Intro To Fusion Trading

by: Arun Chopra CMT, CFA

Summary

What is Fusion Trading.

What is Factor Investing.

How 'Fusion Strategies' target types of businesses vs. traditional factor models.

Editor's note - this article is meant to introduce Arun Chopra's Marketplace service, Fusion Trading.

I wrote this article to introduce my multidisciplinary approach to financial markets and stock selection I designed over the years. I call this approach 'Fusion Trading'. I'm hosting a service by that name on Seeking Alpha's Marketplace, so I wanted to explain the approach.

Most have heard of each component I use, fundamental research, technical analysis, and behavioral finance. Some swear by one or the other, some are more open to combining disciplines. My approach combines all 3 in a comprehensive and unique way.

Through access to better and much more in-depth research tools, I've created fundamental stock models (Fusion Strategies) that target specific combinations of 'factors' investors should look for in individual companies.

My strategies target specific types of businesses and share dynamics that succeed in public markets. I then monitor price and behavioral action, timing our entries and exits. I communicate the majority of my ideas through video and detailed charts.

By using fundamental research first, multi-time frame technical analysis second, and behavioral signals third, I look to own positions anywhere from multi-week swings to longer term position trades. The power of fundamental factor models is that before I even start my more detailed research, I already have sense of what type of business I am looking at.

I can then spend more time getting to know the company and the story. In today's fast-moving markets and increasing technologies, we can capture opportunities quickly while still in a prudent way.

What is Factor Investing

Traditionally, factor investing has been associated with value, growth, momentum and size tilts as part of an attempt to beat the buy and hold indexed strategies. These are the 4 more commonly discussed 'factors' that have gained a lot of institutional support particularly in this cycle.

BlackRock describes factor investing in the diagram below. On the right side (in blue), we have what they call style, pertaining essentially to stocks. This includes traditional value, momentum, size, quality, and so on.

Source: BlackRock

In a relatively new paper, Professor Lu Zhang from Ohio State's Fisher College of Business looked at over 400 market 'anomalies' found in a variety of research over the decades, to determine what if any 'factors' are statistically relevant to outperformance. To my knowledge, it is one of the most comprehensive studies of these factors, or market 'anomalies'. This takes the BlackRock information above one step further.

The chart below shows different market phenomenon that people have attempted to identify over the years. You can see momentum, value vs. growth, profitability and so on.

One big takeaway for me was that Zhang's research of past studies often showed an inability to actually test the original ideas. The chart below shows how essentially half of these so-called 'anomalies' simply cannot be replicated.

Source: Alpha Architect

Having said that, there were some factors that could be tested and showed statistical relevancy. I will spare you the details, but they primarily included profitability, investment, and momentum factors.

This doesn't surprise me given what we are trying to do in the equity market (own profitable, growing, and attractive businesses with eventually rising share prices).

But let's humanize the above a bit more. What are we really talking about?

Back to Zhang's own words on his research. In an interview with Wesley Grey of Alpha Architect, the bottom line question is below, given only two factors what would Zhang choose after all his research?

Low investment and high ROE.

Source: Alpha Architect

This combination of factors actually produced significant outperformance over the last 40 years.

The chart below is non-logged, so be aware of the visual exaggeration. However, the historic returns are clear. The bottom line is small-cap low investment high ROE businesses have outperformed. Again, this is not a major surprise. Ultimately, you can start to see some of the research here simply 'backtests fundamentals', originating from research ideas.

Source: Lu Zhang

At the same time, what can we really do with this information? To simply say over 40 years, you will make more than the averages assuming you buy 'high ROE-low investment' companies, or say 'profitable-high momentum' stocks is a good starting point, but that's all it essentially is. In practice, by that stage, a stock can carry a lot of intermediate term risk (particularly momentum), especially for traders or those looking to enter new positions.

Again, while the above factors have additional benefits over the long run, how does it help us find companies to trade and invest in the now. Why should we only focus on size differences (small cap tilt above) when some of the biggest, strongest companies often outperform in time frames we care about (2 months, 6 months, 1+ years). They too carry important fundamental factors.

