Technically Speaking, December 2021

Hello readers, and welcome to the December issue of Technically Speaking.

We’re now in the last month of the year and before you know it, 2022 will be upon us!

It’s been quite a year for the market, hasn’t it? Don’t get me wrong, a crazy bull market (like 2020) is absolutely great, but lessons are learned when the market is choppy. And choppy it has been! When we chart back in history, it becomes quite clear that Year 2 in a bull market is basically moody at best! That’s pretty much what the market did this year.

We did get to experience several new things, however. Who would’ve thought that a Reddit thread could drive the price of Gamestop shares higher 18-fold!? The power of volume (and latent frustration) is what it comes down to, I guess. Adding to that, we now live in a world where compensation can be issued entirely in Bitcoin and you can buy land on Decentraland! NFTs are now a thing, and with a little more effort, you can make one yourself! Clearly, we live in a market which is vibrant, dynamic and ever changing. In this new age market, the average market participant definitely has a lot of catching up to do with all the new developments. If that’s something that is overwhelming you, then take a deep breath and get down to basics. It does seem like these concepts are here to stay, and it’s never too late to learn something new. Just don’t ignore it – that might turn into regret soon!

The market as we’ve seen has been messy all year round. While one month ago, we saw some breakouts come through, we’re back in range-bound territory when it comes to the US SMIDS (Small and Mid-caps). The large cap indices are going through a correction regardless of the geography you pick up, and risk-on indicators continue to move sideways. What’s also not holding its ground is the US 30-year yield; that has broken below the summer lows of 1.75%. Crude Oil has corrected to levels close to $66, US Dollar Index is trading around $96 and precious metals are still the worst place to park your money.

So, what does all the above mean for the market? A little bit of this, and a little bit of that. We have to be selective and treat each chart by its own merit. The market is messy and doesn’t seem to want to clear the haze out just yet.

Keeping that in mind, this month we have views on the US and Indian Equity market as well as something from the Fixed Income space to help understand the current trends better. Those of you looking to build a system, we haven’t forgotten about you! Dig in and you’ll find something interesting. There’s always something for everyone, like a buffet!

Wishing everyone a delightful December, Merry Christmas and a Happy New Year!

I’ll see you on the other side of the year. Until then, Think Technical!

Rashmi Bhatnagar, CMT

Editor

What's Inside...

President's Letter

Brett Villaume

Congratulations to Makenna Barbara, winner of the Charles H. Dow Award for 2021! Her paper, “The Efficacy of Modified Momentum...

Month Ahead: Looking for Relative Outperformance in the S&P 500

Milan Vaishnav, CMT, MSTA

The month of November saw Equities starting to relatively outperform again compared to other asset classes like High Yield Corporate...

Options: Short Strangles

Sean McLaughlin

The majority of trades we do here with All Star Options tend to be directional in nature. And why not?...

Will the Banking Bloodbath Continue?

Kush Ghodasara, CMT, CFP

Stock markets around the world have been in mayhem over the past week and many market participants expect it to...

Volatile Market Environment

Arrush Adityadev

Indian markets are going through volatile times. What makes it so is a tug of war between DIIs and FIIs....

CMT Association Targets Higher Education Initiatives

Buff Dormeier, CMT

The CMT Association co-sponsored one hundred sixty students from 27 universities at the Student Management Investment Fund Consortium Conference (SMIFC)...

Signal Diversification

Jim Denholm

There is no perfect investing system. But there are unlimited effective ones.

Diversification has been touted as a key component...

The 30-Year Breaks and Treasury Spreads Tank

Private: Ian Culley

US Treasury yields are a mess.

Short rates are holding up fine, with the 2-year yield pressing to its highest...

Association News

Marie Penza

Membership

The CMT Association would like to congratulate the following members on their new positions:

Craig Fullen, Esq., CMT, Of...

President's Letter

Congratulations to Makenna Barbara, winner of the Charles H. Dow Award for 2021! Her paper, “The Efficacy of Modified Momentum Based Technical Indicators on U.S. Equities: A Study of Parabolic SAR,” provides a thorough examination of the study of technical indicators’ usefulness in creating alpha, including Welles Wilder’s Parabolic SAR. You can read the paper in this year’s Journal of Technical Analysis, Issue 71, available here.

