Combining Money
Management, Portfolio Metrics,
and Strategies for Investing and
Trading
Discussed by:
Paul Grems Duncan
Leader, Tri-State Investors Group
July 16, 2001
1
Today’s Topics
– a few that will help your
trading/investing
 Three strategies that appear to be working
right now
 Effective Volume Overview and a review of
some candidate stocks
 Metrics
2
Admin
 Example
files are located in my forum at
http://forums.effectivevolume.com
 Directions on how to access these files are
at the end of the presentation.
3
Portfolio Metrics: Do We Care?
 Yes!
 Portfolio
Metrics help us understand
whether the changes we make to a portfolio
are beneficial.
 To use metrics though, you have to keep
some form of log… (which I will provide an
example… )
4
My Favorite Portfolio Metrics
 Calmar
Ratio
 Mathematical Expectation
 Pessimistic Return Ratio
 There
are others (Sharpe Ratio, Sortino
Ratio, Upside Potential Ratio, etc.) but they
are more difficult to understand and apply
consistently (in my opinion).
5
The Concept of Drawdown



What is Drawdown (DD)?
Drawdown is the measurement from the maximum
(equity, price) peak to the lowest value AFTER the
peak.
Perceived Drawdown is:
• the mechanism that causes us to sell a stock in a decline,
resulting in us locking in losses rather than having
confidence in our mechanical systems.
• the enemy of mechanical trading.

There IS a distinction between intra-trade DD and endof-trade DD – end-of-trade is far more important!
6
Drawdown Example:
Daily Russell 2K Since 1987
7
Calmar Ratio


What is the Calmar Ratio? CR is a very simple metric that relates
return to drawdown.
Easy to remember:
𝐶𝑅 =





𝐶𝑜𝑚𝑝𝑜𝑢𝑛𝑑𝑒𝑑 𝐴𝑛𝑛𝑢𝑎𝑙 𝑅𝑒𝑡𝑢𝑟𝑛 (𝐶𝐴𝑅)
𝑀𝑎𝑥𝑖𝑚𝑢𝑚 𝐷𝑟𝑎𝑤𝑑𝑜𝑤𝑛 (𝑀𝐷𝐷)
If CR < 0, your CAR is negative, and you’re losing money. This is a
bad system.
If CR ~ 1, Reward to Risk is 1:1. In general, you lose a dollar for
every dollar gained, but time frame is important.
If CR = 2, for every dollar lost, you gain 2 dollars. Good system.
If CR = 3, for every dollar lost, you gain 3 dollars. Great system!
Practical, winning systems generally have a CR > 1.50
Example of CR = 0.82
(CRR = 30.5%, MDD = 37.4%), 12/2/08 to 12/2/09
AAII Accelerated EPS Strategy (Modified Shadow Stock Portfolio Criteria)
9
Example of CR = 5.07
(CRR = 41.6%, MDD = 8.20%), 5/4/09 to 5/4/10
AAII Accelerated EPS Strategy (Modified Shadow Stock Portfolio Criteria)
10
Steps to Track Calmar Ratio
 1)
You need your equity curve, either real
or backtested.
 2) Download CR-CalculationExample.xls at
my forum at Effective Volume (once you’ve
registered, of course).
11
CR Moves with Time!
(Thankfully, Not Fast)
1996 – 2010, AAII Accelerated EPS Strategy
(Modified Shadow Stock Portfolio Criteria)
We’ll discuss how to use CR
and timers to improve a strategy
later in the presentation
Average = 2.02
+/- 1.31 Stdev
Ugliness
12
Criticisms of CR
 The
definition uses the compounded annual
return (CAR); this isn’t practical for short
bursts of trades as the time frames do not align.
Trades occurring in a 4-week burst do not
extrapolate to 12 months very well.
 Correspondingly, many people simply use total
return (if less than 1 year) and the actual MDD.
The purists will shutter, but this latter method
works until a solid history per strategy is
developed.
13
Mathematical Expectation
 What
is Mathematical Expectation (ME)?
 ME is the “average take-home” amount in a
trade scaled by the % of winning trades for the
strategy (you have a strategy, right?)
 All you need is:
• Average winning trade amount
• Average losing trade amount
• % winning trades for the strategy
 In
the long haul, ME MUST BE > 0.
ME Example




