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Hello Tom and Karel,
The paper on Modern Portfolio Theory (MPT) is here:
http://www.automaticinvestor.com/articles/mpt.html
Basically I believe that if we AIM a sufficiently diversified set of stocks individually (i.e. one stock per AIM portfolio) we can invest in riskier stocks at the individual portfolio level (I call it the microscopic level) than we would normally be comfortable with.
This is because our overall portfolio (i.e. the sum of all our individual AIM managed portfolios) will be managed using MPT (the macroscopic level) and thus reduce our risk (back to where it falls within our comfort zone).
This means that if we choose a point on the Efficient Frontier (EF) for a given risk level, we can expect higher returns -- because the EF will be shifted upwards relative to the EF created by using the same stocks, but not managing them with AIM. Similarly if we choose a given expected return level on this shifted EF, we'll expect a reduced risk level (compared with the non-shifted EF).
The reason I like this idea is that AIM's strength is aimed at managing risk for individual portfolios (i.e. on a stock or a basket of similar stocks). AIM doesn't do anything about overall portfolio management. Whereas MPT deals with overall portfolio management (i.e. Asset Allocation). This makes AIM and MPT natural partners in anyone's investment plan.
Later this year AI 2.0 will include some features that will allow easier use of AI with MPT.
Please let me know if you have any questions on this.
Thanks,
Mark.
http://www.automaticinvestor.com
Hello Conrad,
"Mark stated profits result from risk within the context of his analysis."
What I actually stated was that if we choose to accept more risk we should expect a greater return (because if we could expect the same return with less risk, we'd choose to minimize our risk).
I didn't state that profits result from risk. In fact I said, "this does not mean that we should invest in absolutely risky things, throw all of our savings into lottery tickets or run with scissors. Nor does it mean that as you accept higher risks you'll necessarily achieve higher rewards."
I'll say it once again, I think Jonathon's original post was saying what I just stated above and your reply to Jonathon was saying something completely different. That is, you were using the term "risk" in a completely different way than Jonathan was.
In your usage, what you say is correct. However it has nothing to do with what Jonathan was saying. Basically it's two different concepts which unfortunately are labelled with the same word (that being, "risk").
So as far as I can tell, both of you are correct in the context to which you're each referring. However this debate really doesn't serve any purpose because you're both talking about different things.
Regards,
Mark.
http://www.automaticinvestor.com
Hello Conrad,
"This is quite different thing than the generalization that profits result form risk"
Yes, that was entirely my point so I agree completely. But I think Jonathan meant the same thing when he said, "Classical economics holds that profit is the reward for taking risk?"
Regards,
Mark.
http://www.automaticinvestor.com
Hello Fox,
Thanks for the idea. I had played around with beta (and other things) some time ago.
The problem I've found with using beta is that the same beta value can result from many different price patterns (not to mention it also depends on a particular market index). One of these patterns might produce good AIM returns while another might not.
However since all we have to work with is beta, we don't have any information about the patterns that produced the beta value. And that's the really important information.
In addition, beta doesn't necessarily work that well on one stock. If stock B has a beta of 2 and the index it's based on rises 10%, that doesn't mean stock B will rise by 20%. It will probably go up by some different amount. There will be a difference between the 20% predicted rise and the actual amount it went up. So Beta is not really a good indicator for one stock. Now if you have a diversified portfolio, these differences will tend to cancel each other out and beta then becomes a more accurate representation.
But since most of us AIM individual stocks we won't get the accuracy. Furthermore using beta is just adding one extra layer between the actual price pattern and AIM parameters. My thinking is that we can do much better by finding a volatility algorithm based directly on the price pattern of a stock or, even better, using the price pattern of the stock directly.
That's where the AI 2.0 optimizer (and model building) comes in. Using the optimizer we try to optimize the various AIM parameters (BR, SR, Min % Sale, Min % Purchase, Initial Cash and Control Increment) using the exact historical price pattern of the stock. This certainly doesn't guarantee that this pattern will continue into the future, but many times it does.
One idea you touched on that I really like has to do with Tom's Idiot Wave. I'd like to incorporate the IW into AIM recommendations (either directly through modifying recommendations or indirectly through modifying AIM parameters).
I've been following the Idiot Wave for almost 2 years now and it's uncanny how it predicts good and bad markets. I think one day AI will have an option to use the IW -- I just need to find the time to test it properly.
Regards,
Mark.
http://www.automaticinvestor.com
Well that's quite the debate going on about risk...
Since AIM is all about managing risk, here's my view on the subject.
When we speak about risk, we're certainly not speaking about the same type of risk you take by gambling at a casino, running with the bulls in Pamplona or investing in a stock your friend's friend said would go through the roof by Thursday.