As Ms. Barbara pointed out in the paper, the usefulness of technical analysis has been debated over the years, going back to an examination of the Dow Theory’s efficacy by Alfred Cowles in 1933. But there are logical reasons why skeptics (primarily academics) have been wary of its usefulness, including two possible reasons she proposes in her paper: 1) the acceptance of the Efficient Market Hypothesis and 2) negative empirical findings in early TA studies.

Every so often, I feel like we could all use a bit of a technical analysis reality check – just a reminder that what we’re doing is simultaneously correct and unpopular. As a financial professional who has been using technical analysis somewhat successfully for a long time, I often forget that many – maybe even the majority – of Wall Street participants don’t appreciate its usefulness. In fact, there are still some folks out there who completely reject TA and scoff at anyone who dares to suggest there’s value to paying attention to price. No, really? Seriously?!! Yes, it’s true.

If the rising popularity of cryptocurrencies has taught us anything, it’s that technical analysis has value. While there are some valuation techniques out there intended to ballpark estimate the intrinsic value of certain cryptocurrencies, like Bitcoin, almost everyone admits that TA is the only method available to trade them. Like a cowboy in the Old West, sitting in the back of the dusty bar, emerging from the dark to protect the innocent townspeople from the desperate criminal who wandered into town, TA saves the day.

Well, it’s not quite that glamorous, but you get the metaphor.

I have my own premise to contribute to the argument as to why TA remains unpopular. “Price is fact, earnings are estimated,” is a saying we’ve all heard before, but perhaps never really thought through the implications of. The way I see it, over the years, Wall Street has cleverly (shrewdly) instituted an unfalsifiable system for peddling recommendations to buy or sell its products and services. It’s called intrinsic value, or fundamental analysis, and its all-consuming, but apparently not enduring methodologies (e.g., the EMH, Modern Portfolio Theory) conveniently allow its practitioners to be wrong 100% of the time and still make a living.

The issue we face as torchbearers of TA is that, like it or not, we live in the land of the real. And since we opened our mouths and proclaimed that “price is fact,” well, we have to provide the evidence that TA works. And we put in the work to try to do so, as Ms. Barbara’s paper and the other articles in the JoTA and this month’s Technically Speaking adeptly display. Nevertheless, we are likely to always face a wall of rejection from those who would rather throw up their hands and deny the reality of price. We are a threat to their existence, after all.

So, there’s your technical analysis reality check. I feel more motivated than ever after writing it, and I hope it inspires you to persist in fighting the good fight. Until next time, keep the faith!

Contributor(s)

Brett Villaume

Brett Villaume is Past President of the CMT Association, having served on the Board of Directors from 2014 to 2023. Additionally, Brett is a Financial Advisor at Equitable Advisors, LLC (member FINRA/SIPC) based in San Francisco, California. Brett previously served as Director...

Month Ahead: Looking for Relative Outperformance in the S&P 500

The month of November saw Equities starting to relatively outperform again compared to other asset classes like High Yield Corporate Bonds, Treasuries, and Commodities. However, renewed Covid fears given the Omicron variant saw the momentum in Equities getting disrupted. Apart from this, the fear of tapering of monetary stimulus at a faster pace further irked the markets. As a result, we saw nearly all Global Equity Indexes reverting to their mean, and many of these equity indexes getting pushed in a broad ranged consolidation.

Amid such volatile times, it becomes increasing difficult to protect profits on one hand, and on the other hand, it becomes equally difficult to spot any fresh investment opportunities that can generate meaningful Alpha during volatile times. A retail investor can choose to stay away from the markets and sit on cash, but a fund manager does not enjoy this luxury. He must, at most of the times, stay invested while looking for relative outperformance of his holdings against the benchmark.

