Dec 10, 2010: Short Term Prediction Experiments
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A few weeks ago I've turned bullish for the next several months. There are several reasons for this shift:
So my macro view for the next several months (at least) is:
- Macro: many of the recent economic reports point to an unmistakable and continuing (though slow) recovery. Improving numbers are the common theme these days.
- Government seems to be determined to keep interest rates low and cheap money abundant.
- While there's some pick-up in credit, most of the cheap money seems to be flowing to the big banks and the "haves" who get it for 0.25%, and lend it out (multiple times) to the "have nots" at 3.75% (best case) to over 20% (in some outrageous credit-card cases). But since there's a shortage of "qualified borrowers" and the money supply seems infinite in comparison, I expect this free money to keep flowing into assets and of course, the stock market.
- Extreme monetary props like QE-2 virtually ensure that fiat money would be devalued. In turn, real-assets: commodities, or real businesses/companies should be worth much more in dollar (or Euro) terms in the coming years.
- The technical picture of stocks is very strong.
- Bonds, especially the long treasury bond, have broken decisively below support, foreign bonds have followed, confirming this major trend change.
- Breadth is impressive. Small caps keep beating large caps despite the much better fundamentals of the large-cap group. Bubbles tend to end with a clear narrowing of the leading-groups: less and less stocks making new highs. Such a scenario seems pretty way off as I write.
- The worst place to be in is debt-instruments and bonds, with the long treasury bond being the worst of the worst.
- The second worst is fiat money and currencies which are being printed like there's no tomorrow. Although, I must add that compared to the Euro, the Dollar actually looks attractive.
- Then come currencies of countries with little or no debt.
- The really good places to be in, are those with "real value". Good growing companies belong to this group, and so are commodities: from grains to oil, to precious metals.
I expect more of the same: excess fiat-money printed and lent to financial institutions, who still need to 'recapitalize' better at near zero rates. This excess money should keep flowing into the markets and keep propping most stocks up, up and away. Given such a backdrop, I would simply buy the dips, and be aggressive to the max in doing so. I would even consider a limited exposure to ATM calls on stocks (on dips) or ATM puts on volatility on spikes.
An experiment in short term prediction of the stock market
About a year ago I signed up to an interesting experiment on a site called "thecapitalinstitute.com":
Among other things, thecapitalinstitute.com runs an experiment in short term market prediction.Each day after the close, players are asked to predict how the S&P500 index would close the next day: up, or down. In my first few weeks attempts I quickly rose through the ranks into the main "G100" group and managed to stay in the ~50-70% correctness range for as long as I kept playing.
Then, I lost interest left my account idle for most of the year. As a result and my rank drifted down for inactivity and I dropped out of the main group for nearly a year.
About 6 weeks ago, I decided to get back to the site and see if, given all that I learned in the past year, I can do better. Indeed, I was doing much better. A few weeks after returning to activity, on Nov 20, 2010, I was at the top of the "members in qualification stage" group with a clear lead, a 80% (ratio of 4 out of every 5 guesses correct, see screenshot), and a chance of returning to the top league:
The detailed record on Nov 21 was:
So, I decided to persist for a couple of weeks longer, which got me into spot #3 in the top "G100" group, with a longer record, and a slightly better correctness ratio of 81% (screenshot):
The detailed record at the close of Dec 10, 2010 was:
One of the techniques I noticed the leaders tend to use is to bet less often. The site allows you to skip betting from time to time, as long as you don't exceed too many "passes" which will get you penalized as a wrong bet. I have been too aggressive skipping only one day out of the last 22 sessions. Even that skip wasn't intentional, I was simply too busy and forgot to vote on Nov 18th. In the coming weeks I will try to see if I can improve my record. Wish me luck.
The algorithm I use for these short term predictions is mostly "manual": I look at high resolution short-term charts (1-minute and 5-minute ticks) and from them, I try to figure the answers to all of:It is a pretty simple and sensible algorithm, and it seems to be pretty reliable as the ~80% correctness results demonstrate.
- What is the prevailing trend/momentum?
- Are there clear oversold/overbought conditions within the trend?
- Are recent leaders weakening or staying the course?
- Breadth: are mid and small-caps outperforming the S&P500?
- Are volume-weighted trends: accumulation/distribution, VWAPs agreeing?
- Volatility trends: is the volatility index (VIX) waxing or waning?
- Are correlations between asset classes increasing or decreasing?
- Are any divergences developing in any of the above indicators?
My plan is to code this algorithm so I don't have to work as hard and so I can cover many ETFs as opposed to only looking at the broad market.
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The above merely reflects my own thinking and actions at the time of writing. Every investor should make up his own decisions based on his risk tolerance, time-frames, comfort-zones, convictions, and understanding. Never investment advice.
Any feedback is welcome.
-- ariel