Rather we're speaking about certain classifications of risk. Because we live in a civilized world, we've come up with abstract concepts that rely on faith in our civilization. One of these concepts is money.
Now none of us need money. Rather we need food and shelter. Money is just a concept that allows us to easily trade things we have (such as our time, skills, material possessions) for things that we don't have. This means that if I was a goat herder (without the money concept) and wanted a car, I would have to find a car manufacturer who wanted goats. However with the concept of money, I'd simply trade my goats for money and then trade the money for the car. The money by itself isn't worth anything (just ask all those people in Argentina who have to pay their debts in US dollars but are paid in Pesos).
Therefore even holding cash is somewhat risky. The lowest risk we can have is to make our own food (farming or hunting) and live in a cave. But even then we have the risk of losing our food and being displaced from our cave by a tired bear. Let's face it, life in general is just plain risky. But back to my point...
Most of us are willing to trade a significant portion of our time for money. That's because we have faith in our government and our civilization. We believe that we'll be able to trade our money for the things we need whenever we want.
Similarly we put our faith in a stock based on that same premise. We believe that the underlying value in a stock is the company. If the company has a solid reputation and produces something that is of value, we expect that it will earn profits well into the future and some of those profits will be shared with us (as owners of that company). There might be short-term fluctuations based psychological effects, one-time problems and such, but over the long-term we hope our chosen company will grow in value because of its underlying business.
Without making this example any more complicated we can see three levels of risk right there.
1. Grow food, live in cave (low risk because you don't depend on anybody for your needs).
2. Collect money (medium risk because you depend on the Government).
3. Buy a portion of a good solid company (high risk because you depend on one company).
The risks I've assigned to each option are relative to these three options. If we translate this into the investment realm, we can see that there are also low risk (e.g. Government backed paper), medium risk (e.g. IBM) and high risk (e.g. YHOO). Again each risk is assessed based on the probability that we'll get nothing back from our investment.
Now if we are guaranteed a 5% return (no more, no less) over the long term by investing in Government bonds, IBM and YHOO, which would we choose to invest in?
I don't know about you, but I'll take the bonds everytime. If the government goes out of business, both IBM and YHOO will be affected. However if IBM and YHOO fold, the government still has a good chance of surviving unscathed. However IBM's folding will have a greater impact on the government than YHOO's folding.
That being the case, I'd expect to earn a better return for YHOO than for IBM or bonds. This is exactly because nobody would want to buy YHOO if the expected return was exactly that of bonds. So we have the famous, "Classical economics holds that profit is the reward for taking risk."
This does not mean that we should invest in absolutely risky things, throw all of our savings into lottery tickets or run with scissors. Nor does it mean that as you accept higher risks you'll necessarily achieve higher rewards. Rather it means that we should expect better rewards for investing in relatively risker things (but things that we believe have a high probability of gaining us profits and a low probability of being wiped out).
And this is how I view risk. Based on the feisty responses flying back and forth, I think there might have been a misunderstanding on how the term "risk" was used.
Regards,
Mark.
http://www.automaticinvestor.com
Hello Tom,
The SDR has arrived safely! There is much rejoicing in the Hing household.
Thanks,
Mark.
http://www.automaticinvestor.com
Hello again Sarmad,
"It is just after reading Mr. Lichello's book -- all 270 pages of chest pumping, horn tooting, etc... -- one just realizes that he said "buy low, sell high. And by the way, I can't tell you what to buy, or when, or what a fair price is."
Ahh, but the real value of the book is that he didn't just say, "buy low, sell high," he actually showed you how to do it. As for the rest (what, fair price, etc.) there are many, many other sources of information for these things.
I wish I could remember the exact quote and who said it, but it goes something like this:
"Want to know how to make money in the stock market? Give me 10 seconds and I'll tell you. Buy Low, Sell High. Want to know how to buy low and sell high? Give me 10 years and I'll tell you."
And for me, that really sums up the advantage of Lichello's system.
Now I think AIM can actually be explained quite adequately in 10 pages, but Lichello comes pretty close on pages 44 to 57 of the 3rd edition. All you really have to do is read those pages and you've got what you need. The rest is filler (after all, how many successful 13 page books have you seen? ;0).
BTW... I received your private email, I'll respond soon.
Regards,
Mark.
http://www.automaticinvestor.com
Hello Sarmad,
Yes, Internet stocks aren't for everyone. Warren Buffet doesn't even invest in technology stocks -- let alone Internet stocks.
Personally I follow the tech/internet industry quite closely so that's where I primarily invest -- since it's what I know the best.
