SKEPTIC’S GUIDE TO INVESTING
Straight Talk for All, Nonsense for None
About - Our podcast looks to help improve investing IQ. We share 15-30 minutes on finance, market and investment ideas. We bring experience and empathy to the complex process of financial wellness. Every journey is unique, so we look for ways our insights can help listeners. Also, we want to have fun😎
Your Hosts - Meet Steve Davenport, CFA and Clem Miller, CFA as they discus the latest in news, markets and investments. They each bring over 25 years in the investment industry to their discussions. Steve brings a domestic stock and quantitative emphasis, Clem has a more fundamental and international perspective. They hope to bring experience, honesty and humility to these podcasts. There are a lot of acronyms and financial terms which confuse more than they help. There are many entertainers versus analysts promoting get rich quick ideas. Let’s cut through the nonsense with straight talk!
Disclaimer - These podcasts are not intended as investment advice. Individuals please consult your own investment, tax and legal advisors. They provide these insights for educational purposes only.
SKEPTIC’S GUIDE TO INVESTING
Unlocking Trading Success with Adrian Reid
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What if you could make trading decisions without emotion clouding your judgment? Join us as we sit down with Adrian Reid from Enlightened Stock Trader, who reveals the secret ingredients for trading success in 2025. Adrian's unique approach focuses on systematic strategies that prioritize models over market noise, incorporating factors like momentum, size, and volatility. Learn how he strategically excludes European markets to focus on regions with the best potential edge and expectancy, navigating through the complexities of markets in the US, Canada, Hong Kong, and Australia.
Delve into the intricacies of trading strategies and risk assessment with Adrian, as he shares insights into using short interest as a quant factor and the distinction between alpha and beta for informed investment decisions. Discover the potential of mean reversion and trend-following strategies to capitalize on stock-specific behavior rather than broader market movements. We also discuss the importance of preparing for potential downturns, ensuring that your portfolio is robust enough to endure market fluctuations.
Explore the art of portfolio diversification and market allocation as Adrian emphasizes the importance of liquidity and maintaining insignificant trades to prevent market influence. Gain insights into strategic diversification across different markets, considering factors like liquidity, spreads, and tax implications. With robust backtesting and a diversified approach, Adrian aims to ensure consistent success, navigating market volatility while mitigating risks. Tune in for a wealth of expert insights that could transform your trading journey.
For more information on Adrian Reid:
https://enlightenedstocktrading.com/free/
Straight Talk for All - Nonsense for None
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Hello everyone, this is Steve Davenport, here with Clem Miller, and today we're honored to be joined by Adrian Gra, adria Reed and Adrian is coming to us from Enlightened Stock Trader down under in Australia and he works with individuals and traders who are trying to use a more systematic approach.
Steve Davenport:Algorithmic trading, systematic trading, are all areas that he feels add the most value and will be opportunities for clients to take the emotion out of their investing. We know that people make the worst decisions at the worst times and, as he mentioned earlier to us offline, he hasn't read a newspaper in 20 years, so he's pretty much eating his cooking and focusing on the models and not focusing on the latest news event on the models and not focusing on the latest news event, the latest political event or the latest shortage in crops in Indonesia. So I think that today's discussion will be great and I hope we can help people understand a different approach to trading so that we can all get better as investors. I'd like to welcome Adrian and Adrian, it's off to you. What would you like to help our investors with today?
Adrian Reid:Steve, thanks so much. Look, I think the intent of this discussion was to talk about factors for success in 2025. I mean, we're coming up to the end of the year was to talk about factors for success in 2025. I mean, we're coming up to the end of the year and I think there's some general principles that would be great if we can kind of share and talk about. And you know, I'd also like to understand a little bit about what you know, your perception of what's going to drive success in the new year and what people should be looking at. But you know general principles to keep people alive in the markets, keep them safe, keep them growing, no matter what crazy things happen. And you know, I think if we could cover some of that in the next 30, 40 minutes, I think we'd be doing pretty well.
Steve Davenport:I agree, Clem. Do you have any factors that you think are important in the process and the principles?
Clem Miller:Well, I don't know, you know. The question is, which factors, adrian, you cover? I think most of the people who listen to us, most of our listeners, when they hear the term factor, they think of the sort of standard, academic factors momentum, which is probably something you cover, I would imagine. Value maybe you don't cover, I'm not sure Value, quality, which you know, profitability, earnings, stability. Also, size might be a factor that you know a lot of people look at. So you know there are a number of different factors that I think most people think of when you use the term factor, or at least our audience would think of as being factors. So let me start by asking you what factors do you cover? Do you look at? What factors do you cover, do you look at?
Adrian Reid:Good question and I think this is important because I'm a purely systematic or algorithmic stock trader. I'm using predominantly price data to make my decisions. Now, that doesn't mean these factors don't come into the models, but it's probably a little bit different to the way many folks use them. So, for example, you mentioned momentum. I mean I absolutely have models which are keyed around momentum. My strategies are either trend following, relative momentum, so rotational momentum, so buying the strongest stocks, selling or shorting the weakest stocks. I have mean reversion models, which is when a stock is going up. If it has a sudden dip, I'll buy it, waiting for expecting the bounce. I have seasonality models, which you know, around holidays, you know around the year end, around you know time of the year, and I have those long and short for a range of different universes of stocks. So you know you mentioned size as a factor. So I think about size as a factor, but the way I do it is maybe different to what you think, what you would typically think. I've got a strategy that trades stocks in the NASDAQ 100. Okay, so large stocks. And that strategy is a rotational momentum strategy, so it buys the strongest stocks and when they're no longer the strongest stocks, it'll sell them and it'll buy the new, strongest stocks. So it's momentum and large size.
