare (PRY.AX) announced that Monday their interests in the company including conditional acceptances exceeded 52%. Tomorrow was the deadline for reaching 50.1% and if reached declaring the takeover unconditional. I sent in my acceptance a few days ago when this deadline was announced. When I get the money I'll apply it to paying down my margin loan. Allco (AFG.AX) is apparently in talks with Macquarie Bank (MQG.AX). I bought more AEP.AX - a fund managed by Allco a few days ago. The fund is trading way under net asset value. I can't see any reason why it should lose value if Allco went under. In fact the fund managers have not been spectacular to say the least. So losing Allco management shouldn't hurt. One reason I guess the price has gone down is that shareholders have sold it to meet margin calls generated by the fall in other shares (which is part of the story of the fall in Allco itself's share price). Anyway, it's now fallen more than 10% below my recent price. Do I buy more? This seems a low risk trade, but maybe there is something I don't know. So I'm unwilling to overexpose myself to that risk.

Clime Capital (CAM.AX) share price fell steeply yesterday as one of their largest investments - Credit Corp (CCP.AX) fell 75%. This was after CCP announced that they were downgrading their profit forecast by about a third and initiating a strategic review. The chairman also resigned. But given the size of the profit downgrade the market's reaction seems overblown? The forward P/E is now just 3 if the company's forecast is realized! I ended up buying more CAM yesterday because I had a lowball limit order in place. Unfortunately, not lowball enough. The stock fell another 10% after that. The manager of CAM, Roger Montgomery is a Buffett worshipper. In Buffett's pre-Berkshire days he would often take large concentrated positions in companies and Montgomery does the same. Montgomery has been convinced that CCP was a good investment and after the price fell from $9 or so to $4 he was buying more. Maybe he's right, but this kind of result will make potential investors wary of investing with Clime (they also have unlisted products) if they are going to continue taking concentrated positions. I'm also an investor in the management company CIW.AX and it also fell steeply yesterday.

So it seems I'm not having much luck with my Australian stock investments. I guess, like Montgomery, I think I'll be right in the end.

Portfolio Construction

Currently our portfolio is allocated like this:



I've explained these different categories previously. Basically "beta" contains mutual funds that are likely to be highly correlated with either the stock or bond market, while "passive alpha" contains funds that are expected to have a lower correlation with general stock market movements and financial stocks whose underlying business is not directly investing in the stock market index. Hopefully, these "passive alpha" investments will generate alpha - a risk adjusted excess return. I call these passive alpha because this is an attempt to earn alpha by investing with other managers rather than through my own trading efforts. Industrial stocks are individual non-financial companies, trading is cash and any very short-term trading instruments, liquidity is cash not dedicated to trading (mostly in Snork Maiden's accounts), asset loans is our rental deposit and car primarily, and borrowing includes margin loans, credit cards etc.

At the moment about 25 percentage points of the portfolio is in stocks within the "beta" category and 43 percentage points are in bonds. When we reach what looks like a bottom in the stock market to me, I plan to switch out of all the bond-heavy funds into stock beta investments. We'll do this by investing in CREF's Global Equities Fund (instead of their Bond Market Fund) and investing in Colonial First State's Geared Share Fund (rather than their Conservative Fund). We'll also shift some of our holdings of the Conservative Fund into CFS's Future Leaders, Developing Companies, and Imputation Funds.

For those who've questioned my judgment that the market is close to a bottom, I'm not planning on buying US stocks in a big way. I will also add individual US stocks in a small way as I did around the 22 January bottom. On the buying list are: IBKR, XLF, BWLD, SSRX, RICK, GOOG, PBD and maybe SHLD, AAPL, and NCT.

I plan on maintaining this same rough allocation between passive alpha and beta, but the beta funds will include a large chunk of a leveraged fund - the Geared Share Fund (geared = leveraged in Australian lingo). In the longer term I plan on having a portfolio beta of about one with a big chunk of passive alpha investments. The goal would be to achieve 10% returns from the stockmarket beta in the long-term and hopefully 10% or so of alpha for a 20% total return. If you use leverage, you can be fully exposed to the stockmarket while also trying other strategies. A simple version of this is the increasingly popular 130/30 funds. A much more sophisticated approach is followed by Bridgewater Associates. What I am attempting is somewhere in between.

SPX Elliott Wave Interpretation

Obviously this interpretation is somewhat subjective but it's not based on looking at this chart alone. If this is right we should see some upside in the next few days followed by more downside. The ultimate bottom would be still 3-4 weeks off. I don't think it will be a lot lower than the wave 3 lows. E-Wave suggests the lowest it will go is about 1225-1230. If that is exceeded we need a whole new wave count.

There is a risk of missing the bottom here. I've posted a lot of bullish stuff recently. But I think I will wait till the next bottom on the weekly chart before taking on a lot more risk.

Realised Gains

As promised, I computed realised trading gains for the last two years:



I could take this back further - the data is coming out of the spreadsheets I use to prepare my tax returns. This data does not include retirement accounts. Going forward, this will be the measure of trading performance. The basic story is that at the beginning of 2006 I quickly built up $10k in profits and then promptly blew it up in June. I rebuilt it again in the next three months blew some up that Autumn, rebuilt and then held onto my securities gains during 2007. In late 2006 I started trading futures. Built up about $9k in profits by the end of June. Then proceeded to blow most of it up in the last seven months. The mean monthly gain over this period has been only $540 and the t-statistic that tests whether that is significantly different to zero is only 0.77. At the end of June I was looking at an average of $1165 and a t-statistic of 1.20. So I was fairly optimistic that my trading was heading in the right direction when I decided to move to Australia.

The challenge is to get things heading back in a good direction in the next few months.

Allco Equity Partners

Allco Equity Partners (AEP.AX) stock price has tumbled to yesterday's $A2.23 (The IPO price was $A6.00!). The most obvious reason for this is their investment in 204.4 million shares of IBA. The share price of IBA has fallen from 92 Australian cents on December 13th to 62 AU cents yesterday. A loss of AUD 61 million to AEP. But in the same period, AEP's market capitalization has fallen by AUD 133 million. On top of this it was already selling at a discount to net asset value. I suppose the price has been pushed down this far due to the negativity surrounding its parent Allco Finance Group (AFG.AX). But AEP has no borrowings and there is no reason for it to collapse even if its manager AFG went out of business. This is one stock I plan to add to in the near future. I sold half my position at $A3.96 on 31st October. In retrospect, I should have sold the lot :)

W-2 Arrived

My W-2 arrived today all the way from the US (together with statements from Ameritrade and HSBC). So soon I can do my US taxes. My records should be good enough to fill in the investment side of things - given the IRS doesn't have any record of my investments and transactions in Australia, accuracy down to the penny is not necessary. Hopefully, this will be my last US tax return. As I was only a temporary resident in the US on an H1-B visa I now revert to a non-resident alien. Taxes are deducted at source on my dividends and I don't need to pay capital gains tax or tax on interest in the US. If I had gotten a green card I'd have had to submit US tax returns and be subject to full resident US taxation until I fell out of permanent resident status. Which is why I didn't go ahead and complete the green card process.