We will examine the use of Relative Rotation Graphs (RRG) as we try to find two such stocks that can offer robust relative outperformance and a potential Alpha against its benchmark. To do this, we scan S&P 500 universe for a quadrant crossover. We scan for stocks whose RS Momentum crosses above 100 regardless of the value of RS Ratio. This means that we look for a stock that either enters the Leading Quadrant from the Weakening Quadrant, OR for those stocks that enter the Improving Quadrant from the Lagging Quadrant.

Whenever the value of RS Momentum crosses above 100, we can fairly take that as a signal of the end of relative underperformance of that stock against the benchmark. Over the coming days, that stock is expected to show resilient performance and relative outperformance against the benchmark.

When we scan the S&P 500 Universe for those stocks whose RS Momentum crosses above 100 on weekly time frame, we get the above result.

At this point, it should also be noted that the more a stock is away from the center point, the greater will be the Alpha that it is expected to generate. Keeping this in view, we take two stocks that are at a maximum distance from the center point — FDX and AMGN.

FDX – Fedex Corp.

Fedex Corp (FDX) has rolled inside the improving quadrant; this marks a potential end to its underperformance against the S&P500 Index. The stock has support at the trend line pattern; support which also coincides with the 200-Week MA, which stands at 212.43. Following a recent corrective decline, it has formed a potential base and is expected to stage a technical pullback from this point. Weekly MACD has displayed a positive crossover; it is bullish and above the signal line.

AMGN – Amgen, Inc.

Amgen, Inc., (AMGN) is another such stock that has grossly underperformed the broader markets on relative terms. Presently, it has slipped below the 200-Week MA which stands at 212.50. However, the recent price move has also seen RSI showing a strong bullish divergence against the price. Just like FDX, AMGN has also shown a Quadrant Crossover; it has entered the Improving Quadrant of the RRG when benchmarked against the broader S&P500 Index.

Both FDX and AMGN are expected to start relatively outperforming their benchmark S&P500 Index. Interestingly, AMGN is also a Dow 30 component. Going ahead, along with relatively outperforming the S&P500 Index, both these stocks are likely to return ~12% to ~15% from their present levels if the technical setup plays out on the expected lines over the coming week.

An exit from these stocks will be triggered if the RS Momentum slips below 100; meaning, the stocks slip again in the Lagging or the Weakening Quadrant again, whichever happens earlier.

Contributor(s)

Milan Vaishnav, CMT, MSTA

Milan Vaishnav is the founder of ChartWizard FZE, Gemstone Equity Research & Advisory Services, and works as an Independent Technical Research Analyst. With a career spanning over 18 years in the Indian Capital Markets, Milan’s primary responsibilities include consulting in Portfolio/Funds Management...

Options: Short Strangles

The majority of trades we do here with All Star Options tend to be directional in nature. And why not? We’re leveraging best-in-class technical analysis to give us an uncommon edge to participate in emerging and/or continuing trends. And if we know anything as Traders, we know that if we have an edge, we should attempt to execute against that edge as often as possible.

Meanwhile, I recognize there is an entire cottage industry around “selling options premium” and for good reason — it works! That doesn’t mean it always works nor does it mean it’s easy. I just don’t like to make it my only thing.

That said, one of my favorite strategies is to sell premium via Short Strangles.

A Short Strangle is a delta-neutral options spread that consists of two legs: a naked short put position and an equally-sized naked short call position. Both option strikes are typically out-of-the-money. Here’s how a typical PnL graph for a Short Strangle would look:

It should be noted that due to the naked options, this type of spread will require margin and we have theoretically unlimited risk if the underlying were to take off in either direction on us.

The first order of business when putting these spreads on is to seek out instruments — preferably ETFs or large cap stocks — that are experiencing elevated implied volatility (IV). When IV is high, options premiums are elevated because market participants are bidding up the cost of calls and puts either to hedge some perceived risk or to take advantage of a speculative opportunity. Now, there is no precise IV value I look for. I just want the IV for the stock today to be in the upper end of the range of where it’s been over the past 6-12 months. High premiums offer us an edge as volatility tends to mean revert and when that happens, the high volatility options we sold at higher prices tend to see their value erode (a great thing when we’re short!)