Adrian Reid:I have small cap models and when typically small cap models and when typically small cap models, I use trend following. So I'll look for stocks that are going up and I'll buy them and I'll hold them until they stop going up and start going down. Then I'll sell them and that's all rules based, and so that might be. They might be small cap models and they will turn on and off depending on what the market is doing. So momentum size, for me not so much sector, because I find that it's easier to keep it simple and have a broad cross-section of stocks in each model.
Adrian Reid:And then I'll use volatility. So some models turn on in high volatility, some models turn on in high volatility, some models turn on in low volatility. And then I'll use country, as you know, I'll call it a factor here, because I trade Australia, us, canada, hong Kong, and so, again, like as a systematic trader, the fact is you use a little bit. Yes, some of them are a bit different, but some of them are the same but used in a different way to maybe what you might think. Does that sort of answer the question?
Clem Miller:It does and raises, I guess, a whole bunch of issues in my mind. Perfect, let's go. So can I ask one question?
Steve Davenport:Sure.
Clem Miller:Yeah, go ahead, Steve. Why no Europe?
Steve Davenport:Oh, interesting.
Adrian Reid:I have a few systems that work for european countries, but uh, they just didn't earn a place in my portfolio. And when I say earn a place, so the way I, the way I think about it, is, I have to have a strategy that has a positive edge. So I need to have positive expectancy. So when I put, when I put those rules into my trading software and run a backtest over the last 20, 30 years of history, it has to have a positive edge, it has to be stable, it has to make money over a broad range of market conditions. That's the first stage gate. The second stage gate is does that strategy actually improve the portfolio that I'm currently running?
Adrian Reid:So I've got, as I said, I've got active strategies in each of those markets Australia, us, canada, hong Kong. If I add a Europe system to that portfolio, it's going to make my portfolio better. So what I'll do is I've got all of my strategies, they've all got a capital allocation weighting to them, and then I get a new strategy and I'll put it in and I'll try is I've got all of my strategies, they've all got a capital allocation weighting to them, and then I get a new strategy and I'll put it in and I'll try different weightings and I'll see if it can be sort of net positive to the portfolio. Does it earn some of that cash or is that cash better off left with the models that I've already got and right now the way my portfolio is constructed, they haven't earned a place.
Steve Davenport:Okay, this raises one question for me, which is Hong Kong. How have you noticed the market adjusting as China has become more active in bringing Hong Kong away from the British system and into the Chinese?
Adrian Reid:Yeah, it's a good question. I really like the Hong Kong market as a trader because it moves very differently to, say, the US market. It also has some different primary drivers, I suppose because its long-term trends can be quite different from the long-term trends in the US market. For instance, I have been long US and short Hong Kong and I've been short Hong Kong sorry, short US and long Hong Kong at different points in time. They can be quite diverse in the way they're moving and that adds a lot of value to the portfolio. But I would say for the time that I've been trading Hong Kong, which is well over 10 years now, the market has been relatively stable in its behavior, not stable in its trend because it's been through bull and bear phases during that time.
Adrian Reid:But I haven't noticed any real underlying shifts in the way the market moves. It's always been a very kind of spiky, you know, sudden momentum driven market, a lot of uh I don't want to call it pump and dump because I'm not sure if that's actually what's happening but a lot of excitement and then trailing off. Uh, there are some pump and dumps in there because there's a you know, there's probably a degree of stocks which don't have a lot of disclosure, more so than the US or Australia. But with the right model, the right system, that's quite tradable and it adds a lot of diversity to the portfolio.
Clem Miller:I can explain why there's spikes in Hong Kong. It's because you have this pattern in China itself of the spikes, retail investors on the A-share market and they get misled, I should say, to invest a lot and then the market falls and then they all try to rush out and there's a relationship there between the A-share market and the H-share market in Hong Kong and it sort of transmits that. So that's got to be the explanation for that. But let me ask you I got some additional questions here. I've got a lot of questions right, every time you talk, I got more questions. That's perfect. So frequency what's the frequency of your data?
Adrian Reid:I use daily or weekly charts. I have some strategies so my shortest duration is one day. So I'll buy on a limit order sometime during the day, sell at the close, but for me that's very short term. My average hold time across my portfolio is many weeks and I've got strategies that hold for many months if the conditions are right. But yeah, always daily data or longer.
Clem Miller:And how many stocks are in each portfolio and what would be the sort of maximum and minimum weights?
Adrian Reid:So the strategies typically have between 10 and 30 stocks in a strategy. So, for instance, my main long side Hong Kong strategy will trade up to 35 stocks at a time and the reason is this pump and dump sort of behavior that you see there can be some risky moves and I want the weight to be very small on each individual stock. I have mean reversion strategies in Australia and Canada and they'll trade a smaller portfolio, so say 10 stocks in the portfolio, and I also have some strategies around ETFs. So that would be one strategy, one instrument. So it's either in or it's out of that particular ETF.
Adrian Reid:So it does vary but generally for stocks, 10 or more in a portfolio, for that system the weightings is you know, if you imagine you've got your whole portfolio and then my maximum system weighting, on the long side at least, would probably be about 15% I'd have to check the numbers exactly but I've got a lot of different strategies going on so I don't have all the numbers right to hand. So let's say the portfolio was 15%, so the strategy was 15% of the portfolio, and if that had 10 stocks in it, then we're talking about pretty small positions.
Clem Miller:Exposure of 1% to 2% of the account per stock stock. So do you use in your models not just price level and direction but also some kind of measure of risk like volatility or beta or something like that I'll use volatility of the stock.
Adrian Reid:I'll use direction and sometimes volatility of the relevant index, and occasionally I'll have models that have other factors. So in the past, for example, I've had exchange rate fluctuations as a factor in a trend following model. I don't use that right now, but I did have a model in the past that had that. So primarily it's price direction of the stock and behavior. So that would include volatility and direction and behavior of the relevant index.
