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Brian Johnson is a proprietary trader in options, futures, stocks, and ETFs. He is also the editor and primary author for www.TraderEdge.Net, a blog offering insights and information to help other traders. Previously, he was the vice president and principal responsible for Lincoln Capital... More
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  • AAR Strategy Beat Benchmark By 19.37% In 2013

    The AAR strategy is a conservative, long-only, asset allocation strategy that rotates monthly among five large asset classes: large-cap U.S. stocks, developed country stocks in Europe and Asia, emerging market stocks, U.S. Treasury Notes, and commodities. It is one of the 20 proprietary strategies that I trade in my account and the only strategy that Trader Edge currently offers on a subscription basis.

    The AAR strategy earned a return of 26.11% in 2013, outperforming its equal-weighted index (+6.74%) by a remarkable 19.37% during the year.

    Remember that the AAR strategy is not an equity strategy. The AAR strategy is based on the Ivy League portfolio framework and every month it has the option of investing in any one of the five diverse investment candidates described above. If none of the five candidates pass their respective trade filters, the AAR strategy remains in cash for the month. Stop-loss orders are used on every trade to control losses and to facilitate position sizing.

    AAR Strategy Returns

    Of the five investment candidates, only the e-mini S&P 500 futures contract (ES: +31.50%) and the EAFA index (EFA: +21.44%) earned positive returns in 2013. Commodities (DBC: -7.63%), U.S. Treasury Notes (ZN: -3.83%), and emerging markets (EEM: -3.65%) all earned negative returns for the year.

    The returns for the five investment candidates are depicted in green (figure 1 below). The index returns (purple) were calculated using the equal-weighted monthly returns for the five investment candidates, excluding transaction costs. Finally, the AAR strategy return was calculated using the actual strategy signals executed at month-end closing prices, net of estimated transaction costs. AAR subscriptions were first made available to the public in July 2013.

    All returns were calculated using prices back-adjusted for dividends and futures roll transactions. All prices and back-adjustments were provided by Commodity Systems, Inc. (NYSE:CSI), one of the leading providers of market pricing data.

    (click to enlarge)

    Figure 1: 2013 AAR Strategy Returns

    If you are not currently a subscriber and would like to learn more about the AAR strategy, there is a detailed description on the AAR Strategy page.

    Disclosure: I am long the current AAR strategy position.

    Brian Johnson

    Copyright 2014 - Trading Insights, LLC - All Rights Reserved.

    Jan 01 1:21 PM | Link | Comment!
  • Market Overbought - But Wait For The Trend Change

    I introduced the concept of market breadth in a post titled "The Secret Weapon of Technical Analysis." Based on current breadth readings, the equity market is overbought and due for a pullback. However, trading against the trend has a low probability of success. The following article examines several market breadth indicators and explains how to spot a change in the price trend.

    Current Market Breadth Readings

    One of the most common technical indicators is the 200-day moving average. When stocks are above their 200-day moving average, that's bullish. When stocks are below their 200-day moving average, the environment is bearish.

    For individual stocks, this concept may have some merit. Unfortunately, when too many stocks are trading above their respective 200-day moving averages, market sentiment is too optimistic and the probability of a pullback increases. Conversely, when too many stocks are trading below their corresponding 200-day moving averages, the stage is set for a near-term bullish reversal.

    Figure 1 below is a weekly candlestick chart of the $SPXA200R, which represents the percentage of stocks in the S&P 500 index trading above their individual 200-day moving averages. Extreme bullish readings occur between 70 percent and 80 percent. The blue horizontal line represents the 75% level.

    Stocks can remain overbought or oversold for extended periods and simply entering the extreme territory is not sufficient justification for a contra-trend trade. Instead, the percent of stocks trading above their 200-day moving average should be extreme AND should decline for a one or possibly two-week period. That would represent the first confirmation of a prospective trend reversal.

    The blue circled regions highlight bearish trend reversal confirmations in Figure 1 below. These regions closely match and typically precede the actual pullbacks in the S&P 500 Index (highlighted with blue circles in Figure 2 below).

    Note that the percentage of issues above their corresponding 200-day moving averages is currently extremely high. However, the breadth indicator has not suffered a single weekly decline. While the risk of a pullback is elevated, the uptrend is intact and I never trade against an established, unbroken uptrend.