When I’ve selected the right instrument, my initial instinct is then to identify the 25 delta strikes for both the calls and puts. But that isn’t always the strikes I end up selecting. More important to me is that the strikes line up just beyond obvious levels of support and resistance.

For instance, here’s a recent Short Strangle trade I put on in $XLI October options:

The horizontal lines represent the short call (107) and short put (98) strikes I had chosen. Notice how those strikes corresponded nicely with overhead resistance and downside support? It just so happened that both of these options were each sporting approximately 25 deltas. It’s amazing how often that ends up being the case. (Market makers are no dummies!)

My profit goal with Short Strangles is always to keep 50% of the original premium collected. Let’s say I collected a $3.00 credit for the spread on Day 1. Once I can buy-to-close the spread back for a $1.50 debit or less, I’ll do so, booking my profits and moving on to the next trade. When I put this $XLI trade on above, it had approximately 6 weeks until October expiration. But it only took me two weeks to cover this spread at my profit target of 50% of the original premium collected in the trade.

Why do I cover at 50%?

Because once the spread loses value (a good thing when we’re short it), we start getting to a point of diminishing returns. Let’s say that spread I sold for $3.00 is now only worth 75 cents. I’ve got a winner on my hands and that’s nice. But now I can only make 75 cents more if I hold all the way to expiration and the options expire worthless — but I’m still holding the entirety of the theoretically unlimited risk! That math doesn’t make sense. It doesn’t make sense to get paid so little to hold so much risk. So I’d rather just cut the trade loose once I’ve earned 50% of the original credit and then move on to new opportunities with less risk.

On the risk management side, I know a lot of people who trade Short Strangles like to move strikes on the winning side to bring in more credits to defend a losing position and that’s fine if you want to put in that kinda work. But for me, I chose my short strikes for a reason (because they were significant support & resistance levels), and therefore I’m going to hold the trade and trust its going to work as long as the stock or ETF stays inside those strikes. But if the underlying moves outside those strikes, why defend it? Clearly my reason for being in the trade (a stubborn range) has been violated and therefore my thesis is busted. I’m not going to defend this trade and argue with the market. No, I’m just going to close the trade, book the loss, and move on. Let it be somebody else’s problem.

I always try to have some strangles working in my portfolio most of the time. They are a good counterbalance to a portfolio of mostly directional trades. When markets start grinding sideways and breakouts are failing left and right, it’s nice to have some delta neutral trades like Short Strangles on the books that profit during sideways churns and offer some much needed profits.

Do you trade Short Strangles? If not, why not? I’d love to hear from you.

@chicagosean

Contributor(s)

Sean McLaughlin

Sean McLaughlin is a 25-year trading veteran, with trading experience in US Equities, Futures, Forex, Cryptocurrencies, and a current focus on equities and index options. A Former Member of the Chicago Board of Trade, Sean first began as a high frequency...

Will the Banking Bloodbath Continue?

Stock markets around the world have been in mayhem over the past week and many market participants expect it to stabilize after just two days of recovery from the low. But I have a difference of opinion on Bank Nifty! Looking at the weekly chart set up of the banking index, it seems as though the Banking Bloodbath has only begun!

So now let’s take a look at some factors of bearish calls on the Weekly time frame on Bank Nifty as can be seen in the chart above. Let’s start with the Elliot Wave counting from the lows of the pandemic. What we notice is that we have unfolded in a perfect 5 wave rally in which the 1st Wave was from 17105-25232, 2nd wave of which was 61.8% of its move- which translates to 20404. Continuing the rally, wave 3 grossed 2 times of Wave 1 to get to 36501, while the 4th Wave was almost a 38.2% correction of wave 3. As wave 5 shouldn’t be greater than wave 3 nor shorter than wave 1, it was perfectly in line with the rules where wave 5 was 61.8% of wave 3, ending at 41289. BEARISH Engulfing at the end of Wave 5 at 41289 –which is a strong reversal candlestick pattern- gave the count more credibility. When it comes to the indicators, MACD has given a minor negative divergence in which when we pinched a new high at 41289 in price, the indicator halted at the previous high making sure that we are in bearish momentum. Another indicator RSI, that emphasises on closing prices, also gave a low degree negative indication and breached the support level of 53 which has been in place since the pandemic low, or since our impulsive move from 17105-41289.

