8.29.10 – Welcome, To The Machine

With apologies to Pink Floyd, “Welcome…to The Machine.”

That verse kept running through my head when I tested the newest offering from The Connors Group, called “The Machine.”  In case you were wondering, ‘Connors’ is Larry Connors, one of the founders of TradingMarkets.com and the author and co-author of numerous books on trading.

The Machine is the first and only commercially available financial software that allows you to build and actively manage customized, quantified portfolios of equities and ETFs.  Accessed through the web, there is nothing for the user to install on his or her computer.  Traders, investors, and investment advisors can choose from thousands of back-tested, statistically valid strategy variations to construct their portfolios. These portfolios enable the user to reduce the volatility of their accounts using portfolios that they design, to out-perform their benchmarks.

The Machine is unique in that it allows the user to:

  • Build customized, actively managed portfolios with both risk and reward taken into account;
  • Reduce portfolio volatility by combining ETF, equity, mean reversion, trend following, and long and short strategies together; and
  • Save time with simple to build and easy to manage portfolios.

One of the most difficult tasks a trader or investor has is achieving consistency in the performance of his or her portfolio.  Emotions can run high in trading, and that will affect your decisions.  But if you use a quantified approach to trading and investing, you can take the emotion out of your trading.

Losses are part of trading and knowing in advance your expected draw-down and how your trading strategies historically performed in bull, bear, and sideways market conditions not only allows you to “sleep easier” but, in fact, helps you create portfolios that reduce the volatility of your account.

As an investment advisor, I know how difficult it can be at times eliminating subjectivity and emotion when making investment decisions and recommendations to clients.  Every client is unique and each has specific risk tolerances.  Having the ability to create custom portfolios that historically have produced positive returns every year with low draw-downs, helps advisors customize portfolios to meet each clients’ investment goals and objectives.

One of the biggest concerns I have with using a new trading application is how to get past the learning curve.  I know many people who have given up in frustration when they “test-drive” a new application and can’t find answers to their questions.  The Machine helps overcome this problem by including two training videos that are very much “step-by-step” in how to construct a portfolio and how to use the application.  As you will see in a few minutes, The Machine has an entire section devoted to Education, including the aforementioned videos, studies on volatility and leveraged ETFs, and a description of the latest books by Larry Connors that explains in depth many of the strategies used in The Machine.

So without further ado let’s take a look at The Machine.  This review covers just one of the features of The Machine – the Portfolio Builder.  Additional reviews will cover the other features.

The first screen you see after Login is a welcome screen, describing each of the component parts of The Machine.  You access these by clicking on the tabs in the upper-right of the screen, e.g., Education, What’s New, Blog, Strategies, Portfolio, Current data, and Help.  You can make any of the screen captures larger by clicking on them:

The user begins by building a new Portfolio.  A “Portfolio” is a list of saved strategies that you run against a database of stocks and ETFs to find those that meet the strategy buy and sell rules.  Clicking on the word “Portfolio” in the top right of the screen brings up a drop-down box that lists existing portfolios you created.  Just click he word “Portfolio” to get to the “Create New” button:

The Machine does not come with any pre-built portfolios but you can copy the portfolios from the webcasts available through the Education tab.   After you create a new portfolio you give it a name; I called mine “Test 1.”  You’ll also see the name Test 1 in the screen capture below, in the upper left under the words “Portfolio Builder.”

Next, you select the strategy or strategies you want in your portfolio.  Click on the Strategies tab on the upper right.  The Machine lets you select from several dozen strategies, characterized as Equity – Mean Reversion; Equity – Trend Following; ETF – Mean Reversion; and ETF – Trend Following.  The screen capture shows you the strategies in Equity – Mean Reversion.  More strategies are constantly being added to The Machine as they are developed and tested by the Connors Group:

For my Test 1 portfolio I selected both long and short equity and ETF strategies as well as a Trend Following strategy, as you can see below:


From Long Equity – Mean Reversion I chose the Long Pullbacks and SO (Sell-Off) strategies.  From Short Equity – Mean Reversion I chose the Short 1 strategy.  From ETF – Mean Reversion I chose the RSI 10 strategy and from Equity – Trend Following I chose one of the strategies.  While the mean reversion strategies are discussed in Larry Connors books, the trend following strategies are currently “Black Box” and the formulas are proprietary.

Want to know what each strategy is and what its formula/trading rules are?  After you select a strategy, it gets added to your portfolio.  I clicked the SO strategy hyperlink and it brings up a screen showing the SO parameters (which I blanked out since they are available only to subscribers):

Under the words “The Machine” you see the strategy name (SO) and hyperlinks for the strategy’s historical returns as well as a description.  Not every strategy has a written description quite yet, since that part of The Machine is still a work in progress.

