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Understanding Analysts and Portfolio Managers

By

Van K. Tharp

Analysts and portfolio managers can influence traders and investors. I�d like for you each to understand a little bit more about them so you can add that knowledge to your big picture understanding of the markets. Remember understanding the big picture of the markets gives you an edge that others may not have. 

As my own interest in this group of professionals grew, I asked if there were any portfolio managers on my Mastermind Trading Forum.  Stephen O�Keefe responded.  Stephen was a portfolio manager for J. P. Morgan Chase (JPM) and has also been an analyst.  He�s also been exposed to a lot of my teachings through the Peak Performance Home Study Course, Peak Performance 101, and the Systems Development Workshop. Consequently, he�s a very rare person who understands expectancy and position sizing and yet has been a successful institutional investor.  At the time of this interview he was away from institutional investing, so free to speak freely.  I�ve found Steve to be full of insights, so much so that I decided to do a two-part interview in my Market Mastery Newsletter. The following is an excerpt from this series of interviews.

Q: So Stephen tell me a little bit about what an analyst does?

A: First, let�s talk about the types of analysts. There are fixed income (bond) and equity (stock) analysts. Within equities, there are fundamental, technical, and quantitative equity analysts.

Q: What�s the difference between equity and fixed income analysis? And what kind of fixed income analysts are there?  Is that the same as well?

A: The key difference between equity and fixed income analysts is that equity analysts analyze the company while fixed income analysts analyze the ability to pay debt. These are very different. In the equity analysis, you are looking at a company from the perspective of an owner: �Do I want to own a piece of this company?� In fixed income analysis you are looking from the perspective of a debt holder: �I own a 180 day obligation, a 3 year note, a 10 year bond of XYZ Corp. Will they be able to make the payments?�   Federal and local government agencies are also huge issuers of debt.

Fixed income analysts generally are fundamentally based and they are often referred to as credit analysts: �Is the issuer a good credit?� They vary by issuers with some looking at companies and others specializing in various government agencies like municipal bonds. The fixed income market is dominated by interest rates so there is a lot of technical analysis of rates. I wouldn�t say there is a lot of quantitative analysis of bonds.

Incidentally, the fixed income market is big � it�s about ten times larger than the stock market. And the currency market is bigger than that. That�s why as professional traders get really big they often move from stocks to fixed income to currencies.

Q: Okay, so what kind of analyst were you and what did you do?

A: I was a quantitative equity analyst. Quants use databases of fundamental information to evaluate stocks and portfolios.

Q: And just for completeness, can a quantitative analyst be technical?   Or is that a non-sequitur?  And if not, what�s the difference between a �quant� and a fundamental analyst?  

A:  An analyst can be a blend of any of the three styles: fundamental, technical, and quantitative.

A fundamental analyst researches companies by talking to management, suppliers, customers, and competitors to get a picture of the company�s competitive position. Then the analyst goes through the income statements and balance sheets for the last few years and projects what they�ll look like in the next year or so to come up with a recommendation on the company.

A quantitative analyst uses databases of fundamental information to decide on a company�s attractiveness. So a preliminary step for a quant is that someone has done the fundamental analysis and stored that information in a database. Examples of groups that do this are Standard & Poors with their Compustat database of historical fundamental information, Value Line, and First Call with their earnings estimate database.

For example, a growth-oriented quant may look for companies with terrific sales and earnings growth rates. This might involve looking at 3 and 5 year sales and earnings growth rates as well as terrific growth in each of the last several quarters.

Q: Are there any other distinctions you want to make between analysts?

A: Well, there are �sell-side� analysts and �buy-side� analysts. Sell-side analysts work for the brokerage firms � these are the ones that you see most often on CNBC television. Buy-side analysts work for investment groups that aren�t part of a brokerage firm. Examples of such firms would be banks, pension plans, mutual fund companies, and independent money management firms.

More to come in a later issue.

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Trading Tip: 

Trading Tip

by  D. R. Barton, Jr.

