A Game Plan For Incorporating “The Totality of Information”

November 8, 2016

Jason Zweig recently made a key observation during an interview with Russ Roberts (via The Irrelevant Investor):

I think if there’s one overriding theme to the book, one of the things I’ve tried to get across in The Devil’s Financial Dictionary is the importance of just being humble before the financial markets. I mean people are humble before nature- think about when you stand on the rim of the Grand Canyon, or you walk to the edge of the ocean, or you look up at the stars, people feel this sense of awe and wonder and smallness because we are small when we compare ourselves with the natural world. Well individuals, and for that matter, policy makers, are small when we compare ourselves with the financial markets, but most of us forget that.  And we think, oh we’ll we have better data or we know something the other guy doesn’t, and in fact we should have that same sense of just being a spec of sand on a long beach and just remember that whatever we know is very small compared to the totality of the information that’s out there.

This begs the question, what is your edge as a financial advisor?  If your edge is “knowing something the other guy doesn’t” how realistic is that edge?  So much of what goes on in the investment management business is centered around people believing that they have insight into why a given security is mispriced.  Taking Zweig’s advice to stay humble as it relates to the totality of the information that is out there goes to the essence of  technical analysis.  For technicians, and specifically those adhering to a trend following/relative strength-based approach to investing, our edge has nothing to do with identifying mispriced securities.  The prices are what they are—the simple intersection of supply and demand.  Our edge is having a disciplined method of identifying and participating in the strongest trends in the market.  Thanks to the power of technology, our trend following models see and incorporate all information in the market that is relevant to our buy and sell signals.

If you need some ammo to help make the case for such a trend following approach.  I would suggest reading (or re-reading) some of John Lewis’ white papers on the topic.  Some of my key takeaways from these white papers:

  • Price is sufficient as an input for trend following models.  There is no need to complicate things with other inputs.
  • Trend following works on stocks, ETFs, and asset classes
  • Relative Strength doesn’t work all the time, but it does work a high percentage of the time
  • Discipline is the key.  Rather than focus on constantly tweaking a relative strength model, it is best to do thorough research up front than then focus on execution after that.  Constantly tweaking a trend following model is no different than not having any discipline.
  • There are best practices when it comes to relative strength models.  Those white papers detail best practices.  Some of those best practices including knowing what box size to use on a PnF relative strength chart and where to set your relative strength rank buy and sell threshold for a given objective.

As a subscriber to DWA research, you have the necessary tools at your fingertips to employ such relative strength strategies.  There is no need to recreate the wheel here.  We’ve done the heavy lifting for you.  Team Builder, Matrix Plus, the Models Page, the Technical Attributes, and Fund Score, DALI.  It’s all there.

It is possible to be humble and confident at the same time.   Humility is demonstrated by not looking beyond price.  The confidence comes from embracing a trend following model designed to interpret those prices in a systematic way.

The relative strength strategy is NOT a guarantee.  There may be times where all investments and strategies are unfavorable and depreciate in value.

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