Alpha Momentum Strategy - Portfolio Report – October 2018, Second Half

As per The Alpha Momentum Strategy:

  • The intermediate trend of the S&P 500 is down

  • The long term trend of the S&P 500 is up

When the system determines that the trend of the stock market is down on one time frame (but not both), like right now, we take a defensive stance and move half of the portfolio to cash. We move to cash in order to protect capital and avoid a deep and prolonged drawdown.

What is the risk in moving such a significant portion of the portfolio to cash? The risk is that the market quickly regains strength and continues higher without us. While our model shows that this can certainly happen (and often does), our model shows us that by taking the risk of missing out on some upside performance, we are increasing the likelihood that we avoid drawdowns of 30%+ like those seen in the early 2000s and during the Great Financial Crisis. This is a risk that we want to take.

We will be executing trades such that the model portfolio reflects the following composition as of close of trade tomorrow, October 12th.

We are in drawdown.

Equity markets have sold off aggressively over the past two days, and the S&P 500 is now 7% off the highs seen earlier this year. When the stock market sells off, and especially when moves lower are aggressive relative to volatility levels to which the market has been recently conditioned, it can be a scary time to be an investor. The stock market becomes a major focus of mainstream news, and it is hard NOT to look at your account values and worry.

As systematic traders, we take solace in knowing that our process has been tested over several decades of market history and that our process has inbuilt methods to defend against large drawdowns. Drawdowns are a part of investing, and having a defined process helps us to make the optimal decision despite incomplete information (“the fog of war”).

As our good friend and founder of Fortuna Investors, Michael Ritger, said yesterday:

“I give no thought to a market move like today until I hear from clients, who might not have the needed perspective. A 3% move has zero impact on any timeframe that matters and our strategies have thrived in 50 year tests that included far worse.”

While the US equity market selloff continued into today, his comment remains valid. We design systems and processes to, amongst other things, protect us from ourselves. The rules have already been determined, now we just need to follow them.

For more context on drawdowns and how they relate to systematic trading and investing, you can read an article that we wrote back during the March, 2018 drawdown in our portfolio HERE.

Thanks for following along!