The reason I mentioned the fabled INSP is to show that making $1,000,000 from $10K is not impossible. I certainly didn't bring it up to suggest you (or anyone else) invest in it.
"I have to make my million the old fashioned way -- earn it."
On this point, I'd rather make my million by having my money work for me. Even people with ultra-high incomes have to work to earn the money they make. Whereas others with properly managed investments make money even when they're not working -- i.e. their money makes them money. (Not that I have anything against earning it, however I think it's more efficient to earn it in the first stage of life and then have it work for you in the next stage).
Regarding AI, the version you downloaded is AI 1.0. It doesn't have the volume model I used to produce the INSP report. This will be in AI 2.0 scheduled for release later this month (it is currently in Beta testing). So you won't be able to duplicate the report.
However you will be able to run some historical analysis reports and set the configuration parameters to your investment style. When AI 2.0 comes out you'll also be able to create your own models using the built-in multi-parameter optimizer.
The great thing about AIM is it can be used according to each investor's personal investment style.
If you have any questions on AI, please feel free to drop me a line (mhing@automaticinvestor.com)
Regards,
Mark.
http://www.automaticinvestor.com
Hello Rien,
Ahh, I see. My favorite is the Porsche index (when the Porsche dealers are having a tough time keeping cars in stock because all of the stock brokers are buying them, it's time to bail).
I was actually hoping you had a fool-proof algorithm for calling market tops... I almost woke my wife up to tell her we were retiring in Bermuda -- right after visiting our local Porsche dealer ;0)
Oh well, maybe next time.
Regards,
Mark.
http://www.automaticinvestor.com
Hello Rien,
"(Oh, and yes, you can know when the top is reached, it's not easy because you have to detach yourself from your own emotions, but it is certainly doable.)"
How can you do this?
Thanks,
Mark.
http://www.automaticinvestor.com
Hello Keith,
Just goes to show you can talk about it all you want but until you actually do it, you don't get anywhere.
Regards,
Mark.
http://www.automaticinvestor.com
Hello Jack,
"That stock must have spiked to high heaven (almost $140), and one would have needed great wisdom to sell a lot of shares near the top of the bubble"
Yes, it did have an enormous spike and yes I agree we probably won't be seeing a market like that again. However you wouldn't have needed great wisdom at all, just enough to follow AIM's recommendations.
Albert Einstein said that compounding was the 8th wonder of the world. But compounding needs time to work, however I think its effects are greatly underestimated and/or misunderstood (why else would the "pay low monthly payments loan" -- amortized over a zillion years -- be so popular today?). However once you run the numbers it becomes apparent that $1,000,000 over 40 years is not difficult to accomplish.
Let's say you put aside an average of $60 a week (i.e. $3120 per year), then if you receive an average return of 9% over 40 years, your end result will be about $1,233,004 (not taking taxes, investment expenses or inflation into account).
Over 40 years most people will be able to put aside much more than $60 a week (especially in their latter years) and I think most will be able to make more than 9% (let's say 11% using AIM). All of a sudden your $60 a week investment at 11% comes to $2,279,466.
That's why I think everyone who's got a decent job, is in their early 20s and is willing to learn a little about investing can have at least a million dollars in the bank when they retire.
However even older folks can do quite well. That same $60 a week over 30 years will amount to about $739,866. It's not $2 million dollars, but still nothing to sneeze at.
Regards,
Mark.
http://www.automaticinvestor.com
Hello Sarmad,
"Lichello never made the million because his method cannot possibly make a million (out of $10k) - except with a contrived example."
While I agree that it would be difficult to make $1,000,000 from $10,000 using any method (not just Lichello's), I don't agree when you say that it is not possible. And I'm not talking about being "possible" the way the Lottery (and Casino) companies use the word either.
Here's an Automatic Investor historical report on an Internet company that I've been following for a couple of years: INSP.
Note that this report was run from the first available INSP price (Dec. 15, 1998) until this past friday. That's a period of just over 3 years. The AI return was $239,811.64 so that's a little less than 1/4 of the return you'd need (note also that it includes commissions but does not include interest on the cash reserve -- which were/are substantial).
Now if you assume a person's investment lifetime is about 40 years (i.e. 25 to 65), then it's not inconceivable that you could use this method to generate $1,000,000 over that time frame from an initial $10,000 (Lichello never said you'd make $1,000,000 quickly). With some proper backtesting and research I'd say making $1,000,000 from $10,000 is very possible, although not probable.
"There is no way to get big gains without risking a wipe-out. And if AIM is protecting us from a wipe-out, it is also preventing us from getting a big gain.
