Low volatility, high returns

In last year´s blog post “A strategy for All Weathers” I mention that there are various ways in which to invest the portion of your portfolio that is allocated to equities. One of the more interesting factors is to bet on the “Low volatility Anomaly”.

Low anomaly what?

Ok, let´s start from the beginning. As we have already seen, in classical financial theory there is a a positive relationship between the Beta or  the volatility (the beta is composed of the volatility of the stock, the volatility of the market and the correlation between market and security) of a stock and its expected return. As the beta of the stock increases we expect to be remunerated with increasing higher returns for this higher larger amount of risk.


What the low volatility anomaly shows empirically though, is that low risk stocks measured by low volatility or low beta tend to outperform their riskier counterparts. In fact it shows that:

  • There is an inverse relationship between volatility and future returns
  • There is an inverse relationship between beta and future returns
  • Portfolios made of minimum variance stocks fare better than the market

This seems very counter intuitive and almost like an arbitrage opportunity. How could a portfolio which is less risky do better than a risky aggregate index? But as we see below, the sharp ratio continuously decreases with increasing risk.


Asset Management: A Systematic Approach to Factor Investing, Andrew Ang (2014)

There are different ways to take advantage of the low volatility anomaly.

Let us construct factor mimicking portfolios consisting of a long position in the less volatile securities and a short position in the volatile ones. We can do this based on realized volatility or realized beta. The portfolios are constructed as follows.

Based on realized beta we construct the “Betting Against Beta” portfolio.


The BAB portfolio scales its position in low volatile stocks up by their beta and scales down the position in risky stocks according to their respective beta. Similarly, a portfolio based on low volatility can be constructed as follows:

unbenanntAs in the BAB case the weights are scaled up and down according to realized volatility and the portfolio is scaled to a target volatility (sigma – target).

So, how do these portfolios perform? Extraordinarily! See yourself!

Asset Management: A Systematic Approach to Factor Investing, Andrew Ang (2014)


Possible explanations

  • Data Mining: The results may simply be subject to the search for “some” anomaly. If one searches long enough one is sure to find something.  This however seems unlikely. Even though the results are sensitive to some portfolio weightings the anomaly can be detected in international equities, US equities, bonds, derivatives and FX.
  • Constrained Leverage: Even though financial theory assumes that everybody can borrow unlimited financial capital seeking to lever his investments, this may not be applicable in reality. Thus, people want to invest in securities that contain a “built-in” leverage. High volatility and high beta stocks facilitate this. Since more people want to invest in these levered investments, prices increase and expected return decreases
  • Constraints: Some institutions may not be able to invest in the low volatility anomaly due to regulatory constraints. Given their weight in the market this allows for the mispricings to occur.

There are many exchange traded funds allowing to invest in this anomaly. Below you see the multi-year performance of BlackRock´s “iShares Edge MSCI Min Vol USA ETF”. We see a slow but steady uptrend. With a management fee of only 0.15% it is a cheap way to play this anomaly for any investor confident about the prospects of stocks with low volatility.


If this is an investment for you is something I cannot foresee. As any other investment strategy this strategy is not without its risks but rather bets on stocks that have been less volatile in the past.



Recap 17.02.2017 – CNAB

After writing about overtrading in my last post I did overtrade some more on Friday the 17.02.2017. I had the biotech United Cannabis Corporation (CNAB) on my watchlist. This recently, had spiked and broken out of its resistance at $1.9. Since my entry rule once again was unclear, greed took over and I entered  a few minutes after market open at $2.07, just at the top. The action reversed and when CNAB could not hold the $2s and went red on the day the stock plunged fast. Just a few minutes after entering I exited at $1.92, with my biggest loss so far. However, once again the exit was well chosen. CNAB fell more and went as low as $1.76. Even though it regained its the low $2s later in the day I would definitely not have held through a decline like this.


What I had not realized before my trade but became painfully aware during the session was that CNAB basically was following the  strongest stock in the Marijuana sector, Cannabis Pharmaceuticals Inc. (CNBX), which in the days prior to Friday already had advanced from $1 to $3. When CNBX had a short morning panic on friday, the same happened to CNAB. When CNBX recovered later, so did CNAB. Below, we can see how the stocks moved together during the session.