Clem Miller:One of the things that I found in my own research for my portfolio, which is basically a fundamental portfolio, but one of the things I found as an explanatory quant factor is the short interest as a percentage of float, and while a high one can create a short squeeze that can push up prices, I think in general a low short interest ratio is actually good. A low short interest ratio is actually good. So you know, what do you? Do you use that and if you don't, what do you think about short that short interest ratio?
Adrian Reid:I think it would be a powerful factor. In order for me to use something like that, I need that information as a daily data series for the entire duration of my data set. Because the way I'm trading purely systematically or algorithmically I don't want to make any discretionary decisions. So my goal is that I don't have to think about any one of my trades. The rules just tell me buy this, sell that, and they tell me exactly how much and when. If I don't have the entire data series for a particular factor or data set, I can't test that rule. So short interest might be powerful and I agree. I think it would be a very useful piece of information. But for me to use it I need short interest on every stock, on every day in the entire history of that stock.
Clem Miller:So I can test it and make a decision.
Adrian Reid:Mark BLYTH.
Clem Miller:JR For you, it would be sort of difficult because as far as I know it's not well, it probably is available, I'm just not aware of it. It may not be available for australia it is from a lot of money in australia well.
Adrian Reid:So I mean most data I think you can get if you're willing to pay for it. But the more you have to pay for it, the more you got a question is it going to be worth it? You know you, because the data has to give you an additional edge that more than pays for the cost of the data. And you know I can get. Frankly, I can get a pretty good edge with data that costs me about, you know, 30, 50 bucks a month.
Clem Miller:It's easy to get a short interest ratio for US traded stocks, including the sponsored ADRs, so not the unsponsored ones but the sponsored ones.
Clem Miller:So that's easy to get and I use that in, uh, in what I look at. But one of the things you know, coming back to your momentum and risk, the reason I was going down that risk direction, uh, was it struck me that maybe there's something, there's some magic in looking at some combination of, of, you know, recent price return and beta, in the following sense that you know that you know, if you have an upward rising market, uh, it could be that any individual stock may be rising faster than the market simply because of beta and not because of some kind of underlying alpha. You could have a negative alpha and have a high beta. And so, thinking about this from more of a fundamental standpoint, which is where I'm coming from, I would rather have stocks that have high alpha because presumably they're going to do better on the upswing and on the downswing Right. So I have in my mind something like you know, return divided by beta ratio Right, or or a return minus index return Divided by beta ratio.
Adrian Reid:And.
Clem Miller:I'm thinking well, maybe that, maybe that and I haven't tested it yet, I've just been theorizing in my own head Maybe that would be something that might have some appeal in terms of being able to tell me, you know, what might be safer if the market should at some point fall, which I think is both Steve's and my concern that we might be headed toward a fall. In particular and I know we talked about maybe not talking about Bitcoin on this call, but with Bitcoin having surged, for political reasons, mind you, for political reasons, I think I stay away from Bitcoin and I think that we're going to see some issues with that, and that might be the trigger I think could be the trigger for a larger market drawdown or the next market drawdown.
Adrian Reid:I really like the idea of separating out a stock's return into alpha and beta and designing a model around, uh, around the alpha. I don't have a model that does that explicitly, um, I do in some of my, some of my models kind of in some way incorporate that concept. So, for example, um, in a mean reversion strategy I'll buy a stock which is dipping heavily in anticipation of a bounce, and by heavily I mean three to four days of very solid moves down sudden. But if the market is hemorrhaging down, that's typically not a great trade. If it's a stock-specific one, often you get better results because everything is not going down simultaneously. Um, so eventually, if the market starts going down a certain level, it'll that mini version strategy will stop taking trades. So, uh, what that? Um, what that results in is, uh, over time, a lot of trades which are driven by the individual stocks behavior behavior, not the overall market's behavior, and that's kind of useful.
Adrian Reid:On the long side, a high beta stock will tend to break out and move more than the market. However, they're more volatile because high beta right. So in a lot of my long side strategies I favor low volatility stocks. So strong breakout, strong price move, low volatility gives very good trend-following results, especially in the Australian and Canadian market. So it sort of indirectly incorporates what you're talking about. But I haven't directly created the formula to do what you're suggesting. But I think it's a great idea. I'll definitely add it to my list.
Steve Davenport:Yeah, I have a similar strategy that I've worked on Clem, that is, I thought okay if I could pick which assets to be in for the foreseeable six months or nine months in terms of a call option. My question was am I paying too much for the foreseeable six months or nine months in terms of a call option? My question was am I paying too much for the beta? So when you look at small cap relative to the S&P, it's got a historical beta of 1.1. And if the S&P is trading with an implied vol, which is the price of a call option, I would say 18, right. And then I look and say, okay, I would anticipate that the implied vol for small cap should be about 1.1 or, you know, about, say, 19 or 20 implied vol. Now if the implied vol in small cap is 15, a little bell goes off in my head and I say I'm getting 1.1 beta and I'm paying 0.8 on the implied. That seems to me to be a wonderful place to be and I've noticed that emerging markets have, you know, a lot of times shown to have an implied vol less than the beta. So therefore I'd say, well, let's get it.
Steve Davenport:And I think it goes into your point about low vol. And there is low vol and I've seen it. You know, when I'm writing calls, mainly it's low. Low vol kills me on the selling call options. But then when I say I'm in a long period where it's a November to April period from seasonality, I say okay, if it is unusually low volatility then I'm playing an unusually low price. Unusually low volatility, then I'm playing an unusually low price and that to me is potentially, you know, going to give me more leverage. Right, the lower implied I pay, the higher the leverage I get on that call option. If traditionally it matches the S&P and the S&P is an 18 vol in six months and it gets about, say, a typical eight to nine times leverage, buying the call option If it's 15, I mean I've had J&J and other names that are low vol, that have traded in the eight to nine percent implied vol.