If you look at the INSP report you'll notice that the average percent of capital at risk was 22.75% So AIM got the big gains WHILE protecting us from a wipe out. In fact the current cash reserve is $223,863.09 (i.e. most of the portfolio's value is in cash). And unlike my first point, this is usually what AIM does.
Finally, the stock started at $2.50 in Dec. '98 and ended at $1.45 in March '02. B&H lost $4200 while AIM gained $229,811.64. So again, AIM was there protecting the portfolio from being wiped-out. And this was not a contrived example -- this was a real stock. And AIM was not tuned for this stock. I simply used the parameters I currently use to AIM all Internet stocks.
Okay, okay... I'll try to anticipate two of your questions.
1. I didn't quite use the standard BTB AIM method. I used the Automatic Investor Aggressive model which takes volume into account -- so technically you might argue that this was not AIM. However the system really is AIM with a volume modification (i.e. the AIM engine still makes the recommendations). I believe it's just as much AIM as using a pumped up split SAFE or a delayed buying/selling mechanism.
2. Yes I have been following INSP for a couple of years (so I didn't just pick this in hind-sight out of all the available stocks) and No, unfortunately I didn't put $10,000 into INSP back in 1998. Rather I purchased YHOO which certainly did okay, but not nearly as well as INSP.
My point is that I disagree with your assertion that it is not possible to make $1,000,000 using AIM.
Having said all of that, I'd like to add another thought (this has nothing to do with responding to your original post -- however your post gives me a good introduction to bring it up).
I'd say that making $1,000,000 over a 40 year time frame is very probable if you apply yourself (i.e. save a decent percentage of your income, diverisfy and invest it wisely). I firmly believe that somebody starting a new career right out of university (say at 22 years old) should have at least $1,000,000 in the bank (not including other assets) by the time he or she retires at 65. Not only is that possible, but it's almost certain if done correctly.
I'm not sure what the average age is on this board (but I'm guessing it's skewed towards the older crowd -- if there's anyone here under 25 years please let me know).
Now if I was in my early twenties again and just out of school, I'd like to find this board (with all of these experienced people who know that investing is not about making a quick buck, but it's about patience and following a proven system). I'd also wish to be wise enough to listen to what's being said. That way when I reached my mid-40s, or maybe 50, while all of my friends were still working I'd be comfortably retired or working on whatever it is I wanted to work on.
Of course I remember when I was just out of school, working at my first real job with IBM, the last thing I had on my mind was investing for when I was 50 or 60. But perhaps there are some wiser just graduated people out there now ;o)
Here's that AI report I mentioned earlier...
AUTOMATIC INVESTOR HISTORICAL ANALYSIS FOR INSP
======= PERFORMANCE =======
Current Portfolio Value: $239,811.64 (10999 shares owned)
Profit or (Loss): $229,811.64
Simple Return: 2298%
Annualized Return: 169%
Buy/Hold Portfolio Value: $5,800.00 (4000 shares owned)
Buy/Hold Profit or (Loss): ($4,200.00)
Buy/Hold Simple Return: -42%
Buy/Hold Annualized Return: -16%
Return on Capital at Risk: 10101.75%
Average % Capital at Risk: 22.75%
Average Commission: $10.00
Original Share Price: $2.5000
Original Share Price Date: 15-Dec-98
Original Investment: $10,000.00
Last Share Price: $1.4500
Last Share Price Date: 01-Mar-02
Current Cash Reserve: $223,863.09
Current Shares Owned: 10,999
Current Security Value: $15,948.55
Number of Purchases: 9
Number of Sales: 8
Regards,
Mark.
http://www.automaticinvestor.com
Hello TF, Thanks, but the information was all developed and explained by Tom (AIM GUY). I'm just reiterating and paraphrasing.
Regards,
Mark.
http://www.automaticinvestor.com
Hello Conrad,
"Now, all other things being equal (which is never the case), if we start 2 AIMs and you make bigger buys that I do early in the game and I make bigger buys that you do later in the game then (eliminating other possibilities) there are two extremes that we consider..."
That assumes that the number of buys are equal -- which probably won't be the case. AIM might make 10 buys on the way down (before it runs out of cash) while Vortex only makes 5 (the first 2 Vortex buys might be smaller than AIM's first 2, but the next 3 might be significantly larger -- then Vortex runs out of cash while AIM goes on to buy 5 more times at a lower price).
Now, as you've mentioned, this all depends on how you set the buying behaviour in vortex. So you could set its behaviour such that it performs as in your last post. However I'd counter by saying that if I thought prices would continue to decline for a long while, I'd set my Buy Resistance (and/or minimum % per trade) differently to compensate.
