Alternative Investments -Measuring Performance

How to measure performance between accounts.



Dealing in Alternative Investments requires a bit of statistical knowledge (the more the better).  So I picked out one component that would benefit someone who handles their investments personally and, at the same time, benefit someone who pays an advisor because it never hurts to ask the right questions.

The following is not investment advice, but one way to assess the advice you were given…

High Frequency Trading or Unconventional Return Periods

When returns are realized at higher frequencies (many times per year), Sharpe Ratios and the corresponding t-statistics can be calculated in a straightforward way.

Assuming there are N return occurrences per year, and the mean (μ) and standard deviation (σ) of the returns are μ and σ, the annualized Sharpe Ratio can be calculated as (μ×N)/(σ×√N) …or (μ/σ)×√N.

The corresponding t-statistic is (μ/σ)×√(N × number of years).

For monthly returns, the annualized Sharpe Ratio and the corresponding t-statistic are (μ/σ)×√12 and (μ/σ)×√(12 × number of years), respectively.  Here, μ and σ are the monthly mean and standard deviation of returns.

Similarly, assuming μ and σ are the daily mean and standard deviation for returns (you traded every day the market was open…please don’t do that:) and there are 252 trading days in a year, the annualized Sharpe Ratio is (μ/σ)×√252 …the corresponding t-stat is (μ/σ)×√(252 × number of years).

The calculators I use to find these metrics are listed in the right-hand column on “my trading desk.” They both have statistical functions.

The Test Statistic

Test Statistics (t-stat,t-statistic) are tricky creatures.  Essentially when evaluating performance, I require a t-stat of 4 or more (the higher the better) before considering a stake.  In the future, I will explain a simple model I use to allocate cash among accounts and strategies according to their t-stat.

Now, here is a simple formula to estimate a t-statistic for unusual return periods:

Test statistic= (μ/σ)×√(N return occurrences × number of years).

Note that “N return occurrences×Number of years” is just the total number of return occurrences resulting from the investment or strategy (either positive or negative).  So, if you closed out 3 trades (at 1%, -2.3% and 3%), that counts as N=3.

Or, if your investment reconciles every 6 weeks, for the past 1.5 years then N=13, (78 weeks / 6).

Remember, it is important to convert your daily/weekly/monthly returns to an annual (yearly) number.  This makes it very easy to compare performance against conventional, low-return investments pushed by financial salesmen.

And since the volatility adjustment is built-in, it is an apples-to-apples comparison.


U.S. Industrial Production

What Is The Federal Reserve’s Industrial Production Index?

Always Check The Economic Calendar

The Federal Reserve’s monthly index of industrial production (and the related capacity indexes and capacity utilization rates) covers manufacturing and mining; along with electric & gas utilities.

The industrial sector, along with construction, accounts for most of the variation in GDP over the course of a business cycle. The production index measures real output and is expressed as a percentage of real output in the base year, 2012.

The capacity index, which is an estimate of sustainable potential output, is also expressed as a percentage of the actual output of 2012 (base year). The rate of capacity utilization equals the seasonally adjusted output index expressed as a percentage of the related capacity index.

The index of industrial production is available by market and industry groupings. The major groupings are:

  • final products (consumer goods, business equipment and construction supplies)
  • intermediate products and materials.

Why is U.S. Industrial Production important?

Investors want to keep their finger on the pulse of the economy because it forms expectations on how various types of investments will perform.

  • The stock market likes to see healthy economic growth because that translates to higher corporate profits.
  • The bond market prefers more subdued growth that won’t lead to inflationary pressures.

Tracking economic data like U.S. industrial production gives investors and traders an idea of what to expect in each market.

The Fed’s Index of industrial Production

The index of industrial production gives us an idea of how much factories, mines and utilities are producing. The U.S. is a consumer-based economy.  The manufacturing sector accounts for less than 20 percent of the economy, however most of it is cyclical variation. Consequently, this report has a big influence on market behavior.

Why does such a small ratio of the economy wield so much influence in the eyes of investors? Remember,  variation = volatility.  Volatile markets will either make or break an account.

Every month, we can see whether capital goods, or consumer goods, are growing more rapidly. Are manufacturers still producing construction supplies and materials? This detailed report shows which sectors of the economy are changing.

Now, the capacity utilization rate is a bit different.  It provides an estimate of how much factory capacity is in use. If the utilization rate gets too high (80-85% range), it can lead to inflationary bottlenecks in production.

The Federal Reserve watches this report closely and supposedly …arguably …sets interest rate policy on the basis of whether production constraints are threatening to cause inflationary pressures -when you hear about changes in inflation, think fixed income, think bond market.