I'll also do Snork Maiden's taxes. Her W-2 arrived at her former office in the US. It should be forwarded to us soon. The Australian tax year ends 30th June and taxes are due sometime in October. So we'll have this fun all over again later this year :)

January 2008 Report

All figures are in US Dollars (USD) unless otherwise stated. This month again saw falls in net worth due to negative investment performance, though our performance was not as bad as the market.

Income and Expenditure



Expenditure was $3,970 - exceptional expenses included expenses on the upcoming wedding - core expenditure was $3,323. This included $231 of implicit car expenses - depreciation and interest. Our core expenditure has been remarkably consistent over the last three months.

Non-investment earnings ($3,598) mainly consisted of Snork Maiden's salary. Her previous employer finally stopped paying her. Snork Maiden's retirement contributions from her employer were $872 - there were three contributions this month for some reason (but only two salary payments!).

Non-retirement accounts lost $11,713 with the rise in the Australian Dollar offsetting $3,739 of what would otherwise have been a loss of $15,452. Retirement accounts lost $405 but would have lost $2,938 without the change in exchange rates. This difference is due to the strong exposure to bonds in our retirement accounts and the stronger exposure to equities in our non-retirement accounts. Trading contributed $577 in my Roth IRA account and $82 to the non-retirement result.

Net Worth Performance
Net worth fell by $US10,905 to $US437,702 and in Australian Dollars fell $A23,167 to $A488,125. Non-retirement accounts were at $US225k. Retirement accounts were at $US213k. So we made negative progress on our first and third annual goals.

Investment Performance

Investment return in US Dollars was -2.70% vs. a 8.17% loss in the MSCI (Gross) World Index, which I use as my overall benchmark and a 6.00% loss in the S&P 500 total return index. Non-retirement accounts lost 4.94%. Returns in Australian Dollars terms were -4.64% and -6.98% respectively. In currency neutral terms the portfolio lost 4.10%.

The contributions of the different investments and trades are as follows:



The returns on all the individual investments are net of foreign exchange movements. Foreign currency gains appear at the bottom of the table together with the sum of all other investment income and expenses - mainly net interest. This month most of the most negative numbers are unlisted and listed Australian funds, while most of the best gains are from short-term trades or new positions.

Progress on Trading Goals

Asset Allocation
Using the simple method of adding up the betas of each individual investment weighted by their portfolio allocation, at the end of the month the portfolio had an estimated beta of 0.58. Using a regression on the last 36 months of returns gives a beta of 0.75 to the MSCI or 0.65 to the SPX. Alphas are 0.52% and 4.65% respectively. A more sophisticated time series method yields a beta of 0.65 and alpha of 10.1% for the MSCI index. There is less difference in the estimate of beta this month between the different methods. This maybe suggests that the Australian Dollar was less correlated with the stock market this month.

Allocation was 34% in "passive alpha", 68% in "beta", 2% allocated to trading, 8% to industrial stocks, 5% to liquidity, 3% to other assets (including our car which is equal to 2.9% of net worth) and we were borrowing 20%. Our currency exposures were roughly 59% Australian Dollar, 31% US Dollar, and 10% Other (mainly global equity funds).

Summary
At the end of the first month of the year we are on track to achieve two out of our five goals (2: Positive Alpha and 4: Gain in Ameritrade/IB Accounts).

Retest Underway

A new downtrend has started in the stockmarket that will test the low established in the week of 21st January. It is likely that at this coming low I will go massively long, unless indicators are telling me otherwise. My moves, up till now, have been very small in comparison. Take a look at the chart of GOOG - there are a nice 5 waves down since the beginning of 2008. The NDX now appears to be catching up in a 5th wave down. From an Elliott-Wave perspective, it's likely that the move from July to August 2007 is a three-wave wave A. We then have wave B from August to early November and since then wave C; with us now in the final wave 5 of C. We can apply the same interpretation to the SPX, except that wave C already got underway in October. The entire formation is an expanded flat. I long suspected that something like this was occurring since July, but didn't know how big each wave would be. Of course I could still be wrong, I don't use E-Wave as a primary method of predicting the market but just one way of putting what is happening into a framework.

My bigger picture is that this move is just wave 4 since the 2002 low and not a major bear market. Expect a bigger correction heading into the four year cycle low in 2010. But expect a bull market before that. Expect most people to be wrong.

The only move I made was buying some XHB puts yesterday. I'm not in a daring mood.

January Trading Results

Results for January are mixed but not bad. Any way I want to measure things I beat the market massively. The MSCI All Country Gross Index was down 8.17% and the S&P 500 Total Return Index down 6.00%. I'm not sure of my overall portfolio returns yet but they were much better than that.

Computing trading returns somewhat arbitrarily, as I have been doing resulted in a $658 gain for the month. My three US trading accounts gained $735 (1.55%) and there is still $5980 to go till I reach breakeven across those three accounts, which is one of my annual goals. In future, I'm not going to break out a trading rate of return separately from my portfolio return as I've decided that the numbers get to be meaningless as I invest more of my cash for the long-term and trade with borrowed money. I'll report the overall portfolio returns, the gain in dollars on my three US accounts, maybe the percent return on my Interactive Brokers account (-8.37% this month) and my realised short-term gains for the month (-$1803).

Bottom line: I made progress on goal 4 (achieving breakeven) and continued to slip back on goal 5 (making money from trading). That is if you measure the latter goal in terms of realised short-term gains. Soon, I'll put together a realised gains series for the last couple of years to get a better picture of how I'm doing. Here is the net equity in my three US trading accounts:



This view shows that the slump since June 2007 is nowhere near as bad as the trading results I've been reporting show. In fact, at this point I am up slightly on that month and if we measure from the big loss in July 2007, I'm not doing bad at all. Especially, when compared to the market. What has been happening is the positions in these accounts that I have considered to be investments have done well, while my short-term trading has gone badly. This shows the importance of diversifying across different styles.

Dumped the Hedge

Too late, but hopefully it was the correct move. Market still seems to be rallying at this point. I should still have a positive trading month for a change at this point.

P.S.

Bad move - I panicked right at the top...


P.P.S.

Really bad move. One reason I abandoned the hedge was that my model stop would have been hit at that point. But the market ended down on the day so I lost... I was up $1600 or so for the month yesterday. Today I'm just short of $600. If I'm lucky I'll have a positive trading month. At the least I beat the market massively :)

I think I'm going to revise the way I compute trading results in future (and redo the results for the last year and a half so all the data is consistent. At the moment it is pretty arbitrary what I am considering as being in the trading results and what is in the investment results. The plan is to include all exchange listed positions held for less than a year in the trading results. That means that there will be revisions to trading results when positions end up being held for more than a year. But this will produce results (including realized and unrealized profit) that are consistent with my trading cash flow results. I'll report the results with and without net interest.

NNDS Releases Great Results

One of my recent investments, NDS, released great quarterly results. With a record of rapidly growing earnings and free cash flow close to stated earnings, I think this firm deserves a higher P/E ratio. This is the third quarter in a row that the company has beaten analysts' expectations substantially. Maybe they'll finally get it and bid the stock up. On the other hand, RBC recently upgraded the stock to a "top pick", which can't hurt :) The company is a subsidiary of News Corporation with around a quarter of the company owned by other investors (Yahoo's number are all wrong) that develops television related technologies.