You will see after each strategy name a variation number, such as “variation 578” after Long Pullbacks.  Why did I select that variation?  The Connors Group backtested thousands of variations of each strategy and I can sort these variations by CAGR (Compounded Annual growth Rate), Sharpe Ratio, Max Drawdown, etc.  The statistics are seen in the picture below:

I sorted this list by Sharpe Ratios.  You will see that higher CAGR’s generally have higher max drawdowns so I selected a variation with a moderate drawdown, a high Sharpe Ratio, a high average % P/L ratio, and a high success %.  That was variation 578.  I followed the same procedure with the other strategies as well.

Looking back near the top of the previous picture you see a box for capital application for portfolio.  While not required, entering in a dollar value enables The Machine to make recommendations as to how many shares of each security you should purchase.  You can leave this box blank if you prefer.

After populating a portfolio with the selected strategy variations, the next step is to assign your allocation percentages. Allocation amounts represent the amount of capital you wish to assign to a variation within a portfolio.  I assigned 20% each to the five strategies.  You may allocate as little or as much capital as you wish. There are no restrictions on allocation percentages.  When new strategies or variations of strategies are added to a portfolio, the allocation, by default, is set to zero. This number may be changed to any percent you wish to allocate to a specific strategy.

After you’ve assigned your allocation percentages satisfactorily, the next step is to calculate your portfolio’s performance reflecting those changes. To calculate the new allocation amounts, click “Calculate” in the bottom right of the Strategy section. It can be found next to the “Clear All” button. The “Clear All” button will clear all of your allocation amounts back to zero.

Before looking at the historic performance of this test portfolio, I’d like to explain how The Machine chooses the stocks and ETFs that generated the portfolio’s returns.

The Machine monitors all ticker symbols on the NASDAQ, AMEX, and NYSE Exchanges that meet the minimum price and volume requirements for the specific strategies.  Delisted ticker symbols are included in the historical returns.  Daily trading signals are generated by analyzing end-of-day data and by ranking all the stocks and ETFs generating trading signals for the next day.

You can limit your database by careful selection of the strategies you choose for your portfolio.  Want to search only for ETFs?  Then only select ETF strategies when building your portfolio.  Don’t want ETFs?  Select only from the Equity – Mean Reversion and Equity – Trend Following strategies when constructing your portfolio.

Once I finish selecting my portfolio I want to see how it performed historically.  Ideally, it will beat the benchmark each year for 10 years.  If I find a year where the performance was subpar I can experiment using different variations of the strategies or even adding/deleting strategies.  One of the features I’m most impressed with in The Machine is how easy it is to make changes and how fast it is to find out the results of those changes.

The lower half of the Portfolio Builder has ten tabs with useful information for the user.  The first tab shows the simulated monthly returns for the last 10 years; the simulated annual return for the portfolio; the annual return for the benchmark (in this case the S&P 500); and the difference.  This Test1 portfolio has beaten the benchmark every year since 2001.  The 2010 monthly data in the screen capture below is through July:


At the bottom of the return tab are very useful statistics that tell the user the portfolio’s Compounded Annual Growth Rate (CAGR), Sharpe Ratio, % Winning trades, average trades per year, the average percentage of the capital that was invested over the ten years, and the how much time during the year the capital was 100% invested:


The Test 1 portfolio had a compounded annual growth rate of 32.69%, a Sharpe Ratio of 3.13, and a winning percentage of 69%.  It averaged 397 trades per year and at any given time an average of only 35% of your initial capital was exposed to market risk (i.e., invested as opposed to sitting in cash).  Note that at no time was the test portfolio fully (100%) invested.  An almost 33% CAGR with an average exposure ratio (percentage of the account capital invested) of only 35%…impressive!  Below you can see the maximum portfolio exposure for the past ten years was in 2010, at 48%.

The Statistics tab lets me look at daily portfolio exposure by percentile, e.g., >=10%, >=20%, etc.  It also shows the exposure by year.  While there are a very large number of signals (well in excess of 1,000 for all but 2002), only a small percentage are actually filled (Fill% between 15% and 22%).  This is because most of the signals came from mean reversion (pullback) strategies that did not pull back to their recommended fill price.  Savvy traders are like professional baseball players – they wait for their pitch!

The Drawdowns tab shows me the maximum drawdowns by year and by day (start and end dates for drawdown periods:

In the Test 1 portfolio I see the max drawdown was -11.82% in 2008 and it occurred between June 20, 2008 and October 9, 2008, for a period of 140 days.

The Equity Curve tab shows you how your portfolio grew (or didn’t grow) over the last ten years.  Ideally, you want to achieve a smooth equity curve with no deep dips or sharp rises:


In ten years this portfolio grew from $100,000 to almost $1.5 million (before taxes).  Commissions are built into the calculation at the rate of 1 cent/share.  Not a bad return, this Test 1 portfolio!

