[Frank]

This thread is to discuss strategies that relate to your ‘other money’ --- the money you either have in a 401(k) or another more conservative account not marked for intraday trading.

My professional background was in asset management. I realized 5 or 6 years ago that I really needed to learn trading better as when volatility becomes high, the trading aspect to money management increases in importance (this move paid off big-time in 2008). So I read book after book on trading. My favorites are Linda Raschkes Street Smarts & Jim Daltons Markets In Profile. I actually eventually went on to write a more formal book review of Daltons book on Traders Lab over two years ago here: http://www.traderslaboratory.com/for...view-3605.html

So after a career in professional money management (~10 years+ and a CFA charterholder) – as well as a ‘career’ in trading – I feel I have a nice diversified background to offer some perspective on how one complements the other.

I believe money managers can learn a lot from traders but traders have a lot to learn from money managers as well.

Successful money managers are good at finding good secular themes and sticking with them. Successful traders are good at understanding volatility and how to use volatility to make lots of money when the market is offering it -- while preserving it when conditions are not good for short-term trading.

I believe that this is where my background has led me --- to merge these two worlds into something coherent. This thread will discuss some of these ideas.

I believe that the fusion of these two worlds is in the Exchange Traded Fund (ETF). This product is actually a very sophisticated product masquerading as something that looks so simple. High-end Wall Street strategy is very often about a money manager calling up Morgan Stanley or Goldman Sachs to execute program trades that execute 'basket trades' --- these long lists of individual trades have the designed effect of altering a portfolios exposure away from one type of exposure and towards another type of exposure (exposure representing a theme, such as an economic sector, large cap vs small cap, growth vs value, stock vs bond, international vs domestic etc...). Well, guess what --- buying 100 shares of XLF (U.S. Financials) and selling 100 shares of EWZ (Brazil Fund) does the exact same thing -- except it does it cheaper. Call it the ‘mainstreamization of program trading baskets’. This is a very powerful (and disruptive) innovation which has destroyed the mutual fund model --- has destroyed many of the premiums options market makers used to get from selling options on 'index baskets' and has opened up access to new segments of the world previously inaccessible. While the mainstream world is trying to find stocks --- the real future is in finding 'markets' -- the regions and segments of the world that are the growth engines of the futrue. This is what ETF's represent.

This thread will discuss methods and strategies for your ‘other money’ --- focusing on ‘global ETF rotation.’ These will be a blend of longer and shorter timeframe strategies -- just not intraday.

Frank

[Frank]

A good ‘ETF rotation’ strategy can be based on the simple yet powerful concept of ‘Find Global Relative Strength’ and overweight it. This does not mean just equities – it can be anything from U.S. Corporate Bonds to Emerging Markets Infrastructure stocks to Country Funds like Canada, Brazil or Australia. The ETF marketplace has 1000 choices that represent many, many segmented trading baskets – all pre-packaged for you by professional index providers like MSCI and Russell and S&P. This is very advantageous -- MSCI is for example part of the same company that does very high-end institutional portfolio management software (the Barra unit of MSCI-Barra).
With some help from an automated software environment – you can find which region of the world and which asset class is showing good relative strength – and then create a portfolio that manages whatever the risk chartacteristics of the chosen markets is. High relative strength --- and risk-controlled through position sizing --- and some portfolio concepts that blend portfolios with low risk bonds or cash to dilute overall volatility to your personal risk tolerance.
Try out this relative strength application for an introductory example:

ETF Relative Strength Backtest


Disclosure: a friend and I developed this website to track global money flows -- it is all free.

[brownsfan019]

Great thread Frank. I do not pay nearly enough attention to this as I get wrapped up in my trading, so I hope you keep this thread going and give us some ideas to work with.

[DugDug]

On this note, a book that seems to be getting some press and covers this area. (I have not read it, and dont have the time to at present, but it might be of interest to this thread)

Amazon.com: A Practical Guide to ETF Trading Systems (9781906659271): Anthony Garner: Books
by AJ Garner (??)

Plus - I have only had a brief look - but great site for the ETFs Frank.

[Kiwi]

Anthony posts over at tradingblox and seems a pretty smart guy so I'd guess the book will be systematic and pretty good.