Hedged

Today's moves:

01/28/2008 15:02:21
Sold 100 XLF @ 27.7801

01/28/2008 15:03:16
Sold 100 IBKR @ 33.18

01/28/2008 15:06:33
Sold Short 300 SPY @ 134.3101

My Ameritrade account is now fully hedged. It still looks like sideways action is in store so I haven't gotten to short. Today the stochastics rose despite the forecast that they'd fall. I'm not surprised by that. It was going to take a major fall in prices to push them down today and I didn't think that likely with everything I've been pointing out.

You'll notice I did a straight short of SPY rather than use an inverse ETF product. This saves me margin interest. I don't know why the inverse ETF's are so popular. Of course it would be cheaper to short an ES futures contract, but that is more hedging than I need and psychological I like to see the hedge in the same account as the stocks it is hedging. That is silly but a lot of what I and other traders do would be silly to a truly rational profit maximizing trader.

NASDAQ 100 / Russell 2000 Divergence and the CBI Indicator

Rob Hanna presents lots of interesting studies on his blog Quantifiable Edges. His latest analysis has highly bullish implications. His CBI - capitulative breadth indicator - indicator is also on a buy signal still. My Nikkei model switched to short today but at the moment I think these models are not very reliable - they are often getting stopped out.

U.S. Tax Rebate Calculator

I found a link to this tax rebate calculator on Boston Gal's blog. It calculates how much of a rebate you should get under the U.S. stimulus plan. Snork Maiden and I should each get $600 unless there is a clause preventing them mailing a check outside the United States.

Symbion Talks to Resume?

Talks between Primary Health Care (PRY.AX) and Healthscope (HSP.AX) are likely to start soon on what to do about Symbion (SYB.AX). I followed EnoughWealth's advice and didn't send in my acceptance of the Primary takeover offer when I realized how conditional the offer was and that the two companies were not allowed to talk till after Australia Day. Maybe this fiasco will be resolved soon.

Short Term Trends: Asia vs. America

Though my US (NDX and SPX) models switched to short at Friday's close, the Australian and Japanese models are still long with no possibility of a short for several days in all likelihood. My guess is that this divergence means global markets will go sideways this week. In fact it is easy to see that if the indices remain unchanged for the next week, Australia will shoot up into the overbought zone as defined by the daily stochastics, while in the US the stochastics will decline. This isn't based though on any historically similar period - I probably should look into finding examples. I'd still expect plenty of volatility this week. But if this happens it will be another strong point in favor of the bottom being in.

The Australian market is closed today for Australia Day (which commemorates the arrival of the first British settlers in Sydney in 1788). But I'll be following Japan and the US futures to see what happens.

Ten Year Low in Bullishness

Ten year low in bullishness. As you'll see these low levels of bullishness tend to be at market bottoms not tops. The contrarian approach fades the crowd and the crowd is bearish now. Investment newsletter writers are too.

Is Apple a Bargain?

After the recent fall in price of AAPL, which I suffered from (but only with a 25 share position - my initial position in any single industrial stock is roughly 1% of net worth), you might think that AAPL was overvalued and saw a fall back to reality or perhaps it still has a way to fall. After all AAPL has a trailing PE of 28 now at the current price and so it was much higher at the recent peak in prices. Analysts are forecasting growth of 22% next year and in the next five years.

However, the correct way to value a company is based on the discounted sum of future free cash flows - cash earnings minus the investments required to maintain and grow earnings at the forecasted pace. If you need to reinvest earnings in order to grow them then you can't as an owner spend those earnings and they shouldn't count towards your valuation of the company. Only those earnings that could be paid out or used to buy back shares without jeopardizing the company's growth should be counted. When you dig into the cashflow statement of many companies you quickly find that the net free cash flow is close to zero or at least much lower than earnings. Take SBUX for example. Operating cash flow in the most recent year was $1.3billion but capital expenditures were close to $1.1billion. The difference - free cash flow was around one third of the $672million earnings number. This is why I won't buy Starbucks as an investment.



But as the table above shows, for AAPL, operating cash flow in the most recent year was $5.47billion and capital expenditures were only $735million. The $4.735billion in free cash flow exceeded the $3.496billion in stated earnings. AAPL is currently valued at 24 times that free cash flow. I wouldn't say that was a bargain, but for a growing firm it is not bad. It is a lot better than a whole lot of other growing tech companies out there. Some analysts play further games with AAPL's earnings by taking out the huge cash stash the company has ($21 per share) from the share price and generating a lower P/E on the remaining earnings. You couId do this with free cash flow too, I guess, though this always seems a convoluted justification for a high share price to me.

BTW don't worry about the "investments" in the investing cash flow section. These are just "short-term investments" if you look at changes in the balance sheet. Apple hardly does any acquisitions so these aren't an important factor in doing a cash flow analysis.

Please criticize this analysis. Maybe I'm completely offbase?

Recession and the Stock Market

According to the NBER the 1990 U.S. recession lasted from July 1990 to March 1991. This is what the U.S. stockmarket did during this period:



The decline in the market began, just when the NBER later claimed the recession had begun - July 1990. The market bottomed in September and October, falling from 369 points to 295 points. 295 is 79.9% of 369. The market went sideways for the year before the decline.

Now after going sideways for a year the market began to decline in October and bottomed so far in January:



The decline is from 1576 to 1270. 1270 is 80.6% of 1576.

I am not using this example to say that the market has bottomed, just that if this is a regular recession the market could have already bottomed. There are lots of doomsday scenarios for the stockmarket out there from the likes of Robert Prechter or Glenn Neely. Those guys could be right but given that valuations are not extreme as they were in 2000 and interest rates very low a much smaller correction of this sort is entirely possible (I'd say likely, but let's wait and see).

Why go back to the 1990 recession rather than 2001? Any recession signal in 2001 was embedded in the bursting of the NASDAQ bubble. I don't believe that the complete decline was due to the upcoming recession, but rather due to the extreme bubble valuations reached in 2000.

It will be interesting if the NBER will eventually decide that the recession started in October.

Stimulus

Not only does a large part of the stimulus package go to groups who are unlikely to spend it, but by the time they send out the checks any recession would be half over. The idea of sending rebate checks is to bring things forward from the time when people file their tax returns for 2008 in 2009. But here are two quicker methods of getting a fiscal stimulus out there:

1. Allow reduced with-holding of taxes from wages in anticipation of a tax rebate. Workers would instantly get a rise in take home pay.

2. If you have a national sales or value added tax you can slash the rate immediately reducing prices and increasing sales (supply curve moves to the right). The US doesn't have this option of course except for some federal taxes like that on gasoline.

Any problems with these policies?

Market Update

I should explain that what I've been trying to do the last several days is position myself in some longer term investments while trying to use trading tools to get good entries. If the market looks like turning down again I'm going to take defensive action and then try another shot at entry at the next low. Friday, US markets spiked higher and then fell back. About the time the opening gap closed and with things not looking like a real recovery was going to get underway I dumped half of my positions in IBKR, RICK, XLF, and BWLD. Today's action has brought forward the model's turning point and in fact it said to get short at today's close. This doesn't mean that Monday can't be an up day but you shouldn't count on it. I wasn't prepared for this and couldn't do anything more before the close - I will attempt to do so on Monday. I'm still up on trading for the month but gave back about half the gain today. My thinking - this is more speculative based on chart reading is that the next low defined by the 5 day stochs will be a higher low. This could be the point for really going long investmentwise if that low is higher and looks like holding.

