May 2018 Report

Another very active month financially. The Australian stock market rebounded quite strongly but then turned over as other markets did. This month was the second month of the futures trading experiment. The first month was the model development phase, while this month was about ironing out the glitches and training myself to trade the model properly (and not give in to gut instinct etc).

The Australian Dollar rose from USD 0.7540 to USD 0.7571. The MSCI World Index rose 0.21%, and the S&P 500 2.41%. The ASX 200 rose 1.09%. All these are total returns including dividends. We gained 1.84% in Australian Dollar terms and 2.26% in US Dollar terms. So, we outperformed both the Australian market and the international markets and slightly underperformed the US market.

The best performing investment in dollar terms was NASDAQ futures gaining AUD 9.5k (this is going to be a theme :)). The second best was CFS Geared Share Fund gaining AUD 8.9k. The worst performer in dollar terms was IPE, losing AUD 1.5k. The best performing asset class was "commodities", which includes futures trading, gaining 6.24%. Hopefully, this will become a near permanent feature. The second best performer was Australian small cap stocks, gaining 2.92%. The worst performing asset class was private equity, losing 0.78%, the only asset class that lost money.

A new feature starting this month is the following table of investment performance statistics. The statistics are computed with the last 36 months of data:

The first row gives the Sharpe ratio for our investment performance in US dollars and Australian dollars. The other statistics are in comparison to the two indices. Beta expresses the change in investment returns for a 1% change in the market. Compared to the MSCI World Index we seem to be slightly geared, while compared to the Australian index we are less sensitive to market movements. Alpha shows the risk adjusted excess annual return. This is how much we are beating the market (or not) adjusted for risk expressed as beta. We have a slightly positive alpha compared to the Australian market and a close to zero alpha compared to the world market. Finally, up capture and down capture breaks beta into the response to positive and negative months in the stockmarket. A greater up capture than down capture ratio is desirable. We do capture more of the up movements in the Australian market and suffer less of the down movements. A hedge fund like return would show this positive skew and a positive alpha. Compared to the Australian market we show some hedge fund like properties.

This month I made money trading futures: USD 7.2k. The table compares my performance to the markets and the models:

I also bought and sold investments in this account and added AUD 25k in cash towards the end of May, so don't expect the starting cash to change with just income earned. My rate of return in May far exceeds the models or markets because of leverage. I mostly traded one contract at a time and so was using a bit over 3 times leverage. I could also select the market where I thought the model signal was most reliable. In the early part of the month I mostly traded NQ (NASDAQ) and in the later part of the month ES (S&P 500). I also traded CL (oil). Most of the gains were made early in the month when the market rose. After that the market mostly went sideways.

I more or less successfully followed the plan for the month, which was to consistently trade one futures contract according to the trades that the model provides, while learning about entering trades more optimally and setting stops. There were some hiccups, particularly on 14 May when I lost much more than the model due to bad trading. I can say that the second of my goals in the experiment - to consistently trade the model - was a qualified success. I was much more disciplined than when I previously traded futures, but still not disciplined enough. The third goal - to earn as much as my salary from trading fell short though I was in the ballpark. I would need to make USD 12.5k to reach the goal. For the next month I plan to work on the same goals and maybe increase the position size when I am particularly certain about the market direction. This is why I added more cash to the account. After adding the money and doing some bad daytrading, which I shouldn't be doing, I had second thoughts about taking a larger position. But I maybe should be trading both stocks and oil simultaneously. Horizontal rather than vertical expansion.

We made more progress towards the new long-run asset allocation:

Total leverage includes borrowing inside leveraged (geared) mutual (managed) funds. The allocation is according to total assets including the true exposure in leveraged mutual funds.

The improvement in allocation, came partly due to market movements and partly due to investment activity. We invest AUD 2k monthly in a set of managed funds, and there are also retirement contributions. Then there are distributions from funds and dividends. During the month, I also:

• Traded futures successfully, increasing the allocation to "commodities" as a result. As mentioned above, I also added cash to the trading account. Just over 4% of net worth is now allocated to trading.
• Added another AUD 10k to the Winton Global Alpha fund, also increasing the allocation to commodities.
• Closed my investment in GMOM, due to poor performance over many years.
• Increased investments in the China Fund (CHN), Boulder Income Fund (BIF), and 3i (III.L).
• Sold my trade in Woolworths (WOW.AX) and made a quick trade in Platinum Capital (PMC.AX).
• Switched from Colonial First State Geared Share Fund to CFS Conservative Fund in a small account I have, which I am planning to close soon (after the end of June distribution). Then I switched back again. Originally, I had this account as a trading account!

Flipped Back to Short

The model was long NQ for one day and lost a little (it remained short ES, surprisingly). Now it has flipped back to short. Given yesterday's post, I'm still thinking this is a limited correction. Here is a possible interpretation based on Elliott Wave Theory:

We are now in wave C of 4. Based on Elliott Wave Theory that wave should stop before price falls below the maximum point of Wave 1, as shown on the graph. I find Elliott Wave very useful in understanding the different things that might happen, but I don't think it is an exact fit to what the market does, especially on very long and very short time scales. Over the time scale shown on this chart, it is particularly useful. On the other hand, Eliott Wave is notorious for continually morphing and following what the market does, rather than predicting it.

Of course, my model has nothing to do with Elliott Wave Theory it is just nice to have some other approach that does not conflict with the model or confirms it.

If you look closely you'll see I'm short from 6911.5 and up quite nicely, but I was up $500 when long yesterday evening too and that reversed...

P.S.
The downside didn't last long! Market turned around in the morning US time and went up, eventually reaching above the top of the triangle in the chart above. At one point I was up USD 1500, but unfortunately I didn't take profits as I was sticking to what the model said to do. Now I am considering doubling my position during the Australian daytime - the US overnight and then closing half in the US morning. If I had done that yesterday I would have ended up on the day. I am going to backtest the strategy of course. 10 years back when I previously was trading futures, I did look at "overnight trading" as a strategy, and now it has come up again.

Model has now flipped back to long. S&P model was short till today, and now has also gone long.

Getting Bullish

The model is switching back to long today. The last seven business days it was short but the market just went sideways more or less and it netted USD 1,200 a contract or 0.85% for the effort. The previous 10 days of being long, by contrast yielded USD 5k (3.67%). That's an indication of the bullishness. Australian and European markets have been more bullish throughout this period - the US market has been lagging perhaps due to relative over-valuation and to all this trade war and other nonsense.

So far for the month, the model is up USD 7k per contract and I am about matching that.

Backtesting 1987

You would want to make sure that your trading model put you in the right direction in the 1987 crash (which I am old enough to remember very well), wouldn't you? So, I backtested the model for 1986-87. The main model would be short going into the crash. But a more primitive model I am using in conjunction with the main model would switch to long on the Friday before the crash. That day the market went down 5%, so it would have already been a bad idea on the Friday. Recently, this secondary model has been doing well and I have combined its signals with my main model. So, we need some new rules about how and why to combine them. In this chart you can see that the buy signal would have come with the price already outside the +/- 2 standard deviations envelope (S&P 500 index):

These are "Bollinger Bands", though I use a 34 day moving average instead of Bollinger's 20 day MA. So, the new rule is not to take that signal when the price is outside the Bollinger Bands and the width of the Bollinger Bands is increasing. That wouldn't change much recently (NASDAQ 100 index):

The secondary model gave some very good buy signals just as price hit the Bollinger Bands in early February and late March. In these cases the price was not outside the Bollinger Bands or they weren't expanding.

The model is short for Monday.