Steve Davenport:Now you can say I don't know how it's going to do relative to the% implied vol. Now you can say I don't know how it's going to do relative to the S&P. Its beta is more likely to be around 1, 1.1. It might be a little less than the S&P but it's reasonable. If your implied's at 0.5, I think you've got to load up the truck, and those are opportunities that I think people should be thinking about in terms of how much am I paying with the volatility and the return that I expect? If I really like an asset class or I really like a stock, I can say, okay, everyone else does, if the implied vol is high and I'm not alone, and that could be a good signal. But it might not be the exact signal I want.
Clem Miller:Hey Steve and Adrian. The wind outside blew something down, obviously, and the power went off briefly, which kicked me off this because it's attached to the Wi-Fi, so I'm back on now who knows how long right.
Steve Davenport:Well, we'll make it with.
Adrian Reid:This is exactly why my trading is automated and in the cloud, because when I have power failures then it doesn't affect my trading decisions. So it's one advantage of being systematic and algorithmic. Hey, on the volatility side, steve, I think you're right. I think it's a really powerful lever or factor in the way we can make our investing and trading decisions. And I suspect that most people don't pay enough attention to volatility or think about it the wrong way.
Adrian Reid:For example, I know a lot of traders who I haven't taught so other people and they get excited by high volatility in a particular stock and my response is well, okay, but does high volatility help you in that case, in that situation where you're making that decision?
Adrian Reid:Because I know that high volatility helps in a mean reversion type scenario and I know that low volatility helps in a trending scenario, trend following type scenario. Because in trend following you want a nice smooth, grinding trend. You don't want to stop that it's bouncing around all over the place, because by the time it hits your stop loss, which has to be volatility adjusted, your overall return is much lower. But if you've got a stock that's moving nice and smooth, then your trailing stock that follows the trend can be much tighter so you can lock in a lot more profits. So understanding what the volatility is, what your strategy is, and does the strategy benefit from high volatility or low volatility, is really great. And then your idea of implied volatility versus beta is also really interesting because it gives you a clue about where things might be going. Definitely.
Steve Davenport:And that's one of the different factors. The other thing I look at is relative. So if Exxon trades at about 90% of the S&P volatility and suddenly it's at 70, I don't have a reason to think that the energy market and the S&P have suddenly found a new relationship. Market and the S&P have suddenly found a new relationship. I think it's probably that we have one big trader who's pushing vol down and I can look at it and say, ok, now is not a good time to write calls, but it is a good time to buy calls. And that's where I believe I mean I'd like to get back to the risk of your overall portfolio.
Steve Davenport:Do you have a like what's your average range for net long?
Steve Davenport:You know how long, how short? And then how do you break down the markets? I mean, do you look and say, gee, in Hong Kong last year I had an alpha of 4% over the benchmark and I only allocated 10% to it. This year I'm going to allocate 20%, because if my models are stronger now, I should be reallocating to first of all the markets that are good and then the strategies that are good, of all the markets that are good, and then the strategies that are good, and so I guess I'd love to know what your ranges are, because it would seem like to me, with the US market, canada, australia and Hong Kong, I can't see how you would put Hong Kong more than, say, 10 percent or 20 percent, but I also can't see how you would take the US down.
Steve Davenport:I mean because I guess I've learned from my experience that liquidity is king. When you're talking about options, liquidity really matters Because you can have an implied vol, but if you can't trade it, it doesn't matter, and so therefore, I tend to stick with very liquid names, because liquid names have the ability for your interpretation of that implied vol or that company's risk is pretty well traded right, whereas you could find companies in Hong Kong, I'm sure, that have ridiculously low vol or ridiculously high vol, and it's not really the company's underlying factors. It's more likely to be a liquidity-related item.
Adrian Reid:Could be. Yeah, so the difference between what you're doing and what I'm doing because you're trading the options, you've got the liquidity is a much bigger issue. I'm trading the underlying stock and I'm trading the stocks directionally, so I'm going long and short the equity.
Steve Davenport:So liquidity is a short MARK BLYTH. I find that the short side on some of those is less liquid.
Adrian Reid:No, david BLAIR. Well, yeah, look, liquidity can be a problem On my short side models. I'll require a much higher average daily liquidity for me to take a position because the risk is higher, and so I want to make sure that I'm going to be able to get out. So while on the long side I might get into a small cap that has very low liquidity of, let's say, half a million dollars to $750,000 per day turnover, on the short side I'd be more looking for, say, $2 million a day turnover to allow me to get in and get out safely.
Adrian Reid:The liquidity requirement there's two bits of it the liquidity needs to be high enough so that the spread doesn't kill me or doesn't kill that model, that system, and the liquidity also has to be high enough so that with my size I don't move the market, and so both of those have to be true. And, uh, for some systems I can cope with a very small level of um of liquidity or daily turnover, but other systems I want it to be to be much higher. I don't need to just trade us stocks, because I mean, most stock markets are humongous compared to any individual investor. You've just got to be careful at what tickers you actually, we actually trade, and so each of my strategies have those rules built into it to make sure that I'll stay out of the stuff that is going to hurt me and I'm allowed to take trades in stocks that do have enough liquidity for me to trade with.
Steve Davenport:Yeah, I also run sales strategies for executives, and so when you're doing that, you have to worry about you know, is there a quantity you're selling going to impact? And so I always use 20% as my number. I don't want to ever trade and be greater than 20% of the market. Do you have any guidelines?
Adrian Reid:Yeah, I would be looking for much less than that typically.
Adrian Reid:So most of the time when the way I've set up my liquidity requirements versus my position sizing, most of the time when I go to the market to place a trade, my trade is very insignificant. It doesn't make a dent, and that's the way I like it, because I don't want to move the market. If my order was in the order book, I don't want people to look at my order and then adjust what they've done as a result of my presence. So my trades are very small and this is one of the reasons why I like very broad diversification, because it allows me much more flexibility about what I trade. With 20 or different trading systems across several different markets, with 10 to 30 stocks in each system, I have very small positions. None of them matter very much to me and certainly none of them matter very much to the market and, to be honest, I think, as a private trader, I think that's a great place to be, because I want to benefit from the moves in the market. I don't want to create the moves in the market.