The SPX weekly chart shows a tentative crossing of the stochastics:



The weekly candle is a doji. All in all a very indecisive read. Anyway, my research shows that weekly stochastics aren't very predictive of anything by comparison with daily ones. Something very interesting is that the McClellan Oscillator rose despite the negative index action:



The NYSE one fell but remained in positive territory. This is a somewhat bullish sign. At the 2002 bear market bottom, the McClellan Summation made a higher low:



Is it possible that the Summation is doing the same thing here?



The NASDAQ summation made a higher low in October 2002, but not now. This time it's at the lowest point in several years.

Update

We've bounced another $4k off the low point and are now only down $16k for the month. I've now made a profit of about $US750 in trading this month, which I hope I can hold onto. No trades for today but I've put a bunch of lowball bids in on Australian closed end funds to see if they get hit. Babcock and Brown (BNB.AX) bought a bunch of EBI.AX and EBB.AX which is a nice vote of confidence after the battering those two stocks have received. Interactive Brokers (IBKR) announced nice results but the stock sold off after hours. I didn't sell (maybe I'll regret this). Microsoft announced very nice numbers and soared AH and currently the NQ futures are up about 15 points. This also lifted AAPL a little AH. So the rally seems intact and my plan is still to hold till Tuesday's close and model depending sell a bunch of stuff and hedge then before the FOMC meeting.

Game Plan

Next Wednesday's FOMC meeting is one day beyond the forecast horizon of my model. At this stage the model is saying to be long till the close Monday or maybe Tuesday. Being long the FOMC meeting looks to be a high risk proposition. I am thinking to stay long through Tuesday and around Tuesday's close sell a lot of my shorter term trades and hedge the rest of my portfolio with SKF. So I would go into the FOMC meeting with a market neutral portfolio that could outperform if the Fed doesn't cut rates. After this week's emergency 0.75% rate cut it's hard to imagine them cutting again, and yet market participants seem to believe that. I'll also go into IBKR's earnings release Thursday afterhours US time long 200 IBKR. I'll probably sell half my position then either way, good or bad. It worked last time.

At this point we've bounced around $US20k off the bottom.

Boulder Total Return Fund

Is today's purchase. I used up the spare cash in my Roth IRA. I had been trying to trade that cash but the amount is small and it's a hassle. I classify this stock as a stock in the passive alpha category. The yield on this closed end fund is way higher than stated on Yahoo. Six times higher. At least that's what the fund says. 30% of the fund's net assets are in invested in Berkshire Hathaway. The fund also has quite a lot of financials, which may stage a bounceback here. I'll report in more detail on my other recent purchases soon.

Wednesday in the US was a crazy day in the markets. Despite the big fall in Apple Computer (and also a mysterious fall in NDS) we ended the trading day significantly up. Probably around breakeven for trading this month so far. The model is long for the next few days. Up till the FOMC meeting. Selling before the FOMC is looking like a good tactic at the moment.

Shift in Allocation

Things don't look as bad today as yesterday. At this point I've shifted 10% of the portfolio into stocks as well as a little into private equity, since the close of last month and increased beta by 0.14 points:



* Note: Private equity, hedge funds, and real estate are all mutual funds or listed stocks with the characteristics of those asset classes.

This has been achieved by reducing cash and increasing borrowing rather than selling other assets. I'll sell a little on a bounce in the market or if the bounce doesn't materialize. Only when the lows are successfully retested will I get really aggressive and start selling stuff to increase stock exposure.

After Hours Stock Trading is Dangerous

My stop order on AAPL didn't work. I then tried to sell and nothing happened. This was with IB. This is too dangerous. I doubt I try that again. I certainly won't on IB. AAPL price is rebounding now. At least I only have 25 shares! Perhaps, even more to the point there is no edge in going long into earnings. It's better to try to trade the number using a stop triggered by the price action after the announcement if anything. I'll probably hold until the next NDX model peak.

P.S.

I realize what I did wrong now. My mistake. Very stupid beginner's mistake. Anyway, trading after hours is still dangerous.

Bought LTR, FF, and BWLD

Was thinking about SHLD but decided against it. Short-term (at least) mistake. Thought about the bounce spread trade - long XLY and XLF and short XLE and XLV. But didn't like the idea of shorting energy at this point (when it was already down 4% on the day). So that one is on hold still. Overall added about 3% of net worth to my stock holdings (borrowing on margin). Nothing radical.

P.S. 3:44pm New York Time (EST)

I added trades of 200 XLF and 100 IBKR.

Strong Weak Sector Pair Trade

An interesting idea - one could do this with sector SPDR's.

Net Worth and Portfolio Update

Our net worth is down around $US39k (AUD 36k) month to date. The portfolio has lost 9.7% in USD terms or 7.8% in AUD terms. On the other hand, I estimate that the S&P 500 is down 13.9% (including the 61 points the futures are down currently) and the MSCI down 16.7% (If world markets fell 5% on average today). Percentwise, I've had worse months:

Sep-02 -18.21%
Sep-01 -15.56%
Aug-98 -13.61%
Jul-02 -13.13%
Jun-02 -11.94%
Feb-01 -10.05%

But they're all from the great millennial bear market and the 1998 correction. In dollar terms (rather than percentages) this is the worst, but in mid-August 2007 we were down more.

Focusing My Effort

Trading SPI (Australian futures) and the Nikkei futures under simulation today. Again, I make money trading the Aussie index but can't seem to get a foothold or handgrip on Japan. Maybe I should focus on practicing SPI trades going forward. I was interested in Japan because the contract size is very small. But if I have to use very wide stops it might not be such an advantage. I think I am going to be practicing for a while yet.

Markets are in "crash mode" around the world. Of course, I now regret buying AAPL and maybe some of my other recent investment purchases. But in total I didn't move that high a percent of net worth into stocks over the last couple of weeks because I knew something like this might happen. My hedge fund stuff is getting hammered alongside my regular equities. The only good thing is we have more than 40% of our portfolio in bonds still. And they are going up.

It's interesting that the S&P 500 started its descent from around the same level as the 2000 high and now the Dow Jones futures are roughly around the level of the 2000 high in the Dow. It'd be nice if those two points would bracket the correction. I won't do anything very radical in terms of buying until any low is retested successfully. By the way, the Australian All Ordinaries Index is now officially in a bear market.

Tried to Trade the Nikkei with Real Money

Did two trades. Both lost. I think I was overenthusiastic to put the trades on despite not very strong signals. Luckily I used stops properly. So I was disciplined at that end of the trade. Back to simulation mode.

Solution to the Trading Puzzle

A week ago I put up a "Trading Puzzle" on the blog, asking what simple strategies resulted in the blue and green equity curves. Today, I reveal the answer. I'm disappointed I didn't get any comments, as I know a lot of people looked at this post. OK, so the blue line is what happens with a stop loss order set at a 1.25% daily decline in the index. In other words, you stay long unless the index is down 1.25% on the day. When a 1.25% down move is hit you get out of the market till the next day. The green strategy is the same except that instead of getting out of the market you get short once the market is down 1.25% on the day. It's amazing how much difference this simple strategy that involves no attempt to predict market direction made this year. Stops can be important.