What it comes down to is the system that wins will depend on how the declining price behaves and the respective tuning parameters.
Either system can be set to maximize returns for a particular price pattern by tuning the appropriate configuration parameter. Vortex would tune the "multiplier" parameter and AIM would tune the Buy Resistance. But since we don't know how the price will behave, neither of us can tune the relevant parameter exactly (if we could then we would know the price pattern and would have no need for AIM or Vortex).
So you're left with two systems that depend on a parameter (it also depends on the price behaviour, but you can't control that). My question then becomes, "if you have two systems that depend on a parameter, which one do you use?"
The obvious answer is that you go with the one with which you have the most confidence and/or familiarity. In order for me to go with some other algorithm I need to see it giving me a significant advantage over what I'm currently using. If all I've done is trade one parameter setting for another one, I don't see the benefit. Furthermore since I'm familiar with the AIM method and I've backtested it and know how it works (which I haven't done for the Vortex method), it makes sense for me to stick with that method.
If we backtrack for a moment and forget about tuning parameters, then Vortex will need to supply a "general case" multiplier. AIM would use whatever BR/SR/Min%perTrade settings were chosen when initially setting up the portfolio. In that case I believe that AIM would come out ahead most of the time. I suppose the only way to verify this is to backtest both algorithm using the testing methods I alluded to in a previous post.
To conclude, I think your idea can work, however I don't believe it has any advantage over AIM in the best case and might be at a disadvantage in the worst case.
Having said all of that, however, I think people should use whatever algorithm they think is best. After all, nobody else cares as much about your money as you do. If you think Vortex is the better algorithm then you should use it.
Whew! That was a much longer note than I had intended to write.
Regards,
Mark.
http://www.automaticinvestor.com
Hello again Conrad,
"The central focus of my effort with the Vortex Method is to buy little as the stock begins to fall, and then increase the buy rate as the stock drops, and managing this so that at some reasonable drop-level most of the available cash is disbeursed. If the stock then keeps falling you simply wait and do nothing. The point of all this is that to the extend that you will increase the buy rate as the stock goes down that the cash is invested more effectively than spending it too early"
My thinking on this is that you will not invest the cash more effectively. Rather you'll run out of cash (possibly) sooner (This actually depends on how quickly you increase your buying and what your initial buy was. My understanding is that you'd start with a lower initial buy than standard AIM and increase on that. However at some point your buys will be more than AIM's and, when you reach that point, you'll probably run out of cash much more quickly. Everything I have to say from this point on is based on this thinking).
In theory what you really want to do is not buy anything at all on the way down. Instead you want to spend all of your cash at the absolute bottom. However that's not practical in reality because you're never sure when the absolute bottom will occur. So you use AIM to average down the cost of each share as the price declines. Hopefully your average share price will be better than if you just bought all the shares at once.
Using the Vortex method it looks like you'll be increasing the size of each subsequent purchase as the price continues to fall. This would mean that your average price will be higher than with standard AIM -- unless the stock price turns around BEFORE you run out of cash, but then you can't know that will happen in advance.
So assuming both methods run out of cash (and both started with the same amount of cash), AIM would most likely have the lower average price. Thus AIM would perform better when the stock price rose again.
Regards,
Mark.
http://www.automaticinvestor.com
Hello Conrad,
The Vealie is a way of staying invested a little longer (which subsequently increases risk a little, but with the possibility of a greater payoff).
In general if an AIM program is throwing off cash, that means that the equities in the AIM program are rising in value (i.e. you're receiving more sell signals than buys). At some point you might feel that you've got enough cash to cover your future buys so you want to stop collecting cash. In essence you want to leave your money invested in the stocks you currently own.
However as the stocks rise, you will receive additional sell signals. AIM is recommending that you sell stock in order to raise cash for the next buying spell. However you feel that you already have enough cash to cover the next buying spell -- and you might also feel that the stock will continue to rise.
So you might be tempted to ignore AIM's sell signal. However as the stock price rises, the sell recommendations will continue to get bigger and bigger. Furthermore, the next buy price will become further and further away (so your stock will have to retrace a great deal before a buy is triggered).
Enter the Vealie... you simply increase your Portfolio Control by (traditionally) 1/2 the new sell recommendation. This has the effect of moving the next buy price towards your increasing equity value as well as lowering (or eliminating) the subsequent sell recommendations. So you stay invested with the number of shares you currently own AND you've moved your next buy price up AND you've lowered your next sell recommendation.
Of course as Newton's 3rd law states, "For every action, there is an equal and opposite reaction." How does this apply to the Vealie?