Steve Davenport:Sure, I think that it's nice in the market. Sure, I think that you know it's nice to be below. I'm just saying that sometimes you like you pick a name that you say. You know this, for whatever reason, has you know, has terms and spreads that you don't like, and I think that's what I try to stay away from. You know those types of options or those types of stocks, because you're immediately adding up. Life is full of friction, and so the question is how much does the friction impact your utility function? Right, yes? And then you've got a utility function and the spread is going to blow you out. Then it becomes less of a good trade, even if it does have a great beta or great fall characteristics.
Adrian Reid:Yeah, absolutely. It's very easy to underestimate the impact of friction costs or slippage in commission on your trading strategies. The way I think about it is I look at what the strategy is and what its raw, what its edge is. So let's say the average profit per trade on a particular strategy was 40%. On average it's a trend following strategy. The winners are huge, the losses are small. I know that I can cope with a little bit of slippage in that strategy because on average, across every trade my profit is 40%. Obviously, not all trades are winners, many are losers. But I can afford then to trade smaller stocks with less liquidity that have a little more slippage, because I know the edge is big. If I've got a mean reversion strategy and the average profit per trade is 0.75%, I can't cope with almost any slippage. So it's got to be ultra liquid stocks and so therefore the liquidity requirements are balanced accordingly. So every strategy has different rules to make sure that it stays safe.
Steve Davenport:Can you just give me one idea of how much you are in the four different markets? Does it vary every year or does it vary every?
Adrian Reid:It varies constantly because of how much my systems are invested or not, but my allocation, my potential maximum allocation, is stable. Over time I will adjust it very gradually as I add new systems or as I retire old systems. But I'm not thinking okay, right now I want more in Hong Kong and less in the US, or vice versa. I don't think about it like that. It's allocated based on long-term correlations and the diversification impact that each strategy in each market bring so variance analysis or something to to compare the different strategies, or so the way the way I do it is, I um all the strategies are back tested.
Adrian Reid:I have the the daily return stream of every single strategy that I run and I combine them in a in a model using weights, and basically the weight is a parameter in my model, so I'll adjust the weight for each of the different strategies to best meet my objectives long term okay yeah, but back to the question how much is any strat in each market?
Clem Miller:sorry clem uh no, go ahead, go ahead yeah, how much is in each market?
Adrian Reid:I mean, I would look there. They're roughly equal. So each of the different markets. So I don't have more in the US because it's a bigger market and less in Hong Kong because it's a smaller market. It's all about how much of my capital do those strategies earn and how many different strategies do I have for that market. So I don't care if the market is big or small. If I found an amazing strategy for the Philippine stock market that I could trade without getting killed by slippage which is impossible, by the way, it's very illiquid. But if I did, that's a very small market but I could allocate money to that and the money that I allocated wouldn't be reflective of the size of the of the overall market. It would be purely reflective of the impact on my portfolio.
Clem Miller:So so I got two questions. Uh, one's kind of a follow-up to the regional question and it is given. Given the countries where you're involved, it strikes me that maybe you might have higher than index bank and minerals exposures. Does that matter to you or no?
Adrian Reid:Look, not really. The strategies are almost all broad market. So, for example, my Australian trend following strategy will look at every single stock on broad market. So, for example, my Australian trend following strategy will look at every single stock on the market. It'll kick out the ones that are too low liquidity, it'll kick out the ones that are too high volatility and it'll take signals from the rest. It doesn't really matter to me which sector they're in Actually. In fact they'll often cluster. So you know banks might be moving or minerals might be moving, and that strategy will load.
Steve Davenport:I think we're losing your, uh, your audio and your signal a little bit went off for a second there. Can you hear me?
Adrian Reid:clem, still I can hear you adrian, okay, cool. Um, so one of my strategies might load up on a particular sector because that sector is moving in line with what that strategy requires, uh, and so that strategy might get heavy on banks or it might get heavy on minerals, um, but that won't be true of all of my strategies because the strategies are quite different. And so, uh, I don't worry too much at the portfolio level because I know there's enough diversity built in that I'll end up, you know, the exposure will move around the market, you know, pretty fluidly.
Clem Miller:Okay, and my second question is how should a taxable investor be looking at all the trading?
Adrian Reid:Well, yeah, this is a good question and it will differ depending on the way you're taxed. When I was living in Singapore, it was a wonderful world because there was no capital gains tax, there was no dividend tax. Basically all of my trading was tax-free. It was fantastic. Now I'm back in Australia, it's quite a different world.
Adrian Reid:So you've got to look at do you benefit from long-term capital gains or are you just in a basically trading profits are income sort of scenario and then design your strategies accordingly? So if you are taxable, then you've got to compete with buy and hold right, because buy and hold there's no taxes if you never sell, apart from the dividends, but just ignore dividends for the moment. So if you bought and held the S&P over time, what do you make, I don't know, like 8%, 9%, 10%, depending on who you listen to and there's no capital gains tax. If you don't sell, again there's no tax advice, like you know, consult your accountant, all that business. But if you're going to then actively trade, you've got to beat that plus tax, like taking into account the tax, and I think a lot of people will, you know, trade and go.
Adrian Reid:Okay, you know I've made a couple of points over the index I'm doing well, but after tax, are you really? So I want to make sure that my returns after tax are appealing and you know part of it is return and part of it is risk, right, I don't want to sit through a 60% drawdown which, if you're a buy and hold investor, you will, right. If you're an active investor, then you can sidestep the drawdown, you can go short and that's going to give you quite some benefit. But my look, my returns before tax are certainly high enough to justify paying the tax of being an active trader and then still beat the market with lower volatility.