So what’s next?

We are already in a corrective wave in the banking index which could unfold in three sub waves A-B-C and the pattern could be either flat or a deep correction. Looking at the indicators, it seems like we could test the starting point of impulsive wave 4 at 30900 but the fall wouldn’t be a free fall. Confirmation of the trend though would be only below 34990, which is a strong support of when we consider the upward sloping trendline.

With the resistance of 37500, the index could test the first support zone at 33900 and if that doesn’t hold its ground then the final support would be at 30900 +/- 250 points.

Contributor(s)

Kush Ghodasara, CMT, CFP

Kush Ghodasara, CMT, CFP is the Proprietor of ‎LuvKush FinServe, a Gujarat Based Financial service house which deals into Research of Equity markets, Research Advisory and Financial Planning consultancy. Kush Ghodasara is registered with SEBI under Research Analyst Regulations Act 2014....

Volatile Market Environment

Indian markets are going through volatile times. What makes it so is a tug of war between DIIs and FIIs. Domestic institutions buy in the morning while foreign institutional investors sell in the afternoon, making it a non-trending market with a bearish bias that comes with a lot of noise.

From a technical standpoint, from the last decent correction, Nifty advanced from 14151 to 18604.

Now the 0.6180 Fibonacci retracement support is placed at 16,702. As the theory of technical analysis stresses more on the importance of the golden ratio of 0.618, so are markets pausing from the long downtrend around this mark.

If the 16700 mark is broken decisively, it will open the doors to further correction towards the levels of 16,200-16,000. Keep in mind, 16,000 was the same mark where the markets broke out of a tight range-bound market.

So far what has helped this correction was fall in crude oil, a leading indicator for the global market. In addition to that, we have the rise in US dollar and Japanese yen. Both are considered safe havens and rise in periods of uncertainty. Rise in the dollar often has a negative correlation with equity markets in India. Similarly, the yen is also considered a safe haven asset and rises in times of panic. Thus, Gold, Dollar, and Yen have a negative correlation with equities. In fact JPY/INR rose by 3% in 3 days. Which is significant for any currency.

Presently, these indicators are near the resistance.

Persistent weakness in gold prices and decline in dollar index suggests concerns of omicron virus are blown out of proportion and markets can correct that in the short term.

On the weekly charts, for first time Nifty is testing the support zone of its super trend. If respected, then the markets can bounce back!

Ratio charts-

Nifty/Gold is currently holding on to good support. Nifty/gold is trading at 9.65. If it goes below 9.40 we can expect a further correction in markets. If there is a decisive close above 9.90, we can expect some short covering the markets. From an Intermarket analysis point of view, gold and equities have a negative correlation.

Nifty relative to Dow Jones Industrial is at a strong support level too. After retesting the breakout zone, the ratio is now inching higher as can be seen in the chart below. This ratio shows the strength of the local market against the Global Markets. Indian Markets are weak if it goes below 0.50, strong if it goes above 0.55.

This is what the charts say, but let’s see how it unfolds!

Contributor(s)

Arrush Adityadev

CMT Association Targets Higher Education Initiatives

The CMT Association co-sponsored one hundred sixty students from 27 universities at the Student Management Investment Fund Consortium Conference (SMIFC) hosted by Indiana State University’s Scott College of Business on Oct. 28^th & 29^th, 2021 in downtown Chicago. Conference speakers included professionals from Ariel Investments, Kingsview Partners, the CMT Association, Stifel, Nicolaus & Company, CBOE’s Options Institute, Invesco, the CFA Society Chicago, Northern Trust Asset Management and Wolverine Trading.

As technicians thoroughly understand, the art of managing money is not something that can be learned by lecture or textbook alone. When real money is at stake, impacting actual lives, the emotional intelligence acquired through genuine experience is a most admired trait by investment stewards. Student managed endowments provide university students (and their professors) the opportunity to gain such practical experiences.

