Journeys of a Bumbling Investor

Rating: Mama desu.

Background: Got interested in reading this book because of its title TrimTabs Investing: Using Liquidity Theory to Bat the Stock Market with the concept of using supply/demand to help in investing.

Key Points:

1. Building blocks of liquidity analysis
   • L1 – Change in net trading float of shares
   • L2 – U.S. equity mutual fund flows
   • L3 – Margin Debt
2. L1 (Change in net trading float of shares)
   • L1 is the net change in trading float of shares (the supply side). If L1 is positive, the trading float of shares is increasing and institutions are a net seller of stock. If L1 is negative, the trading float of shares is shrinking and institutions are a net buyer of stock.
   • L1 = New Offerings + Insider Selling – New Stock Buybacks – 2/3 New Cash Takeovers – 1/3 Completed Cash Takeovers
   • Note: when a cash takeover is announced, 2/3 of the dollar amount is included in the L1 formula. The final 1/3 is included when the takeover is completed. This is because arbitrageurs typically buy 2/3 of the stock of the target company within a week of the deal’s announcement.
   • Data source: Dealogic, www.theonlineinvestor.com, Thomson Financial
3. L2 (U.S. equity mutual fund flows)
   • L2 measures U.S. equity mutual fund flows (the demand side).
   • L2 = Amount of cash investors are investing in mutual funds that invest in U.S. stocks – Amount of cash investors are withdrawing from mutual funds that invest in U.S. stocks
   • L2 is typically a contrary indicator. Inflows into U.S. equity funds tend to peak around market tops, and outflows tend to peak around market bottoms.
   • Data source: Investment Company Institute (ICI) monthly release @ www.ici.org/stats/mf/index.html, U.S. Department of Treasury release on foreign purchases and sales of U.S. securities @ www.treas.gov/tic/s1_99996.txt    
4. L3 (Margin debt)
   • L3 is the change in the amount of margin debt used to purchase stocks, as reported by the member firms of the NYSE.
   • L3 rises rapidly when investors are very optimistic about the future prospects of the stock market (usually after prolonged period of strong returns). L3 falls significantly after a prolonged period of poor stock returns.
   • Data source: NYSE Member Firms Customers’ Margin Debt @ www.nyse.com/pdfs/marginMMYY.pdf
5. Anatomy of Bull and Bear markets
   • At the beginning of bull market
     • L1 – strongly negative
     • L2 – negative
     • L3 – negative
   • On the way up
     • L1 – remain negative
     • L2 – increasingly positive
     • L3 – slightly positive
   • At the top
     • L1, L2, L3 - strongly  positive 
   • On the way down
     • L1, L2, L3 - increasingly negative
   • At the bottom
     • L1, L2, L3 - strongly negative
6. Lower-risk strategies using liquidity theory
   • Strategies vary contributions and holdings according to expected liquidity conditions. Five stances are adopted based on estimates of daily L1.
     •  < -$800 mil = Strongly bullish
     • -$800 mil to -$400 mil = Bullish
     • -$400 mil to $400 mil = Neutral
     • $400 mil to $800 mil = Bearish
     • > $800 mil = Strongly bearish
   • Perform dollar-cost-averaging by splitting the monthly investment into a stock index fund (SIF) and a bond index fund (BIF). The split proportions will range from 100% in SIF when strongly bullish, to 100% in BIF when strongly bearish.
   • Higher risk strategies involve shorting the market when strongly bearish, e.g. investing 100% in Rydex Ursa Fund (RYURX) which is 100% short the S&P500.
7. Aggressive strategies using liquidity theory
   • More aggressive strategies involve the use of leverage (i.e. margin), and investing in securities such as ETFs and futures, but with similar principles as the lower-risk portfolio strategies.

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