System 12. Portfolio Construction and Rules

The logic behind System 12 strategy is deceptively simple:
a. By using best available stocks scanner, select 12 biggest by market capitalization US companies.
b. Invest into these stocks continuously, while they are in uptrend.
c. Don't invest if they fall in downtrend.
d. Use rules only - to differentiate between b and c above.
e. Don't break the rules.

American MegaDozen.
According to FinViz, these are 12 largest American enterprises:

Since these stocks commonly referred to as 'mega-caps', I call this list Mega Dozen (MD).
This is MD:
http://stockcharts.com/freecharts/candleglance.html?AAPL,GOOGL,MSFT,XOM,AMZN,FB,BRK/B,JNJ,GE,WFC,T,JPM|B|P5,3,3|0
This is SD - Second Dozen - next 12 stocks by market cap:
http://stockcharts.com/freecharts/candleglance.html?PG,WMT,VZ,PFE,CVX,V,MRK,ORCL,HD,INTC,BAC,KO|B|P5,3,3|0
These two lists need to be re-evaluated monthly for any changes and positions need to be revised accordingly. MD stocks are the biggest and the best, but its not written anywhere that they will remain to be so. Some will fall and never come back, but they are always replaced by new 'winners' in stock market, as in life.

S12 Requirements:
Minimum account size to run a System12 portfolio is $40,000, considering initial allocation of 12 equal positions of about $3000 each, with more than Standard Position Size cash reserve for replenishment. Read about 'How to Bet' here (link)
-note- I attempted to do it will less money and found results unsatisfactory. Don't repeat my mistakes - learn from them!
At larger sizes, System 12 becomes increasingly more efficient, as dividends accumulate and costs decrease. All my systems are designed to be run at 10 times of minimum allocation with almost no changes to execution (for my own future use), but S12 really stands apart. This thing can be traded with virtually unlimited amount of money, as MD stocks are some of the most liquid traded securities. A million dollars?  10 million? Just look at a volume figures for these stocks - you can do it on an opening tick and the Market will not even know you are there.

System 12 requires daily monitoring. I found it unnecessary and even counterproductive to watch these stocks intraday. We are not day-trading here, but portfolio needs to be reviewed nightly on closing basis and stops placed or adjusted. This should not take more than 15 minutes.

Personally, I think S12 should be traded in tax-efficient account, like an IRA. First of all, MD is a heavy object and moves slowly. Beneficial effects of this strategy will not be apparent in a period of few months, but over a year or two. It would be nice not to pay any taxes in the interim. Secondly, S12 has extremely efficient re-entry procedure (see 'Trade management'), unfortunately disregarding wash-sales (if investment bought and sold for a loss within 30 days, a loss can't be applied to offset gains for tax purposes). Since typical IRA does not observe wash-sales rules, our lives are made a little easier.

S12 Rules:
1. Take positions only in stocks trading above 200 day simple moving average. Any stock with daily close under 200dma is DISQUALIFIED from System12 and must be sold.
2. Any remaining stocks are AVAILABLE for purchase above 50 day simple moving average.
3. BUY all stocks that are Qualified and Available from MegaDozen (MD) first. If not all MD stocks  can be purchased, then go to Second Dozen (SD) and continue to buy until 12 positions are filled.
-note- an edge of System12 is in largest of mega-caps. The lower you go into SD, the more this edge dissipates. You must consider this very carefully.
4. Sell any position if daily closing price is below 50dma.
5. Use Positioning Period (PP) of 1 week (up to 5 trading days) to enter and exit positions. There will be more about this in a next article on 'Trade Management' (post link).
6. S12 portfolio can not have more than 12 positions. No margin. No leverage.
7. S12 portfolio can be partially or fully in cash for unspecified period of time. No trades beyond MD and SD are permitted.

