Combining Portfolio Metrics and Strategies for Investing and

Trading

Discussed by:Paul Grems Duncan, Leader, Tri-State Investors Group

http://forums.effectivevolume.com

http://greekgodtrading.blogspot.com

September 13, 2011 1

Admin Example files are located in my forum at

http://forums.effectivevolume.com Directions on how to access these files are at

the end of the presentation. Information presented here is for educational

purposes only. I am not recommending that you buy/sell any security, nor am I responsible for decisions that you make to your own portfolio. Take ownership for your actions!

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Portfolio Metrics: Do We Care? Yes! Portfolio Metrics help us understand

whether the changes we make to a portfolio are beneficial.

To use metrics though, you have to keep some form of log… (which I will provide an example… )

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My Favorite Portfolio Metrics Calmar Ratio (covered tonight) Pessimistic Return Ratio (covered tonight) Mathematical Expectation (omitted due to time

constraints)

There are others (Sharpe Ratio, Sortino Ratio, Upside Potential Ratio, etc.) but they are more difficult to understand and apply consistently (in my opinion).

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The Concept of Drawdown What is Drawdown (DD)? Drawdown is the measurement from the maximum

(equity, price) peak to the lowest value AFTER the peak. Perceived Drawdown is:

• the mechanism that causes us to sell a stock in a decline, resulting in us locking in losses rather than having confidence in our mechanical systems.

• the enemy of mechanical trading. There IS a distinction between intra-trade DD and end-

of-trade DD – end-of-trade is far more important!

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Drawdown Example:Daily Russell 2K Since 1987

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Calmar Ratio

Example of CR = 0.82(CRR = 30.5%, MDD = 37.4%), 12/2/08 to 12/2/09

8AAII Accelerated EPS Strategy (Modified Shadow Stock Portfolio Criteria)

Example of CR = 5.07(CRR = 41.6%, MDD = 8.20%), 5/4/09 to 5/4/10

9AAII Accelerated EPS Strategy (Modified Shadow Stock Portfolio Criteria)

Steps to Track Calmar Ratio 1) You need your equity curve, either real

or backtested. Build it! Track it! 2) Download CR-CalculationExample.xls at

my forum at Effective Volume (once you’ve registered, of course).

3) Calculate your Compounded Rate of Return, as well as your Maximum Drawdown

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CR Moves with Time!(Thankfully, Not Fast)

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1996 – 2010, AAII Accelerated EPS Strategy (Modified Shadow Stock Portfolio Criteria)

Average = 2.02+/- 1.31 Stdev

UglinessUglinessUgliness

Criticisms of CR The definition uses the compounded annual

return (CAR); this isn’t practical for short bursts of trades as the time frames do not align. Trades occurring in a 4-week burst do not extrapolate to 12 months very well.

Correspondingly, many people simply use total return (if less than 1 year) and the actual MDD. The purists will shutter, but this latter method works until a solid history per strategy is developed.

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Pessimistic Return Ratio (PRR) Pessimistic WHAT? Created by Ralph Vince and published in

“Portfolio Management Formulas” (ISBN 0-471-52756-4), this is a REALLY good method to understand your profitability and whether your methods will work in the longer haul.

PRR is like ME but it gets better as the number of trades increases.

Pessimistic Return Ratio

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PRR Example

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Steps to Track PRR 1) Download “

ME-PRR-CalculationExample.xls” from my forum at Effective Volume – this is a log that auto-calculates PRR (yes, this file also calculates Mathematical Expectation).

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Example Trade Log for Autocalculating PRR

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Enter Tradesby Strategy

Worksheet Auto-calc’s VariousParameters

ME-PRR-CalculationExample.xls

Review of Metrics Calmar Ratio: Compares gain to

drawdown. Tells you if you’re taking too much risk (DD > gain is bad)

Pessimistic Return Ratio: stronger approach of the two, it tells us how good a strategy is, and it improves as the number of trades goes up

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A Look into the AAII Shadow Stock Portfolio

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AAII Shadow Stock Portfolio Standard AAII portfolio: http://www.aaii.com/model-

portfolios/stock-rules Focuses on Small Cap stocks between $17 and $200M in size Performance over last year has been quite good, but

historically?