Clem Miller:Okay, Steve. Those are my questions, Adrian and Steve.
Steve Davenport:Okay, I guess when you look at a strategy and you say this strategy is working really well for me in Hong Kong, do you then take it and export it to Canada, and export it to the US and do a back test and say I guess how much of your overall allocation has the same strategies working in different markets and is there a limit? And you say I won't have like trend following If I do two and a half percent trend following in Hong Kong, you know I have overall 10 percent trend. Do you ever get into the? This strategy has become all of my, you know? Does your alpha ever get disproportionately in one or another place such that you worry about? Well, how can I maintain this? If this variable goes, my other variables haven't been producing what? Do you look at it and say every dog has his day and I'll just let this run until. I'll let this horse run until we have to take it and put it out to pasture.
Adrian Reid:Yeah, it's a bit of both In my capital allocation. I primarily work on the strategy. So I get the equity curve of the strategy and I add it to the portfolio and adjust the weights. But then I have a report that says, ok, how much is in trend following, how much is in mean reversion, how much is in rotational momentum, how much is long, how much is short, how much is US, australia, hong Kong, canada? So I know what those percentages are and the most important thing is to not be in a situation where you can get hurt, because if we end up with a drawdown that's too big for us to survive and recover from, we're out of the game, and then that's the worst thing. That's too. That's too big for us to survive and recover from, we're out of the game, and then that's the worst thing that can possibly happen. So I don't have exposure to any one market that would permanently take me out of the game if something catastrophic happened. I don't have exposure to any one strategy. You know, let's say trend following, mean reversion, rotational momentum, et cetera, call them strategies. I have a fairly balanced allocation to each and then underneath that I have system, and so there's several trend following systems in Australia, there's several trend following systems in Canada, et cetera. And so I have a very small allocation to each system etc. And so I don't have I have a very small allocation to each system.
Adrian Reid:My favorite strategy is trend following because of a lot like I know it's worked. It's always worked. I believe it will continue to work and if you back test my trend following strategies on us data back to 1950, it worked right, it's clearly got an edge and it's clearly stable. So I really like that. So I'm I'm heavier on trend following than I am on mean reversion, because I know in market panics mean reversion can hurt you. It doesn't always, but it can. So I don't want to really load up, for example, on mean reversion and that's reflected in my capital allocation percentages. It's not a conscious decision I'm making at the time. It's a pre-made decision when I did the allocation calculations.
Steve Davenport:Yeah, I guess my thing with the whole backtesting. You know I've worked with some people who have used backtesting in a way that was, let's just say, less than fully fair and balanced. They seem to always backtest stuff, that gave them this alpha, and when I use similar rules to backtest, it suddenly wasn't enough data and then I needed to use more data, and the rules aren't always applied by chief investment officers as wisely and balanced as you are. Let me put it to you that way.
Adrian Reid:I completely agree, most people do it badly.
Steve Davenport:So I guess the big question always is do you think that the past is going to be an indicator of the future? And I've looked at history on volatility and you can tell. When Glass-Steagall was overturned in the US in 1999, the implied vol of the market went up and it allowed all of these banks and other institutions to take more risk with their balance sheet. And guess what, if you take more risk with your balance sheet, there's a higher probability that you're going to have a problem with your balance sheet.
Steve Davenport:a higher probability that you're going to have a problem with your balance sheet, and I guess I wonder whether you know what I mean there's. I always think that the most important thing is when not to trade, not necessarily when to trade that sometimes there's a it's becoming apparent that something isn't the same or right with a particular model or with a particular market. And I look at the US market right now and call me crazy, but I feel like it might be overvalued, I think there might be too much enthusiasm and therefore I look at the metrics and I say you know, is this a good time to put on shorts or put on, you know, put options maybe, but um, there's a. There's obviously a lot of momentum behind Um. So let's talk a little bit about momentum and how do you measure momentum as as a signal and whether it's going to become a bigger signal going forward?
Clem Miller:Yeah, and can I? I want to add an addendum to what the question that Steve just asked, which is you know, when you look at momentum and you look at the price series that undergirds momentum, do you take into account any kind of I forget there's a term for it in stats, I forget what it is, but basically it implies that the data that's older has less weight in your formulation than newer data.
Adrian Reid:Data You're talking about recency bias, yeah recency.
Clem Miller:Well, I mean, yeah, well, there's recency bias. That's not what I'm talking about. What I'm talking about is it goes to Steve's point about Glass-Steagall. I mean, do you give a much lower weight to data that's five years old? Oh, I see, yeah, yeah, yeah, than to data that's like last week.
Adrian Reid:Short answer is not as much as you'd think. Like last week versus the last five years, for example, last week is noise, but in the vast majority of instances the very recent short-term data is noise, but when you zoom out there's trend, there's momentum. So I would say look the data of 30 years ago and the way the market moved is not as important as the data in the last three to five years. Okay, but um, you know, I want to come back first to an earlier question that, um, that steve sort of didn't quite ask but kind of hinted at, which was, um, you know, do we is the is the past predictor of the future? And the way I think about it is if I backtest a strategy and it lost money in the past, it's going to lose money in the future. Just because I started trading that strategy today doesn't mean it's miraculously going to turn around and start making money. So the first stage gate is did the strategy work in the past? And if it did, then maybe it can work in the future and therefore we might be able to make some money on it. The second stage gate is how robust were the profits that it made in the past?