Accordingly, as of today, S12Portfolio should look like this:
http://stockcharts.com/freecharts/candleglance.html?AAPL,GOOGL,MSFT,AMZN,FB,BRK/B,GE,WFC,JPM,PG,V,MRK|B|0

You can poke around fundamentals of these stocks via FinViz (link), but I tell 'ya - this is one helluva portfolio. Conservative and diversified, but definitely skewed towards technology and financials - market leaders of the past few years. Good. Even better, considering that it was picked not by some biased analyst, but by Mr. Market himself. I don't need to have an opinion (AMZN has crazy P/E) or make predictions (I would never have picked FB). A "bloodless verdict of the marketplace" is already reflected in these 12 stocks. Just follow the rules...

...until next week, when I will expand on a topic of "Trade Management", including Positioning Period (PP), 'by-pass' conditions and usage, and rare (but dreadful) Emergency Exit (EE).

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.this is a second article in 'System 12' series.
Read Part 1: System 12. American MegaDozen. Introduction.
-reading part 2-
Read Part 3: System 12. Trade Management 
Read Part 4: System 12. Performance and Risk
Read Part 5: System 12. Portfolio Initiation  
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VIDEO: S&P500 Price Movement, Sectors and NYSE

In this video I discuss a progression of weekly SPY trend, based on interpretation of my Composite Score Indicator (CSI).
Sell Signal warning on a week of August 22, 2016, weak condition of S&P sectors and relative under-performance of NYSE composite index ($NYA). Also I talk about multi-year sideways grind, with bear market stuck in-between (yes, bear market - I'll explain next week), and illustrate how personal investors walked away from trading.

DART v2 System Start

I recorded a video how orders where placed and reviewed reasoning of my decisions during opening trades of DART v2 strategy. While on a surface everything sounds benign and almost sleepy, in reality I had a full-blown crisis on my hands. Never mind kids raising a ruckus around a house, I can live with that. But when internet went out I didn't know what to blame. My network is fine and all computers are in order, but of course I went ahead restarting, reloading and powering on-n-off stuff, until I heard some scribbling outside. THIS is the day when Comcast decided to rewire whole neighborhood and send a big and mean looking (but very polite) man to scale a wall of my house in order to cut my fucking internet cable. Took them 2 hours, which was pretty good considering... like I said here (link): "System start is always rocky. Always!"

But, as evident in this video, everything went swimmingly on my end. Orders went thru, positions were filled, all according to plan. This is a beauty of the Market - the game is always on. You can go ahead, do your thing, be busy with everyday nitpicking, while Market continues to work for you. Observe:

DART v2 Opening Allocation

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DART pick

Every week, in this space, I intend to highlight one of the stocks picked by DART method.
It may come as a surprise (at least it was to me), but many of these 'DART picks' are not popular stocks. I personally have never heard about many of them on TV, or read in blogs. Even surveying Twitter and StockTwits did not return many results that were not an advertisement or some mindless click-bait. This makes me very curious - what is this strategy really investing into? I want to stress that I am not attempting to have an opinion or personal bias about any of these stocks. DART portfolio functions just fine without convoluted predictions about uncertain future prospects of it's components. It doesn't mean I will seize to ask questions: "What If...?" And you, dear reader,  shouldn't either. Really.

BRCD - Brocade Communication Systems - is a kind of business internet runs on. It is also a kind of a business - the more I read about them, the less I understand what they do. "Solutions", "innovations", "automation" and such meaningless generalities litter their business description. Company website didn't offer any help either, being an endless re-direct nightmare, I couldn't get to a page with description of a kind: 'this chunk does this', 'this hunk connects in between', 'this is how much it will cost' etc. Methinks, they either want to baffle investors with bullshit, or dazzle themselves..., but never mind that. DART doesn't need to take these conflicting points into consideration at-all.

Here is what DART Strategy does:
On August 26, 2016, right after open, BRCD collapsed by 12% on earnings announcement and became a 'worst' losing stock of DART portfolio.
According to selling rule 'b' from Original DART article post (link), BRCD has to be sold immediately. Observing a waterfall decline in a first half an hour of trading, I patiently wait for a local low to form, in order to put a Good Till Canceled (GTC) on-stop sell order just a couple of ticks below. This order will be aggressively trailed up, until caught.