AAII MSSP PerformanceActual vs. Vanguard 500 Idx & Vanguard SmCap Idx

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AAII MSSP PerformanceActual vs. Modeled, 1997-2010, corr = 0.816

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Avg CR = 3.49 +/- 5.14

MDD = ~49%

AAII MSSP Performance The assumption here is that the modeled

performance is “adequate” at corr = 0.816 (1.0 = perfect, 0.0 = no correlation)

The drawdown of 49% would most likely have caused most to bail long before this occurred, then losing out to subsequent gains in 2009 and 2010.

The average CR of 3.50 is very, very good, but, the standard deviation of +/- 5.14 suggests major losses (3.5 – 5.1 CR < 0 – BIG PROBLEM)

How to stabilize CR by reducing MDD?

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Improving AAII MSSP Performance

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“Market Cap Favoritism” – There are certain periods in the cycle that Small Caps underperform

Chart is the RATIO of Russell 1000 (Large Caps) to Russell 2000 (Small Caps) – R2K is in the Denominator

Favor Small Caps

Favor Small Caps

Favor Large Caps

Favor Large Caps

AAII MSSP PerformanceGated w/ Russell 1K/2K Favoritism

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Avg CR = 4.59 +/- 5.76

MDD = ~28%

Stockcharts can Assist in Analysis

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http://stockcharts.com/h-sc/ui?s=IWB:IWM&p=D&yr=3&mn=0&dy=0&id=p89665290604

AAII MSSP Conclusions It’s possible to use CR (as well as other metrics) to

quantify adjustments to a strategy. The AAII MSSP strategy is a good strategy, but

management of the drawdown must occur or we’ll lose confidence in the system.

The general trend of favoring large caps or small caps certainly helps to provide confidence that we’re not running with small caps when the large caps are dominating.

Right now (Sep11) it appears that large caps are favored, so this strategy will have you exposed if you are long.

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Determining the Trend

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This is a TOUGH Market(for trend following)

http://www.automated-trading-system.com/resources/trend-following-wizards-fund-performance/

Professional managers, many of whom are formal “Turtles”, had a good month in July (August not yet published) but overall, are even on the year.

Note that the range is 35% in

less than 9 months

What is the Present Trend? Pascal Willain, creator of the Effective Volume concept,

presents the status of the market trend according to his EV metrics at his EV web site: http://forums.effectivevolume.com/content.php?539-20DMF

The system is based on the money flow of large players into sectors, determined by individual stocks and ETFs.

Pascal’s system allows for three states: Long, Cash, and Short

While you must be a subscriber to the forum for signal content, the fees are quite reasonable ($50/quarter, $149/year) and entitle you to the 1000+ equity database of EV data. Registration is free and he’ll let you kick the tires for a couple of weeks on a trial basis if you ask. Just tell him you heard the offer from me.

(Disclaimer: I receive nothing for telling you this)

What is the Present Trend?

Positive Trendline =

Bullish

Diverging S&P 500 Price Action

http://forums.effectivevolume.com

Intraday MF not going down =

Bullish

What is the Present Trend?

Presently, Money Flow, as of the close of markets Monday, September 12th, was showing that money flow was continuing to flow INTO the markets. This is bullish.

There has been great uncertainty as to the Greek situation as well as our domestic jobs programs, which have weighed heavily on the markets.

Pascal’s system is telling us that we need to be ready to go either way, but since money flow is still positive, I’m more bullish than bearish on the short-term trend.

Of course, if the markets reverse …

Effective Volume – aka “Follow the Whales”

Effective Volume separates minute-by-minute volume and price movements, resulting in assigning volume movement to two groups:• Large Effective Volume (LEV): volume attributed to institutionals and

other big players. Occurs because once the bid/ask is satisfied, the price must move up if the bid is unsatisfied, else the price must drop if the ask is unsatisfied

• Small Effective Volume (SmEV): volume attributed to retail buying and selling of an equity. Typically, small selling does not move the price a significant amount over extended periods of time.