Well first of all, by ignoring AIM's sell recommendation (regardless of whether you choose to increment PC or not) you're opening yourself to a little more risk (e.g. if the stock suddenly lost 90% of its value you'd be holding more of it because you didn't sell as AIM suggested).
Secondly, you're introducing some subjectivity to the mix (e.g. you have to decide how much cash is enough) and you're performing some prediction whether you know it or not (e.g. predicting you have enough cash to cover price declines and/or predicting the current stock's upward trend will continue).
I hope that clarifies the Vealie concept somewhat. Whether it's useful or not solely depends on YOU and your specific situation.
BTW... Automatic Investor has an automatic Vealie function and AI 2.0 adds the ability to pull a Vealie with one mouse click (thanks to Don Carlson for that suggestion) -- so you don't have to directly mess around with the Portfolio Control.
Regards,
Mark.
http://www.automaticinvestor.com
Hello Arawat,
Thanks for the suggestion. I'll incorporate it into the relevant reports.
Regards,
Mark.
http://www.automaticinvestor.com
Hello Butch,
Yes, that's a good idea and there will be something similar available in the next few months. However AI 2.0's goal is to remain easy to use, so a traditional report builder is out of the question (since it requires at least a high-level understanding of the underlying data model).
Having said that, however, there will be a simplified "report builder" that masks the data model.
What I'm really interested in finding out is what kind of information AIMers find useful. Then I can prepackage some standard reports that a user can generate with one mouse click.
Thanks for the feedback,
Mark.
http://www.automaticinvestor.com
Hello "Ned,"
I'm not the "AIM GUY," but perhaps I can help out.
AIM stands for AOL Instant Messenger. An AIMer is someone who uses the AOL Instant Messenger.
Basically we use it to send messages back and forth about our stock charts. These charts keep a record of the various items we have in stock at our stores. So someone who owns a 7-11 who might be running low on Slurpee mix needs to know that so he can re-stock (and of course update his stock chart).
Reading stock charts can be a bit difficult when you're new, however (as with anything) it gets easier as you become more experienced. To start, I'd forget about all of the other columns and just concentrate on the "Quantity" column. As you gain experience you can start looking at (and tweaking) the others.
So if you're looking for information on stock charts and AOL Instant Messenger you've come to the right place.
Feel free to ask any questions about it (remember the only silly question is the one that's not asked).
I hope this helps a bit,
Mark.
http://www.automaticinvestor.com
Hello Tom,
"That lists all stocks' individual values, their individual cash reserves the grand total and the initial cost."
Thanks for the feedback. I will add this report to AI 2.0.
Regards,
Mark.
http://www.automaticinvestor.com
Hello Conrad,
Backtesting does not prove that future returns will be anything like past returns. However it is the best tool we have and is significantly better than just arbitrarily picking some parameter settings and going with them.
"with back testing you know what the stock is going to do and you can fiddle with the knobs to optimise for the dips and crests."
What you've described is known as overfitting. If you backtest improperly then your tests are quite useless because anyone can come up with parameter settings that maximize returns for a given set of data. However these parameters probably won't do well with the majority of new data. And that's the key to backtesting.
You MUST divide your data into two parts: "in sample" data and "out of sample" data. You use in sample data to optimize your parameters (in AI 2.0 the process of optimizing parameters is called "Model Building") and then test your results on the out of sample data. If the results are similar to what you saw with your in sample data, then you should feel quite good about your model (i.e. your model has been confirmed).
However if your out of sample test is significantly different from your in sample test, then you would have a low level of confidence about your model. The other important fact is that the more data you use to build your models and the more market types they include (i.e. Bear, Bull, sideways), the better your model will be.
Finally you should calculate the statistical error in your results.
To sum up, while backtesting does not guarantee great results, it certainly increases the probability of seeing great results over simply setting parameters based on plucking numbers out of the air or going with what somebody told you.
Regards,
Mark.
http://www.automaticinvestor.com
Thanks for the feedback Tom.
I just completed adding a report that shows all portfolios owned and the current recommendation (i.e. Buy with Value, Sell with Value or Hold), total portfolio value, total cash reserve and total security value for each portfolio.
I've got a few more on my list and "all trades" is one of them.
Regards,
Mark.
http://www.automaticinvestor.com
Hello Steve, "I'll get you next time!"
By the looks of it that'll be sometime next month
Let me know how you make out with the Alpha version of AI 2.0.
I'm putting together some reports that'll be included in the next version for all alpha testers to look at, so any suggestions would be most appreciated.
I'm planning to release the beta version within the next week.
Regards,
Mark.
http://www.automaticinvestor.com
Hello Steve,
I was away from my computer a little earlier and thought #1000 would be history by the time I returned. But it wasn't so I thought I'd pull a Barry and go for it.