The Ultimate Political Move:  Revaluation of the Chinese Currency

When there is cheering on both sides of the aisle, you know that a really good political move was made.  After the Chinese government revalued the Yuan on Thursday, the Shanghai Composite Index jumped three percent.  And while U.S. markets dropped modestly on Thursday, they rebounded on Friday � this despite bad performances by market darlings Microsoft and Google.

So what are we to make of this revaluation that is seemingly good news on both sides of the Sino-American markets?

Firstly, don�t jump to any conclusions that this will be a windfall for the American economy.  The small 2.1% revaluation will not make any substantive changes in the trade deficit or the global competitiveness of American made goods.

About all that I can see happening is a temporary slowdown in the China protectionism debates in Congress and a crack in the door for the policy wonks in China.  They now have a tool that will allow them to make significant changes over time, if they so choose.

According to the announcement by the Chinese government, the Yuan (or the Renminbi, as you like) will be allowed to float in a fairly narrow band of 0.3% per day.  While this seems like a very small amount (and it is), this float conceptually gives the Chinese government the tool that they need to make more significant changes down the road. 

For example, if taken to its extreme, the Yuan could be moved up to six percent per month or 70+ percent per year and still remain within the guidelines already given.  (None of the analysts that I respect think that the Chinese government intends to do any more revaluation in the near future.)

Again, this strikes me as a very shrewd political move.  The Chinese government can move things around, as they like, but the financial world still sees a very tight daily float, and it appears that the market is already treating this like the status quo.  The value of the dollar hasn�t changed appreciably.  The only true benefactors of the Yuan revaluation so far seem to be those who are long the Japanese Yen.

So is there anything for the trader to do relative to the Yuan revaluation?  In my opinion, not much in the short term.  Give the Chinese government a hand for their nifty political move that will pave the way for a smoother visit to the U.S. for President Hua.  Other than that, keep an eye on the Yuan�s value (maybe using a weekly chart) and see if the Chinese financial folks allow a gradual move toward market valuation (which would mean an appreciation for the Chinese currency) or if they keep a tight leash on the current valuation levels.  In the short term, my best guess is that we�ll see the tight leash.  If you want to make a long term play, though, I�d bet with the Yuan as being one of the great international currencies; long-term appreciation of this currency should be an excellent speculation.

D. R. Barton, Jr. will be teaching the upcoming Proven Tactics of Swing Trading Course, August 2005 and is a featured speaker in the Van Tharp Institute Course, Make Money Work for You. 

He is the Chief Operating Officer and Risk Manager for the Directional Research and Trading hedge fund group. D. R. has been actively involved in trading, researching and teaching in the markets since 1986.  D. R. has taught extensively in many investment areas including intra-day trading, swing trading, and cutting edge risk management techniques. 

His writing credits include co-authoring Safe Strategies for Fin-ancial Fre-edom and co-creator and contributing author on Fin-ancial Fre-edom Through  Electronic Day Trading.

Listening In... 

Daytrading Equities Control Methods, Are They Useful?? 
Author: AL 
Date: 07-23-05 02:47

Hello, I am somewhat stymied by a particular issue and I would very much appreciate it if any fellow traders could shed some light on this question of mine. I have traded equities for a very long time and over the last 5 years, I have been profitable. I position trade and have a clearly defined complete plan. On that part I need no help. 

Over the last two years I have begun day trading stocks and I have been crafting my methods all the while, and trading on a very limited basis for practice. This has been a roughly breakeven venture so far. I have developed what I think are some very strong edges. I have all the requisite hardware to support this type of trading. I have read a few day trading texts that mention a couple of different "loss control" techniques and I am wondering if they are valid or just arbitrary tools that over the long haul do not create any meaningful advantage. So I will describe each one of these loss control techniques.

1. Put only a single trade on at a time. Let that 1st trade become profitable or stopped out before opening another position in a different stock. If you are able to put on a second position in a different stock because you are profitable on the first one, the rule then again applies to the second position, do not put on a third position until the second one either shows you some profit or you stop out of it. The idea here is that this prevents one from getting hit (stopped out) on several positions at once. No mention is made in the text that it would be unlikely for all of your positions to get stopped out, if, let's say you had put on 6 of them without following the rules, if 3 of them were longs and 3 of them were shorts. I just mention that as an important aside.

