TTM’s Trend Aggregation concentrates on several factors when striving to generate strong returns, including:
Momentum is the tendency of investments to persist in their performance. In other words, sectors that outperform during a given time period tend to continue to outperform.
Momentum analysis should first be used to determine whether to allocate money to stocks, bonds or cash and then to decide which stock and/or bond sectors are the strongest. For the stock portion, the Trend Aggregation model does not look for exposure to all asset classes. Instead, confirmed trends identify the strongest sector for positioning investments.
Countertrend analysis looks for signals to buy when markets are oversold and sell when they are overbought. This type of analysis takes advantage of the fact that over the short term markets are dominated by noise, fear and greed. This causes the market to overshoot on the upside and downside before eventually snapping back to equilibrium. Countertrend trades are typically much shorter in duration than momentum trades.
Trend Aggregation hedges market risk by moving out of stocks during difficult markets. If bonds are attractive, the move is there. When bonds are not attractive, the move is to cash.
Traditional tactical asset management diversifies portfolios through different asset classes, which is referred to as perceived diversification. Trend Aggregation uses actual diversification by combining non-correlated methodologies or return streams.
Traditional asset allocation, which uses perceived diversification, attempts to achieve diversification by having different asset classes, i.e. large stocks, small stocks, international stocks, etc. These assets might appear to be somewhat undiversified when looked at over different time horizons, but their returns originate from the same metric, rising stock prices, while their risks originate from the same metric as well, falling stock prices. Therefore, a drawdown in one asset class is usually accompanied by a drawdown in the others as investors indiscriminately sell equities during market downturns.
Actual diversification, which is used by Trend Aggregation, is accomplished by diversifying through multiple tactical methodologies, time frame variation, market basket variations and underwater correlation analysis.
Trend Aggregation uses underwater correlation analysis to combine uncorrelated methodologies with different return streams. Underwater correlation looks at how methodologies are correlated during downturns. For example, a momentum methodology will buy an asset when it is high and sell it when it starts to weaken. A countertrend methodology will buy an asset when it is weak and sell it when it starts to strengthen. You could apply each methodology to the same investment and get a completely different return stream.
Traditional straight line correlation takes a series of returns for two or more asset classes or methodologies to determine whether the return series is correlated. This type of analysis only establishes whether the asset classes or methodologies were correlated over a chosen time period. Straight line correlation doesn’t answer the most important question, as well as the reason for diversification, which is when one asset class or methodology is in a drawdown, how is the other one performing?
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