Technical Tools for

Long-term Investing

October 22, 2013

 Long Term Technical Analysis
 This webinar looks at technical tools and concepts that
can provide important information to fundamental and
macro managers working on longer timeframes.
 Technical tools are more than short-term timing tools.
– Can help assess the overall health of a market trend
– Can quantify many risk factors
– Can lead managers toward a more complete understanding of
how to manage risk and positions
 Technical tools can also be effectively combined with
fundamental or other criteria.

© 2013 by Waverly Advisors, LLC. All rights reserved. No part of this document may be reproduced or transmitted in any
form or by any means without the express written consent of Waverly Advisors.
 Outline
 Technical vs. Fundamental Trading Tools
– The problem of randomness
– Differences
 Challenges of Technical Analysis (TA) on Higher Timeframes
 Some Cautions
 Applications
– Primary idea generation
– Filtering and trade management
– Risk management
 Understanding volatility
 Hedging
– Portfolio construction

© 2013 by Waverly Advisors, LLC. All rights reserved. No part of this document may be reproduced or transmitted in any
form or by any means without the express written consent of Waverly Advisors.
 Randomness in Markets
 Price movements are often random.
– i.e., they fit random walk models very well.
 If markets were truly random, it would be impossible to
make “excess returns” from trading.
– Excess returns are returns above the “baseline drift” available to
index investors.
 Academic research is divided on the question of whether
price movements are random.
– General consensus is that higher timeframes tend more toward
randomness.
– Shorter timeframes (particularly intraday) show clear distortions
from random walks.

© 2013 by Waverly Advisors, LLC. All rights reserved. No part of this document may be reproduced or transmitted in any
form or by any means without the express written consent of Waverly Advisors.
 Challenges of Randomness
 Randomness hides the “truth” of our trading systems
and results.
– Must use statistical tools to see what’s really going on
 The baseline drift is the hurdle rate for investors.
– Why? You could earn it with no work and minimal risk, so
you must be sure your efforts are being compensated.
– More complicated for shorter-term traders.
 Performance is highly variable.
– Again, need statistical analysis of trading results.

© 2013 by Waverly Advisors, LLC. All rights reserved. No part of this document may be reproduced or transmitted in any
form or by any means without the express written consent of Waverly Advisors.
Example: Hypothetical Trading System
 Wins 50% of the time. Wins are always 1.2R
 Loses 50% of the time. Losses are always 1.0R
 What is the expected value of this system?
(50% * 1.2) – (50% * 1.0) = 0.1
 (What does this mean?)
 Assume we trade 250 trades from this system, risking $2,000
per trade with a starting equity of $100,000.
 “Should” end up with $150,000
(250 * $2,000 * 0.10) = $50,000 profit

© 2013 by Waverly Advisors, LLC. All rights reserved. No part of this document may be reproduced or transmitted in any
form or by any means without the express written consent of Waverly Advisors.
Results Are Not Always What You Expect

© 2013 by Waverly Advisors, LLC. All rights reserved. No part of this document may be reproduced or transmitted in any
form or by any means without the express written consent of Waverly Advisors.
 Human Performance Varies
Babe Ruth’s Hit Rate, 1951-1968

© 2013 by Waverly Advisors, LLC. All rights reserved. No part of this document may be reproduced or transmitted in any
form or by any means without the express written consent of Waverly Advisors.
 Managing Randomness
 Much of what you see in the markets and in your
own results may be highly random.
 Do not assume that any pattern is necessarily non-
random.
 People have very poor intuition about randomness.
 Understand the math behind trading.
– Simple statistics, but important.
 Understand that results can only be evaluated over a
fairly large sample size.
– Avoid making decisions based on a few examples.
© 2013 by Waverly Advisors, LLC. All rights reserved. No part of this document may be reproduced or transmitted in any
form or by any means without the express written consent of Waverly Advisors.
Technical vs. Fundamental Analysis
Technical Analysis Fundamental Analysis
 Uses past price data  Uses outside information
 Becoming more accepted  Well-accepted by many investors
 Key concept: Human behavior  Key concept: Valuation matters.
– How have investors reacted in the – What is it really worth?
past? – absolute or relative.
– Can look at one market or many.
 Can be effective on all time  Mostly effective on longer
horizons. timeframes.
 Many misconceptions about what  Many misconceptions about what
works. works.