Investment Returns in the Millennial Decade

The source of this table is this week's edition of Barron's, which I subscribe to. US stocks have not been a good investment so far this decade. Of course if you dollar cost average in you would have bought quite a lot at lower prices in 2001-2004. even better if you'd tried to time the market any time in 2002. Dollar cost averaging the SPX over this period returned 3.81% by my calculation. The MSCI World Index (All Country Gross) returned 4.18% p.a. So foreign stocks weren't that spectacular either. Moom's return over this period BTW was 7.2% per year. As "The Fly" would say: "Odd, no?" :)

Leucadia National

I bought some shares in Leucadia National, which has long been on my watchlist. Essentially it is a listed private equity firm. They should find some good opportunities in current market and economic conditions. I'm classifying this as a "passive alpha" investment in the asset class "private equity".

Should I Go to Live Daytrading?

My last two weeks of simulated trading have gone very well. I'm trading in a disciplined and profitable fashion. Here are the results of my trading of the Australian Share Price Index Futures over this period (all amounts in Australian Dollars):



A movement of one point on the index results in a gain or loss of $A25. Commissions are $A5 each way. As you can see though I am profitable I'm only gaining a few points of movement a day. If I was prepared to give trades more leeway I could capture a lot more points. As the following statistics show I am averaging about $A250 a day, which is pretty much my medium term income objective:



But there is the potential to make much more. Mostly also I only made trades in the morning while some big moves happened in the afternoon. The trades also average out over each day, so that I only had one losing day and then only lost $A20. On average I made $A80 per contract or about 3.5 points. The z-score (t-statistic) for individual trades, which tests whether they are significantly different from zero is 2.21 and for daily totals 3.42. In both cases, based on the sample, the probability that the results are random is very low. I won about 3/4 of trades but am still seeing the average loss on losing trades being greater than average gain on winning trades.

This chart shows my "equity curve":



My Nikkei trading over this period has been even more successful, though it made far fewer virtual dollars. So what is the problem? This chart of all my simulated SPI trades shows what the issue is:



The first trade on this chart was made on 10th December. Things went well until two days of bad losses around the turn of the year. What happened then? I lost control, pulled stops and traded two contracts at once. In other words I blew up. The sample since then is relatively small. How do I know that I will retain my discipline with real money and not blow up again? The z-scores for the entire period shown on the chart are around 1.30 which leaves a moderate probability that the results are purely random.

You're probably wondering what the red line is. That's what the equity curve would look like if I had honoured the stops and not traded an extra contract.

AAPL Trade

Doing a small long AAPL trade. Price should rise into options expiry in theory after being beaten down - traders redeeming ITM put options push the price up as put writers cover their hedging short positions. And next Tuesday is Apple's earnings release.

First European Stock Investment

I bought 40 shares of Bekaert - a Belgian firm that mainly focuses on steel wire products (including tyre wires) as well as some high tech materials and coatings. They also have a research lab in China. The firm is 40% family owned and pays a decent dividend. An online acquaintance said he was investing and I think he is worth following on this. Yes I bought the shares on the Belgian Stock Exchange. With Interactive Brokers this is fairly straightforward. I just asked online for permission to trade Belgium which was instantly granted. I then placed the order in the usual way. Interactive Brokers then extended me a loan in Euros to cover the purchase. I didn't bother paying for Euronext data. You can trade an exchange without paying for the data through IB. Yahoo provide the data with a fifteen minute lag, which is good enough for long-term investing. If you are interested in European stocks the Yahoo UK site has far more information than the US finance site. I don't know why they can't link this info through to the US site. After all the UK site knew which stocks I'd most recently requested quotes for on the US Yahoo Finance site!

New Private Equity Investment

Yup, another new investment. ING Private Equity Access. I heard about this one from Enough Wealth. He sold 20,000 shares and still holds 80,000. I bought 6000. The stock is a fund of private equity funds. I am also invested in Allco Equity Partners, which is a single fund, though with its recent large investment in IBA it has more money in publicly listed stocks than private equity. My main reason for investing in IPE is that it is selling way below the book value of its investments. At some point hedge funds and private equity will no longer be the pariahs they've become since August and the price to book ratio should rise. I have more private equity investments on my watchlist. I only have 2.3% of my portfolio invested in these two stocks.

The larger question is whether the stockmarket is bottoming here?



Looking at the chart you can see three very similar candles at the end of the current move down and the previous two major moves down. On the other hand, the stochastics do not appear to be bottoming here. The model allows for up to 2 or so days of downside from here. The weekly chart has reached the lower Bollinger Band in a similar way to the 2006 and 2007 lows. However, in 2007 the market declined considerably after bouncing from the BB. There's not yet any good sign of a bottom in the McClellan Summation on a weekly chart. The same goes for the bullish percentage. So I am very cautiously adding these new investments here, putting 1% or less of the portfolio into each. I'm not doing anything radical yet.

New Investments

PeopleSupport and NDS. PeopleSupport is a takeover play. There is an offer for $17 on the table and it could be raised... maybe. The company's business is offshore outsourcing of services. I've owned NDS before, it's been beaten down in the recent market correction and seemed like a good point to buy in again. The company is majority owned by News Corporation and is in television technologies.

No Takers for the Trading Puzzle?

So far no-one has commented on the trading puzzle. The strategies are very simple. At the end of the week I will reveal all, whether I have any responses or not. I the meantime, my simulated trading of the Australian Share Price Index is going well and I am feeling more and more confident that maybe I really could do this. I will wait though till I have statistically significant results before going live. I am using very tight stops. The stops really define the risk/reward ratio and the size of the contract (near $A150,000) becomes less important. At the moment I am only getting a fraction of the return possible on a single contract because I am getting out of trades very fast. If I gave each trade more leeway I would have higher returns but also higher volatility or risk. I've averaged $A150 per day so far but recent days are much better than that. I'm also beginning to have some success trading mini-NIkkei contracts.

How Much Does it Cost to Get Married?

You hear a lot about $30k plus weddings. Our wedding will be small and simple. Having few guests obviously reduces costs. That's not on purpose, but our friends and family are scattered across the world. My mother and brother will be the only two coming from overseas, or out of town for that matter. Here is a rundown of our expected costs at this point:

Celebrant's Fees: $A400 - this includes filing our marriage registration etc.

Location: A mountainside in a nature reserve overlooking the city - free. If in the unlikely event that it rains that morning (most rain is in afternoon thunderstorms at this time of year) we will go to the restaurant where we are having lunch to hold the ceremony (again for free).

Snork Maiden's dress: RMB 3000 or so. Yes, made in China but not cheap :)

New shirt for Moom: $A45 - otherwise Moom will wear existing clothes.

Ring for Moom: We were quoted between $A400 and $A700 for an 18ct white gold V size (British ring size) comfort fit 4mm plain wedding ring. We now plan to pay $US250 for one from Blue Nile delivered to a friend in the US and then sent to us here.