    All of the charts below are available on

    (click to enlarge)S&P 500 Index - % Above 200 MA through 2-12-13

    Figure 1: S&P 500 Index - % Above 200 MA 2-12-13 (

    (click to enlarge)S&P 500 Index - Weekly Chart Through 2-12-13

    Figure 2: S&P 500 Index - Weekly Chart 2-12-13 (

    Another contrarian market breadth indicator is the percent of issues in a broad market index or on an exchange that are bullish based on the long-term point and figure method. If you would like a refresher on point and figure charting, please revisit "The Easiest Way to Identify Trends."

    As was the case above, when the percent bullish indicator becomes extreme (70 percent to 80 percent), the probability of a reversal increases. Figure 3 below depicts the weekly percent bullish indicator for the S&P 500 index. The blue horizontal line represents the 75% warning level.

    Figure 4 below depicts the weekly percent bullish indicator for all of the issues on the NYSE. The blue horizontal line represents the 70% warning level.

    The blue circled regions in Figures 3 and 4 highlight bearish trend reversal confirmations based on the percent bullish indicator. Again, these regions closely match and typically precede the actual pullbacks in the S&P 500 Index in Figure 2 above.

    (click to enlarge)S&P 500 Index - % Bullish Through 2-12-13

    Figure 3: S&P 500 Index - % Bullish 2-12-13 (

    (click to enlarge)NYSE % Bullish Through 2-12-13

    Figure 4: NYSE - % Bullish 2-12-13 (

    Confirmation of Trend Change

    One or more weekly declines in one or more of the market breadth indicators is the first step in identifying a prospective trend reversal. However, before establishing a contra-trend trade, it would also be prudent to see evidence of a change in the actual price trend. There are many ways to do this:

    • A break in the daily or weekly trendline (see "How to Draw Trendlines & Avoid Severe Losses.")
    • One or more closes below a daily or weekly moving average
    • A DMI crossover
    • One of the many other trend confirmation indicators of your choice

    Possible Investment Vehicles or Strategies

    After confirming a trend change using both breadth and price, there are several ways to implement a bearish strategy. You could obviously short ETFs or futures. Futures are liquid and they trade overnight, which would allow you to eliminate gap risk by using stop loss orders that could be triggered after hours. Futures also have low commissions and tight bid-ask spreads. Finally, futures have a symmetric payoff function, which makes them easier to understand.

    If you are an experienced option trader, you have many more investment alternatives. First, you could sell out-of-the money bear call spreads above the current market price (see Active Trader Article titled "The Science of Selling Options").

    You could also execute a bearish diagonal spread, which I explained in detail in a January 2013 Active Trader article titled "Option Strategies for Bull-Market Reversals." Unfortunately, this article is not yet available for download.

    Both of these strategies would allow you to profit - even if prices were to move slightly higher or remain unchanged. The positive yield (Theta) component of these strategies improves the percentage of profitable trades.

    Regardless which strategy you choose, understand your exit strategy in advance and identify stop loss levels to control your risk if the trade moves against you.


    When market breadth indicators are overbought and breadth and price both turn down and confirm a trend reversal, the probability of a market pullback increases significantly. Breadth is currently above the extreme thresholds for most if not all market breadth indicators. However, breadth has not yet begun to turn down and the price trend remains intact. Confirmed trend changes in breadth and price should signal a high probability reversal.

    Brian Johnson


    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

    Feb 14 7:20 AM | Link | Comment!
  • More Proven Stock Screens Earn 20%+ Annual Returns

    This is a follow-up to my recent article on Seeking Alpha titled "Proven Stock Screens Earn 20%+ Annual Returns." In that article, I introduced several value-oriented, fundamental stock screens that have generated historical returns of 20% to 40% per year, all of which were constructed using tools available with a Zacks Premium Subscription.

    The source for the screen definitions and total returns was a book titled Finding #1 Stocks, written by Kevin Matras, a vice president of Zacks Investment research. Matras was kind enough to permit me to explain the rules for several of these screens and to document their historical results in this article.

    This article will describe another promising screening methodology from Zacks and will also document the results for eight highly successful stock screens available through AAII's Stock Investor Pro Service.

    Zacks Industry Ranking

    The Zacks Rank is not limited to just individual stocks. The Zacks Industry Ranking is the average Zacks Rank for all stocks in the industry. While this is a simple concept, it generates excellent results.

    For the period 2000 through 2009, Matras calculated the total return for the stocks in the top 50% of Zacks industries and the total return for the stocks in the bottom 50% of Zacks industries (using weekly rebalancing). The top 50% earned a cumulative return of 266.9%, while the bottom half earned a cumulative return of only 73.7% (nearly a 4 to 1 advantage). What if you had invested in the top stocks (Zacks #1) in the top 50% of all industries? The cumulative return would have soared to 963.4%.

