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Model Background

The goal is to use cash as part of your overall portfolio, adjusting equity holding size during the year based on Macro valuations.

Model Theory

The fundamental theory is that macroeconomic conditions lead stock market prices. If true, producing accurate, forward-looking economic forecasts (i.e. ATL Fed GDPNow) could provide clues to the future direction of the major stock indices (i.e. SP500).  Often times, stock market prices are controlled by sentiment - greed and fear - which can lead to disconnects between price's "fair value". The model wants to buy the market when price is a discount to fair value, and short the market when price is a premium to fair value.

The model isn't a crystal ball. Trade signals are based on Probabilities and Statistical methods, producing different trades with differing probability of success. Overall, model is right 2 out of 3 trades.

More recently, research has been focused on limiting maximum exposure to the stock market.  Today's markets are faster than ever, and high velocity of price movements is normal.  With high velocity markets, scaling strategies developed by the models help spread out the investment into a long or short position.

The model is not a HFT or intraday scalping algorithm, only changing the position about 2-3x a month, on average. The model is a pure directional bet on whether the SP500 will rise or fall, which during bull or bear markets, is able to profit from not only the major trend but also sell into the minor counter-trends. The result is a system designed to beat the SP index by profiting when the market loses during pullbacks.

Application of Theory - Strategy Choice

Once you have a system that produces an estimated fair value for the stock market, the next step is to decide which strategy fits the desired results. The model produces not only a prediction of direction of SP500, but also a probability strength of signal.

One could create a hedged strategy where Shorting SP is utilized, which makes profits possible during a market decline. This hedge fund approach is best combined with another long-only portfolio. This Long/Short 100% version of the model is employed by the firm's commodity pool.

Another option is to supplement the long-only strategy, using the model to change equity weighting allocations, making better timed buys and sells. Scaling between 0% long to 200% long at MAX BULL. Selling means taking profits, not shorting the market.

The graph shows 1999-2012 backtesting results of the Long-Only 200% model theory as compared to passive index investing in the SP500.


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