A strategy has demonstrated a record of only 20%
winning trades.
The average profit per trade is $10K
The average loss per trade is $2K
Is this a winning strategy?
𝑀𝐸 =
𝐴𝑊
1+
∗ 𝑃𝑊 − 1
𝐴𝐿
• Where: AW = average winning trade amount
• AL = average losing trade amount
• PW is the % winning trades
15
ME Example (con’t)
 In
the long run, this example should be
profitable, as the ME is shown to be > 0.
16
Steps to Track ME
 1)
You need to start tracking your trades with a
log.
 2) You need to track what strategy is being
used for a specific trade (you DO have (a)
strategy(ies), right?)
 3) Download “ME-PRRCalculationExample.xls” from my forum at
Effective Volume – this is a log that autocalculates ME.
17
Example Trade Log for
Autocalculating ME
Worksheet Autocalc’s Various
Parameters
Enter Trades
by Strategy
ME-PRR-CalculationExample.xls
18
Pessimistic Return Ratio (PRR)
 Pessimistic
WHAT?
 Created by Ralph Vince and published in
“Portfolio Management Formulas” (ISBN 0471-52756-4), this is a REALLY good method
to understand your profitability and whether
your methods will work in the longer haul.
 PRR is like ME but it gets better as the number
of trades increases.
Pessimistic Return Ratio

Here’s how PRR is defined:
𝑃𝑅𝑅 =
•
•
•
•


𝑊 − 𝑊 ∗ 𝐴𝑊
𝐿 + 𝐿 ∗ 𝐴𝐿
W is the number of winning trades
L is the number of losing trades
AW is the average winning trade amount
AL is the average losing trade amount
Per Vince: PRR > 2.0 are good systems. PRR > 2.5 are excellent
systems.
Also per Vince: We need at least 24-28 trades in a system to know
whether it’s a viable system
20
PRR Example
 Suppose
we have a system with 13 winning
trades, 5 losing trades, with $288 taken
home on each trade that is won, and with
($33) lost on each trade that goes against
our methods.
13 − 13 ∗ 288
𝑃𝑅𝑅 =
= 11.299
5 + 5 ∗ 33
21
Steps to Track PRR
 1)
Download “ME-PRRCalculationExample.xls” from my forum at
Effective Volume – this is a log that autocalculates PRR (yes, this is the same file
that also calculates ME).
22
Review of Metrics
 Calmar
Ratio: Compares gain to drawdown.
Tells you if you’re taking too much risk (DD >
gain is bad)
 Mathematical Expectation: The “edge” of a
strategy – we want positive numbers only here.
 Pessimistic Return Ratio: the best of the three,
it tells us how good a strategy is, and it
improves as the number of trades goes up
23
Strategies
24
AAII Shadow Stock Portfolio



Standard AAII portfolio: http://www.aaii.com/modelportfolios/stock-rules
Focuses on Small Cap stocks between $17 and $200M in size
Performance over last year has been quite good, but
historically?
AAII MSSP Performance
Actual vs. Modeled, 1997-2010, corr = 0.816
Avg CR = 3.49
+/- 5.14
MDD = ~49%
26
AAII MSSP Performance
The assumption here is that the modeled
performance is “adequate” at corr = 0.816 (1.0 =
perfect, 0.0 = no correlation)
 The drawdown of 49% would most likely have
caused most to bail long before this occurred, then
losing out to subsequent gains in 2009 and 2010.
 The average CR of 3.50 is very, very good, but, the
standard deviation of +/- 5.14 suggests major losses
(3.5 – 5.1  CR < 0 – BIG PROBLEM)
 How to stabilize CR by reducing MDD?