    It would not be practical to purchase all of the Zacks #1 rank stocks in the top 50% of industries on a weekly basis, due to the large number of stocks meeting these criteria. However, that does not detract from the value of this type of screen.

    Regularly screening for Zacks #1 rank stocks in the top 50% of all industries would be an efficient way to create high-quality working lists of 100 or more candidates for further research. The odds would be in your favor, even before you began applying your own technical and fundamental research process, which should allow you to generate even higher returns.

    Other Screening Options

    Zacks is not the only vender to offer screening tools. The American Association of Individual Investors (AAII) offers screening software with an extensive database. The product is called Stock Investor Pro (SI Pro) and is available for approximately $200 per year. Weekly updates are included in the subscription fee and are available via download.

    Unfortunately, SI Pro does not have a backtesting feature, which is not surprising for software costing only $200 per year. However, AAII does report the historical results and the specific filtering criteria for 63 different stock screens that are available with SI Pro. The results are updated annually in the January issue of the AAII Journal.

    As a result, you could review the historical performance of every screen and choose the screen that best meets your investment needs. You could even customize the screens or create your own, but you would not be able to determine how these changes would have affected the results.

    Figure 1 below contains a select list of some of the top-performing SI Pro screens for the past ten years. The name of each screen is provided in addition to its category. You will notice that some of the screens are based on the investment philosophies of some well-known investment practitioners. AAII distilled these philosophies into objective rules and used those rules to scan for stocks.

    All of the SI Pro returns assume monthly rebalancing. The 10-year compound annual return and the average number of holdings are also provided below for each screen. The selected screens all generated returns between 19% and 30% per year. For the same period, the S&P 500 index earned a return of only 0.90% per year. All of the data in Figure 1 below were from Wayne A. Thorp's article "2011 Year-End Screening Review: A Difficult Year for Stocks and Strategies" in the January 2012 issue of the AAII Journal. An updated list should be available in the January 2013 issue of the AAII Journal.

    In Figure 1 below, I included one screen with poor performance to highlight the importance of earnings revisions. Stocks that had earnings revisions of -5% or worse earned a ten-year compound annual return of -4.3%. Stocks that had earnings revisions of +5% or better earned a ten-year compound annual return of 28.9%. The returns for these two SI Pro earnings screens adds additional support for the Zacks Rank, which is also based on earnings revisions.

    (click to enlarge)

    Figure 1: AAII SI Pro Study

    Stock Screens in Practice

    You could use one of the actual screens above, customize one of the above screens, or even create your own stock screen from scratch. However, please remember that any time you change the criteria for a screen, you could adversely affect the performance of the screen. The only way to know for sure is to run a new backtest with the new screening criteria. If you do not have access to Zacks Research Wizard (or a similar tool), please use caution when modifying the criteria of a proven stock screen.

    If your chosen screen has a small number of holdings, it could be possible to allocate a portion of your capital to the strategy and purchase every security that passes the screen. If your screen has a large number of holdings, you could use the list to create a stock universe of high-performing stocks.

    You could also combine the securities from several screens to create your stock universe. You would then need to use additional technical and/or fundamental criteria to identity the best candidates in your universe. You would not know the historical performance of such a strategy, but at least you would be working from a group of stocks that had outperformed the market in the past.

    Finally, you could continue to use your existing strategies, but incorporate what you have learned from the return studies presented in this article. For example, here are a few exclusionary rules that you might consider adding to your stock-picking process:

    Do not buy stocks that fall into any of the following categories:

    • Zacks #5 Rank
    • Bottom 20% of Zacks Industry Rankings
    • P/CF ratio above 30.0
    • P/E ratio above 40.0
    • P/S ratio above 4.0
    • P/B ratio above 4.0
    • PEG ratio above 3.0

    Based on the results of the Zacks studies, securities with the above characteristics have historically lagged the market and should be avoided.

    The screens presented in this article are only a small sample of the screens available through AAII's SI Pro or via Zacks Premium Service. In addition, Kevin Matras describes a number of other profitable screens in his book Finding #1 Stocks.

    Knowing the specific characteristics of stocks that have historically outperformed (or underperformed) the market in the past will give you a significant security selection advantage in the future.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

    Additional disclosure: Brian Johnson is a paying customer of Zacks. Trading Insights, LLC (the owner/operator of TraderEdge.Net) has an affiliate relationship with Zacks.

    Tags: long-ideas
    Nov 28 3:12 PM | Link | Comment!
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