I want to note, that it is not uncommon for these stocks to reverse their entire earnings decline and more. Let the Market sort it out, by banishing all wishful thinking! 'Usually' does not mean 'always'. Nothing is 100%. Just like i said here(link): "Most of Best List stocks don't react much to earnings...", well, this one did. 'Most' is not 'All'. So, for now, we have a clear task at hand - selling BRCD and finding new candidate for replacement. Real time updates are available on a private Twitter feed @SWID_iBergamot or wait for next episode of this series in a week or so...

 

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System 12. American MegaDozen. Introduction.

I developed System 12 in January 2013, but idea for it was my pet peeve long before that.

See, people are running around, looking for stock tips, trying to guess what companies are destined for greatness and ever expanding share price. It's been this way since forever and will be like this long after we are gone. If they stop screaming (extra Jim Cramer) and listen to the Mother Market, they just may learn that die is cast, the race is over and winners are announced. System 12 gives rational speculator an ability to bet on winners while the race is still on.

System 12 (S12), aka American MegaDozen, is a rule based, (almost) mechanical, statistical system designed to invest in 12 biggest and the best companies in USA by using multi-position dynamic strategy. With application of rules, filters and risk control measures, this method increases investor chances of buying and holding leading multinational corporations for months (even years) while their share prices increase and sidestep devastating once-in-100-years bear markets that seems to happen every couple of years (or so).

S12 companies are so big - they dwarf everything else by comparison. Their combined market cap stands at whooping 4.4 Trillion dollars, up from 'only' 3 trillion in 2013. Imagine, if Mega Dozen was a country - it would be 4th or 5th biggest economy in a World! Lest not forget that the biggest three of all - Apple (AAPL), Alphabet (GOOGL) and Microsoft (MSFT) - are actually larger than entire Russell 2000 small cap stocks index (RUT). All two thousands of them...

This remarkable size discrepancy is really not that unique.
The phenomenon of 'extreme' is thoroughly explained in books of Nassim Taleb, famous trader, writer and philosopher, who calls our world "The strange country of Extremistan" (link):

"In Extremistan, inequalities are such that one single observation can disproportionately impact the aggregate, or the total...   if we are in the domain of Extremistan, and we use analytical tools from Mediocristan for prediction, risk management, etc., we can face enormous surprises. Some of these surprises may be positive and some may be negative, but their impact will likely exceed what we are prepared for."

I strongly recommend his books "Black Swan" and "Fooled by Randomness" for anyone who wonders how this order of things came to be and what to do about it.

Clever Eddy Elfenbein observed in 2014 post(link): "Wall Street is comprised of a small number of stocks that are very, very large, and several thousand stocks that are tiny". Correct! Moreover, it's been this way throughout most of modern history and especially in 21st Century. Further, he notes:

"...market cap of the S&P 100 makes up about 62% of the market cap of the S&P 500...The S&P 500 makes up about 77% of the entire value of the Wilshire 5000. Despite its name, that index has 3,663 stocks... S&P 100 is about half of the Wilshire 5000. The remaining 3,563 make up the other half..."

This is the World we live in and this is the Market we are given. Don't blame me, I just work here...
Meanwhile we can exploit this peculiar circumstance with reasonable expectation of 'positive surprises'. This is what System 12 is designed to do.

System 12 completely disregards personal biases, gambling urges, economic forecasts and CNBC talking heads. What it offers is a superior stock selection tool and procedure for Stress Free Investing. Why worry about GDP doing this, or economy doing that? Why agonize over conflicting market predictions, or chase latest over-hyped IPO?
The Market already made its verdict and announced it loudly over these interwebs... Listen...

You can take it from here... or wait for next week article, where I will outline portfolio construction and trading rules.
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.this is a first article in 'System 12' series
Read Part 2: System 12. Portfolio Construction and Rules 
Read Part 3: System 12. Trade Management 
Read Part 4: System 12. Performance and Risk
Read Part 5: System 12. Portfolio Initiation  
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VIDEO: S&P500 Price Movement and Sectors

In this video I discuss a progression of weekly SPY trend, based on interpretation of my Composite score Indicator (CSI). Relative trend stages of the sectors can be seen in image below the video. I note a double sell signal in Industrials $XLI and explore possible scenarios.