2. The second loss control technique suggests that any time you have a consecutive run of 3 breakeven or loss trades(any mix of them) consider not trading for the rest of the day. It seems this is a rather stringent requirement. Many days can start off in such a fashion and yet the rest of the day can produce some very nice trades but one would not be around to cash in, that means money lost. 

3. Lastly I have seen in some texts the idea of setting a daily max loss limit. This is the one control technique that makes the most sense to me, it's the easiest to implement and the logic of it is easy to see. Though I must say with what Van has taught us about negative runs with the marble game and such, it's seems a little challenging to come up with a figure in this respect. In my own case, a single R loss represents roughly 50$ at this point
so if I had to guess I would say that if I am down 6 R I would probably not want to stick around for the rest of the session, but again is this is not just an arbitrary filter. I say 6 R because that would be $300 and I have seen that a very good day for me would be $900 to $1000. Based on my fairly close observation. So my logic goes one really good day should be able to wipe out three very bad days. the strange thing is I have never seen two very bad, back to back days, with the edges I use. So it seems like I should be doing very well with my method. The fact is my best was + $400 and my worst day was -$150 those have been the extremes. The bulk of all other days have been very much inside these boundaries, with a slight edge to the gain side of the ledger. The reason these outcomes have been so truncated is that I am wrestling with these "control rules" I have mentioned in particular rules #1 and #2, with respect to rule #3 I guess I arbitrarily choose to stop for the day around -75 to -100 simply because having used rules 1 and 2 so far in the day and yet questioning their value at some level, I feel I need to follow some kind of bailout plan. 

To put it in context, throughout the day since my universe of stocks is so large 10,000 or more, by using my edges to identify trade set-ups and out those set-ups, good entries, I am able to generate a very large amount, at least 100, of legitimate "edge" trades. So, it seems like I am underutilizing my resources, my largest number of entries/exits in a given day has been 7. I have both of Van's earlier books, but specifically in Financial Freedom through Electronic Daytrading, that he wrote with Brian June, there is never any mention made about the kind of loss control techniques that I talk about above, and I have scoured the book from front to back looking for such. It does of course go into a complete discussion of position sizing. Thus the book basically suggests taking all of your qualified entries, up to your available buying power, and just letting the position sizing (fixed %= R) take care of loss control. 

Again, I would be very grateful to receive some guidance/ insight into the validity of loss control techniques (#1,#2,#3) I described above, as I would like to fully engage my method rather than dance around the ring with it as I am doing now. Thanks, to all the forum members. AL


Reply To This Message 

Daytrading Equities Control Methods, Are They Useful?? 
Author: PMK 
Date: 07-25-05 09:22

Al,

If you believe that the markets are fractal in nature, and that they exhibit the same behaviour whatever time period you look at, then why are you investigating different stop-loss or loss-control mechanisms for your daytrading to your longer term trading?

You stated that you have been profitable over the last 5 year period in longer-term trading, but only breakeven in day trading over the last 2 years. What you need to do is to compare your results (number of winners, average size of winner, average size of losers, and commissions, cost of implementation errors) for you longer-term trading to your day trading and see where the differences are.

It may be simply that your day trading systems are not positive expectancy (due to higher implementation costs) or not suited to your psychology (more implementation errors), rather than being in need of more rigid methods of loss control on a daily basis.

As for the 3 control methods. If your trades are truly independent events with a random distribution of the winners and losers, then #1 and #2 simply reduces your opportunity without changing your overall expectancy. #3 has some validity to suspend trading if conditions are not favorable for your system (or yourself), but I believe this should be more a factor of prevailing market conditions and how your system trades in them, or your own personal 'fitness for trading level' than simply 'if I lose X then my system is not working I am not performing well today'.

Hope this helps

Paul

Reply To This Message 

Re: Daytrading Equities Control Methods, Are They Useful?? 
Author: AL 
Date: 07-25-05 22:06

What can I say PMK. I am always amazed by the sharpness of your insights. I will re examine the things you mentioned. A million thanks. I hope I can return the favor. Good trading to you. AL

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