Ring for Snork Maiden: Prices for a 3mm platinum comfort fit J size ring ranged from $A800 to $A1400. Blue Nile want $US465 for a 2.5mm ring that seems hard to order in Australia. BTW she doesn't have an engagement ring. But neither does my sister-in-law. My brother doesn't have a wedding ring. Fedex will charge $US72 to ship both rings to us in Australia from the friend in the US.

Photographer: $A260 for two hours of time with a CD of photos costing an extra $A300-500. Albums or prints would be for another price. Another photographer told us the minimum package was $A1480.

"Reception": Actually, lunch at a vegetarian Chinese restaurant. Probably around $A35 per person. We aren't sure on numbers yet but could be from 10 to 15. We spent $A100 on "research meals" to decide where to go :) Also plenty of petrol driving around checking out locations and restaurants, meeting the celebrant and photographer. Could be 200km? About $A40 of petrol. Probably throw in $A100 or so for some decent wine/champagne from a liquor store across the street at the lunch.

Hair - Snork Maiden said - "you have to get your hair cut anyway". At this point, she doesn't feel like getting special hairdressing or makeup for the wedding.

Flowers: Snork Maiden said: "Put $A100 for now".

So the grand total is: $US2865

This isn't counting the cost of my mother and brother getting here or staying here which will be a multiple of this. We are also going to Sydney for a week after the wedding (Snork Maiden hasn't been there yet, apart from the airport :)) and I'm not including that. Probably; late in the year we will travel to China, but that's a whole other story.

Trading Puzzle

The red in the chart is the NASDAQ 100 index. The blue and green are two simple trading strategies. The blue strategy has a beta of 0.84 to the index and annual alpha of 11.4%. The green strategy has beta of 0.69 and alpha of 24.0%.

What are the two strategies?

What is My Trading Niche?

I can't handle overnight trading. At least not any time soon. It makes me way to anxious. Wanting to stay up all night watching the US market. And then making bad decisions when I am tired. This morning I had the debacle of the stop order I forgot about. Now this afternoon I ended up selling out of the Australian market at the low point of the day (so far). I had the wrong type of warrant. These are so called "barrier warrants" that are delisted if the index hits the exercise price. They trade similarly to futures with a hard stop at the exercise price. But the price even a few points above the barrier is more than would be implied by the simple points difference between the current price and the barrier. The index fell to a a few points above 6000 and so I sold the warrant. Of course the index never got quite to 6000. It did go as low as 6000.2. And then it rebounded. So I sold at the worst possible point. I should have had a regular option style warrant or one deeper in the money. All the regular warrants are out of the money. The reason we even got near 6000 without me selling earlier is because I was in "swing trading mode" with the model set stop of a 1.25% loss. Last night I stayed up till after 4am watching the US market because I was anxious about the market. I can't go on like this. I know logically that the model in the long run makes money but I can't handle the short-term fluctuations unless I am staring at the screen. With daytrading, you can choose when you want to trade and when you are not trading just ignore the market (except maybe thinking about the opportunities you are missing). Maybe after daytrading for a while I can get back to swing or overnight trading, if I can build up some profits first. So next week I will be back to papertrading SPI and Nikkei daytrading and maybe again doing some real US trading either in the evening or early morning (no overnight Australian time position). I'll hold my positions in US stocks and options until the model says to sell them. I do seem to be able to handle those mentally for some reason.

I can use the model to decide on whether to look for long or short trades, but not be too wedded to it. I thought that econometrics based modeling is where I could have an edge in trading, but my psychology, at least at the moment, doesn't seem to be able to handle it.

P.S.

I was stopped out of my Nikkei trade too. Oh well. I have some ideas about what to do with the model along the lines some commenters have occasionally made. Sorry to be cryptic. But for now I am a daytrader (as well as an investor).

Dumb Tricks with Order Entry

I woke up this morning to find I had a short position in the NASDAQ futures I didn't know about! Unfortunately, the market was up. I closed the position for a $460 loss wiping out most of the profit on my Interactive Brokers account for the week.

How did this happen? I must have left in place a stop order I forgot about without a matched actual position when I went to bed. This is easy to do on the IB platform. My new enthusiasm for stop orders turned around and bit me :) I'm not used to having them in place so didn't pay attention when I logged out of my account. Oh well, I'm still up in trading for the month.

My other dumb trick was going long instead of short earlier in the session. This happens, but it is careless. My real mistake was not immediately reversing the trade. Instead I started justifying why a long would be better. I knew this was a bad thing to do and it was. In the end the market let me get out at a profit once Bernanke started speaking. But I wasted a bunch of time I could have been sleeping up till that point.

Jumping the Gun

I jumped the gun and went long the Nikkei and Australian Index before their models formally signalled to do so. I guess I was overenthusiastic to start trading them and was used to when I didn't have models for these indices and relied on the US models for direction. The US models were long already. The two Asian models are long at today's close. I obviously still need to improve my discipline!

My restaurant stock post has proven popular (according to Google Analytics). I kind of jumped the gun there on Chipotle Mexican Grill :) On a weekly chart it still doesn't look so bad. But the daily looks pretty horrendous. Until yesterday that is. I thought of doing a trade on it yesterday but had second thoughts, which was good as I was still too early to go long.

Annual Report: Asset Allocation

The table shows our asset allocation at the account and security level at the end of 2007 (before my recent flurry of trades). The split by currency is not perfect - for example the CFS Conservative Fund has foreign (to Australia) investments while Platinum Capital is partially hedged into Australian Dollars. "Passive Alpha" investments obviously have plenty of correlation with the market (I call them "passive alpha" to distinguish them from my own active trading). I include in this category all financial stocks and funds whose performance would be expected to contain significant sources of return which aren't pure stockmarket beta. This includes a fund of hedge funds (EBI), hedgefund like funds (Hussman, TFS, Platinum Capital), real estate funds (Challenger, TIAA, Newcastle), and private equity (Allco). The Clime fund (CAM.AX) is a long-only closed end fund but deliberately does not track market benchmarks and is very focused. My rationale for counting a stock like Interactive Brokers (IBKR) as alpha is that the majority of their income comes from market-making. If this isn't a source of alpha in the financial markets, I don't know what is. There are also fund management companies (Clime and EBB), a bank (HCBK), and insurance companies (Berkshire and Safety). Beta investments are more traditional mutual funds, which can be pure stock plays or diversified or even bonds, which have less stock market beta. We only had one trading position at the end of 2007 - Beazer (a homebuilder) put options. It was doing OK. I only have two non-financial stocks listed under "industrial stocks" - Symbion and FTS. I don't believe that I have an edge in picking individual stocks so I don't do much of it. But investing in a bank stock, for example, is a way of indirectly getting exposure to a financial asset class (loans) that is hard to invest in otherwise. All the other categories of accounts either support our lifestyle or investing (margin loans). By using margin loans we are 98% invested in long-term investments as well as having 6% allocated to trading, while having liquidity for everyday life.

The table doesn't split things down by retirement and non-retirement accounts. 47% of the total is in retirement accounts.

In retrospect, I have been too conservative in my beta investments in the last couple of years, though now it is beginning to pay off to some degree. On the other hand, my passive alpha investments, which had been doing well, took a distinct turn for the worse from the August "quant crisis" onwards. I plan to get more aggressive in my beta investments once there are some clearer signs of a bottom in the stockmarket. I'll also be adding new passive alpha investments and aiming over time to reduce the percentage allocation to Australian Dollars.

