Book Reviews, Trading

Book Review of Smarter Investing in Any Economy by Michael Carr

The full title of this book is Smarter Investing in Any Economy: The Definitive Guide to Relative Strength Investing by Michael J. Carr (2008).

This book goes through many different ways relative strength (RS) is calculated, and then uses backtesting to determine the best RS calculation and optimize parameters for various trading systems. Despite the book being less than 200 pages though, it felt really wordy. There is a lot of text which flows from one topic to the next, making hard to decipher the key points. The way the book addresses the “smarter investing in any economy” in its title is basically to use RS to invest in the best (in terms of RS) sector ETF, asset class ETF, and international ETF.

One interesting bit from the book is on Charles Kirkpatrick’s RS strategy, which reminds me of Joel Greenblatt’s magic formula. Greenblatt was going for cheap (EBIT/EV) and good (ROIC), while Kirkpatrick was going for not crazily expensive (P/S),  good (EPS growth) and stock performing well (RS). Ranking stocks using a combination of simple criteria appears to work well. And combining fundamentals and technicals is always a good way to go for stocks.

Martin Pring’s Business Cycle

  • Stage 1: Economy continues to go down — buy bonds
  • Stage 2: Economy bottoms — buy stocks
  • Stage 3: Economy picks up — buy commodities
  • Stage 4: Economy continues to go up — sell bonds
  • Stage 5: Economy tops — sell stocks
  • Stage 6: Economy starts to tank — sell commodities

Relative Strength Calculations

  • Differences of prices
    • RS = P(today) – P(1 month ago)
  • Normalized rate of change
    • RS = [P(today) – P(12 months ago)] / P(12 months ago) * 100
  • Ratio of prices
    • Example 1: RS = [P(today) – P(12 months ago)] / [Index(today) – Index(12 months ago)] * 100
    • Example 2: RS = X / Y * 100
      • X = [P(today) – P(12 months ago)] / P(12 months ago)
      • Y = [Index(today) – Index(12 months ago)] / Index(12 months ago)
  • Back-weighted ROC
    • Example 1: RS = {[P(today) – P(12 months ago)] – [P(today – P(1 month ago)]} / P(12 months ago) * 100
    • Example 2: RS = {[P(today) – P(12 months ago)] – 0.5*[P(today – P(1 month ago)]} / P(12 months ago) * 100
  • Front-weighted ROC
    • RS = {[P(today) – P(12 months ago)] + [P(today – P(1 month ago)]} / P(12 months ago) * 100
  • Price/moving average ratios
    • RS = P(today) / MA(26-weeks)
  • Ratios of multiple moving averages
    • RS = MA(10-weeks) / MA(26-weeks)
  • Averaging different time periods
    • RS = MA(10-weeks) * MA(26-weeks) / 2
  • Alpha
    • Intercept obtained when regressing stock returns against market returns
  • Alpha (Robert Pierce)
    • RS = 99-week moving average of price changes
    • beta = % change between the lowest price and highest price in a time period
    • alpha = RS / beta
    • Divide the alphas into percentiles (higher alpha stocks are better)
  • H.M.Gartley’s Velocity Rating (1945)
    • Look for large swings in the stock indexes (usually 10% or more).
    • Velocity rating of a stock = % change in the stock / % change in the index * 100
  • Momentum of comparative strength (Christopher Hendrix)
    • MoCS = [12-period EMA of (Stock / S&P500)] – [26-period EMA of (Stock / S&P500)]
  • Multifactor RS (Frederic Dickson)
    • For a list of stocks, rank them using each criteria separately, from 1 (best) to 100 (worst), e.g. inpercentiles
      • Price / 52-week high
      • Price / 26-week high
      • 4-week % price change
      • 13-week % price change
      • 26-week % price change
    • For each stock, its rank is the sum of its rank in the separate criteria
    • Rank the stocks based on their ranks, and categorize them into their percentiles from 1 to 100.
  • Risk-adjusted RS
    • RS = [P(today) – P(12 months ago)] / [Index(today) – Index(12 months ago)] / StDev(P) * 100