Although I have not done the research to this claim, yet we all confidently know, most technicians did not come to technical analysis via higher education. Most of the technicians I know came to TA pragmatically. The traditional market theories and academic concepts learned and later employed did not adequately suffice our desire for achievement. This is the same situation students (and professors) of student managed endowments now find themselves in. Enter the CMT Association, introducing practical technical analysis concepts in addition to educational partnering opportunities for professors and associate membership benefits for CMT-inspired students.

The main objective of the conference is to deliver experiential learning, record best practices surrounding investment management, and provide professional development for finance students. The attendees engaged in networking events, panel discussions, competitions, and presentations involving portfolio construction and management (using fundamental analysis and technical analysis), behavioral finance, using derivatives in risk management, and impact of current economic changes on financial markets.

Two other CMT charterholders attended the consortium as university faculty members. Fellow CMT Edward Zychowicz had this to say: “The SMIFC conference and the SMIFC report competition are great learning experiences for the students. The interaction with students from SMIFs across the country is richly rewarding for the students as are the various presentations with finance professionals. As the faculty advisor to the Hofstra SMIF, the SMIFC conference affords me the opportunity to interact with faculty from across the country and to share respective SMIF experiences and learn from each other. Having an increased role at the SMIFC for the CMT Program is wonderful to see. The added criterion to the portfolio building project of technical analysis is an important advancement. This will highlight the importance of not only infusing Investment and Portfolio Management courses with more technical analysis concepts and applications, but it should encourage more stand-alone Technical Analysis courses at schools, as students and faculty recognize the importance. All in all, the students are tremendously satisfied with the SMIFC and the conference, as am I.”

During the conference, students demonstrated their knowledge through competitions on two Projects. Project 1 was a Poster Session (sponsored by CMT Association and Indiana State University). Students’ teams from SMIFC universities were judged on fund performance in 2021, display and visual quality, and presentation of investment strategies and results by students. The University of Tennessee – Martin took first place and $1,000 cash prize; Indiana State University placed second and won $750 cash prize; Taylor University placed third and won $500.

Project 2 was a portfolio building competition – sponsored by the CMT Association and Indiana State University. This project is an exercise of creating a long-term investment strategy and building an investment portfolio employing both fundamental analysis and technical analysis. The project consists of two parts. The first part, teams of 1 to 3 students were asked to create a paper trading portfolio with $100,000 invested in equities. Each team created a portfolio of up to 10 stocks and wrote a 5 to 8 page (including exhibits) paper describing their investment plan. These papers demonstrated their understanding and application of both fundamental analysis and technical analysis concepts. Technical analysis was one the criteria that could be used for selection, allocation, position sizing, and risk management of their portfolios.

As one of the judges for this competition, I was pleasantly surprised with implementation of technical analysis incorporated into their strategies. One paper cited Lo’s 2000 paper on double bottoms and inverse head & shoulders patterns as well as Brock’s (1999) and Han (2014) papers on moving averages. These students incorporated these concepts through the CANSLIM method propagated by O’Neil’s Investor Business Daily. Another university used a top-down approach to identify stock candidates. They then purchased those stocks trading above their moving averages and displaying relative strength. Yet another university created perhaps the most unique security screen of a rising 60 Day EMA combined with a put call ratio of less than one. These remaining candidates were ranked by relative strength divided by volatility. When all the judges scores were counted, Hofstra University ranked first winning the $1,000 cash prize; two teams from Indiana State University place second and third, collecting prizes of $750 and $500.

After the awards, I gave a presentation on technical analysis. The students were a very engaged and receptive audience. I could see the excitement in their eyes as I explained the logic and rationale of technical analysis. The energy really soared when I showed them my own application of technical analysis in my portfolio management strategies. When finished, a very long line of students and professors formed asking questions, wanting more. Many students commented it was their favorite talk of the conference. Several professors requested visitations or follow up. Professor Chuck Boughton from Truman State University had this to say: “Conferences like the SMIFC are critically important to the professional development of our students. Most current undergraduate finance curriculum are light on both technical analysis and derivatives. To understand how the techniques are applied and actually used in the field are valuable contributions from the practitioners that so generously contribute their time and expertise. This time and expertise help fill in the gaps in the undergraduate experience. All of us associated with the SMIFC conference are very appreciative on the long-standing and continuing support of the CMT Association.”