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READ: Dow Theory by Robert Rhea

Being a student of the market n' stuff, I love to study old original theories. How they self-distracted, or changed, or endured through decades that follow? What can we learn from the original thinkers of the past?

I got seduced by definitive title "Dow Theory", thinking its a complete text with strict plan to follow. Mr Rhea performed a valuable service in thematically combining excerpts from newspaper articles to form a general outline, but its hardly a step-by-step manual. Basic tenets of Dow Theory are plastered all over internet and they are just as vague and contradicting as Rhea's own book. Here is wiki link, if you don't know.

An unexpected and pleasant surprise was an Appendix, taking up more than half of this book. In it, there are 26 years of periodical editorial column by William Peter Hamilton, one of original editors of Wall Street Journal, from 1903 to 1929. A weekly-to-monthly review of market movement with interpretations of Dow Theory. As it happened, in real time, in a words of participant...
Its like blog, only 100 years ago. Awesome!

October 27, 1913
"It is well to repeat the occasional caution given in this column, that the averages make a good barometer, viewed from disinterested point, but are calculated to ruin anybody if treated as a 'system' for playing the market."

January 5, 1911
"There is nothing in the averages to dogmatize about. They are an immensely valuable guide when studied over long periods in the past. They frequently give useful indications of the tendency of market's short swing. For day-to-day trading they are not only valueless but would probably be dangerous as well."

March 29, 1926
"The passionless barometer is disinterested because every sale and purchase which goes to make up its findings, is interested. Its verdict is the balance of all the desires, compulsions and hopes of those who buys and sells stocks. The whole business of the country must necessarily be reflected correctly in the meeting of all these minds, not as an irresponsible debating society but as listening jury whose members, together, bring more than the counsel or the judge can ever tell them in finding what has been called the bloodless verdict of the marketplace."

January 20, 1913
The market does not trade upon what everybody knows, but upon what those with best information can foresee. There is an explanation for every stock market movement somewhere in the future, and the much talked of manipulation is a trifling factor."

July 19, 1910
"There is in Wall Street a small but very useful section of traders which is oftener wright than wrong, and its methods, often unconsciously, are strictly technical, bearing very little reference to conjectures based upon crop prospects or politics."

April 4, 1923
Evey day brings its new experiences, but it is tolerably certain that we shall not have the record of a bull market in which the little speculators successfully liquidated at the top, getting their information from the comic strips in the newspapers."

July 30, 1923
"...the man who picks a wrong stock for speculative purchase, or, more rarely, the right stock at the wrong time... He has no use for the stock market as a barometer of the country's business. He believes he can make money by reading the barometer first and reading business afterwards, or not studying it at all. ...attempt to do both things leads to inextricable confusion."

December 10, 1929
"Mr Hamilton's editorials were widely read and there is an abundant evidence that time and again they exerted a positive and practical influence. Their appeals to thinking men and women may perhaps be attributed in large part to the facility with which he brushed non-essentials aside and went straight to the hart of the question."

Get the book. Go straight to appendix. You'll love it!


Clicking on this link will take you to Amazon.com. If you buy this book or something else I will receive small commission that helps to support this free website.

DART v2

      If we make mistakes, Buffett confesses, it is either because of (1) the price we paid, (2) the management we joined, or (3) the future economics of the business. Miscalculations in the third instance are, he notes, the most common.* Robert Hagstrom, Warren Buffett Way*

Original DART Strategy is based on principals of common sense investing into prosperous American enterprises. Although it has foundation in fundamental analysis of securities, DART looks beyond income statements and balance sheets. Our focus is on basic and broad characteristics that are both hard to manipulate and signs of good business at the same time. This prudent strategy attempts to deliver a narrow dynamic list of sensibly priced stocks of best companies in USA, for immediate investment. Although statistical lens is impartial, it can not see what is hidden, nor it foresees the future. I don't pretend to predict prospects of stocks I invest in, and apparently Mr. Warren Buffett ain't got a clue either. Good, there are already two of us and I'm in a pretty good company...