Adrian Reid:So a strategy has certain parameters, certain factors, certain weights, whatever you want to call them. And let's say it's got a 200-day moving average and it's got a 50-day breakout and it's got a volatility threshold of this much. You've got parameters, input parameters, that define the strategy. Now if you put those input parameters into the model, you backtest it and it worked. That's the first tick. But if you vary those parameters a little bit and the model breaks, it's not a good strategy, it's not a good model. It will fail in the future. But if you put those parameters in and you vary them widely let's say plus or minus 20 to 30%. So 200-day moving average, down to 150-day moving average, even maybe down to 100-day moving average and up to a 300-day moving average, down to 150-day moving average, even maybe down to 100-day moving average and up to a 300-day moving average, if the strategy still makes money, then it's a much more robust strategy.
Adrian Reid:And so for me to trade a system, it's got to have very robust parameter values that will work over a wide range of values, and then I choose values that are right in the middle of a very broad range of good profitability. In that situation do I believe that that system can make money in the future? Yes, is it a guarantee? No, but that's why I have many different systems with a small capital allocation to each. I'll monitor the performance of them and if the performance decays, I'll turn one off permanently and then I'll find something else to replace it. And when you've got 10, 15, 20 different different systems running, turning one off is not that big of a deal, like if it's clearly if the edge is eroded, something has shifted in the market. Uh, you know, there's been a step change in volatility or there's some change in the market microstructure that has affected the profitability of the system. You can turn one off and it doesn't hurt you too much.
Clem Miller:Okay.
Steve Davenport:Yeah, there's one. I mean I agree with the positive side and the long side, but what I've spent most of my career doing is I try to identify those black swan type events, or the likelihood of a black swan type event and a negative event. And so when you look at the last 20 years and you do the backtesting of my model for seasonality, there were only about six main events and for years you could have no event, no negative event.
Adrian Reid:So you're spending money that is wasted and the hedges are expensive, right.
Steve Davenport:Hey, you know my five year number isn't good. I'm going to get rid of that. You know I'll use the example of CalPERS in 2020. Calpers got rid of the tail hedge in February. They had it on for five years. Guess what? It didn't work for those five years. So they said we're not going to put any of our money there. And guess what? February 2020 would have been really nice to have that strategy on, to have that strategy on. So I guess that's what I. When I say things don't work, I mean in a consistent enough way that the back test indicates your true probability of success.
Adrian Reid:Yeah, I think it's actually really insightful because a lot of investors will have a behavior of turning something off, stopping doing something that they think is not working, but it's actually doing exactly what it was supposed to do. And so I've got a strategy on the short side and I actually trade this strategy almost exactly the same in the US, hong Kong and Australia and it on its own doesn't look very good. I mean, it makes money over the long term, but let's call it a high single digit compound annual return. But the drawdown profile of that strategy could be up to 30%, 35% drawdown. So by single digit returns, 35% drawdown is kind of like well, it's not a very good strategy and it's got long periods of drawdown and long periods of poor performance. But when does it make money? It makes money in a month of application, right, and it makes money exactly when everything on the long side is in drawdown, correct, and it does it fast.
Adrian Reid:So for me, I you know the way I think about that is I need to make sure my portfolio will be okay, no matter what happens. And so I do some mental scenario analysis and say, okay, well, what happens if the market drops 30%, 40%, 50%, 60%? What will happen in my portfolio and I, okay, this system will kick in. This system will kick in. This system will kick in, they'll make a lot of money. Those systems will go into drawdown. Then they'll go to cash. This system will keep trading and will lose money.
Adrian Reid:So that's not a good thing. And I need to make sure that by the mental scenario analysis my portfolio will be okay, not just by the back test, because we know the past is not going to be exactly representative of the future. We need to use our imagination and say, okay, what could go wrong here? And you know I spend a reasonable amount of time dreaming up okay, what could go wrong? Would my portfolio survive? How deep might my drawdown get? And then I go and look at the back test as well to try and validate on the actual data as much I can.
Steve Davenport:Yeah, my last comment is going to be I've spent a lot of time looking at heteroscedasticity, which is that volatility recent volatility begets volatility. And so, while you think that getting to 35% volatility means that you have to experience 20, 25, 30 before you get to 35, but you can have an event that puts you at 35, and then, all of a sudden, there's no reason for it, but it will go to 40 and it will go to 45. And you're you know, if you're not aware that, hey, this isn't necessarily macro, specific and practical or reasonable, it's just, you know, an event where the volatility is begetting volatility. So I think that you know, in some regards, that's where I kind of separate from the backtesting, because I feel like, hey, there could be an event you know, china in the South Seas decides to, you know, blockade Taiwan.
Adrian Reid:Okay. I think it's actually worse than that. That, though, because there could be an event that suddenly begets massive volatility, but it's not. That's not the problem. The problem is what if there's two events that coincide that historically have never coincided, and the volatility is so much more, or the drop is so much more than what has been historically evident? I think that's what we got, because we fool ourselves into thinking that the sequences of events in the past is what could happen in the future, but in reality, bad things can stack together in quick succession with no reasonable correlation, but that can affect the markets dramatically, and that's the sort of mental scenario analysis that I think is important to overlay, on top of the backtesting. I believe you have to backtest because you need to know that the strategy worked, and worked over a wide range of market conditions, but you can't just close your eyes and say, well, in the last 30 years it was fine, so it'll always be fine. I don't think that's sensible.
Steve Davenport:Yeah, and I also think that the end of your statement that said in similar conditions, you know, I mean, I don't know if we can really say that a 2020-type scenario is necessarily different than a 2024 scenario of a military event and a pandemic is one thing and a volatility of a military action is another, but they could look and feel when you're just looking at return distribution, you know they could look exactly the same. Oh, absolutely yeah.
Adrian Reid:They're very different.
Adrian Reid:Yeah, the way I analyze this, I have a model called the market system map and basically there's all sorts of fundamental real world things that can happen. I mean, you could dream up thousands of impossible events, some that have happened, some that haven't happened yet and they could affect the market in some way. But at the end of the day it comes down to a very small number of things that can actually happen in the market. Right Market reactions the market can have a primary uptrend, it can be going sideways, it can be going down. Within that, that trend could continue for the foreseeable future, there could be a shock against the trend or the trend could change to another direction. So there's three primary directions, three possible actions.
