Robust Relative Strength

In your research and learning about methods and systems you have probably come across the term “Robust“. Robust in this sense basically means that changing markets and changing parameters will not cause it to stop working. Relative strength is extremely robust  something that can be shown with Monte Carlo testing

In Michael Covel’s The Little Book of Trading, the section on trend follower David Druz has this to say:

A robust system works over many types of market conditions and over many timeframes. It works in German Bund futures and it works in wheat. It works when tested over 1950•1960 or over 1990•2000. Robust systems tend to be designed around successful trading tactics not designed around specific types of markets or market action. And here is the amazing thing about robust systems: The more robust a system, the more volatile it tends to be!… Druz gives this advice: “There are whole families of trend trading ideas that seem to work forever on any market. The down side is they are very volatile because they are never curve-fit. They’re never exactly fit to any particular market or market condition. But over the long run, they do extract money from the market.  You want to be focused on how you divvied up the risk in your portfolio, how much risk you take in each market, how many contracts you trade in each market, that’s the stuff that really counts…if you have money management wired, you can let volatility go because you know it doesn’t have any correlation with the risk of ruin. You can use volatility to your advantage.”

You can substitute sectors, industries, ETFs and stocks for the word markets above.

Because they are not optimized, they tend to be volatile.  We see this especially during periods when markets are relatively trendless or are in the midst of a changing trend. This is where the optimizers come in creating conditions that will avoid this or that particular drawdown volatility, There is always some specific method that is optimized and perfectly adapted to the current market—but as soon as the market character changes, it may fail miserably.

Here, you are accepting a different trade-off.  It will probably never work perfectly in any market environment, but it will probably work pretty well in a wide range of conditions.  That’s a pretty good description of how relative strength works.  It goes through rough stretches but generally manages to adapt enough over time to deliver good long-term performance.  The trick for investors is to sit on their hands during the rough stretches—a truism for any long-term winning method, whether relative strength or value.

A systematic, structured methodology of comparing the price performance of one security to another

  • Each security is ranked in comparison to the other inventory members
  • Numerous research studies conducted by both Dorsey, Wright & Associates and others show that consistent exposure to the highest relative strength ranked securities results in better investment results than exposure to poorly ranked securities on a relative strength basis.
  • Relative Strength strategies capitalize on performance differences between asset classes or within asset classes.
  • Directionless or narrow markets and markets with transitioning leadership tend to be periods when relative strength as a strategy will struggle.

Source: Dorsey Wright’s Systematic Relative Strength blog

Now sit back and think a moment about this site. Most of the Prudent Trader site concentrates on Relative Strength. Be it in my watch lists based on the works of Charles Kirkpatrick, or William O’Neal of Investors Business Daily.  The reports on Sectors, Industries, ETFs and indexes all containing quite a few relative strength data points – Overweight, Underweight, Market Perform and rankings amongst piers

Talking Points and Market Calm: Pimco Sees `Abnormally’ Low Volatility:

Who’s Afraid of 1929? (Philosophical Economics)
Rational Exuberance? (Alhambra)
What is the difference between investing and speculation? (CFA Institute)
This Time is Different, Yet with the Same Ending (John Hussman)
It’s Time to Opt Out of Impulse Buying (Sketch Guy)
Two charts that show why the housing market is off track (Wonkblog)
Beware of reading too much into fear gauge (WSJ)
Gauging Investor Sentiment (A Wealth of Common Sense)
Can Yellen Float Above Politics? (Bloomberg View)
Goldman Sachs: 15 cheap stocks for an expensive market (MarketWatch)
Time is running out to solve our transportation funding crisis (WonkBlog)
Morning People Are Less Ethical at Night (HBR)
Five ways the American health care system is literally the worst (Vox)
Google: The New Bank (Armstrong Economics)
Few Consumers Actually Heed Social Media (HBR)
Robot Doctors, Online Lawyers and Automated Architects: the Future of the Professions? (The Guardian)

Market Calm: Pimco Sees `Abnormally’ Low Volatility

Have a Great Day!