Next steps: in February, university students will employ the knowledge accumulated in part 1 of the Portfolio Building project to compete in the CMT’s live investment challenge (part 2). For this most robust competition, the CMT Association is partnering with Optuma software, a technical analysis platform, to build the paper trading platform allowing University portfolios to compete against one another. Awards will be presented by the CMT Association to the winning teams based on portfolio performance on absolute and risk adjusted basis.

Alumnus, is your university taking part? How about your local university? If this opportunity to partner with higher education excites you or if you have connections or resources to help us succeed, please contact the association at academy@cmtassociation.org or go to: https://cmtassociation.org/academic-partner-program/ for additional information.

Contributor(s)

Buff Dormeier, CMT

Buff Dormeier serves as the Chief Technical Analyst at Kingsview Wealth Management. Previously, he was a Managing Director of Investments and a Senior PIM Portfolio Manager at the Dormeier Wealth Management Group of Wells Fargo Advisors. In 2007, Dormeier’s technical research was...

Signal Diversification

There is no perfect investing system. But there are unlimited effective ones.

Diversification has been touted as a key component of a proper investment portfolio for decades by the financial industry. But asset diversification misses the point entirely. The purpose of diversifying a portfolio is to prepare for varying outcomes.

Owning different assets won’t do that. Correlations rise during periods of volatility. So you get underperformance when markets are strong, and not a corresponding amount of outperformance when markets are bad.

So what can you do?

Easy … diversify your signals, not your assets.

Any investment process is going to go through periods where it is out of sync with markets. A pure trend following system is bound to have whipsaws. Momentum-following systems can give buy signals at tops and sell signals at bottoms.

By recognizing the flaws in one system, you can develop another system to help offset the negative effects of those flaws. Then it becomes a decision of how much exposure you want to one system versus another. Or in reality, exposure to a variety of different systems.

Let’s look at an example of a trend following system combined with a momentum system.

Trend System: Long SPY or Cash. 100% in SPY above the monthly pivot point, 100% cash below it. Buy and Sell signals are based on a specified period of consecutive daily closes above or below this level.
Momentum System: Long S&P 500 Sector ETFs based on a weekly RRG chart, using SPY as the benchmark. Stop losses based on a percentage decline from purchase price.

(These are simplified versions of actual investing systems that we use at IronBridge Private Wealth.)

Let’s first look at a chart of a long/cash trend system using SPY and pivot points.

This chart shows us a few things:

The green shaded areas are when the system is long SPY. Un-shaded areas are when it is in cash.
The system is designed to be in most of the uptrend, while avoiding the major bear markets.
During periods of volatility, this system experienced whipsaws. These whipsaws can result in both underperformance relative to the S&P 500 index, as well as experience losses in the portfolio.

By itself, this is not a bad system. However, what if we could combine this system with another one that didn’t reduce exposure on the smaller pullbacks?

The goal of a complimentary system to the strategy above would be to maintain exposure during the times when the trend system was in cash. The un-shaded areas above did not result in major market declines. After all, there are lots of 5-10% pullbacks over time, and many of them are quickly recovered.

Knowing what you’re trying to achieve, you can then create a system that is aimed at staying invested during those pullbacks. It could be created using RRG charts, moving averages, other trend markers…the options are endless. Plus, instead of having an exit based on that signal, you could have a simple stop-loss that is likely to not be triggered during these declines.

Your buy and sell signals in the second system are both independent and complimentary of the first system. And they are simple enough to be repeatable over time. You could even layer in ways to create potential outperformance in the uptrends to further enhance the effectiveness of the combined systems.

You can still diversify your asset exposure in addition to diversifying your signals. Simply apply the same rules to US stocks, international stocks, bonds, crypto … you name it.