Pay particular attention to equities and groups that have: • (+) money flow and/or (+) total effective volume (TEV), AND• (-) decreasing price action

Divergent EV Stocks If you are a member or on a trial, you can

get a daily view of these stocks here:

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Top EV Positive Divergent (Long) Candidates for 9/13/11

35http://www.effectivevolume.eu/content/Reports/DIVA.xls

Let’s look at the first 4 (arbitrary choice) to see why these are candidates …

How to Review Equities @ EV Site

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KEX – Closed 9/12 @ $54.80

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Distance between 20d trend line and daily is large, but upsloping trend is bullish.

Upside target: $71

Downside floor: $47

Huge spike up in LEV suggests possible surge in price pending;

SPTN – Closed 9/12 @ $15.44

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Trendline has just turned up stock is starting to be accumulated.

Note strong Large Effective Volume (LEV) push which started around 9/7

Upside target: $21

Downside floor: $14

IACI – Closed 9/12 @ $39.54

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Trendline has just turned up stock is starting to be accumulated.

Note strong Large Effective Volume (LEV) push which started around 9/2 or so

Upside target: $44

Downside floor: $35

BBBY – Closed 9/12 @ $58.01

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Trendline is strongly bullish since positive

Constant accumulation by large players while retail players ignore

Upside target: $64

Downside floor: $55

The Day’s Summary We covered two relevant metrics to assist you with your

portfolio: CR and PRR We looked at the AAII MSSP performance, and then suggested

a method to improve drawdown which will help CR in the long run. The method is not related to the strategy at all (What was it? Hint: Russell 1K vs. Russell 2K)

We looked at how to use EV web site large player money flow to determine whether the trend is up or down. Right now indications are bullish, as money continues to flow into the markets.

We used the EV DIVA.xls file to present selective candidates for evaluation.

There are files to download at the Effective Volume site. You must register to view these files; directions follow on the remaining slides.

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From Pascal Willian, Creator of Effective Volume:

If you are interested in becoming a member at the Effective Volume site and accessing the EV data, there is a special offer for AAII participants:

Go to http://www.effectivevolume.eu/EV_Subscribe_Special.html

and if you mention that you’re an AAII member and attended this presentation, you’ll get $10 off the yearly subscription of $149 (most of which goes to charity – see the web page). This will give you daily access to EV data on over 1000 stocks and 200 ETFs. It is an eye opening experience to your investing/trading.

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Paul Duncan(703) 509-5332

grems8544@gmail.com

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Registering for Access to Presentation Files (and Paul’s Forum)

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Step 1: Registration Page at Effective Volume

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http://forums.effectivevolume.com/register.php?

In the Registration QuestionPlease state “Registering perPaul Duncan / AAII Wash DCMeeting”

Step 2: Confirmation of Registration

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Step 2: When you receive an email confirming your registration, click on the link in the email. You will receive the following screen:

Step 3: Registering for Paul’s GGT Forum

Step 3: After you receive the previous screen, you’ll have to wait for an admin-type to approve you into the forum. You will receive an email when this is completed.

IF you specified that you were from the AAII group, you should be automatically added to the GGT Forum. Here is how you check:

1) Log In to http://forums.effectivevolume.com 2) (next slide)

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Step 3: Checking/Registering for Paul’s GGT Forum

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Click this First

Click this 2nd

See if this says “LeaveGroup” or “Join Group”Feel free to join the othergroups – it is free.Paul’s is the

GGT Group

Access to AAII Presentation Files

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This thread “Links” contains the links to the files;They are at the BOTTOM of the thread.

File Location w/in Thread

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The Excel (and tonight’s PowerPoint) files will be located under this header

Note: this is message #1 of the thread – it is at the BOTTOM of all the messages