Monday, July 20, 2009

Correlations between Commodity Trading Advisors & Trend Follwers

Correlations Between Commodity Trading Advisors & Trend Followers

A question I encounter often is, what are the correlations between your trading and other commodity trading advisors. More so…what makes you different.. Both are great questions..First in my opinion out of the thousands of commodity trading advisors, I would only consider diversified trend followers. This cuts out the options strategies that I have seen too often blow up. Next in all of my years… I have only seen one short term who can consistently grind out a positive return..( and I have invested with her). Most short term traders have not held up over the years. The next most important issue is risk.. How does the commodity trading advisor or trend follower define and manage risk. This cuts the playing field tremendously. Even some commodity trading advisors don’t understand the golden rule of risk per trade..risk per sector…open trade equity risk. It is not the return on investment.. it is the amount of risk needed to tolerate those returns.
So I would only compare us to other trend following diversified ( large basket of potential markets) that understand risk. More so… I would compare us to commodity trading advisors who trade multiple systems as there is no magic system. Even with all of this said…how are we comparable in our niche.. What is interesting is that in our niche, commodity trading advisors have similiar but different results. Put it this way..why do commodity trading advisors throughout the world in different offices seem to have similiar good periods and lackluster returns. For example last year was a great year for commodity trading advisors in our niche…and this year… nothing.. absolutely nothing is happening..The answer is quite simple… we are like fishermen.. if the fish don’t does not matter how good our fishing poles are. Trend following can only be successful when there are trends. The reason there are correlations between commodity trading advisors is that the markets are open to those who are aware to take advantage of the trends.
Even with all of this said.. how does one explain the difference in the degrees of returns in the good times..and the drawdowns in the choppy periods…Very simple.. going back to basis… RISK. How much risk does a commodity trading advisor look to take on. Very simply..the bigger the risk per trade.. or sector allocation..or open trade equity allowable..the greater the return…but more importantly..the greater the draw down.

If you really want to succeed in commodity trading & futures trading. You have a choice…you can take the arduous path of learning for yourself or you can allocate to a professional commodity trading advisor in which you understand exactly how he/she trades…how he/she manages the risks inherent in trading and have the patience and discipline to stay with them at 4-5 years. More so I would suggest allocating no more than 5% ( even less) of your net worth to any idea…If you seek to compound your way to wealth… these are the tenants of potential success..

Andrew Abraham Video:Commodity Trading & Trend Following

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Sunday, July 19, 2009

Sentiment Stock Market Overview-Increased Allocations to Equities

Sentiment Stock Market Overview: Increased Allocations to Equities

There is a lot of material to cover in this week’s stock market sentiment summary, so let’s get started:

Sentiment Surveys
According to the weekly retail investor AAII survey, 29% of respondents are bullish - a tiny increase from last week. Meanwhile, 47% of respondents expect the market to decline going forward - an increase of 8% points.

More interestingly, the AAII asset allocation to equities continues to increase. The last time we looked at this in early May 2009, it had recovered from the abysmal level of 41% - the lowest on record. Now it is at 57% with most of the increase coming from a reduction in cash holdings which were at one point the highest on record at 45%.

While as a contrarian the ideal situation would be a continued pessimism (low asset allocation to equities), this isn’t really realistic. It is normal for people’s expectations to be recalibrated once the shock of a system wide meltdown recedes. And we also need for an orderly march towards optimism if the market is going to recover. That is the only way that new money will flow into equity markets and by increasing demand, drive up prices. We are far from extremes of 70% allocation that would provide cautionary signs. So it is a good sign that we are seeing growing optimism from this indicator.

ChartCraft’s weekly Investors Intelligence measure of newsletter editor’s sentiment is - oddly enough - split exactly down the middle: 35.6% bears and 35.6% bulls. Although this is rare, the more important thing is that this is a continuation of a short term trend in the increase of those pessimistic about future market prices and a decrease in those optimistic. Not long ago the bulls outnumbered the bears 2:1 but now, they are the same.

The Hulbert Stock Newsletter Sentiment Index, which tracks a small group of newsletters which try to time the market, is 15% points lower now than it was in early June. For those that time the Nasdaq, the mood is even gloomier: 27% points lower today than in June.

When you consider that almost all indexes are now trading slightly above last month’s highest levels, this gives new life to the spring rally. This is because while the recent decline spooked the average market timer enough to reign in their horns, the following sharp rally which made up for those losses did not made them rejoin the bullish camp. This reticence to become optimistic once again in the face of higher prices is bullish from a contrarian viewpoint.

While Wall Street strategists may get paid much more than the average retail investor, their prognostications have, on average, equal dependability - which is to say, not much. Just as the retail investors were fleeing from the bear market by reducing equity allocation and building cash and fixed income levels, the Wall Street strategists were also doing the same. In fact, their lowest level of equity allocation since 1997 coincided with the March 2009 low. And once again, in lockstep with their retail strategists, they’ve upped their equity allocation slightly in response to the higher stock market prices.

The Bloomberg Professional Confidence survey for US equities fell to 39.56 - its lowest level since March 2009. Any reading below 50 implies that respondents expect lower prices ahead for the Standard & Poors 500 index. This was the second consecutive monthly drop since it reached a high of 51.6 in May 2009. So while optimism increased in line with higher prices, the subsequent range bound and choppy trading caused many to abandon that position and take defensive postures. This general mood is also confirmed by a separate study by Merrill Lynch which suggested that large institutional money managers were ‘underweight’ the US equity markets. The majority cut their exposure to US markets in July 2009.

Rydex Sector Funds
According to Jason Goepfert, the Rydex Sector investors have rushed out of equities giving a contrarian signal. Rydex Sector funds are used by aggressive position traders and investors to gain exposure to specific parts of the wider stock market, much like sector ETFs. Among the myriad statistical measures that Goepfert keeps track of is the percentage of the Rydex Sector funds which have assets above their 50 day moving average. The rationale is that when itchy trigger fingered market timers are bullish, they buy into these high beta funds to ride the market higher. But when they get scared, they sell and retreat into money market funds, sending the Rydex Sector assets tumbling.

As all contrarian indicators, Rydex Sector investors are wrong as a group. So historically, when very few of the Rydex Sector funds has assets above its 50 day moving average, it has indicated that there is enough fear to induce higher prices. Right now, we aren’t yet at previous extreme levels but we’re very close.

Options Sentiment
The CBOE put call ratio (equity only) dropped to just 0.58 - which means that calls were bought about twice as much as puts. Just a few days ago, at the beginning of the month this ratio was 0.86 as moderate fear of a market drop was the prevailing mood in the options exchange.

The options sentiment on the ISE mirrored the same changing mood as the call put ratio (equity only) reached 184 - meaning that 184 calls were bought for every 100 puts. However, since the 10 day moving average which smoothes out the short term volatility is mired in neutral, we do not have a defining signal from this indicator.