Now we come to the heart of Portfolio Builder: the trade recommendations.  The tabs are self-explanatory – Long Signals, Short Signals, Long Scale-Ins, and Short Scale-Ins.  The signals are generated a few hours after market close.  Here is long signal generated on August 2 for a potential trade the next day:


Acme Packet, Inc. (APKT) closed August 2 at 27.11.  The long signal for “tomorrow” is a limit buy of 153 shares at 26.03.  Also shown is the Historical Volatility and the two-day RSI.

Here are the short signals that passed through the strategy filter for August 3.  Note that there are more short signals than long signals:


When no signal is generated there will be a message that no matching records were found:

Trend following signals occur less frequently.  The last signal was generated June 8, 2010 and I’m writing this on August 2.  This tab shows the symbol, entry date and price, last price and percent change, the industry group, and the strategy number.  Since only one trend following strategy was selected for this portfolio, all the stocks will show the same variation was used for their selection:

Not a Brokerage Firm

The Connors Group is neither a brokerage firm nor a registered investment advisor.  You can use whichever broker or advisor you want to execute your trades.

Cost­

Now we get down to the nitty-gritty: how much does this cost?  The Machine has an annual lease fee of $10,000 per year for individuals.  Connors Research Group advises a minimum account size of $100,000 and that makes sense – the annual lease cost is 10% of a $100,000 portfolio.  Even should you make 30%/year, after the annual payment your return is down to 20%.  That’s quite a hit.

There are two ways you can lower this percentage.  The first way is to have a larger account.  If your account is $200,000, then the fee is only 5% of your capital.  The second way is to share The Machine with a trading buddy.  The signals are generated after the market close and are not updated during the trading day.  You and a buddy could each access The Machine at different times in the evening, and split the cost.

For investment advisors the fee is higher: $14,000 paid quarterly or $10,000 lump sum.  This cost will go up next year but advisors who sign up in 2010 will have this price locked in for three years.

Is it Worth It?

Are you an active trader?  Are you looking to create a diversified portfolio that employs multiple methods to reduce risk?  Are you a swing trader comfortable with a portfolio where the average holding period of the stocks is 3 – 5 days?  If the answer to any of these questions is Yes, then you should consider The Machine.

The Machine is also ideal for intermediate and long-term investors looking to use quantified trend following strategies.  They recently added an ETF Trend Following strategy and will be adding more of these strategies, so they are making efforts to make The Machine suitable for investors and active traders with a longer time-horizon.

If you are interested in learning more about the strategies and methods utilized by The Machine, you may want to pick up Larry Connors and Cesar Alvarez’ books: “High Probability ETF Trading” and “Short Term Trading Strategies That Work.”  Both books are available on the TradingMarkets site or on Amazon.com.

Want More Info?

Serious traders or active investors looking to quantify their risk and maximize their gain owe it to themselves to take a serious look at The Machine. You can find out more information at:

http://presentations.tradingmarkets.com/1027285/introduction-to-the-machine?utm_campaign=Affiliate&utm_source=MachineBlogger&utm_medium=DavidSteckler

Or call 888-484-8220 ext . 6121 (in the U.S.), 973-494-7323 (International).  If calling, ask for Mark Angil and refer to Code 48, or e-mail him at mangil@cg3.com (also refer to Code 48).

The URL identifies to TradingMarkets that you found out about The Machine from my blog.  They are tracking which sources bring them the most inquiries and are offering readers of my blog a special bonus if you subscribe to The Machine – a free, three-month subscription to Larry Connors’ Daily Battle Plan, worth $500.  Here is what you’ll receive each day:

  • Larry’s top high probability ETF set-ups.
  • A 3-5 minute pre-market audio report directly from Larry giving you his insights for the day.
  • Larry’s Daily Market Analysis of the financial markets to provide you with his insights on current market behavior.
  • Larry’s Trading Lesson of the Day will help you learn from a trading veteran of nearly 30 years. It’s like having Larry as your personal trading coach each day!
  • Access to the Daily Battle Plan Model Portfolio track record of every trade since 2008. You can readily track the 80% success record by ETF trade, date, and return. Plus you can track new positions every day.
  • And get over one year’s worth of Larry’s Trading Lesson of the Day, so you can study previous lessons to improve your trading.

You can learn more about Larry’s Daily Battle Plan at the TradingMarkets.com web site.

So give The Machine a try!  You get a free one-week trial when you test-drive The Machine.  My blog has a box at the bottom of each day’s entry where you can post comments.  If you take advantage of the trial, please post your comments and I’ll share them (with your permission) with my readers.

About Dave

David Steckler enjoyed 24+ years of experience as an investment counselor and portfolio manager before retiring. A former professor at Lindenwood University in Missouri, he also was a member and past president of the American Association of Professional Technical Analysts (AAPTA), and a member of the Market Technicians Association (MTA).
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