Adrian Reid:There's only nine things the market can do, and when I'm constructing my portfolio, I want strategies that can profit from lots of those, from a high percentage of those nine different behaviors. Definitely, when the market's going up smoothly, can I profit? Yes. Trend following when the market's going down and it's volatile, can I profit? Yes. My short side strategy when the market is sideways and volatile, can I profit? Yes, mean reversion, and so by having strategies that profit from different market behaviors, then does it matter so much Okay. Is there a military event? Is there a health event? Is there a macroeconomic sort of event? Not so much, because as long as I can profit from whatever the market does in response, then I feel like I'm okay.
Steve Davenport:Sure, how does that feel? Does that make sense? Yeah, it makes a lot of sense. I think I want to become a systematic trader. It takes away all the decision-making and allows me to spend more time looking at the pond than putting my feet up, you know.
Adrian Reid:Well, look, it's a bit like that. The execution is very simple, day to day. I don't have to think and worry about all of those things. I've done a lot of thinking and analysis in advance to get to the point where I can trust the systems enough to let them run no matter what's happening. To get to the point where I can trust the systems enough to let them run no matter what's happening and I think a lot of people underestimate the upfront kind of preparation and analysis to build the confidence, because you have to keep trading.
Adrian Reid:Once you commit to a strategy, you want to keep trading it. If it's in a drawdown, which is normal, you've got to keep trading it so you can guess what come out of the drawdown. But if you panic and you quit the strategy, you're quitting in drawdown and so your account just ends up going down and down and down if you keep having that behavior. So we've really got to build confidence in our rules so that we can keep following them. That's the upfront work. Ongoing is easy because you're just basically following the system For yours, for your approach, you've got a lot more ongoing thinking to make the decisions, but you can start. You know you don't have the big chunk of upfront work to kind of design the strategies and whatever. I mean sort of Obviously there's a lot of learning involved so you can make sensible discretionary decisions. So there's work either way. I guess that's the point.
Steve Davenport:Adrian Reed. Your insights and your ideas are wonderful. I really appreciate your time today.
Adrian Reid:If you, you know, can you give us the primary drivers of success that I think everyone needs to understand. You need to be able to profit from different market conditions. If you're a long only investor and you're going to hemorrhage in a bear market or a sudden event at some point, you're going to get into trouble. So I like a diversified portfolio of strategies. I want to be able to make money in up markets, sideways markets and down markets. I also want to diversify globally, internationally, because while the US market might be strong right now, it might be weak in the future, and if it was weak right now, it might be strong in the future. So I want to be able to profit from different economies. I think that's really important. So diversification much more broadly than you think is typically something that's really powerful.
Adrian Reid:Risk management is always underplayed by individual investors. I want a very small amount of risk on any one stock. I want a pretty small amount of risk on any one strategy and I want to spread my risk across different economies, because that way nothing will hurt me to the point that it's catastrophic. The number one objective of all private investors and traders should be to stay in the game. We have to first stay in the game, because if we make a thousand percent this year and then lose a hundred percent next year, we're out of the game. Because if we make a thousand percent this year and then lose a hundred percent next year, we're out of the game. We've got nothing left.
Adrian Reid:But if we make steady returns over time and we don't have drawdowns that are catastrophic and take us out, then we can build wealth, and that's what it's about. So we need patience, and I think patience is a characteristic, a trait which investors and traders need to really build on. We need the patience to do the work, we need the patience to wait for the signal, we need the patience to wait for the exit, and we need to understand that we can have emotions, but we can't act on the emotions, because the emotions are almost always wrong when it comes to the markets. Systematic trading, I think, helps with a lot of this, because the emotion is taken out of the day-to-day decisions and we can just follow the rules.
Steve Davenport:That's a great summary, I think we Clem would you agree with that? I mean, we've talked about timeframe, we talk about patience, we talk about discipline and I think that all of those things you're taking to another level with the long and the short end. Most of our clients don't have the sophistication to get involved in the short, but they are. You know, they can get more well diversified and start to look at some other things that might have characteristics that will buffer them or help them when they need it. So I think your summary was right on point. Right, I agree.
Clem Miller:And Adrian, I think we'd love to have you back on the program in the future to talk about some additional things.
Adrian Reid:Yeah, I think that'd be great. I mean, I really enjoyed this. I enjoyed the conversation. I really like having conversations like this with smart people who have a different approach to me, because I walk away I've got a whole list of things I need to test now, because you've said some things that I haven't thought of, or you approach the market a different way to what I do. But there's some things over there that I can incorporate and see if they can improve some of my systems, and I think that's really powerful and that's why people should be listening to shows like this. That's why people should be reading books. Even if you're successful, a little bit of an edge, a little bit of an increased edge, compounds massively over decades. If we could just uplift our edge by a couple of percent and execute on that year after year, in 10 years time, 20 years time, we are so much better off.
Steve Davenport:So that's what we're doing to help people find, whether it's through lower cost investing, whether it's through lower, you know, higher sharp ratios, higher information ratios. I mean, if we can give people one thing to help them make their financial lives better and make their results better, I mean that's what we feel gives us. You know, we go to bed happy at night. So, absolutely, I think it's great and I appreciate you coming on and I appreciate your insights and I look forward to working with you in the future. Nice, thank you everybody. I'm skeptics guide and I hope you enjoy this and, if you did, please like and share and we look forward to bringing more guests like Adrian Reed and more insights into these markets, because I think we're going to need it. Insights into these markets, because I think we're going to need it. 2025 could be a volatile ride and we want to have some stabilizers in the car so that we don't scrape along the bottom of the road. All right, thank you everybody. Good night.
