- Experienced market professionals, paid millions of dollars annually, protect themselves by skillfully hedging at-risk firm capital required to serve big-money investment clients.
- Their intelligent actions and repeated client orders reveal just how far they think the prices of specific investments are likely to be pushed by funds and institutions with money muscle.
- Besides frequent daily client conversations, continually operated world-wide information gathering systems update their extensive current knowledge bases, evaluated by research staffs.
- Behavioral analysis of these actions tell which securities' prices are skillfully foretold by these pros over years of daily observations.
- That integration of information and judgment, when known, makes direct comparisons of widely diverse ETFs possible, practical, and profitable for individual investors.
It also reveals serious, widespread investing misunderstandings...
... Like the nature of investment risks, which are all ultimately reflected in securities' prices.
The most serious investment misconception is that an investment's price change risk is static, describable by statistical analysis of past history of prices, in terms of measures, like "beta" that change infrequently and in small amounts, insensitive to current price.
Because "beta" has proven to be an unreliable forecaster of coming market price behavior, many thoughtful investment professionals have turned to other approaches, including behavioral analysis. Here is an illustration of how such analysis can help.
In the following picture of price range forecasts for Direxion Daily Mid Cap Bull 3X Shares ETF (NYSEARCA:MIDU), profit opportunities and risk-reward balances are often undergoing change. The vertical lines of the picture are the hedging action-implied forecasts of coming prices, not the actual past price ranges usually shown in stock "charts". The heavy dot in each line is the end-of-day market quote at the date the forecast was made. It splits the forecast into upside and downside prospects. Their balance turns out to have significant, important implications for future price behavior.
(Used with permission)
The behavioral analysis employed in generating these forecasts is a forward-looking process updated daily in real-time. It is based on established investor motivations and practices, and has not changed in over a decade. Embedded in the investor actions are a full range of economic, political, and fundamental factors collected world-wide and analyzed by teams of evaluators employed by the market-making firms.
The data beneath the picture repeats the current forecast and market quote, and uses the upside-to-downside balance to examine the price change results of MIDU subsequent to similar prior MIDU forecasts. The Range Index [RI] measures what percentage of the forecast range lies below the then current market quote. It currently is 72, or nearly 3 times as much downside prospects as upside. The thumbnail picture of all MIDU RIs over the past 5 years shows it to be an above-average condition.
Returning to the data row under the larger picture, there were 94 prior forecasts for MIDU at this level out of 1261 days, and their average price gain, following a standard portfolio management discipline (TERMD), to be described next, was +2.5%, reached in average holding periods of only 18 market days; which compounded annually, produces a +40% rate.
Also in that data row is the indication that 9 of every 10 of the 94 produced gains, and that the average of most serious points of price drawdown below the market quote at time of forecast was -7.1%. These details are the product of TERMD, our standard Time-Efficient Risk Management Discipline. That discipline sets the top of each forecast range as its sell target, with the position taken as a result of the forecast to be closed out at the first day it or more is encountered at the market's close. If not reached in 3 months from the date of the forecast (63 market days), the position is closed. Otherwise, the position is required to be held, regardless of price.
TERMD forces a common judgment-free outcomes measurement on all subjected investment alternatives, sensitive to the forecast balance between upside and downside prospects as seen before the fact. That makes possible direct comparisons between investment alternatives at any common point in time, one which takes present price implications into consideration historically, which we regard as essential.
To that end, every market day we evaluate the hedging actions of the market-making community of major firms and exchange specialists to derive an aggregate-behavior forecast for each equity investment, where such analysis is possible. Currently, out of nearly 3500 securities, some 2500 are available each day.
Given their current Range Index [RI] values, historical data can be assembled for the comparisons that may be helpful in guiding portfolio management decisions as to entry and exit emphasis for individual securities. Below is a table of such data, restricted to the more attractive Exchange Traded Funds [ETFs].
Explicit price range forecasts, implied by hedging actions, are in columns (2) and (3). Risk and return prospects are matched by the upside change potential reward in the (5) column (+6.8% for XHB), against an average (-5.9%) of the worst price drawdowns (6) following 343 prior forecast experiences of (12). Those priors produced average gains (9) in holding periods (10) amounting to annual rates of return in (11). Odds of having a profitable investment experience are shown in (8), while (13) measures how well (9) covered (5). Column (14) pits (5) against (6), and (15) integrates all these components into a figure-of-merit ranking measure intended to suggest comprehensive desirability.
Your sense of attractiveness may well differ from these systematic guidances, and that is what makes markets work. But here you have some extensive history of what has transpired following forecasts like what is currently being seen by highly paid market experts.
How this data gets used
As an example of the kinds of considerations that an investor might entertain, let's look at the PowerShares QQQ Trust ETF (NASDAQ:QQQ). It offers a nearly +5% upside, and has had fairly trivial subsequent emotional stresses of -2.8% price drawdown extremes. But its mid-range price (RI of 41) doesn't provide much upside appeal, even though prior experiences have come to maturity in average holding periods of 9 weeks (45 days), which when repeated, would compound into an annual rate of +26%.
While that is considerably better than the +16% of the broad market tracking SPDR S&P 500 Trust ETF (NYSEARCA:SPY) - (not shown) - the alternative of ProShares UltraPro QQQ ETF (NASDAQ:TQQQ) has had annual rates of gain of +61% and offers an upside of +8.8%. TQQQ tracks the same Nasdaq 100 index as QQQ, so what's going on?
A little research reveals that, although not made clear in its text name description, TQQQ is internally structured so that its price is designed to move (up or down) each day at 3 times the rate of QQQ. That is further reflected in its MM forecast experience of worst-case price drawdowns (a proper measure of risk) of -9.2%, compared to QQQ's -2.8%. So now the question (that only you can answer) is: Do you want the suggestion (not a promise) of a 61% rate of gain badly enough to be willing to live through seeing over 9% of your capital invested disappear? The disappearance at that point may be temporary, but for the moment, if you can't stand it, you might make the loss permanent.
Your odds of it only being temporary (win odds of 86) are about 7 out of 8 (87%). But you may feel that reaching for a 61% rate of gain when +26% may be readily available instead of simply settling for +16%, that's being greedy, and who needs more stress in life which is already amply supplied?
Or you may reflect: "Junior will never get to go to college if I settle for 26%."
It's your call. It has to be.
All we can do is provide some sensible perspective not available elsewhere. If others can provide further useful guidance to make investment decisions easier or more productive, you should include them in your portfolio management as well.