27
Improving AAII MSSP Performance
“Market Cap Favoritism” – There are certain
periods in the cycle that Small Caps
underperform
Favor Small Caps
1/03 – 9/08
Favor Large
Caps
6/06 – 5/08
10/08 – 3/09
Favor Small
Caps 6/08 – 9/08
4/09 - Present
Chart is the RATIO of Russell 1000 (Large Caps) to
Russell 2000 (Small Caps) – R2K is in the Denominator
28
AAII MSSP Performance
Gated w/ Russell 1K/2K Favoritism
Avg CR = 4.59
+/- 5.76
MDD = ~28%
29
Stockcharts can Assist in Analysis
http://stockcharts.com/h-sc/ui?s=IWB:IWM&p=D&yr=3&mn=0&dy=0&id=p46574665355
Green =
Small Cap
Favoritism
Ratio is below
trend – Small
caps are looking
better, so watch
for it
30
AAII MSSP Conclusions
It’s possible to use CR (as well as other metrics) to
quantify adjustments to a strategy.
 The AAII MSSP strategy is a good strategy, but
management of the drawdown must occur or we’ll
lose confidence in the system.
 The general trend of favoring large caps or small
caps certainly helps to provide confidence that
we’re not running with small caps when the large
caps are dominating.
 Right now it appears that small caps are just coming
into favor again

31
Mean Reversion Strategies
What is Mean Reversion?
 Mean reversion is when a stock or ETF gets
overbought or oversold to the extent that after some
period of time, buyers/sellers converge and move
the price to the mean.
 Markets generally are in a trend or are meanreverting. It’s important to have tools for each
market.
 Larry Connors and Cesar Alvarez have developed a
number of strategies to take advantage of this
phenomenon

A Comment on Mean Reversion
Strategies
 The
psychology of mean reversion is
opposite to that of trend trading.
• In trend trading, you add to your position as it
increases.
• In mean-reversion trading, you add to your
position as it falls
 If
you are not prepared to see negative
numbers, then in trendless markets, you
may be better suited to sit on the sidelines.
33
Favorite Connors’ Mean
Reversion Strategy
Connors calls it “TPS” for Time-Price-Scale In
 This is an aggressive strategy
 Focused on ETFs
 You “scale-in” to a position as the price drops on
the long side in a 10%-20%-30%-40% fashion
(which equals a 100% position when all done)
 Connors’ has conducted much of his work using 20,
non-leveraged, highly-liquid ETFs
 What are the specific rules of this strategy?

34
Connors’ TPS Strategy (Long)





1) ETF is above the 200d MA
2) RSI(2) is below 25 for two days in a row. Buy 10% at the
close.
3) If prices are lower on the close than your previous entry, buy
20% at the close
4) Repeat #3 until you attain 40%
Exit on the close when the 2-period RSI closes above 70

A PDF copy of Connor’s book has been uploaded into the
Effective Volume forum; there are more details there.

How has the strategy performed?
35
Connors’ TPS Strategy (Long)
20 ETF Inception to 12/31/08




1159 Trades
Average % P/L = 1.45%
Average Holding Time = 6d
% Number Winners = 89%
20 ETF from 1/1/09 to 7/15/11





405 Trades
Average % P/L = 1.67%
Average Holding Time = 5d
% Number Winners = 93%
ME: 0.203
36
Connor’s TPS Strategy (Long)
Equity Curve, 1/1/09 to 7/15/11
37
Connor’s TPS Strategy (Long)
Trade Distribution, 1/1/09 to 7/15/11
Note that there
are a few trades
that fell -14%
38
Connors’ TPS Strategy (Short)
20 ETF Inception to 12/31/08




648 Trades
Average % P/L = 1.97%
Average Holding Time = 6d
% Number Winners = 81%
20 ETF from 1/1/09 to 7/15/11





59 Trades
Average % P/L = 1.39%
Average Holding Time = 6d
% Number Winners = 75%
ME: 0.163
39
Connor’s TPS Strategy (Short)
Equity Curve, 1/1/09 to 7/15/11
40
Connor’s TPS Strategy (Short)
Trade Distribution, 1/1/09 to 7/15/11
Note that there
are a few trades
that fell -12%
41
Optimizing Connor’s TPS Strategy
 One
criticism that I have of this strategy is that
it can tie up capital. On the bottom of the
previous equity graphs there is a graph to the
Number of Open Positions. For the nonleveraged ETFs, this could be close to all 20
positions.
 What about using leveraged ETFs, and simply
reduce the position size?
 This next test uses the Direxion +/- 3x
Leveraged ETFs
42
Connors’ TPS Strategy (3x Long)
1x 20 Long ETF 1/1/09 to 7/15/11





