A.I.M. Users Bulletin Board

[ls7550]

Using vWave to determine appropriate leverage

The weekly calculated single sector (stock) vWave (appropriate cash reserve for each AIM) is divided by 1.5 to determine the diversified portfolio vWave - the indicator of appropriate amounts of AIM cash reserves across all AIM's.

An alternative is to use the single sector vWave as a indicator of how much leverage is appropriate to be employed at any one time, by subtracting the vWave from 100%.

AIM can provide similar total gains to 100% buy and hold, but do so with less stock exposure. A AIM that averages 80% stock, 20% cash for instance might compare to 100% stock gains.

As the broad average vWave = 50% cash, that implies average 50% (1.5 factor) stock leverage (100 - vWave = 50% leverage). Instead of 20 individual AIM's each allocated 5% weighting and each having half in cash reserves (collectively 50% stock, 50% cash), hold 30 AIM's each with half in cash reserves (collectively 75% stocks, 25% cash). Or alternatively revise each of the 20 individual AIM's to each have just 25% cash reserve instead of 50%.

At more recent 60% vWave levels that implies 100 - 60 = 40% leverage, such that 40% overall stock exposure scales 1.4 times to 56% stock exposure (44% total cash).

At the 2009 lows when the vWave was indicating 15% cash reserves that implies 85% leverage, such that 85% stock exposure x 1.85 leverage = 157% total stock exposure. Whilst that would entail having to employ leveraged ETF's in order to gain such exposure (or other derivatives), having been 157% loaded into stocks at the 2009 lows would have considerably enhanced the rewards from the subsequent stock market recovery/rebound. In practice however the vWave indicated reducing exposure relatively quickly so you'd have scaled out of employing leveraged ETF's relatively quickly. By the time the vWave was back up to 38%, you could have totally ejected the employment of leveraged ETF's (62% stock exposure x 1.62 leverage = 100% stock).

Here's a pre-calculated table of values

Vwave %	Stock Exposure % 
 65	47 
 60	56 
 55	65 
 50	75 
 45	85 
 40	96 
 35	107 
 30	119 
 25	131 
 20	144 
 15	157 
 10	171 
 5	185

And if leverage is something you'd rather avoid then yet another alternative is to use beta (rotate into stocks with higher beta when the vWave is relatively low, low beta when the vWave is relatively high).

Clive.