Posted | by David Moenning |

With so many big events on the calendar this week (North Korean Summit, Sprint merger ruling, FOMC meeting, ECB meeting, BOJ meeting, as well as the ongoing trade negotiations and data on retail sales, industrial production, and inflation data) there is little doubt that the algos are primed and ready to react to the headlines. As such, volatility is likely to return to the game and we should probably have a plan.

So, the question is, how should one play all the potential big, bad events on the calendar?

If I've learned anything over the years about the algo-induced volatility that tends to occur in reaction to these types of events/crises/headlines/tweets/rumors, it is that the freak-outs usually wind up being what I'll call "market noise" and that staying in tune with the primary trend of the market is more important than trying to "time" the next five hundred Dow points. You see, the bottom line is the primary market trends tends to resurface once the volatility subsides.

For years, I have contended that the character of the market changed in 2010/11 as high-speed and high-frequency trading began to dominate the action in the stock market. In fact, a recent Bloomberg report backs me up, citing data from Goldman Sachs and Aite Group that showed the percentage of algorithmic trading in the stock market rose from approximately 25% in 2004 to nearly 70% in 2017. A separate study by Morgan Stanley puts the percentage of high frequency trading in the stock market even higher - at 84%. So, again, in my opinion, the market has become noisier than ever.

It is for this reason that several years ago I began moving toward a longer-term approach to manage portfolio risk. I felt that trying to manage the short- or intermediate-term action in the market had become exceptionally difficult due to the increase in both the number and the size of the whipsaw trades created by the increased intraday volatility.

I also believe that the algos tend to exaggerate daily moves in the markets, which wind up triggering a lot of false signals for short-term traders focusing primarily on price action.

From my seat, the answer was to step away from the arms race occurring in high-speed trading. I did not have access to co-located computers and I could not implement millisecond trend-following systems. So, I decided the better play was to simply ignore the "noise" and focus on the big-picture trend of the markets.

Instead of trying to "play" every wiggle and giggle on the chart, I wanted to focus on the primary trend. You know, the major bull/bear cycles. I learned a long time ago that getting the mega moves right, such as the bull from 1990-2000 and the bears of 2000-02 and 2008, was where the real money was made. Where people's futures were made.

To be sure, this is easier said than done. But after 25 years of developing risk-managed strategies, I felt I had a pretty good base from which to work.

For example, I knew that I could no longer rely on a single investing indicator or model, then set it and forget it. Heck, I couldn't even depend on a single trading methodology. No, I have learned that Ms. Market has a tendency to fool any/all such strategies - and usually at the most inopportune times!

In all seriousness, the problem with such an approach is the markets and the drivers of markets are constantly changing. And while my compliance people hate it when I make "absolute statements," there is simply no single indicator that has been able to consistently get the market moves right and adapt to the market mood changes over long periods of time.

This caused me to recognize that I needed to use multiple methodologies in my approach. In other words, I couldn't be just "a trend and momentum guy" if I wanted to succeed over the long-term. Nor could I focus only on fundamentals... or monetary policy... or valuation, etc. No, it ALL needed to be included.

What I came up with is a two-pronged approach. One "weight of the evidence" model focuses on the technical stuff such as trends, momentum, and mean reversion indicators/models. And a separate model focuses on the fundamental stuff like earnings, the economy, the Fed, yields, inflation, etc.

The idea then is to focus on the "message" from the "weight of the evidence" in terms of both technicals and fundaments. If the message from the models is positive, it is probably best to stay invested in stocks and buy the dips. If the message is negative, it is likely a good idea to focus on preserving capital. For me, anyway, this is a logical approach that is unlikely to be "fooled badly" by the next tweet or rumor out of places like Italy.

Circling back to the initial question at hand, the way I plan to handle this week's plethora of inputs is to continue to focus more on the "state of the models" than any line in the sand on the charts or the hysterics from the talking heads. And since the models are currently in pretty good shape, I'll likely use any downside volatility (especially if it is violent) to add to positions and put any available dry powder to work.

HCR Awarded Top Honors in 2018 NAAIM Shark Tank Portfolio Strategy Competition

Each year, NAAIM (National Association of Active Investment Managers) hosts a competition to identify the best actively managed investment strategies. In April, HCR's Dave Moenning took home first place for his flagship risk management strategy.

Press Release

Want to Learn More? Contact Dave

A Word About Managing Risk in the Stock Market

Thought For The Day:

Always and never are two words you should always remember never to use. - Wendell Johnson

Wishing you green screens and all the best for a great day,

David D. Moenning
Founder, Chief Investment Officer
Heritage Capital Research

HCR Focuses on a Risk-Managed Approach to Investing
Must Read: What Risk Management Can and Cannot Do

HCR's Financial Advisor Services

HCR's Individual Investor Services

Questions, comments, or ideas? Contact Us

At the time of publication, Mr. Moenning held long positions in the following securities mentioned: None - Note that positions may change at any time.


The opinions and forecasts expressed herein are those of Mr. David Moenning and may not actually come to pass. Mr. Moenning's opinions and viewpoints regarding the future of the markets should not be construed as recommendations. The analysis and information in this report is for informational purposes only. No part of the material presented in this report is intended as an investment recommendation or investment advice. Neither the information nor any opinion expressed constitutes a solicitation to purchase or sell securities or any investment program.

Any investment decisions must in all cases be made by the reader or by his or her investment adviser. Do NOT ever purchase any security without doing sufficient research. There is no guarantee that the investment objectives outlined will actually come to pass. All opinions expressed herein are subject to change without notice. Neither the editor, employees, nor any of their affiliates shall have any liability for any loss sustained by anyone who has relied on the information provided.

Mr. Moenning may at times have positions in the securities referred to and may make purchases or sales of these securities while publications are in circulation. Positions may change at any time.

The analysis provided is based on both technical and fundamental research and is provided "as is" without warranty of any kind, either expressed or implied. Although the information contained is derived from sources which are believed to be reliable, they cannot be guaranteed.

Investments in equities carry an inherent element of risk including the potential for significant loss of principal. Past performance is not an indication of future results.