405 Trades
Average % P/L = 1.67%
Average Holding Time = 5d
% Number Winners = 93%
ME: 0.203
3x ETF from 1/1/09 to 7/15/11





163 Trades
Average % P/L = 4.33%
Average Holding Time = 5d
% Number Winners = 89%
ME: 0.492
43
Connor’s TPS Strategy (3x Long)
Trade Distribution, 1/1/09 to 7/15/11
Note that there is
1 trade that fell
>60%
44
Connors’ TPS Strategy (-3x Short)
1x 20 Short ETF 1/1/09 to 7/15/11





59 Trades
Average % P/L = 1.39%
Average Holding Time = 6d
% Number Winners = 75%
ME: 0.163
-3x ETF from 1/1/09 to 7/15/11





70 Trades
Average % P/L = 1.53%
Average Holding Time = 8d
% Number Winners = 74%
ME: 0.091
45
Connor’s TPS Strategy (-3x Short)
Trade Distribution, 1/1/09 to 7/15/11
Note that there is
1 trade that fell
>30%
46
Connors’ TPS Strategy Conclusions
 TPS
has a positive ME in all 4 cases (nonleveraged, leveraged, long, short).
 The greatest “edge” (ME) is going long with
the +3x Leveraged Direxion ETFs, followed
by going long with the +1x original ETFs that
Connor tested.
 The greatest net gain per trade is long with the
+3x Leveraged ETFs ( +4.33%/trade),
followed by long the +1x original ETFs
(+1.67%/trade)
47
The IWM and GDX Robots





Pascal Willain and Billy O’Nair have created two very focused,
mechanical trading systems that are available at the Effective Volume
web site which are profitable.
The first system, which uses IWM and related ETFs, is based upon the
20d Money Flow, established using Pascal’s Effective Volume tools,
as well as precise entries/exits using pivot levels, statistics, and
risk/reward ratios. This is a combination mean-reversion and trendfollowing system.
The second system, which uses GDX, is based upon money flow,
looking specifically for extremes, then fades these situations. This is a
mean reversion system.
These two instruments were chosen because they are not highly
correlated.
Detailed FAQs can be found on the Effective Volume site, under the
heading “Robots”. You must be a registered member to view.
48
Theoretical Equity Curve for
IWM Robot
49
Theoretical Equity Curve for
GDX Robot
50
Paul’s IWM Robot Performance
 Just
started getting
really serious with
the IWM Robot.
 15 total trades, 10
long, 5 short.
 ME: 4.58
 PRR: 1.08 (but
only have 15
trades)
51
Summary of Strategies
 The
AAII MSSP strategy is a good strategy
which can be improved upon by incorporating
a larger signal which kicks you out when small
caps are out of favor.
 When trend-following does not work, meanreversion via Connor strategies can keep some
income moving in.
 Pascal’s and Billy’s robots are proving their
worth, and a forward test of the IWM robot is
very profitable.
52
Effective Volume –
aka “Follow the Whales”

Effective Volume, developed by Pascal Willain, separates
minute-by-minute volume and price movements, resulting in
assigning volume movement to two groups:
• Large Effective Volume (LEV): volume attributed to institutionals and
other big players. Occurs because once the bid/ask is satisfied, the
price must move up if the bid is unsatisfied, else the price must drop if
the ask is unsatisfied
• Small Effective Volume (SmEV): volume attributed to retail buying
and selling of an equity. Typically, small selling does not move the
price a significant amount over extended periods of time.