Further, fundamentals are not the only way to analyze an opportunity, especially for active markets with public pricing (there is no timing component). Standard valuation/factor 'only' methods often miss one of the most important marks, that is finding what is becoming or is valuable now.

I approach using factors to outperform through a slightly different lens. 60+% of past 'studies' can't be tested, so why waste the time. This isn't academia. Many get arbitraged away (or that is at least the thought). So why look backward.

Let's think constructively going forward, using fundamentals, technicals, and behavioral finance.

The market is full of different types of successful businesses and opportunities, characterized by a combination of fundamental factors (operations, strategy, business model), price factors (sector momentum, accumulation, distribution, bases, trends) and share/behavioral factors (ownership, compensation structures, incentives).

Through a combination business/investment/trading modeling with new and better tools, I've created a variety of specific factors I want to own, essentially 'Fusion Strategies'.

Below are some highlights of the strategies I have created:

Strategy Summary:

1. Four Stars - The top four operating metrics of any successful business. Companies that consistently lead their peers in performance, brand, and market share, generally are in this list.

2. Rocket Stocks - A simple yet dynamic two-factor model combining fundamentals and behavioral research. These businesses deliver an unusually high profit, generally due to a niche that is relatively defendable. Further, they are tightly held. Some of the largest winners come from this list. This is my favorite strategy.

3. Short Squeezes - A great strategy for reversals and continuation trades when used appropriately.

4. Cash Kings - Businesses that scale. When combined with charts these names can catch bids, especially when sales pick up as incremental revenue falls to the bottom line and earnings momentum picks up. This hidden factor, scale, can result in significant reratings in valuation.

5. Movers and Shakers - I often default to these names when I'm bullish/bearish on a particular sector. Automatically incorporates momentum and gives us an opportunity to outperform the sector benchmark.

6. Revenue Growth - What it sounds like, the upper end of market growth. A straightforward factor with a timing and momentum twist. Ultimately, it's when to focus on these names that matters most, not just the fact they are growing.

Plus two brand new strategies....

7. Real Yields - Not a bond product, but designed to incorporate bond investment dynamics into the research analysis, while keeping equity upside.

8. V2's - V2's focus on the reinvestment factor, proven to create long-run equity outperformance by staying ahead of the competition. Companies with a high likelihood to innovate are on this list.

My background

As a Chartered Financial Analyst and a Chartered Market Technician I am uniquely qualified to work in both fundamental research and technical analysis. As a lifelong student of financial market behavior, I incorporate psychological components that are often more important that the numbers and patterns we all generally know. Having been in markets for nearly two decades, I know the importance of the human element, a stocks story, and what can work in what trading environment.

My experience spans research as biotech analyst to wealth management to working directly with traders and active investors. This includes larger traders for some well known hedge funds and buy side portfolio managers. My work on behavioral finance has also been published in the MTA's technically speaking.

My goals are to provide you with Fusion stocks to invest and trade in, alert you to opportunities across assets as they develop, and keep you informed about market developments that go beyond the traditional news and noise.

I've run Fusion Point Capital for 2 years outside of Seeking Alpha. Here's what some of my members have said about the service:

  • Great trading video today, thanks. I appreciated you spending time going through the multi-chart in detail, and your asides on prior analogies.
  • Thank you for taking a few minutes to annotate and type up your thoughts for me, very appreciated. Your ideas on hidden levels are super-interesting
  • I am impressed with how many factors/stocks/macro issues you can juggle simultaneously. Love your graphics.
  • Many thanks for the detailed explanation. Makes sense. The videos are definitely helpful so the more the better
  • Recently joined and enjoying your analysis and brain power on the markets.
  • Thank you for fixing the intel link, and more importantly, for your video response to my questions. I really appreciate your time and interest in my questions.
  • Thanks so much for responding so quickly, and so thoroughly. It obviously took time to formulate your answers.
  • Thanks for a unique and well structured service.

Sign up here for immediate access to an assortment of 'Four Star Stocks', 'Rocket Stocks', 'Cash Kings' and more: Join Fusion Trading Today

Disclosure: I/we 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.