Using Intelligent Behavioral Analysis To Avoid Market-Driven Losses

Includes: ASPS, LL, MNK
by: Peter F. Way, CFA

Want to improve your transaction-by-transaction winner-loser ratio? And improve your portfolio's ongoing overall rate of return?

Why not get some help from the market professionals who are out there everyday, playing the odds, using feedback from world-wide information-gathering systems and in-house staffs of researchers, constantly making small bets on nearly every trade they're in on? Oh, you don't talk with them? Perhaps this line of analysis can help.

Watch how market-makers are protecting the firm's at-risk capital as they facilitate the filling of big-money-fund volume orders to buy or sell stocks and ETFs. From their hedging actions it can be determined just how far they think their clients are likely to push prices, up and down.

Then compare what they are doing now with how those stocks' prices behaved in the past, after similar hedging. When strong odds of sizeable higher prices are seen, test how buys would have behaved in a time-disciplined portfolio setting.

Be sure to examine every case of prior similar self-protective actions by the market pros, usually across several years. This tells how well they really anticipate each issue. And it varies, name by name.

Investment attractiveness needs to be ranked by the tradeoff between size of likely net payoffs, and the odds of incurring losses of tolerable size. When the market does not offer any candidates with prospects inside reasonable limits, don't make new commitments.

Attractive candidates often have histories of dozens to hundreds of days where protective actions like those of the present have led to profits, typically over 6-7 week holding periods, at annual rates of gain approaching or achieving triple-digit levels. Willingness to be active and careful of your time investment is what significantly ups your rate of return.

Win-loss ratios from this approach often have been of the 3 out of 4 to 7 out of 8 nature, with maximum draw-downs from cost in single digits. But there are no guarantees, and each prospect comes in its own odds and payoffs wrapper. Selectivity counts, both for the pros, and for you.

Here are three stocks that are currently resisting the market's slide. They all have good histories of prior experiences from current-day market-maker forecast actions. They are Altisource Portfolio Solutions (NASDAQ:ASPS), Questcor Pharmaceuticals (QCOR), and Lumber Liquidators (NYSE:LL).

Background information on these stocks can be obtained from many on-line services. But the value contribution of market pros' outlooks can't be. It takes special insight and a lot of work to apply the behavioral analysis to these well-informed, highly motivated, at-risk, active investment professionals.

Avoiding market-driven losses also needs some serious thinking about what conventional buy-and-hold (and-forget?) portfolio management does to risk exposure and unnecessary acceptance.

While the market-makers' risk exposure time horizon tends to be hours to days, their concerns often are from hazards that could arise any time in weeks to months. Such risks may be less likely near at hand, but still are present and potentially dangerous.

Portfolios invest not only capital, but also time. When it comes to measuring investment progress by rate of return, the time investment becomes more important than the capital investment. Holding time limits are a discipline that is increasingly important as markets have evolved technologically.

The following table lines up the important considerations:

(Click to enlarge)

The extent of protections being sought, and the way they structure their defenses is what produces the range of forecast prices in lines 6 and 7. Those imply the potential price change percentages in lines 4 and 5.

Today's balance of upside-to-downside prospects are the most recent addition to an array of daily prior forecasts with various reward-to-risk prospects. Looking only at those priors with expectations at least as favorable to a buyer as at the present, we determine the odds of gaining or losing from a current buy and subsequent "blind" (as to timing) sale any time in the next 3 months, in line 1.

The average size of those historic win or loss opportunities are in lines 2 and 3.

Put into a hypothetical (long investment) portfolio situation with a strict holding time discipline, each of those select prior forecasts can be averaged into a potential set of return and risk possibilities. Our benchmark discipline sets the top of each forecast as its sell target and limits the holding to two months from the buy date. Each position has its own fixed target and time clock, regardless of subsequent events.

When a sell target is reached that position is liquidated and the capital is available for redeployment. If the target is not reached by the patience time limit, it is closed out regardless, and the gain or loss is added to the other forecast results, as is the holding time.

Line 9 indicates how often each stock's targets were reached from its specific set of like prior forecasts, and line 10 tells the average simple percentage gains achieved. Positions that had to be timed out often incur losses, and when added to line 10, line 11 results.

Average daily gains are compiled from lines 11 and 12 and are used to compute line 13.

Line 14 lists the average of worst drawdowns during each of the holding periods in each stock.

Lines 15-19 offer a background of each investment's overall data history. Line 20 reaffirms the involvement of big-scale investors.

These expectations have been drawn from our current actuarial histories of the stocks and are provided for your information. They are not to be construed as recommendations for or against investment, nor solicitations for any such actions.

The following pictures tell how each stock's daily market-maker forecast (the vertical lines) have ranged about its price (the heavy dot). Often trend of forecast can be reassuring -- or a caution.

Remember, forecast attraction for a stock can vary day to day, as proportions of the range above and below the market price change.

(Click to enlarge)

(Click to enlarge)

(Click to enlarge)

We wish merely to provide possibly useful comparative information for those interested in the stocks and their future activity, as viewed by well-informed, highly-motivated, active, at-risk investment professionals.

Past results are no guarantee of future actions. But odds-players often have more satisfying results than those ignorant of key elements of their surroundings.

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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.