EV money flow, which is determined by buying/selling of
institutional investors by averaging individual money flow
within ~92 industry groups, can tell us what the markets are
doing overall and whether we should be long, cash, or short.
How I (Paul) Use EV

Let’s say that I have a stock candidate. Since 30% of
the price movement is historically related to institutional
buying, I check the EV site to see if
• 1) the industry group/sector that the stock belongs to has
accumulation across many stocks in the group. Institutionals
typically buy multiple stocks in a hot sector
• 2) if the stock is showing a positive divergence in large
effective volume compared to small EV.


There is a movie posted EV site that I created and which
shows how I navigate the different information.
GGT (Paul’s system) and EV work together nicely to
identify early breakouts; here’s an example:
54
GGT + EV Stocks

These are favorable EV stocks for Monday
(VNR, CL, MDVN, DVN, and CDE). Two are
showing EV buying: CL and CDE. VNR just
turned into a GGT New Long, which is
favorable. Let’s look at the first 3:
55
VNR
Group just issued a “buy”
signal because large
player strength has
jumped above 0%
Notice how Total EV is
converging on
trendline… stock is being
accumulated
56
CL
Group recently signaled a
“buy” but has dropped
back below 0 and the
trend line. CL is a “wait”
Upward trending average
line shows constant
accumulation
57
MDVN
Group recently signaled a
“buy” and trendline is
just crossing 0 from
below – very bullish for
group.
Weaker TEV trend line
but the fact that TEV has
crossed above is very
positive
58
The Day’s Summary

We covered three relevant metrics to assist you with your portfolio:
• CR, ME, and PRR





We looked at the AAII MSSP performance, and then suggested a
method to improve drawdown which will help CR in the long run. The
method is not related to the strategy at all (What was it? Hint: Russell
1K vs. Russell 2K)
We looked at Connor’s TPS Mean Reversion Strategy and found a
strategy that slowly, but with a positive edge, generates profits. We
concluded that the 3x leveraged ETFs have a better edge and better
gain than their 1x counterparts.
We looked at two mechanical strategies that have phenomenal
backtesting performance and the initial forward test is going very well.
We looked briefly at how I evaluate GGT + EV stocks, specifically
using the EV web site after I have candidates.
There are files to download at the Effective Volume site. You must
register to view these files; directions follow on the remaining
slides.
59
From Pascal Willian, Creator of
Effective Volume:



If you are interested in becoming a member at the
Effective Volume site and accessing the EV data, there
is a special offer for AAII participants:
Go to http://www.effectivevolume.eu/EV_Subscribe_Special.html
and if you mention that you’re an AAII member and
attended this presentation, you’ll get $10 off the yearly
subscription of $149 (most of which goes to charity –
see the web page). This will give you daily access to
EV data on over 1000 stocks and 200 ETFs. It is an eye
opening experience to your investing/trading.
Further, if you’re interested in the IWM and GDX
robots, let me (Paul) know, and I’ll see what I can do for
a free trial.
60
Registering for Access to
Presentation Files
(and Paul’s Forum)
61
Step 1: Registration Page at
Effective Volume
http://forums.effectivevolume.com/register.php?
In the Registration Question
Please state “Registering per
Paul Duncan / AAII Wash DC
Meeting”
62
Step 2: Confirmation of
Registration
 Step
2: When you receive an email confirming
your registration, click on the link in the email.
You will receive the following screen:
63
Step 3: Registering for Paul’s GGT
Forum
Step 3: After you receive the previous screen,
you’ll have to wait for an admin-type to approve
you into the forum. You will receive an email when
this is completed.
 IF you specified that you were from the AAII Wash
DC group, you should be automatically added to the
GGT Forum. Here is how you check:
 1) Log In to http://forums.effectivevolume.com
 2) (next slide)

64
Step 3: Checking/Registering for
Paul’s GGT Forum Click this First
See if this says “Leave
Group” or “Join Group”
Feel free to join the other
groups – it is free.
Paul’s is the
GGT Group
Click this 2nd
65
Access to AAII Presentation Files
This thread “Links” contains the links to the files;
They are at the BOTTOM of the thread.
66
File Location w/in Thread
Note: this is message 1 of the thread
– it is at the BOTTOM of all the messages
The Excel files will be located under this header
67
Paul Duncan
(703) 509-5332
grems8544@gmail.com
68