Best RS Strategy from Backtest

  • Winner: RS = ratio of moving averages
  • Investment universe: 33 Fidelity Select Sector mutual funds
  • Time frame: January 1, 1990 to December 31, 2007
  • RS periods: 15-weeks for longer time period, 8-weeks for shorter time period
  • Quantity to purchase: 1 fund (buy the top RS fund initially)
  • When to buy: Portfolio reviewed weekly. Use weekly close of Friday, or Thursday if Friday is closed. Transaction price is the fund’s NAV after the close on the following Monday.
  • When to sell: Any fund with RS rank of 1 through 23 will continue to be held. Sell when rank is 24 or higher.
  • Initial Stop: 5%
  • Trailing Stop: 6%

Best Risk-Adjusted RS Strategy

  • Adjust a RS calculation
    • Risk-adjusted RS = RS / StDev(26-week RS)
  • Best risk-adjusted RS is the RS using normalized rate of change, second best is alpha / StDev.

Risk Management Using the Equity Curve

  • Use a 30-week moving average on the equity curve.
  • Trades from the system are only accepted when the equity curve is above its moving average.
  • Close any open positions when the equity curve falls below the moving average.

Weekly Trading System Using Three RS Strategies Combined

  • RS = alpha / StDev
  • Sector Strategy
    • Universe: 12 iShares stock sector ETFs
    • RS period: 40 weeks
    • Cutoff: Sell when rank 8 or more, swap with top-ranked
    • Initial stop: 5%
    • Trialing stop: 10%
  • Asset Allocation Strategy
    • Universe: 13 iShares asset classes (Gold, bonds, emerging markets, value, growth, MSCI EAFE, etc.) ETFs
    • RS period: 35 weeks
    • Cutoff: Sell when rank 10 or more, swap with top-ranked
    • Initial stop: 5%
    • Trailing stop: 7%
  • International Strategy
    • Universe: 17 iShares international ETFs
    • RS period: 40 weeks
    • Cutoff: Sell when rank 8 or more, swap with top-ranked
    • Initial stop: 5%
    • Trailing stop: 5%
  • Risk management
    • Use a 50-week moving average on the equity curve as a “stop” on the trading system.

James O’Shaughnessy’s RS Strategy

  • RS = one-year rate of change
  • Hold 50 stocks with the highest RS, rebalance annually. This strategy beat the market but has greater risk.
  • Combining the RS strategy with fundamentals reduces risk.
  • Best method is combining RS with low P/S ratio.

Charles Kirkpatrick’s RS Strategy

  • Buy rule: Stocks meeting all of these criteria are bought
    • Relative strength  >= 90th percentile
      • RS = weekly close / 26-week MA of price
    • Relative EPS growth > 90th percentile
    • Relative PS ratio < 30th percentile
    • Market cap > $500 million
    • Price > $5
  • Sell rule
    • Sell when RS falls below 30th percentile; OR
    • when EPS rank falls below 50th percentile
  • Frequency
    • Stock screen is run weekly.
    • If a new stock passes all the tests, it is bought at the open on the following Monday.
    • If a current holding hits the sell criteria, it is sold at Monday’s open.

Retirement RS Strategy

  • Simple Strategy
    • RS = 26-week % price change, calculated on a weekly basis
    • Invest all the money in the fund with the greatest RS.
    • The fund is held while it is among the top 3 strongest funds (out of 12) and sold when it falls to ranking 4 or below. When sold, it will be replaced by the fund with the highest RS.
  • Optimized Strategy
    • RS = alpha / StDev
    • RS period: 22 weeks
    • Invest in 1 fund at a time
    • Cutoff: rank 3 or more
    • Initial stop: 9%
    • Trailing stop: 11%





One thought on “Book Review of Smarter Investing in Any Economy by Michael Carr

  1. keep it up. Your book reviews are awesome

    Posted by investinkl | September 2, 2014, 8:43 am

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