[Frank]

I am going to elaborate on my last post:

In a recent institutional research piece by Goldman Sachs targeted at European portfolio managers, they offer various ways to trade ‘the divergence theme in the Eurozone.’



In the note, they discuss the problems with domestic demand in Europe within the construct of strong global growth, led by the BRIC (Brazil, Russia, India, China) theme. This note was on April 28th and followed a similar note discussing a similar theme targeted at US portfolio mangers.

The basic idea of the note is to “Go long international growth & short Eurozone domestic demand.” In both research pieces, they do lengthy analysis of long lists of ‘basket trades’ that portfolio managers could do to implement this longer-term trend. The bottom line of these studies was to create a long basket of stocks (to be long) that has companies with high sales exposure to the strong parts of the world and create another basket with high sales exposure to mainstream Europe and go short that basket.
I should point out that these types of basket trades by portfolio managers may not be with a high level strategy in mind – perhaps you have a new account and you just want to get it invested in line with other accounts – or had some outflows from your funds and need to increase cash to meet the outflow.

To execute this, you would submit a list of trades, with quantities of shares, to a firm like Goldman or Morgan Stanley or Merrill Lynch and say ‘buy(sell) this basket of 70 stocks on the market close today.’ Then, Goldmans quantitative ‘experts’ figure out how they are going to both ‘guarantee you closing price’ – and make money for themselves. They ultimately do some kind of elaborate combination of trades that hedges themselves --- and can use the liquidity in the futures market with a hedge ratio or whatever else they do to create a profit for themselves – and then they charge an extra fee to the buyside firm to do the program trade.

Now – enter ETFs. Think about what you can do now – you can buy any of 1000 pre-set trading baskets that were created by index construction experts at MSCI, S&P, Russell etc. In some cases, such as at Schwab or Fidelity, you can do this for zero transaction fee. Its like the world has aligned in favor of the small investor/advisor here. This is very powerful.

I should go on to note that in this most recent research piece by Goldman on ‘trading the divergence’ --- they spend nearly 1/3 of the report going into backtests of their newly created trading baskets. Well, with ETF’s – the trading history total return chart of the ‘basket’ is known. You don’t have to simulate it with high-end, expensive portfolio management software --- you can just run the total return chart.



So this is the power in ETFs: 1) the index has been constructed for you by index experts already (the people at firms like MSCI are every bit as smart (I would say smarter) as the people at your typical large financial institution) – they know what they are doing. 2) the trading history of the ETF ‘basket’ is known and 3) you haven’t done any actual work yet and you are already analyzing the characteristics of the ‘ ETF basket’ (its volatility, out/underperformance, historical relationships etc).

The bottom line is that banks makes good money recommending these kinds of things for portfolio managers. The longer the list, the more the profits. Big portfolio managers with huge assets under management cannot buy most ETF’s – the ETF’s just aren’t big enough. But you – as the small advisor, small hedge fund or individual investor can -- and that is what our site is all about -- leveraging the inherent and underrated power that ETF’s bring to neutralize the investment landscape.

(by the way, our relative strength model pointed towards this weakness in Europe months before Goldman wrote research on this – just go into the ETF screener and move the date back to January and see for yourself)

Frank

[TheDude]

It is quite interesting what strategies ETF's can allow.

Not a trade, but just something I'm following (since Feb this year) to get other ideas flowing is
SPXU & BPO (buying both)

SPXU is an ETF that is short the S&P components. In other words, if you buy this, you are short the S&P. Thats interesting to me because it seems to be targeted at those who have a bearish view of the S&P, but do not like the idea of going short; perhaps long only fund managers (I don't know if I'm joking there???!!), or retail traders who dont like the perceived risk or too traditional to take the margin account.

BPO is simply the stock with the highest Beta that I could find, currently at 1.99

An interesting pairs trade which to my thinking in a bull market should pick up volatility returns of BPO, while taking out the returns of the stock market. I'm collecting beta.

Like I said, this is just something I'm tinkering around with. I know it could be done better with options, or better product choice - the main purpose is to see how it behaves which in turn generate other ideas....

[Frank]

In my experience, Betas are not stable -- something might have a really high beta looking back but then suddenly just trade with the market for a 0.99 beta.

The other thing is that volatility itself is not static -- so a high beta in a high vol market might be tricky when vol goes dead:

www.etfreplay.com/etfimages/vol99.png