Trading China

by: David Kotok

By Matt McAleer, Sr. Vice President & Portfolio Manager

With the recent explosive moves in the Asia-Pacific equity markets and more specifically the China markets, clients and observers have inquired as to our thoughts on our positions in the Far East. We currently have overweight exposure to Asia in our International model as well as an allocation in our Tactical Trend model. At Cumberland Advisors, our ETF strategies are managed with multiple research inputs, with the goal being to identify favorable risk/reward opportunities from both a fundamental macro view and a disciplined price analysis. The price analysis is focused on trend identification, relative strength, and weekly momentum work. It is not enough to identify an interesting investment theme; we have to be able to highlight entry points and more importantly exit points. The price analysis feeds our trend, relative strength, and momentum models.

Our China trade was initially put on last summer as many of the securities that track China broke into a positive trend with increasing relative strength versus our International benchmark (the iShares MSCI ACWI ex-U.S. Index ETF (ACWX)). The buying of a security is always the easy part of the trading equation. It's the sale that is a challenge. We work with stop losses to either trend breakdowns or to a predetermined price that confirms that our work was wrong. The distance from these stop losses helps us to craft a position size that our current risk appetite can tolerate. Position sizing and building a position are two of the most important factors in trading, though they are rarely covered in market analysis. We will follow up with a live example in the near future, but this note is focused on the broader topic of what to do with China from a trading standpoint.

One of the toughest trading scenarios that we encounter is the handling of a position that has worked well and has moved well north of its trend line or any natural stop point. We have that situation with multiple Asia-Pacific ETFs in our International and Tactical portfolios. With trend and relative strength very strong, we lean on momentum analysis to help manage the trade. We calculate and analyze momentum on a daily, weekly, and monthly basis and observe positive and negative changes based on price and time elements. Daily tracking is normally too short-term for our strategy, but the weekly calculation works as an effective complement to our trend and RS work. With the 5/28 action in China, the weekly momentum on the Shanghai index that we follow has turned negative, which is a very natural occurrence after a large down day. We now look for follow-through on a daily basis. Over the past year, the weekly momentum on the Shanghai index has turned negative multiple times but has stayed negative for only 1-2 weeks. This is a very short time in our work and is indicative of a very strong market. If a negative period extends beyond that time, we will have to become more cautious.

Currently, we are treating the 5/28 decline in our Asia-Pacific ETFs as a pullback in a strong trend. These ETFs currently trade in a pattern of higher lows and higher highs, which is ideal from a trend analysis standpoint. We shall see what China and the Shanghai index have in store for us over the next week or so. One thing we are sure of, the markets are always interesting!