In order to function properly, Dart Strategy Portfolio has to deploy multi-position rotational methodology, in which both winners and losers are being sold in efficient manner. I personally designed and traded several systems with 10-12 positions and can attest that it was sufficient. The most recent example was a test run on this very strategy, discussed in previous DART post (link) Loaded Gun. But can it be done with less? If investing in stocks is nothing more than throwing darts at stock-tables, can we get a better dart-board? DART v2 is expected to do it with 6 Standard Position in $20,000 portfolio, but even I am not sure if it is possible.

Dart is a strategy to scan available database of fundamental information, looking for good business, priced at good value, in order to build a definitive watch list from which to select a trading candidate. Call it Best List because, believe it or not, this is the best this Market has to offer. Not my opinion, its just is... I outlined basic selection criteria in original Dart article post(link), and they proved to be absolutely valid. This Best List is remarkably small, but has to get even smaller for DARTv2.

First consideration is 'plaque of all small accounts' - costs! The commissions really add up and eat into any gains, while accentuating losses. Luckily, Best List already has a solution available - many of these stocks pay a dividend of 1.5% or more, which according to past tests more than offset costs of Standard Position Sizing.  I think that to run this method in less than 20K account is not feasible, while employing multiples of this amount will effectively negate costs and increase dividend income. I estimate that portfolio will need a trade every two weeks, with expectation for a rocky start. System start is always rocky. Always!

Secondly, I don't want to buy high price/sales ratio. Generally its a recipe for disaster, because price already risen far enough for somebody to take some profits... and its never yours truly... At the same time I don't want any huge mega-caps, because I have other methods to deal with those (System12). Besides, if second objective of Dart is to hunt for companies to be bought, then its not a 100Bil behemoth - they are the ones who doing the buying... lol

I added a 'short' qualifier, based on this simple logic: Shorts are smarter than me and they are sniffing something. Short interest of more than 10-20% of the float is especially alarming, considering how financially sound these stocks look on paper. Do I really want to be on the other side of THESE GUYS trades? Don't get cute with money, son.

The above results is ALL I got. Six of these will be bought Monday, on open, all at ones, at equal size: BRCD,ADP,IILG,MSM,GPC,CMI, and the rest will stay for replacement, or until something better comes along. I made these choices in an interest of diversification, but really all ten are good to go.
http://stockcharts.com/freecharts/candleglance.html?BRCD,ADP,IILG,MSM,GPC,CMI,GNTX,BEN,SWKS,FAST|B|P5,3,3|0

Practically, there are only two ways to Start a System - you buy them all at once, or you don't. :)
Guess how I operate?
Strictly according to rational position sizing and portfolio management, as discussed in 'How to Bet' post (link), I will buy about $3000 worth of each, keeping the rest as cash reserve for future replenishment. (Trust me, these flowers will need a lot of watering).
Next update will be published in a week to ten days, so we can analyze portfolio initiation, see about changes that needs to be made and review rules for selling. Do you know 'WHY to SELL"?

 Meanwhile, I remind that this is still a simulation, although set up as realistic as possible. I will host it at Investopedia
http://www.investopedia.com/simulator/portfolio/?gameid=357126

November 10, 2016. New simulator for fully synchronized DART v2:
http://www.marketwatch.com/game/dart-v2/portfolio/holdings

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 New version of scan (Finviz link) is definitely something of extreme, as evident by small number of results. I am sure that somewhere between this and the original settings are a lot of great stocks that can be found and traded. Specifically, if curious learner follows scan link he may discover a small group of financial stocks. What are they doing here, I wonder. I remember back in December of 2015 I noticed another peculiar looking group of similar stocks. Go look what happened to them since... I can smell an experiment! Can you?