- New Science in old markets -

Userguides

Summary guide to the HED analysis

At HED we analyse markets with the aim of predicting what they will do next and when they will do it. We use tools from behavioural finance, most of which we have either built ourselves or shared in developing. The common thread is feedback, in which a cause and effect are linked in a loop that can magnify the effects or diminish them – usually called positive or negative feedback. We take particular care to use plain English at all times in our published editions except for some technical terms which are defined here. They are:

Extensions and Compressions. These both come from measuring the market sentiment at multiple time-frames and using the results to see when current conditions will change -

Extensions

Reveal that the mood has become uniform in a trending market meaning those who can join in have already done so and the trend is about to end. Trends often reverse at, or soon after, an extension although this is more common after a down trend. The trend may also ‘flatten-off’ prior to a sideways period which the fundamentals ‘catch up’ with the price. Examples of both are shown here. A new trend will start in due course, and if this does not happen immediately after the extension then it will often do so after the opposite kind of sentiment signal, which are called:

Compressions
Reveal that the mood has become uniform in a trending market meaning those who can join in have already done so and the trend is about to end. Trends often reverse at, or soon after, an extension although this is more common after a down trend. The trend may also ‘flatten-off’ prior to a sideways period which the fundamentals ‘catch up’ with the price. Examples of both are shown here. A new trend will start in due course, and if this does not happen immediately after the extension then it will often do so after the opposite kind of sentiment signal, which are called:

 

Both extensions and compressions are calculated from looking back at multiple strings of price behaviour and then looking for patterns in a measure of trend called 'H'. They provide a snapshot of the current condition of market sentiment.

Turns mark turning points

Using historical data on the various cyclical occurrence of highs and lows in any market, we apply non some non-linear analysis to derive future dates when more highs and lows are likely to occur in future, This produces a calendar that we publish every month in AlphaMail:

Turns mark future dates when we expect a market to stop trending one way and start trending another. We identify turns by disassembling the multiple price cycles that are generally present in all markets then re-combining the underlying ‘driving’ cycles to see where important highs and lows should occur in the future. We publish the dates in advance with some indication of the strength of each turn - and the component parts of it, from US stock market sectors through every other category that we watch. This example shows the turns due in April 2018:
April 18 Turns
Commentary and advice

We write commentary on the general state of the markets in 'HEDlines', making firm trading recommendations from time to time and these tools described above are a significant part of the analysis that we use. We also keep an eye out for the general rise or fall of feedback effects as these can dominate the markets at any time frame. This gives early warning, so we were the first to notice (in 1996) that the introduction of the Euro would magnify Germany’s export success and penalize the Southern European economies and that the first-ever real-estate boom would then start in Germany. We used this same approach to warn of a real estate bubble in the US and the attendant risks to the banking system there, in 2007 before it was obvious to most others. These longer-term observations are rare.

Trades and portfolios
The analysis leads to some firm trading recommendations that are published in HEDlines. These do not include a stop-loss or a price objective and sometimes HED doesn't provide an exit to the trade - just an entry.

Using these recommendations, a sample portfolio is traded in futures markets. It is constructed from up to ten positions held at once, each entered at the time it is published here or shortly afterward. Each position is allotted a fixed amount of risk and its size is determined by looking at the recent volatility of that instrument. Smaller positions are taken in markets that have been moving a lot, larger positions in those that are quieter. Each is held for a maximum of 3 weeks if it comes from daily-scale analysis, three months if it comes from weekly-scale work and possibly even longer if a strong favourable trend has developed. The number of contracts for each position may vary widely, due to the specifications of the contracts involved and HED has determined the ideal size for a trading 'unit' that can include all the necessary positions in the adjusted sizes needed to keep risk roughly constant.

The portfolio manager is encouraged to 'trade around' the position by taking shorter-term trades in the same direction as the recommendation, so for example if there is an outstanding recommendation to sell US equities the portfolio will only take 'short' trades in various US equity index futures. The details of any of these extra short-term trades are not published here but could easily be replicated by any competent trader.

Perfomance through March '18

Results

This is the result of trading a portfolio containing a single trading 'unit' since it took its present form  in October 2017. The profits and losses are totalled and shown cumulatively by the red line, whereas the futures margin deposit used to support the  trades is shown in blue. These are averaged and the note points out that the maximum margin used at any one moment sometimes reaches $150,000.

This is shown as an illustration and test of methods only and should not be considered an offer to investors to manage money.

Full userguide available here