Remember, in finance “fixed income” does not mean your grandparent’s monthly government subsidy.

The bond market can be highly sensitive to changes in the capacity utilization rate. However, in this global environment, global capacity constraints may be more significant to fixed income than domestic capacity constraints.

The Meaning of It All

Industrial production and capacity utilization indicate trends in the manufacturing sector, but also whether resource utilization is strained enough to forewarn of inflation.

Also, industrial production is an important measure of current output and helps investors identify turning points in the business cycle –recession expected, get ready to buy equities  …recovery expected, be prepared to sell.

The bond market will rally with slower production and a lower utilization rate as capital flows out of equity and into bonds. Bond demand will fall when production is high and the capacity utilization rate suggests supply bottlenecks.

The production of services has gained prominence in the United States, but the production of manufactured goods remains key to the economic business cycle. A nation’s economic strength is judged by its ability to produce domestically.

Many services are necessities of daily life and would be purchased regardless of the business cycle. However, consumer durable goods and capital equipment are purchased when the economy is expected to strengthen.

When expected demand for manufactured goods decreases, it leads to less production along with declines in employment and income.

The three most significant U.S. sectors are motor vehicles/parts (auto loan bubble?), aerospace and information technology. Volatility in any one of these sectors can affect the U.S. economy.

Industrial production is subject to some monthly variation. The three-month EMA or year over year percent changes provide a clearer picture of the trend.

If you want to learn how to connect the dots without spending thousands of dollars on the CFA exams, It’s all right here in the desk reference I use: Global Macro Trading

If you need a Kindle to read it on:  $15 Off A New Kindle Fire HD  or a $79 Kindle Reader

Homanns Heirs  c1746
Homanns Heirs c1746

British Retail Sales

How important are British retail sales?

Always check the economic calendar

The British Retail Sales Survey

Retail sales are the total revenue from stores that sell durable and nondurable goods. British retail survey data include all online businesses whose primary function is online retail.  The data also cover internet sales by other British firms, such as supermarkets, department stores and catalog companies.

Headline British retail sales are reported in volume terms but are available in both forms. The data are derived from a monthly survey of 5,000 businesses in Great Britain. The sample represents the whole retail sector and includes the 900 largest retailers and a representative panel of smaller businesses, including internet sales.

Collectively, all of these businesses cover approximately 90 percent of the retail industry –in terms of turnover.

Old Map (35)
The survey data covers 90% of Brit retail

Why are British Retail Sales important?

Consumer spending is a major component of the economy and market players continually monitor spending patterns. The monthly retail sales report contains sales data in both pounds sterling (£) and volume. British retail sales data exclude automobile sales.

The pattern in consumer spending is often the foremost influence on stock and bond markets.

  • For equity, strong economic growth translates to healthy corporate profits and higher stock prices.
  • For fixed income (bonds), the focus is whether economic growth is stretched overboard and leading to inflation –building a case for interest rate hikes and decreasing the expected value of existing bonds.

The ideal economy walks a fine line between strong growth and excessive (inflationary) growth.

The British Retail Sales survey not only gives you a sense of the big picture on the big island, but also the trends among different types of retailers. Perhaps ground tackle sales are showing exceptional weakness but navigation electronics sales are soaring (have you seen those prices lately?!). Trends derived from retail sales data can help you spot specific investment opportunities and preempt expectations.

British Office of National Statistics


U.S. Philly Fed Survey

What Is The Philly Fed Survey?

Philly Fed Business Outlook Survey

This business outlook survey is a diffusion index of manufacturing conditions within the Philadelphia Federal Reserve district of the United States.  It is widely followed as an indicator of manufacturing sector trends.  Most important is its correlation with the ISM manufacturing index and the index of industrial production.

Why is this important?  By tracking economic data such as the Philly Fed survey, investors will get a picture of what the economic backdrop is for the various markets.

The Philly Fed survey gives a detailed look at the manufacturing sector’s course and speed. Since manufacturing is a major sector of the economy, this report has an influence on market behavior.  Generally, change in manufacturing activity is positively correlated to change in currency demand.

Lastly, some of the Philly Fed sub-indexes provide insight on commodity prices and other clues on inflation (affecting fixed income). The bond market is highly sensitive to the Philly Fed Survey because it is released early in the month before other important indicators thus forming expectations that traders and investors act upon.

Fair Winds!