Thursday Trading Update

The NASDAQ didn't disappoint.

So I sold my remaining BZH put, bought 100 NCT and 1000 SPI (Australian Index) call warrants. This is my trading position now:

1 Nikkei Mini Future
1000 SPI 6000 Mar Call Warrants
2 QQQQ Jan 44 Calls
100 NCT
200 RICK
100 IBKR
100 SBUX

It adds about 0.14 beta to my portfolio. So hardly very aggressive.

The US models are long, the Asian models are on the cusp of going long.

I also bought back the BRK/B share I sold a little while ago (now have two again). But that's accounted for as an investment not a trade.

Another Trading Update

Just bought my first Nikkei Futures contract - a mini contract that is worth $13,000 or so. This is a model based trade, which I'll hold till either stopped out or the model changes direction. This is the smallest futures contract I can trade. I feel I am understanding my model better in the last few days since I integrated together the three separate programs and I am pleased with my recent SPI daytrading in terms of discipline. So I'll continue to trade the model as I started yesterday. I now have the flexibility to put model-based trades on in either US, Australian, or Japanese markets. Going forward I am likely to diversify across these to reduce risk further. Currently, the US indices are long, the Australian is still short for probably the next day, and the Nikkei is on the cusp of long or short. It's a borderline case. I might buy some FXI later too.

According to Bespoke Investment the NASDAQ index has gone up on the ninth day all eight times that there have been eight consecutive down days in the last twenty four years. Eight isn't a big sample of course, but eight in a row is interesting. Will the streak be broken. The model is pointing up. But it was pointing up yesterday too.

Using the Model to Trade Australian Warrants?

I've been papertrading the Australian Stock Index Futures and I think I am beginning to get the hang of it. This is daytrading. The contract is very big - more than $A150k and I wouldn't be happy trading it overnight any time soon I think. So now I have a model for the Australian market I started looking for an instrument to trade it. My first thought was individual large cap Australian stocks such as Commonwealth Bank, Woolworths, and AMP. I have done this before but it is too expensive.

The next obvious idea is to trade an ETF - STW - which tracks the SP/ASX 200 Index. To trade $A60,000 it would cost me $82 in fees each way in my margin account plus margin interest. The average model trade yields around 1% - so this is a big chunk of the expected $A600 profit. This amount by the way is roughly the value of an ASX SPI Mini Contract which is 2/5 the size of the full size contract. Unfortunately IB doesn't allow trading of this contract.

As is often the case in Australia, the solution is to go to the options or warrants (investment bank issued options that trade like stocks) markets. I would look for an in the money warrant that has little time premium to get as close as possible to trading a futures contract. Trading $A60k of underlying stock would involve a premium of $A3-4k. I would plan to trade this in an old non-margin account I have at Commonwealth Securities, which is linked to my Adelaide Bank CMT (money market fund). For trades under $A10k the fees ($29.95 each way) are the same as in my margin account but I avoid paying a little interest (the difference between the margin and savings rates). I've set up my trading screen there with the relevant warrant codes.

I'll let you know if and when I do this for real. If I do, I'll include this Australian account in my monthly trading statistics.

Trade Update

I sold half the SBUX position to take some profits and got stopped out of the QQQQ position. Before I went to bed I moved my stop up from $47.60 (as set by the model) to $48.15 - just below the low at that point for the day. It's good I did. The NASDAQ Composite is down around 50 points at the moment. The SBUX and BZH positions are up on the day but the others are all down now...

Cramer Revisionism

Cramer's revisionism. Cool video pastiche.

First Real Trade of 2008

The slow stochastics crossed over on NDX so the model is long at the close. My models have been doing very well recently. I now have four: NDX, SPX, Nikkei, and All Ordinaries. After integrating the three separate econometric models into one it's now easier to maintain models of more indices. Anyway, I sold one BZH put (I keep one) and bought 400 QQQQ, 200 RICK, 200 SBUX, and 100 IBKR. The idea is to put on a more diversified model based swing trade. For some reason also stock feel safer than futures. I also went long NQ in my papertrading - the short trade I closed would have made $3000. I'll continue paper trading Australian and Japanese futures too. Barron's recommended Starbucks at the weekend and I am also playing a bounce in the restaurant stocks idea. I shouldn't have sold all of my RICK and planned to buy back at the next low. So here it is. Same with IBKR. I'm accounting all of these as trades, though, rather than investments as I don't think this is the market bottom yet. I'm wary of Starbucks as an investment too. The stock looks cheap based on earnings and their growth rate. But those earnings are only growing through massive capital investment. As a result, SBUX's free cash flow is a fraction of earnings. And it is free cash flow rather than earnings that we should use to value stocks.

P.S.

I got a lucky break on this trade - right after the market close SBUX announced they are bringing back Schultz as CEO and undergoing a restructuring. The stock is up 8% last time I looked.

Annual Report: Income, Expenditure, and Net Worth Gain

Here are last year's number for comparison. Compared to last year we spent more than twice as much (even though we were only spending as a couple for the last 4 months of 2007) and did more saving in retirement accounts and less in non-retirement accounts.

Looking at 2007, we brought in $50,773 in after tax non-investment earnings not counting retirement contributions. We spent $55,582. So we spent $4,809 out of investment earnings. Expenditure was very high due to the last 4 months of the year being our expenditure as a couple and the move to Australia. Still we managed to keep about $17,000 of our investment income, which is more than twice as much as needed to compensate for inflation.* I also made $1,667 in contributions to my Roth IRA account which came out of after tax income. After taking this into account, our net gain in non-retirement accounts ** was $31,870. Reported net worth in these accounts increased $49,543 due to the addition of Snork Maiden's $17,672, which was merged into the accounts at the end of August.

Total retirement contributions were $16,244 including the Roth IRA contribution. Pre-tax earnings on the accounts were $10,635, taxes $1,002, and gains due to the rise in the Australian Dollar $15,263. These sum to a total of a $41,140 gain in retirement savings in US Dollar terms.

At first glance all these numbers look very healthy, both on their own and compared to last year. But expenditure is steeply up and I only expect it to be a little lower this year. And so much of the contribution to net worth growth came from the rise in the AUD which actually makes us poorer in Australian Dollar terms. That is unless we were to cash in our AUD gains, buy USD and the AUD would then fall back again. I'm not going to make a big bet like that but plan to continue to move towards having a smaller allocation to related investments. My next post will be the final part of this annual report, laying out our current asset allocation.

* I took away the tax credits from core investment income and then subtracted the spending from investment income to get this number. A quirk of my accounting is that investment income is shown pre-tax and other income is shown after tax. Other income is the sum of all after-tax non-investment income and net tax refunds. The tax credits on investment income include for example U.S. tax on dividends that is being deducted at source now that I live in Australia. I count the pre-tax dividend as investment income but as I don't receive the part that is deducted as tax I need to enter a line for tax credits in the accounts in order to find actual saving and net worth change.

** I don't call them "taxable accounts" as the earnings in Australian retirement accounts are taxed, though at a lower rate than regular income.

