- You can, by knowing what they do to protect their at-risk capital.
- That tells just how far they think its price can go, both up and down.
- Their prior implied price range forecasts have a history of subsequent price moves.
- That history tells when their forecasts are best on this ETF, and by how much.
- Behavioral analysis in action: Follow the money, the smart money, when it is being smart. You don’t need to know all of why they do what they do.
Are you an expert on European political developments?
Neither am I. For me it is a fascinating field of ignored education, my maligned attention in a knowledge rush to embrace Arabic - the numbers, that is.
But of the moment, the actions of the best-informed, best-resourced players in the ETF investment game are telling us that if we want to make money this is a time to pay attention to shares of Direxion Developed Markets Bull 3X Shares (NYSEARCA:DZK).
The DZK is a volatile, structurally-leveraged ETF, designed to move in price some three times as far on a daily basis as the MSCI EAFE index of hundreds of established-company stocks in economically well-developed countries. Its official description is as follows:
The MSCI EAFE Index is recognized as the pre-eminent benchmark in the United States to measure international equity performance. It comprises the MSCI country indices that represent developed markets outside of North America: Europe, Australasia and the Far East.
Neither political intrigue over the Euro nor international corporate competitive secrets are what hold our attention here. We're just after what's likely to happen to the price of this DZK, in the space of the next 3 months.
The folks most likely to know are the market-making professionals who daily are motivated by their own profit plans to put employer-firm capital at risk in the process of helping their clients adjust their portfolio holdings of this ETF.
They have the arbitrage and hedging skills to protect that capital from its exposure to risk. And they have world-wide exhaustive information-gathering systems staffed by local expert evaluators and integrators, equipped with cutting-edge communication systems to stay (usually) a step ahead of their big-money clients. Their sense of what the risks are currently is probably as good as can be got.
They also have no interest in our knowing what they know, or our getting in their way.
But they can't protect their exposed capital without leaving footprints in the protection markets. What they are willing to pay for protection, and the way they choose to do it tells just how far they think the prices of things in their interest are likely to go.
We know how to translate their actions into forecasts of probable coming prices. Here is what they have been thinking about DZK's prospects, daily for the last 6 months:
(used with permission)
The vertical lines of this picture are forward-looking forecasts of coming price prospects, not the backward-looking histories of actual prices found in most stock charts. The heavy dot in each line is the end-of-day market quote at the time of the forecast. It separates the expectations range into upside and downside components.
The balance between those parts often has implications for future changes in price. We measure that balance with the Range Index [RI], whose value is the percentage of the whole forecast range that lies below the then current market quote; in this case it currently is 9.
The rather brief life of this ETF still provides us with over four years of daily forecasts and Range Indexes. The distribution of RIs is pictured in the thumbnail at the bottom of the picture above. A 9 is clearly near the extreme low end of the distribution.
We examine the subsequent price progress of each stock and ETF following every forecast, striated by their upside-to-downside proportions. A standard table is constructed, with columns measuring cumulative price change week by week for 16 weeks, or almost 4 months.
The rows of the table start at a middle blue row that is an average of all days' price changes; the subject's underlying average price trend during the most recent 4-5 years. Then each row above and below that average progressively excludes those forecasts with more even balance between upside and downside, including only the more extreme forecasts at the top and bottom rows of the table.
The #BUYS column counts the number of days' forecasts included, with the current-day balance row indicated in magenta. Past price changes in the 10-11 weeks after such forecasts with current prospect proportions of 10 to 1 have run at annual rates of 35% to 45%, 3-5 times DZK's average +10% to +12% trend. This appears to be a better than average time to consider a buy of DZK.
But how to know when to take the profits and run?
A more comprehensive measure of DZK's current prospects comes from applying our standard Time-Efficient Risk Discipline test to its past forecasts' performance. That test places a cost on each forecast day's hypothetical holding at the closing price of the next market day after the forecast. The top of the forecast range is set as a sell target, to close out the holding on its first equal or greater end of day price experienced. If that has not happened by the 63rd market day (3 months) the position is closed out regardless of gain or loss, but not before.
The results of that test are shown in the one-line data table below the 6-month daily block trader forecast picture above. In the four years (1063 market days) of forecasts available to us, 23 have been at the present-day forecast balance level of an RI around 9.
With the 23 put to the test, the average closeout gain was +15% in 28 market days or an annual rate above +250%. There were 20 profitable positions and 3 losses, a ratio of 87 out of 100 or 7 out of every 8. During each holding period a record was taken of the worst-case price drawdown below cost. Their average was -10.8%. Obviously most holdings recovered from that condition, since only 3 actually lost money and the gains net of the 3 losses were substantial.
Now we are looking at an upside price prospect in DZK of +10% higher, with odds of 7 to 1 that it may produce a result that will be +10% instead of -11%. Why may it turn out to be one, rather than the other? We don't know, and really don't care much.
What is important to us, and we believe to most investors, is the perspective gained in knowing what can reasonably be expected to happen, for good, or for not so. Similar perspectives on several alternative equity investments allow the intelligent choice of which alternative to prefer among those available, if capital is present now and needs to be put to work.
In today's real-life situation there are 15-20 alternative choices with varying competitive prior experiences coming from their earlier forecasts like today's. (They are available by subscription at our website, blockdesk.com)
Only one has demonstrated comparable annual rates of gain, but has 4/10ths of its forecast range to the downside instead of DZK's only 1/10th. One other equity has an 18% upside target with a 97 / 100 win rate but averaged longer holding periods that reduced its pace of wealth building from DZK's +250% rate to "only" +150%. Another has had worst-case price drawdowns of only -4% with a current upside prospect of +14%, yet has only demonstrated net gains smaller than its present sell-target objective. Still, it has had net gains large enough to build wealth at a +200% rate.
Many dimensions can, and should, enter into a capital commitment decision. But they should be the investor's choice, since he/she has to live with them, particularly when market prices are not behaving as desired. Those stress situations are where discipline is most likely to break down and mistakes get made.
Perspective needs to be personal. Easiest to have for the individual investor, hardest to develop among an investment committee. But essential in both cases. A DZK buy here is quite logical and attractive from several points of view.