Antique Maps of the WorldMap of Europe Willem Blaeu c 1650
circa 1650

Emerging Markets: Flash PMI

Emerging Markets: Flash PMI

Emerging Markets Purchasing Manger’s Index

This week the Flash PMI for Emerging Markets will be released.  The flash Composite Purchasing Managers’ Index (PMI) provides an early estimate of current private sector output.

The flash data are released around ten days ahead of the final report and are typically based upon 75-85 percent of the survey sample. Results are synthesized into a single index which can range between zero and 100. A reading above (below) 50 signals rising (falling) output versus the previous month and the closer to 100 (zero) the faster is output growing (contracting).

The report contains flash estimates of the manufacturing and services PMIs. The survey is produced by IHS Markit and uses a sample of around 5,000 manufacturing & services firms.

Manufacturing firms located in:

  1. Germany
  2. France
  3. Italy
  4. Spain
  5. Netherlands
  6. Austria
  7. Ireland
  8. Greece.

Services firms located in:

  1. Germany
  2. France
  3. Italy
  4. Spain
  5. Ireland.

The report is significant because other investors/traders value it –economic data such as the PMIs  indicate what the economic backdrop is for the various markets:

  • Equity investors like to see rapid economic growth because that usually translates to higher corporate profits.  However, increased corporate profits may occur without any growth whatsoever.
  • Forex traders like rapid growth as well because that is one indicator of demand for a country’s currency.
  • The fixed income (bond) market prefers slow to no growth and is extremely sensitive to whether the economy is growing too quickly due to inflationary pressure.

So which market do you think the central pirates banks cater to?

Homanns Heirs c1746

Have A Calculated Edge

Do you have a calculated edge?

It is important to have an edge as a trader.  But, what is an edge?  And how do I act on it to minimize risk and profit consistently.

The generic definition of an edge is this: an edge is a higher likelihood of one outcome happening over a second outcome.

With this definition in mind, let’s take a look at a simple scenario that illustrates an edge.

If you play heads or tails, with a friend, with a coin that you know is weighted more on one side (heads by 70%) than the other (tails), does it make sense to try and predict whether the number of heads will exceed the number of tails by the end of the day?

No, because each outcome is not random, you know that over time if you keep calling heads you will be wrong more often than you are correct.

The exact same can be said about trading. Simply put, once you have found an edge, all you have to do is keep applying that edge to the market whenever it presents itself.  Different traders hold different kinds of edges.  The type of edge you hold matters little.  What matters is that your edge is profitable and can be applied consistently.  And, if you have multiple edges, that definitely matters!

There is no point in guessing whether the next trade is going to be a winner or a loser. Guessing is futile.  Don’t guess your way into a soupline. When your edge is present, you don’t need to guess what the ruling market will do next.

Do you have a clearly defined edge?

So what is my edge?  I have multiple edges since I prefer a good nights rest …and need my beauty sleep.

My #1 edge is Mindset –I know that money is a means and not an end.  I know that markets rule 24 hours a day, non-stop.  Missing a trade means nothing, losing a trade means little.  I know there are many more trades that are correlated  and time-lagged to any that I miss or lose.

My #2 edge is Money Management  —the money management model I developed over the years minimizes risk and adapts to trader performance.  When I take a loss, it is minor …gains always exceed losses.  My model is based on the work of great minds like:

  • Ed Thorpe
  • Claude Shannon
  • John Kelly, Jr.

At least one of those names should ring a bell.  Afterall, Claude Shannon (M.I.T.) is the father of modern Information Theory!

My final edge is market analysis which I learned from taking the first two CFA exams; as well as learning entry & exit points according to price charts (technical analysis).

If you want learn how to gain an edge in the market, go visit the fine folks who taught me:  Infinite Prosperity, a Corp. Authorised Representative of Alpha Equities & Futures Ltd ABN 76131376415

What is your edge?

When thou sittest to eate with a ruler, consider diligently what is before thee…              –prov XXIII


Preparations are key.


Would you cast off the lines before checking for foul weather?  How about leaving port without a radio check?  Ever been at sea without a storm anchor?  Would you enter the harbor without checking the tide?   Only if you’re an Oscar.

To navigate the sea of emotion and fear in the markets, you must be able to asses the waves, weather and readiness of the ship.  All in conjunction with one another.

Some refer to this as “stacking confluence:”

  • Market Condition:  check charts, avoid indecision and choppy waters.
  • Market Phase: enter when the tide pulls back.
  • S/R: go long from support lines & short off resistance lines.
  • Indicators: If you use a compass,  understand its underlying principle.  
  • Price Patterns: Look for one of the primary price patterns.
  • Candlestick Patterns: keep an eye out for deceleration in price.

Any less than four given factors and I tie-off to starboard, sails down.