© 2013 by Waverly Advisors, LLC. All rights reserved. No part of this document may be reproduced or transmitted in any
form or by any means without the express written consent of Waverly Advisors.
Technical Analysis: Core Concepts
 Human behavior, in groups, is at least partially
repeatable and predictable.
 Buying and selling pressure (conviction) move prices.
 A useful construct is to think that prices are shaped
by two forces
– Mean reversion: tendency for large moves to be reversed
– Momentum: tendency for large moves to continue
 Whatever edges might exist in the market, they are
small.
– Statistics (research)
– Discipline (application)

© 2013 by Waverly Advisors, LLC. All rights reserved. No part of this document may be reproduced or transmitted in any
form or by any means without the express written consent of Waverly Advisors.
Technical Analysis on Higher Timeframes
 Higher timeframes tend to be more random.
– Academic research that finds that markets random walk
usually focuses on weekly/monthly intervals.
– Shorter intervals have more departures from random
walks.
 The blend of mean reversion and momentum varies.
– Varies between different asset classes
– Different on different timeframes
– Broadly speaking, equities tend to mean revert and shorter
timeframes tend to be more mean reverting.

© 2013 by Waverly Advisors, LLC. All rights reserved. No part of this document may be reproduced or transmitted in any
form or by any means without the express written consent of Waverly Advisors.
Technical Analysis on Higher Timeframes
 Sample size is an issue.
– All trading methodologies are only meaningful over a large
sample size.
– Luck (good or bad) can happen on any one trade.
 Relatively low trade frequency makes learning more
difficult.
– Evaluating results also harder, due to smaller sample size.
 Technical tools may be effectively combined with
fundamental or other criteria at higher timeframes.

© 2013 by Waverly Advisors, LLC. All rights reserved. No part of this document may be reproduced or transmitted in any
form or by any means without the express written consent of Waverly Advisors.
Applying TA on Higher Timeframes
 We want to use tools that show a statistically verifiable
edge and avoid those that do not.
 Tools that show, broadly speaking, whether buyers or
sellers are in control may also be useful.
 There is always a certain degree of randomness in the
market.
– Our tools must respect this fact.
 Tools to approach with some caution:
– Support and resistance
– Any type of “levels”
– Moving averages
– Trend indicators
– Candlestick patterns

© 2013 by Waverly Advisors, LLC. All rights reserved. No part of this document may be reproduced or transmitted in any
form or by any means without the express written consent of Waverly Advisors.
Levels: Your Eye Can Be Tricked…

© 2013 by Waverly Advisors, LLC. All rights reserved. No part of this document may be reproduced or transmitted in any
form or by any means without the express written consent of Waverly Advisors.
…By Random Price Levels

© 2013 by Waverly Advisors, LLC. All rights reserved. No part of this document may be reproduced or transmitted in any
form or by any means without the express written consent of Waverly Advisors.
Moving Average Fade Break Test

© 2013 by Waverly Advisors, LLC. All rights reserved. No part of this document may be reproduced or transmitted in any
form or by any means without the express written consent of Waverly Advisors.
 MA Fade Break, 50 SMA

© 2013 by Waverly Advisors, LLC. All rights reserved. No part of this document may be reproduced or transmitted in any
form or by any means without the express written consent of Waverly Advisors.
MA Fade Break, 200 SMA

© 2013 by Waverly Advisors, LLC. All rights reserved. No part of this document may be reproduced or transmitted in any
form or by any means without the express written consent of Waverly Advisors.
Fade Close Outside Previous Bar’s Range

© 2013 by Waverly Advisors, LLC. All rights reserved. No part of this document may be reproduced or transmitted in any
form or by any means without the express written consent of Waverly Advisors.
Moving Averages, Explained?
 Particularly in equities, the effect of any moving
average is wholly explained by normal mean
reversion.
 We see similar effects with any or no moving average.
 Based on statistical analysis, caution is needed when
using moving averages
– Support and resistance? No.
– As actual levels to enter and exit trades? Maybe.
– But what about the slope of a moving average?