But before implementing any type of investing system, you must be able to back-test it. This accomplishes a few important things:

It forces you to create rules. You cannot back-test without specific buy/sell criteria.
It allows you to objectively identify flaws. You can hope a system works in various market environments, but you won’t know for sure until you see the actual data.
It allows you to test the effectiveness of complimentary strategies. Again, you don’t know if it works until you see it.
It helps eliminate the biggest source of risk: YOU. Getting your emotions out of the process is the single most important aspect of any system. You can’t predict the markets, so stop trying.

Strive to create disciplined and repeatable investment processes, based upon diversifying your signals.

By doing this, you can then create an effective system for you or your clients in any market environment.

Contributor(s)

Jim Denholm

The 30-Year Breaks and Treasury Spreads Tank

US Treasury yields are a mess.

Short rates are holding up fine, with the 2-year yield pressing to its highest level since early February 2020, while on the other end of the curve, the 30-year is breaking down to new 52-week lows.

It seems the bifurcation we’ve seen among stocks has made its way to the bond market. So that raises a couple of important questions …

Could these mixed signals coming from the bond market be just that – mixed signals – and nothing more? Or is the bond market suggesting more downside pressure for cyclical assets in the coming weeks and months?

Let’s look at a few charts to shed light on these pressing questions by highlighting critical levels.

First, we have the 30-year yield rolling over to its lowest point during the trailing 52-weeks:

The longer end of the curve breaking down is concerning. It doesn’t necessarily need to keep pace with shorter duration rates, but it still needs to participate on some level. Last week’s resolution lower does not suffice, nor does it bode well for cyclical value stocks and commodities that are already under pressure.

As long as the 30-year is below 1.90, we must imagine that the reflation trade and global growth narratives are struggling to find traction, especially if T-bonds are catching a bid.

Not only are longer duration rates taking out their summer lows, but so is the 2s/10s spread:

The 2s/10s spread contraction is another data point suggesting more downside action in rates further out on the curve. It also implies that the 10-year yield is under pressure as well.

And that’s exactly what we’re seeing as the 10-year broke below the key 1.40 level last week:

We’ve been focused on the 1.40 level for several years now … and for good reason. Yields bounced at this very same area in 2012, 2016, and 2019. Though there might not be price memory, investors are keenly aware of this level.

If it were to continue to slide, making new lows like the 2s/10s spread or 30-year, we’d be looking at about 25 to 30 basis points of downside from here. That’s a big move, and it would have profound implications for risk assets.

Upside participation among stocks and commodities is most likely narrowing if investors are being rewarded for buying bonds.

But what would it take for the global growth and reflation narratives to get back on track?

For starters, yields have to stop going down. The 10-year needs to reclaim 1.40, and the 30-year needs to get back above 1.90. It would also be constructive if treasury spreads widened and the yield curve steepened.

Of course, we’re not seeing any signs of that today, as the market paints quite a different picture.

Contributor(s)

Private: Ian Culley

Ian Culley has been a member of the CMT Association since 2018. He is a technical analyst at All Star Charts where he focuses on commodities, currencies and fixed income. Ian provides weekly commentary and analysis rooted in classic charting principles and...

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Membership

The CMT Association would like to congratulate the following members on their new positions:

Craig Fullen, Esq., CMT, Of Counsel at Porter Wright Morris & Arthur LLP

Yug Patel, Content Creator at Crypto Gems Youtube Channel

CMT

Now that the December 2021 test administration has nearly concluded, early registration for the June 2022 test administration will open on December 20^th. Fees for the exam have not increased, so be sure to take advantage of early registration; early registration will end on February 14^th.

The Association receives several emails from new candidates about the exam, and most of that information can be found on the website under CMT Program/Policies and Procedures. The page contains information about program fees, cancellations, grading, what you need the day of the exam, etc. I encourage all candidates to peruse the page to get a better understanding of the exam’s policies.

The CMT Association would like to congratulate the following members who received their CMT Designation in November 2021.

Claudio Catalani
Clarke Long
Anders Nyberg
David Malyga
Jared McCutcheon
Rahul Mudliar
Karan Pai
Au Pak Sze
Michail Platamonas

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Marie Penza

Marie Penza serves as the Director of Member Services for the CMT Association.