I am “somehow” glad about this loss since it demonstrated how unsystematic my trading approach is at times. I hope I will not lose capital on these obvious mistakes again.

  • I need 100% unambiguous rules about when/why and how to enter a position, i.e. I need to define the catalysts.
  • It is of crucial importance to identify the market leaders of a specific sector. These have to be monitored and offer the best opportunities on the long side. The laggards on the other hand are more noisy.While the leader CNBX ended the day up 36.5%, CNAB just got even. This is closely related to.
  • Focusing on trades with great reward/risk. Every night when scanning for possible opportunities there are 10+ stocks that are somewhat interesting. However, only a few stocks offer the combination of truly great setup and liquidity. Much of the moves of stocks still is random and therefore I have to cut through the randomness and resist the temptation to trade mediocre setups.

Talk to you next week.



Lessons from Overtrading

Just a short update. Today I learnt a lesson about overtrading and how my rules need to be as specific as possible. During the premarket session IMMU behaved crazy again and was up to as high as $6.1 from its previous close at $5.23. Just as on Friday profit taking kicked in and before the market open the stock traded at around $5.5. But then as opposed to the last trading session, when the market opened the stock lost considerably and dropped to $5.25 in the first two minutes.

Recently, there had been many great dip buying opportunities – cases in which strong stocks sold off sharply in the morning just to come back even stronger after finding a base. The human  pattern finder that I am, I thought every stock that declined in the morning would be an opportunity as this. When IMMU strengthened a little bit, I  entered my position at 5.36. However, just after a few minutes support at $5.3 got taken out and I excited my position at $5.28. This does not sound too bad and indeed my risk control is not too bad and particular my exits are well-chosen most of the time (IMMU at the time of writing trades at $5.07). However, given the genius that i am I had considerably increased my position size since I did not want to make the same mistake as on Friday. Accordingly, my position size was double the size of Friday and adding transaction costs I lost a little more than I gained on Friday.


All in all nothing dramatic. But there are again two things to reflect on.

  1. Yes, as I pointed out on Friday my position size has to be appropriate. However, this implies that I go in big when the odds are in my favor. While there is nothing wrong with trying to dip buy a decreasing stock if all variables align, since momentum works against you in a situation like this the odds are weaker than buying into a breakout. Therefore, I definitively have to weight the odds of a given trade with its position size.
  2. I really wanted to trade today. Due to my university schedule and the American market hours I am only able to trade the market-open on 2 out of 5 days. Since today was one of thees days this made me really want to trade. This obviously is the wrong attitude. I should only enter trades that offer the highest odds of success even if this implies not trading at all.



The Pain of Winning

This Friday (10.02.2017) during the pre-market trading session I became aware of Immunomedics, Inc. (IMMU), a healthcare/biotechnology company. Pre-market this was up to as high as $7 dollars from the previous close of $4.3.


What had happened? After a fast news check I found the catalyst. A press release stated that IMMU had entered into a exclusive licensing agreement regarding cancer therapy with Seattle Genetics, Inc (SGEN), an $8.5 billion company. The agreement stated that IMMU will receive an upfront payment of $250 million while SGEN will be granted exclusive rights for the development, production and sale of IMMU´s drug candidate sacituzumab govitecan. Additionally SGEN will purchase 2.8% of IMMU´s equity for $15 million. This alone would elevate IMMU´s implied value strongly. Prior to the announcement it had a market capitalization of just $455.55 million. Besides the market capitalization I looked for IMMU´s float (90.54 million) and short interest as percentage of the float (25.17%).