Annual Report: Investments and Trades

I've already reported on annual investment and trading cash flows and rates of return. Today, I break things down into how much was made or lost on each security, fund, future etc. I invested in or traded. It's all in this table, which is an annual version of the ones in my monthly reports.



Last year's results for comparison. Again, there are more investments towards the top of the table and trades towards the bottom of the table. As last year the largest amount of money was earned by the Colonial First State Conservative Fund and Option (option is the retirement version of the fund). But the second best investment last year - EBB and EBI - is the worst this year. Platinum Capital was also a good performer last year and a poor one this year. I made decent money trading US stock indices but lost on the Australian index. I made a really dumb trade in Salesforce.com. Last year, Newscorp and Hansen featured as dumb trades. Trades in Apple contributed nicely in both years (but I should have invested in Apple instead!). There are contributions from trades exploiting the housing-credit disaster - IYR, Toll Brothers. Lehman, and Beazer - all winners. My investment in HCBK and the TIAA Real Estate Fund worked out as plays on the best in real estate, while Newcastle Investments, decidedly did not work out.

Well all the rest is there for you to see in the table.

Move is Complete

Snork Maiden's stuff arrived today, finally, after quarantine delays. They found some insect in the container. Now our apartment looks like a mixture between a garage sale and the tomb of Tutankhamun.

I've found a way of integrating the three separate stochastic trading models I was running. So in future I will only have to run one model for each index which will make things easier. I'm still looking for the optimal way to use the output so that decisions could be of a black-box type with no skill involved.

December 2007 Report

All figures are in US Dollars (USD) unless otherwise stated. This month saw a fall in net worth in US Dollar terms partly due to the fall in the Australian Dollar and partly to poor investment performance due to the continuing decline in global stock markets this month. Both these trends were milder than last month. Net worth also decreased in Australian Dollars terms. Trading results were bad and I stopped active trading to focus on improving my trading performance using simulated trading.

Income and Expenditure



Expenditure was $3,547 - there were no exceptional expenses. There were $315 of implicit car expenses - depreciation and interest - so actual cash expenditure was $3,212.

Non-investment earnings ($5,924) included another refund of work-related expenses from Snork Maiden's employer. She also again got paid by her previous employer. We've told them to stop paying and we may need to pay this money back, but for the moment I am counting it as income. Snork Maiden's retirement contributions from her employer were $559.

Non-retirement accounts lost $6,052 with $1,414 of the loss resulting from the fall in the Australian Dollar. Retirement accounts lost $1,731 but would have lost only $405 if exchange rates had remained constant. This gain is due to the strong exposure to bonds in our retirement accounts and the stronger exposure to equities in our non-retirement accounts. Trading contributed around half the loss in the non-retirement accounts, but actually came out slightly positive in my Roth IRA.

Net Worth Performance
Net worth fell by $US4,759 to $US448,556 and in Australian Dollars fell $A1,161 to $A511,233. Non-retirement accounts were at $US237k. Retirement accounts were at $US211k.

Investment Performance



Investment return in US Dollars was -1.72% vs. a 1.08% loss in the MSCI (Gross) World Index, which I use as my overall benchmark and a 0.69% loss in the S&P 500 total return index. Non-retirement accounts lost 2.51%. Returns in Australian Dollars terms were -0.88% and -1.70% respectively. In currency neutral terms the portfolio lost 1.11%,. Summing up the year, we gained 18.35% (USD) vs the MSCI with 12.18% and the SPX with 5.5%. Our non-retirement accounts are up 21.68%. Australian Dollar returns were competitive with the SPX. In currency neutral terms we gain 9.8% for the year.



The contributions of the different investments and trades are as follows:



The returns on all the individual investments are net of foreign exchange movements. Foreign currency gains appear at the bottom of the table together with the sum of all other investment income and expenses - mainly net interest. Trading resulted in some of the biggest losses - QQQQ/NQ and ES. Otherwise, no clear story emerges this month except that EBB.AX and EBI.AX continue to perform poorly.

Progress on Trading Goal

I lost $2,003 in trading . The loss is 6.92% of trading capital. The NDX was down 0.2% for the month. For the year, trading generated $9,749 or a gain of 35% vs. an NDX gain of 18.4%. So in the end I beat the market, but with a lot more risk and volatility.

Asset Allocation
Using the simple method of adding up the betas of each individual investment weighted by their portfolio allocation, at the end of the month the portfolio had an estimated beta of 0.47. Using a regression on the last 36 months of returns gives a beta of 0.81 to the MSCI or 0.60 to the SPX. Alphas are 0.55% and 6.44% respectively. A more sophisticated time series method yields a beta of 0.97 and alpha of 7.6% for the MSCI index. The extra beta generated by these methods is due to the correlation between equity returns and the Australian Dollar in recent times as a result of the "carry trade".

Allocation was 29% in "passive alpha", 66% in "beta", 6% allocated to trading, 3% to industrial stocks, 7% to liquidity, 3% to other assets (including our car which is equal to 2.8% of net worth) and we were borrowing 14%. Our currency exposures were roughly 60% Australian Dollar, 30% US Dollar, and 10% Other (mainly global equity funds).

Stops: The Key to Success in Day Trading

I wanted to give this post a positive title. All experienced traders know that the key to being profitable is to set stop losses and use them. Even a system which generates random entries to the market could be profitable if the exit strategy is systematic. If you set and use appropriate stops you can be profitable. Beyond that it is all about increasing profitability and/or reducing variance. I emphasized day-trading here because my model that uses daily data can be profitable without stops. In intraday discretionary trading you can't apply such sophisticated strategies. At least I can't. A black box systematic program maybe could trade without stops intraday.

Anyway, the point is that I know all this stuff but still make the mistake of not honoring my stop-loss even when I'm now trading with imaginary money. Here is my equity curve trading the Australian Stock Price Index Futures with virtual money:



The blue line is the actual equity curve and the red line what would have been if I had stuck with my planned stop. This looks a lot like my real money trading in recent months. A slow consistent climb followed by a fall off the cliff.

So why did I screw up? This chart shows the SPI futures:



They open at 9:50am Sydney time. Ten minutes before the stockmarket. The first five minute bar was red and my NDX and Nikkei models were short so I went short. Very quickly the market reversed and my plan was to exit if the market traded above the opening price, which would show that my idea that the market would trend down from the open was wrong. We can also see here that my stochastic oscillator crossed over and moved up, showing me that I am wrong on this idea that the market is going to go straight down. This should be a slam dunk to get out. So why didn't I?

When the actual stockmarket opened, the first five minute bar was up, but the second one was red:



I "hoped" that the market was actually going down here. This was just noise though as shown by the stochastics - and the first ten minutes of trading in the Australian market is pretty meaningless as each stock is opened in alphabetical order over the first ten minutes (the Dow Jones index is similarly meaningless in early trading in the US). So I should have just ignored this. But hope got me into a completely wrong train of thought that the market would turn down despite all the evidence to the contrary. 20 minutes in I even shorted a second contract at 6352 (the first was at 6341). Eventually, I capitulated above 6370.

I'm disappointed that I'm trading this bad even with virtual money. OTOH I can't wait till Friday when the Japanese market next trades to get practicing again on Nikkei futures.