The Machine Monthly Newsletter (October 2010)
FROM THE DESK OF LARRY CONNORS
Welcome to our first issue of The Machine Monthly Newsletter!
We’re excited by the launch of The Machine with new customers signing on daily. As we grow The Machine Community, we’ll keep you updated through this newsletter sharing with you new trading education, new trading strategies, interviews with traders successfully using The Machine, along with the many ways that The Machine can help you grow your portfolio.
Also, we’ve recently expanded The Machine with The Machine Lite. A number of people requested a streamlined version of The Machine and we launched this version three weeks ago. And in late November we’ll be launching The Machine Pro which will include systematic day trading strategies and portfolios, along with many market neutral portfolios for those traders looking for a quantified way to hedge their portfolios.
If you are not all ready part of The Machine community, please contact us and a free trial will be arranged for you. And if you are part of the Community, I welcome you. We’re continuously adding new features and improving The Machine and it’s because of the your feedback, ideas and suggestions which has allowed The Machine to continue to grow rapidly.
Thank you again and enjoy this issue of The Machine Monthly Newsletter.
-Larry
Larry Connors is CEO and co-founder of The Connors Group and TradingMarkets.com
BUILDING A 3-D PORTFOLIO
By: Rob Davenport
The investing world is full of folk-lore. One of the most prominent is the traditional 60/40 balanced portfolio guidance. For decades financial advisors have promoted the advantages of having one’s account roughly 60% allocated to stocks and 40% allocated to bonds. The premise was that this was an approximation of the Modern Portfolio Theory (MPT) efficient frontier. And, of course, the mutual fund industry profited immensely from this promotion.
The MPT has been widely challenged in recent years. And, in The Machine community we are firm believers in active management instead of ‘buy and hold.’ Nevertheless, there are parts of MPT that are useful even though the theory as a whole is widely viewed as flawed.
The key component of MPT that we can benefit from is the concept of risk management through diversification. However, the power of diversification does not come from traditional asset class based diversification. The real power of diversification comes from diversifying your investment methods.
In other words, we want to combine different types strategies. Trend following strategies perform best in up markets. Short strategies work well in down markets. And active strategies provide opportunities in sideways markets.
When designing portfolios with The Machine we want to maximize the diversification of our portfolio by using strategies from each strategy group. This should allow us to reduce the drawdowns and volatility.
There are 7 groups of strategies in The Machine:
- Equity Active (Mean Reversion) Long
- Equity Active Short
- Equity Trend Following Long
- ETF Active Long
- ETF Active Short
- ETF Trend Following Long
- ETF Trend Following Short
These strategies fall into 6 different groups on three different axes:
To balance our portfolios perfectly we should balance in each of these 3 dimensions. If our assumption is correct this should produce a low drawdown, low volatility portfolio with acceptable returns. Our objective is:
60% Stocks : 40% ETFs
60% Active : 40% Trend Following
60% Long : 40% Short
It so happens that it is very easy to create this three dimensional 60/40 balance with The Machine. All one needs to do is to allocate 20% to each of the three equity strategy groups and 10% to each of the four ETF strategy groups.
20% Equity Active (Mean Reversion) Long
20% Equity Active (Mean Reversion) Short
20% Equity Trend Following Long
10% ETF Active Long
10% ETF Active Short
10% ETF Trend Following Long
10% ETF Trend Following Short
Viola! You have 60%/40% in three different dimensions!
Now let’s look at how this works in an actual portfolio. But to make this more interesting, I’m not going to take the top variations available in any strategy group. I’m going to go deep into The Machine and choose strategies that likely no one is using. This will be a true test of the robustness of The Machine.
First, I’m going to eliminate over half the strategies in The Machine and many, if not most, of the highest performing strategies. I’m going to do this with the filters in the Strategy Selector. I’m going to filter such that I only look at equity strategies with an average volume > 2.5 million shares and, additionally, I’m going to eliminate all strategies with a maximum positions = 5.
Now to make it even more interesting I’m going to take the 50th ranked variation (by CAGR) in each of the 7 strategy groups. Here’s the portfolio after filtering half the strategies and selecting #50 in each group.
Portfolio Strategies
Selector Strategy
Portfolio Results
I think it’s safe to say that this will be a VERY unique portfolio. I think it’s also safe to say that there are likely many thousands of portfolios that you can create with this same approach that will out-perform this one. So let’s see how this performs.
Here’s a summary of the portfolio’s performance:
| Metrix | From 2001 – Aug 2010 | From 2006 – Aug 2010 |
|---|---|---|
| CAGR | 14.28% | 16.02% |
| Sharpe | 2.27 | 2.36 |
| Maximum Drawdown | -6.52 | -6.52% |
| Win % | 70% | 70% |
| Maximum Exposure | 60% | 60% |
This balanced portfolio comprised of strategy variations found deep in The Machine had simulated returns of almost 15% annually and never dropped more than 7% from its peak high. That’s better than 95% of the money managers on Wall Street!
The portfolio achieved single-digit drawdowns with a 14.28% annual return. This was achieved with 7 strategies that all had double-digit drawdowns and only two of the strategies had > 11% annual return. This is the power of combining different strategies from each of the 7 strategy groups. This is the power of diversifying in all three dimensions.
Rob Davenport is Chief Marketing Officer for The Connors Group
Q&A WITH KEVIN
By: Kevin Heller
What happens if every stock falls below its 200 day moving average?
For the strategies that are disclosed to our clients, the following is generally true regarding entry positions: for long and short equity strategies the close must be above the 200 day moving average; for ETF (main and leveraged – no inverses) the long must be above the 200 day MA and the short must be below the 200 day MA.
In the backtesting to date there has never been a period when every stock fell below the 200 day moving average. Typically there are groups of stocks which are inversely correlated to the general market during bear market periods.
What’s the difference between Ultimate Power Ratings and The Machine Lite?
PowerRatings is a proprietary, statistically validated rating method for stocks, ETFs and leveraged ETFs. It is based on a comprehensive algorithm back-tested against tens of thousands of stock and ETF trades. The higher the rating, the greater the short term historical gain.
The Machine allows users to harness the power of rigorously tested and quantified trading strategies developed by Connors Research. The Machine allows users to build portfolios combining strategies, based on the criteria you select, that may include Equities and/or ETFs with long and/or short positions across single or multiple time frames. Compared to other products that rate stocks, The Machine require no sifting or sorting because it automatically generates a unique set of signals each day dependent upon the user’s selected portfolio. These portfolios enable investors to reduce volatility while consistently out-performing industry benchmarks.
WHAT’S NEW IN The Machine
- Videos from last month’s Community Meeting are available for viewing on The Machine under Education – Presentations for all current users.
- Equity Curve Export – Users can now export the daily returns data for their Equity Curve for any of their individual portfolios.
- September return numbers will be available by the end of this week for all users of The Machine.
- To learn more about other recent additions and enhancements to The Machine, please check out our What’s New
- The next The Machine Community Meeting is schedule for October 28, 2010 at 4:30 pm for all full users of The Machine.