During the pre-market session profit taking kicked in and  the stock retraced to the mid  4s, still up on the day. Given the news, the price action and the short interest I wrote in my watchlist:

“major contract winner, almost doubled pre-market and now is down. This may be dip buy/buy of the breakout of the morning high”

My reasoning was as follows:

  1. Even though the stock had given back the majority of its gains it was still up percentage wise double digits on the day. Given the strong short interest many short sellers would be under water and try to cover when the more liquid morning session opened.
  2. The news were very bullish. Firstly, IMMU was to obtain an up front payment that consisted of more than 50% of its market capitalization. Secondly, the purchase of the equity stake by SGEN implied strong confidence from a major company. Thirdly, the sheer size and thus credibility of SGEN made the news of the transaction even more bullish.
  3. When the market opened I imagined two possible scenarios that would make me interested: 1) profit taking would slash the price down a little bit. Shorts would jump in to cover, immediately bidding the price up again. In this case my plan was to look for a base and buy the dip with tight risk control in case of a further decline. This was the riskier option. 2) Shorts would start to cover and this in conjunction with momentum buyers  would cause a morning spike. If this situation would emerge,  I was committed to by into the break out of the channel that had materialized in the morning session between $4.6 and $4.8.

When the market opened scenario 2) materialized.


The stock broke the resistance at $4.8 on strong volume and I entered at $4.82. At this time the buyers gained control and the stock went to $5.1. At this point I saw a wall of sellers on level 2 and took my profits, selling at $5.11. This turned out to be a good call since the stock retraced back to the low $4.90s. I just had made a return of 6% in a few minutes. I decided to continue playing the same pattern and entering on the break of the previous high after a retracement had occurred.  As you can see below there was ample opportunity to do so.


Especially the breakouts in the high $4.10s and $5.30s materialized just as I had imagined. I had my finger already on the buy button – but I just could not do it. Psychology came into play: “What if I give back my profits? What if end up losing money on this trade?” Of course, I  did not trade IMMU that day anymore. Therefore I left a possible gain of $1 dollar a share (in excess of 20% return) on the table. This “theoretical” $1 per share is no result of hindsight bias. If I would have adhered to my plan I would have captured the meat of the move. I might have given back some profits and paid considerably more in transaction fees but I would have rode the trend.

Many of the most successful traders, especially in the trend following community, claim that not taking an opportunity when it presents itself can be considerably more adverse to trading performance than loosing. When I see an opportunity that offers favorable odds I have to take advantage of it.

I learned two main lessons:

  1. As well when day trading, I should have a clear trading plan for each stock on my watchlist. This plan has to be in written form and should include all possible eventualities, including entries, exits and especially position size.
  2. Given my account size (I recently have funded my account and now trade with an appropriate account size) and the very tight stop loss that I had set myself, my position size was way, way too small. I should have entered this trade with much bigger. The liquidity in this trade was very high and would have allowed me to trade more shares. Playing with a bigger position size will allow me as well to scale in and out of a position. This means that when I am up on a trade I can either add or take some of my shares off the table. Thus I will have already locked in some profits and can be more patient with the rest of the position, letting the winners run.

Even though I traded this far from perfectly, I felt exhilarated after the trade. For the first time my predictions completely materialized and I felt that with further studying I will be able to thrive in this niche.



An Outlook on America

As we start into the second month of 2017 I would like to cast the focus on the United States of America, its economic outlook and ponder on the crazy thought that Donald Trump actually might be right.

2017 is likely to be a year of transition and huge importance for countries all around the world. Geopolitical conflicts in the middle east, strengthening populism in Europe, weakening emerging markets and the rising threat of terrorism characterize the uncertain global environment. And let us not forget about the mad man who just took over the role as American president. This year is not going to be boring in any case.

Given this global theme, there are compelling reasons to look more closely on the prospects of the world´s most powerful nation. The conclusion: American equities still offer strong potential!

Given the current price levels of equities and the DOW JONES to new, historic highs this may seem like a courageous statement . In fact, US equities have been more expensive than current levels only 10% of the post world war 2 time.



I think, there are three factors to consider:

The General Global Economic Development

The trend of positive economic growth is expected to continue and even accelerate in 2017. This not only goes for the US but can be expected globally. Besides the United Kingdom, which may suffer from Brexit symptoms, the European Union is expected to continue its recovery. The repercussions of the UK leaving the European Union are likely have only effects. Whether London can survive as Europe´s financial hub is just one question the British nation will have to face.