© 2013 by Waverly Advisors, LLC. All rights reserved. No part of this document may be reproduced or transmitted in any
form or by any means without the express written consent of Waverly Advisors.
Slope of 50 SMA as Trend Indicator

© 2013 by Waverly Advisors, LLC. All rights reserved. No part of this document may be reproduced or transmitted in any
form or by any means without the express written consent of Waverly Advisors.
 Uses of Trend Indicators
 Conventional wisdom is to buy and to avoid shorts
when a trend indicator is up, and vice versa.
– Many trend indicators allow a neutral condition as well.
 Often it is suggested to use higher timeframe trend
condition as filter.
 Test procedure:
– Categorize returns by the previous bar’s trend condition.
 This is critical. Otherwise, you assume information you
would not have had at the time.
– Look at average returns, categorized by trend condition.

© 2013 by Waverly Advisors, LLC. All rights reserved. No part of this document may be reproduced or transmitted in any
form or by any means without the express written consent of Waverly Advisors.
Slope of 50 MA, Categorical Returns

© 2013 by Waverly Advisors, LLC. All rights reserved. No part of this document may be reproduced or transmitted in any
form or by any means without the express written consent of Waverly Advisors.
Triple Moving Average Trend Indicator
 Apply multiple moving averages to a chart.
 Only trade when they are in the “right” order.
i.e., only buy when the faster period moving
averages are higher than the slower period.
 Can also use slopes of multiple moving averages.
 A common variant uses 10, 20, and 50 SMAs.

© 2013 by Waverly Advisors, LLC. All rights reserved. No part of this document may be reproduced or transmitted in any
form or by any means without the express written consent of Waverly Advisors.
Triple MA Trend Indicator, Categorical Returns

© 2013 by Waverly Advisors, LLC. All rights reserved. No part of this document may be reproduced or transmitted in any
form or by any means without the express written consent of Waverly Advisors.
Moving Average Conclusions
 Based on extensive data analysis, there appear to be
no “special” moving averages.
 Moving averages do not provide support and
resistance that is distinguishable from any random
level.
 Trend indicators suffer from lag and may put the trader
on the wrong side of the market.
– The slope of a moving average is not a reliable indicator of
trend.
– Trend indicators derived from the position of multiple
moving averages are not reliable indicators of trend.

© 2013 by Waverly Advisors, LLC. All rights reserved. No part of this document may be reproduced or transmitted in any
form or by any means without the express written consent of Waverly Advisors.
 Technical Analysis for
Long-term investors
 (Long term: weekly, monthly, or quarterly periods.)
 Understand that any tool is going to take 1-10 or
more periods to play out, so consider this on your
timeframe.
 Possible applications
– Primary idea generation
– Filtering and trade management
– Risk management
– Portfolio construction

© 2013 by Waverly Advisors, LLC. All rights reserved. No part of this document may be reproduced or transmitted in any
form or by any means without the express written consent of Waverly Advisors.
 Primary Idea Generation
 One potentially useful concept is to buy up-trending
markets and to short down-trending markets.
– In some cases, simple is better.
 Can trade specific patterns.
– Pullbacks
– Failure tests
 Equity traders can focus on relative strength leaders.
 Equity traders can also focus on specific patterns in
individual names.
– e.g., Waverly Advisors’ Equity Screens.

© 2013 by Waverly Advisors, LLC. All rights reserved. No part of this document may be reproduced or transmitted in any
form or by any means without the express written consent of Waverly Advisors.
 Simple Ideas Can Be Robust
 Want to be long markets that go from lower left to
upper right.
 Want to be short markets going from upper left to
lower right.
 Think that you are squinting at the chart or looking
from across the room.
 How to handle specific entries?
– Use very large stops, but risk management will be difficult.
– Use specific patterns to enter.
– Combine with other criteria.