Regards,
Mark.
http://www.automaticinvestor.com
Define what you mean by a short time ;0)
regards,
Mark.
http://www.automaticinvestor.com
Hello Everyone,
This reminds me of day trading. Sitting by the keyboard waiting for something to happen.
http://www.automaticinvestor.com
Actually now that I think about, what charts do you also find useful or wish that you had?
Regards,
Mark.
http://www.automaticinvestor.com
Hello Everyone, for those who use AIM software and/or spreadsheets, what kind of reports do you find useful (or wish you had)?
For example, do you ever want to see all of the buys and sells in a portfolio? Or perhaps all of the price updates?
Note that I'm asking about reports as opposed to charts.
Thanks,
Mark.
http://www.automaticinvestor.com
Hello Conrad,
Yes, you are correct. There are a myriad of ways to operate AIM and I'd be surprised if any two people operated it in exactly the same way over the course of one year (even discounting stock selection).
I've come to the conclusion that the only way to actually determine which way is best is to methodically backtest. Of course this is nothing new as traders have been doing this for decades. I'm starting a push with the hopes of seeing AIMers jump on this particular bandwagon.
That way when someone says this way or that way is "better," he'll have numbers to back up his claim.
As for the reference system you referred to, I think we already have one -- that being buy and hold. In my mind B&H is the ultimate reference system. If you can consistently beat B&H with less risk, then you have a winner in my opinion. To take this further, the ultimate reference system is to buy and hold a major index (DOW, NASDAQ, S&P). If you can AIM the index and consistently beat it with less risk, again I think you have a winner.
Nice to see you over on this board. Quite frankly I'm surprised at just how quickly everyone jumped from SI. Now that's a particularly fine example of how quickly things can change for online companies.
Regards,
Mark.
http://www.automaticinvestor.com
Hello ET, Lichello has always recommended a 5% minimum trade (5% of equity value) until the 4th edition of his book (where he bumped that number up to 10%).
The Automatic Investor software implements this as well as a fixed dollar amount. I think Newport uses fixed dollar amount and fixed number of shares (somebody please correct me if I'm wrong about this).
Last year there were a number of interesting posts on SI regarding the use of minimum dollar values, minimum % of equity and minimum number of shares.
In general, I find that as your portfolio grows, using a minimum % is better. For smaller portfolios that are just starting out, a minimum dollar value is better. I don't find using a minimum number of shares that useful, however there are AIMers out there that do find it useful.
regards,
Mark.
http://www.automaticinvestor.com
Hello Jack,
AIM + volume is the algorithm I use to incorporate volume as well as price into AIM recommendations. In Automatic Investor 2.0 it's called the Volumizer.
I've posted a bit about it over at SI and on TMF. Basically I believe that there are two important variables that represent a stock at one instant in time -- price and volume. Since AIM only uses the price to make its recommendations, I think it's only using half of the available information. So about a year ago I started experimenting with volume. The results were excellent (I posted a couple of notes on SI with some results, see http://www.siliconinvestor.com/stocktalk/msg.gsp?msgid=16898984 and http://www.siliconinvestor.com/stocktalk/msg.gsp?msgid=16900749 ).
Since you're an AI 2.0 alpha tester, you can try the Volumizer by either selecting the "Aggressive" model on the configuration panel, or clicking the "Volumizer" checkbox to turn it on (again on the configuration panel).
Let me know if you have any other questions.
Regards,
Mark.
http://www.automaticinvestor.com
Hello ET,
I tested all of the DOW stocks and most of the Naz 100. I also tested a wide variety of 2nd and 3rd tier Internet stocks (e.g. INKT, CMGI, ICGE) as well as some highly volatile issues (e.g. MSTR).
I usually used time periods starting from 1970 (sometimes I went back to the 1960s, but only in a few cases) and continuing to 2002 (or I used the first date that data was available for the stock if they weren't available in 1970).
In order to test, I did the following:
1. Start with the earliest available date and test for 5 year periods (e.g. for IBM, start with 1970 and test from 1970 to 75, then 1971 to 76, 72, to 77, etc.). I then repeated this process for 3 year and 10 year periods.
2. From 1990 to 2002 I performed similar tests, but this time using 1 year periods in addition to 3 year and 5 year periods.
3. I compared the results between the various Initial Cash settings as well as to buy and hold. For these tests I used the Standard lichello AIM settings (i.e. 50/50, 67/33, 80/20 with 5% minimum purchases -- I tried using 10% minimums, but that didn't work well so I stuck with the 5%).