A threat for European development may pose the rise of populist parties. Of special concern will be the elections in both Germany and France. While I do not expect the populist party “Alternative Für Deutschland” (AFD) to dramatically affect  the outcome of the elections, terror attacks and sexual abuse by people with a refugee background will strongly strengthen the far right. Nevertheless, a political revolution is not to be expected. Similar counts for France where Marine Le Pen will most likely not take over as the new French president. However, in 2016 both Brexit and Trump´s election were regarded as highly unlikely and therefore we cannot preclude more Black Swans in 2017. Besides Europe, a slight recovery in the Emerging Market lead by plagued Russia and Brazil may strengthen the global outlook.

Monetary and Fiscal Policy

Much has been talked about the threat of inflation in the last few months. However, the main global concern still should be disinflation. Globally there is excess capacity both in terms of labor supply and industry supply. For inflation to emerge, excess demand or a shortage of supply are prerequisites. However, given the fact that one may be more concerned about a shortage in demand, it is difficult to imagine a major inflationary period. On this background the balance sheets of central banks such as the EZB and the BOJ are expected to further increase. Supportive monetary policy will be accompanied by active fiscal policy in the United States. Donald Trump will act according to his promises and fiscal policy may take the form of infrastructure programs and/or tax cuts.

Donald Trump

Much has been written about Donald Trump and his public lapses. But it may be appropriate to look through his outrageous personality and highly questionable views on equality, religious freedom and immigration and think about economic effects of his aimed protectionist policy.

“Sadly, the American dream is dead!”

That´s what Donald Trump claimed during the election campaign. He quickly spotted a guilty party – China. China flooding the world with low price products and America´s subsequent loss of manufacturing labor constitutes “the greatest theft in the history of the world” according to the new man in the white house.

Economists, indignantly claimed this to be ridiculous. In international economic thought free trade is beneficial for everyone. Every country produces the product which it has a competitive advantage in. In the American-Chinese case this means China exports cheap, labor intensive manufactured products while the US skill intensive goods and services. Economic theory predicts a mutual increase of GDP per capita as a result of this integration. Jobs lost in manufacturing will be replaced by jobs in higher paying higher skilled labor and at the same time consumers can buy cheaper  products. It is a win-win. As a student with a bachelor´s degree in economics this was my direct response as well.

Sadly, while it may be true that in aggregate nations become wealthier through trade, there are severe distributional repercussions. Skilled labor becomes even more demanded while unskilled labor is not needed anymore. The wage gap widens. The claim that workers just choose the next best job is not applicable to reality. People in general will not leave their family, home and friends to move to another state looking for a job, just to start all over again. More importantly, manufacturing workers will not directly be qualified to work in high-skill labor jobs. The reallocation process in fact seems to be slow. Losses in manufacturing jobs in a geographic area correspond to overall job decline of the same magnitude  for as much as ten years. This loss of jobs may result in the end of industries and may be exacerbated through decreased local demand. The death of communities is the result.

Even though it sounds populist the American loss of manufacturing work can be partly attributed to China´s rise. Through the Chinese “Reform and Opening” in the 1970s hundreds of millions of people migrated from the rural less productive agricultural industry to cities to work in production. Between 1991 and 2013 Chinese exports grew from 2% to 20% of global exports. China has developed from a backwards nation to a world class competitor. While this has elevated hundreds of millions of Chinese workers out of poverty it has affected the Western world.

China entered the World Trade Organization in 2001.  During the time frame between 2000 and 2007 an estimated 1 million manufacturing jobs were lost in the United States due to China´s increased trade with the US. As much as 40% of the drop in manufacturing activity may be due to the trade shock that followed China´s entry into WTO even controlling for technological effects.

Why do I mention all of this? The point is, that it may in fact be beneficial to not disregard manufacturing workers. Even though protectionist reforms can be truly harmful and the lost manufacturing demand will most likely not be restored, Donald Trump in fact may have reason in protecting the “weak”. After all, increased manufacturing labor would increase domestic demand.

