Written by Jeff Miller, A Dash of Insight
— This post authored by Mark Hines
Our previous Technical Thoughts considered the pitfalls of trying to win every trade. If you missed it, a glance at your news will show that the key points remain relevant.
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This Week – Do Your Trades Fit Your Style?
Like months to a flame, traders often try to copycat whomever has the hottest hand. Unfortunately, this often ends badly because the trades don’t necessarily fit each individual’s style. For example, when developing our trading systems, our early models were often viewed as “suggestions” by the traders using them. However, we quickly learned that providing a momentum model to a “buy the rips, sell the dips” trader simply does not work.
According to Michael Martin, the author of “The Inner Voice of Trading,” traders should “befriend [their] emotions and make them allies not antagonists.” One reason for this “Stock Exchange” series is to illustrate different approaches and styles via our different models.
When implementing our models in practice, we don’t force trades when there are none. Similarly, we rarely skip trades – and only when there is some exceptional news that the model would not recognize. For example, when there is a buyout offer for a company we do not buy the target and we take it out of our universe. We know that the risk reward is poor, but the model would not.
Expert Picks from the Models
This week’s Stock Exchange is being edited by our frequent guest: Blue Harbinger (also known as Mark D. Hines). Blue Harbinger is a source for independent investment ideas focused on value and income opportunities.
Holmes: This week I bought American Airlines (AAL). This stock’s dip over the last month is the sort of set up I like to see. From the chart below you can see it is below its 50-day and 200-day moving averages. However, it has attractive upside over the next six weeks.
Blue Harbinger: As a contrarian and a value investor, I actually like your buying style, Holmes. I’d much prefer to buy something when the stock price has just pulled back. However, I also like to dig deep into the details. Have you considered that American Airlines doesn’t hedge its fuel costs, and it has racked up a fairly high amount of debt in order to maintain its relatively young aircraft fleet?
Holmes: I’m typically in and out of my trades in about six weeks, and that timeframe is fairly insignificant to the age of the fleet. Also, it seems like a smart move not to hedge the fuel costs considering oil prices continue to be much lower than they were three years ago. And unless there is some extreme shock in the markets, I suspect energy prices won’t move too dramatically during the time period I hold the shares.
BH: So if you’re planning to hold this position for only about six weeks, what exactly is it that you like about American Airlines?
Holmes: My style is based on dip buying and mean reversion, and this stock is setting up nicely for a rebound in the coming weeks.
BH: I like dip buying and mean reversion too, but I like to hold on to my positions for much longer than six weeks.
Holmes: Interesting, however there is simply too much opportunity to profit more significantly over shorter time periods. Your longer-term strategy seems boring, and it simply does not fit my style.
RoadRunner: There is more than one way to skin a cat, Holmes. I can appreciate your typical six-week holding period, considering mine is usually around four-weeks. However, your mean reversion strategy doesn’t exactly fit with my style. I like to buy stocks that are at the bottom of a rising channel, and if you look at the chart below you can see why I like Activision Blizzard (ATVI) this week.
BH: The rising channel makes sense considering Activision Blizzard beat its own earnings guidance in Q2, and it provided full year guidance that exceeded consensus estimates. Also, as the following grahic shows, the company has been focusing on building strong franchises for its video games. If you recall, we covered the importance of franchise value previously (Stock Exchange: How Durable Is Your Franchise?).
RR: I appreciate your efforts to dig into the company’s franchise value, however that’s more of a long-term thing, and I don’t suspect it’ll materially impact the price over the next four weeks. However, I do suspect it will rise back up to the top of the channel, but it’ll only hold that position for so long. How about you Athena and Felix, what do you like this week?
Athena: I don’t have any trades this week, and I’m not going to force anything.
Felix: Same here. No trades stood out for me this week, and I’m not going to force anything either. However, for your reference, here is a look at my rankings this week.
BH: Thanks Athena and Felix. How about you, Oscar, what have you got?
Oscar: I have an interesting one for you guys. This week I like IBUY, the Online Retailer ETF.
BH: That is interesting considering the “death of retail” narrative that been reverberating across the market. Some investors believe all “brick and mortar” retail stores are going to get “Amazonned.”
I looked through this ETF’s holdings, and it’s diversified across a lot of the online retail names that you’d expect (Like Amazon) as well as a few interesting surprises.
Oscar: I like IBUY because it has a lot of momentum (as shown in the chart below). My typical holding period is also about six weeks, my exit strategy is to rotate into a new sector, and I control my risk with stops.
BH: Personally, I think the death of retail narrative is a little overblown, but that probably doesn’t matter much since you usually only hold for a little over a month. Have you considered this ETF’s expense ratio (0.65%) and the fact that it still has just under $100 million in total assets?
Oscar: I’m comfortable with both of those (expense ratio and asset under management). Plus, I’ll be in and out of this trade within six-weeks.
Conclusion
One of the common reasons why many traders like model-driven investing is because it’s supposed to take the irrational emotions out of trading. However, if the person managing the model has the ability to override it, then emotion becomes an ongoing challenge.
One way to prevent emotions from antagonizing your trades is to select a trading approach that fits your emotions. Our models all have different personalities, and we’ve learned the importance of using a model that fits the personality of the person running it. By selecting a trading approach that fits your emotional style, your chances of error are reduced, and your chances for success go up.
Stock Exchange Character Guide
Background on the Stock Exchange
Each week, Felix and Oscar host a poker game for some of their friends. Since they are all traders, they love to discuss their best current ideas before the game starts. They like to call this their “Stock Exchange.” (Check it out http://dashofinsight.com/background-stock-exchange/ for more background). Their methods are excellent, as you know if you have been following the series. Since the time frames and risk profiles differ, so do the stock ideas. You get to be a fly on the wall from my report. I am usually the only human present and the only one using any fundamental analysis.
The result? Several expert ideas each week from traders, and a brief comment on the fundamentals from the human investor. The models are named to make it easy to remember their trading personalities.
Getting Updates
We have a (free) service for subscribers of our Felix/Oscar update list. You can suggest three favorite stocks and sectors. Sign up with email to “etf at newarc dot com”. We keep a running list of all securities our readers recommend. The “favorite fifteen” are top ranking positions according to each respective model. Within that list, green is a “buy,” yellow a “hold,” and red a “sell.” Suggestions and comments are welcome. Please remember that these are responses to reader requests, not necessarily stocks and sectors that we own. Sign up now to vote your favorite stock or sector onto the list!