For the most part, the lower the initial cash setting, the better the performance. One interesting note is that most DOW stocks had better Buy and Hold performance than the performance obtained by using AIM (with any initial cash setting). This leads me to believe that the majority of DOW stocks really aren't well suited for standard AIM.
When adding volume to the mix, however, AIM did much better with the DOW stocks (compared to standard AIM. I posted the results over at the SI board earlier this year), however Buy and Hold was still slightly ahead.
On the other hand, most of the Naz 100 stocks and Internet stocks significantly outperformed buy and hold with AIM using Volume. Some stocks (e.g. ICGE, MSTR) showed losses with Buy and Hold, but hundreds of percent gains with AIM + volume.
Others (e.g. YHOO, ORCL) showed gains with Buy and Hold but much larger gains with AIM + volume.
The lesson I took away was simply this, without proper testing you cannot be sure that AIM (standard or with Volume) will beat buy and hold for a particular stock (actually you can never be 100% sure since the past is no indication of the future, but at least you can have a better idea of what is probable assuming the stock's characteristics don't change).
To date there has not been an easy way to historically test stocks and funds. So most AIMers use an ad hoc, gut feeling strategy. This might work most of the time for the experienced people, but what's really needed is a step-by-step checklist on how to test stocks for AIM.
Testing involves much more than simply running a few stocks through a spreadsheet or an AIM software's historical analysis module and viewing the results. There should be a methodical method in place that allows you to properly test all stocks in the same way (i.e. over a wide variety of time periods and market conditions).
There are many methods that can be employed (from outside the AIM realm). One of the ones I like the best is called Walk Forward Testing (search for it in Google for more details). In fact I think it is so valuable that I'm planning on adding it to AI 2.0 as a free update later in the year (it'll be combined with a genetic algorithm to automatically perform optimizations on the various AIM variables -- such as BR, SR, minimum percent per trade, etc.)
At that point, at least AIMers will have a globally accepted testing method in which to compare results.
On another note, the testing I've done over the past year has taken a substantial amount of time (even with the aid of my trusty computer). Late last year/Earlier this year (when I was working on AI 2.0), I implemented a couple of improvements that make testing easier. AI 2.0 includes a multi-analysis function that allows you to enter symbols in a text file and then analyze all of these stocks with one mouse click. (What I do is go to a Web page that lists all of the symbols I'm interested in, e.g. the Dow 30 stocks, and copy them to a text file. Then I use this text file as the input into the multi-analysis function).
Since I've started using this, I've been able to significantly cut down on the time it takes to test. When AI 2.0 is released you can try this function for 30 days free of charge (AI 2.0 alpha testers can try this function now).
Some of the results I've seen (compared to B&H) have really been surprising (especially with some stocks that I had thought were good AIM candidates).
I'm sure that as more people start using this tool in AI 2.0 we'll see many more surprising results.
I'll post more on the subject of testing in the future. If others have testing methods they follow I'd be glad to hear about them.
I'm also curious to know how many people actually backtest the stock(s) they're AIMing. Any comments?
Regards,
Mark.
http://www.automaticinvestor.com
Hello Tom, Yes I did do the comparison for 100/0 and it usually outperforms the others.
The funny thing is that it usually outperforms in all kinds of markets (over the long term -- 5 years +), not just the bull markets as you'd expect.
Regards,
Mark.
http://www.automaticinvestor.com
I've back tested a few things brought up on the various AIM boards, here are the results...
In general,
1. starting with 80/20 usually gives better results than 67/33 or 50/50.
2. Using a minimum transaction size of 10% stock value usually gives worse results than 5%.
3. Monthly updates usually give worse results than weekly or daily updates.
4. The decay method, recently resurrected, didn't appear to work well. The vast majority of results I saw created decreased performance.
regards,
Mark.
http://www.automaticinvestor.com
Hello Matthew,
If you want to track the Nasdaq 100, there is an Exchange Traded Fund (ETF) whose symbol is QQQ.
I don't personally AIM it, but I think there are others out there that do. Anyone?
Regards,
Mark.
http://www.automaticinvestor.com
Hello John,
Yes, Automatic Investor 2.0 is scheduled to be released next month (March). Once it's released all registered AI 1.0 users will be able to upgrade for $19US.
AI 2.0 will sell for $197US (the CD Version will be $10US more).
I'll keep you updated and let you know when the release date is approaching.
Regards,
Mark.
http://www.automaticinvestor.com
Hello Matthew,
Yes, you're on the right track. I'd also suggest that you try running some backtests on your Tech Mutual fund with your settings (over various time frames) in order to get a feel for how it would have performed in the past.
Regards,
Mark.
http://www.automaticinvestor.com