Additional factors

Sharmin Mossavar-Rahmani, chief invetsment officer of Private Wealth Management at Goldman Sachs mentions more factors in favor of American equities. She estimates the probability of a 2017 recession in the United States to be 15%. On the other hand during an expansionary period the probability of positive equity returns is as high as 86%.

She makes the claim that another argument for American equities is the general condition of the country. Since the financial crisis people have tended to be very pessimistic about the US and optimistic about other parts of the world such as China.

But while both private households and the financial sector in the united states have considerably saved and improved their balance sheet since the end of 2008, (previous economics contractions where accompanied by dissavings) the Chinese Credit to GDP gap (defined as the difference between Credit to GDP ratio and its long term trend) widens strongly, implying increasing debt burdens.  Additionally, China is fighting capital outflows of 1.3 Trillion Dollars while the US was the main target of inflows and foreign direct investment in the recent past.

Thus, despite differing views, the gap between the US and many other countries is actually widening. In terms of GDP per capita, it is still the richest major economy in the world. The oil sector has increased, making the US produce as much as 10 million Barrels a day. Still the country is unprecedented in terms of economic strength, R&D and innovation and the aforementioned points summarize why I consider the US to offer much potential in 2017.





Back to the dead

Happy (late) new year,

After 1.5 months of intensive exam preparation (and failure) I finally have time to study and act out my gambling habit. During the last month my anticipation to trade had become so big that my trading finger just itched a little bit too much. Just two days back into the process I day traded (and lost) again.

The Living Dead

Last November I mentioned how the shipping sector went hot and many stocks multiplied their prices more than twenty fold within a few days before eventually collapsing (Donald Makes Shipping Great Again). The leader of this group without any doubt was DryShips Inc. (DRYS) going from $5 to $120 before being halted by the SEC.


A collapse and continuous downtrend followed until volume and price spiked the 30.01.2017. On this day the stock increased its price by double digits sending a signal to the trading world:  DRYS is still alive!. On 31.01.2017 then the incredible happened. Volume spiked from 25 million to over 150 million shares traded and the stock price doubled, closing strong. With its background this development obviously not only caught my attention.

Given its rise from the dead I suspected that there was opportunity for DRYS to spike again. Both short sellers and buyers would remember the November development and so selling pressure would be weak was my conclusion. During the pre-market session on 02.01.2017 then DRYS confirmed the bullish pattern and broke through the prior days high of $5.8. This meant that the stock would gap up.


The pre-market high was reached at $6.20 and then continuously the stock bounced between this high of the day and the area around $5.94 which defended many times. Shortly before the market open, $5.94 defended the second time with buyers coming in at this level.


My plan at this point was to enter into a possible breakout above the $6.20 level. I argued that at this point given the gap up many short sellers would be seriously under water and try to cover. I expected a morning squeeze. While I wanted to wait for the breakout I was concerned about the volatility of DRYS and about my ability to enter the my position. So, two minutes before the market opened I decided to enter at $5.99 and set my stop below support in the $5.70s. A mistake as it turns out.


When the market opened a wall of sellers emerged. Nevertheless the stock made an attempt to spike to the high of the day but then collapsed in the minutes that followed. I had problems getting out of my position but ended up filling at $5.69.

Given the minuscule account size I am trading with with this broker I lost 9% of my account size including transaction costs but only 4.3% disregarding these fees.


  1. Patience. By entering the trade I did not follow my rules. I bought when the stock was trading in between support and resistance. There were equal odds to were the stock could go. Even if I would have missed the morning spike I should have waited for the breakout of the high of the day.
  2. Dip Buy. This premature entry hindered me a few minutes later to dip buy the stock when it bounced a Dollar after the morning panic.
  3. Position size. I played with a very, very small position size as you can see by the role which transaction costs played in this trade. While this hinders any profit potential I realized this time how much more comfortable I felt betting a small sum of money. Especially during my learning phase during which I will probably loos more it may be appropriate to play small.

You might be thinking at this point: “This idiot! When is he finally going to realize that he should not day trade?! He looses every time!”. You may be 100% correct with this. However, I am determined to continue and I am confident that I will make succeed!