© 2013 by Waverly Advisors, LLC. All rights reserved. No part of this document may be reproduced or transmitted in any
form or by any means without the express written consent of Waverly Advisors.
Keep It Simple: OK to Buy

© 2013 by Waverly Advisors, LLC. All rights reserved. No part of this document may be reproduced or transmitted in any
form or by any means without the express written consent of Waverly Advisors.
 Ok to Short

© 2013 by Waverly Advisors, LLC. All rights reserved. No part of this document may be reproduced or transmitted in any
form or by any means without the express written consent of Waverly Advisors.
Trendlines Can Be Useful

© 2013 by Waverly Advisors, LLC. All rights reserved. No part of this document may be reproduced or transmitted in any
form or by any means without the express written consent of Waverly Advisors.
Swing Analysis Can Define Trend

© 2013 by Waverly Advisors, LLC. All rights reserved. No part of this document may be reproduced or transmitted in any
form or by any means without the express written consent of Waverly Advisors.
Idea Generation: Relative Strength
 The concept is that buying and selling pressure move
markets, so market participants have already voted.
 The markets that have gone up the most over a time
period are considered the leaders.
– Measurement period is a problem.
 Average several different periods?
 Since it takes a lot of buying pressure to move
markets significantly, we can assume that these
markets are generally supported by institutional
investors.
– This concept must be adapted for commodities and forex.

© 2013 by Waverly Advisors, LLC. All rights reserved. No part of this document may be reproduced or transmitted in any
form or by any means without the express written consent of Waverly Advisors.
 Trading Relative Strength
 At first glance, it seems that buying relative strength
leaders and shorting the laggards would be a winning
strategy.
 But much academic research and practical
experience shows that it is not. (Mean reversion is
the problem.)
 One solution is to combine relative strength with
other tools.
– Two possible ways to do this.

© 2013 by Waverly Advisors, LLC. All rights reserved. No part of this document may be reproduced or transmitted in any
form or by any means without the express written consent of Waverly Advisors.
 1) Create a High Relative
Strength Universe

© 2013 by Waverly Advisors, LLC. All rights reserved. No part of this document may be reproduced or transmitted in any
form or by any means without the express written consent of Waverly Advisors.
2) Use Relative Strength as a Filter
 As an example, assume that you have a set of stocks
that have screened well under a fundamental system.
 First eliminate those that are blatantly in downtrends.
– Maybe move to secondary list to watch for change of trend.
 Next, focus more attention on those that are relative
strength leaders.
– True relative strength leaders have different trading
characteristics.
– Understand the risk and potential volatility.

© 2013 by Waverly Advisors, LLC. All rights reserved. No part of this document may be reproduced or transmitted in any
form or by any means without the express written consent of Waverly Advisors.
 Using TA as a Filter
 Create a set of buy candidates through another
system or set of criteria. (E.g., fundamental)
 Use technical tools to “permission” trades.
– Be careful of lag.
– Some systems may be “early”. (e.g., a fundamental system
that identifies value before it moves.)
– Think about how a technical filter might interact.
 Use technical tools to select the best candidates.
– Relative strength
– Trend integrity
 Make sure your filter works like you think it does!
© 2013 by Waverly Advisors, LLC. All rights reserved. No part of this document may be reproduced or transmitted in any
form or by any means without the express written consent of Waverly Advisors.
 Example of a Technical Filter:
Stocks at 52 Week Highs
 A common technical filter combined with fundamentals:
only buy stocks that are at or near 52 week highs.
 The logic is that a stock going up is supported by buying
pressure, and that the market has already voted.
 This is very logical, but, unfortunately, there is a
complication.
 Buying stocks at 52 week highs puts you on the wrong
side of one of the strongest statistical tendencies in the
market: mean reversion.

© 2013 by Waverly Advisors, LLC. All rights reserved. No part of this document may be reproduced or transmitted in any
form or by any means without the express written consent of Waverly Advisors.
Trading 260 Day (~52 week) Channels
(at least 5 days between entries)

© 2013 by Waverly Advisors, LLC. All rights reserved. No part of this document may be reproduced or transmitted in any
form or by any means without the express written consent of Waverly Advisors.
 Trade Management
 It is also possible to combine entry signals from
another methodology with technical criteria to exit.
 Examples:
– Break of trendline. (Be careful.)
– Swing analysis change of trend
– Discretionary pattern analysis
 Look for strong patterns to emerge against the trade
direction.
 Useful for some traders, but be careful of subjectivity.
– Mechanical trailing stops

© 2013 by Waverly Advisors, LLC. All rights reserved. No part of this document may be reproduced or transmitted in any
form or by any means without the express written consent of Waverly Advisors.
Mechanical Trailing Stop Example

© 2013 by Waverly Advisors, LLC. All rights reserved. No part of this document may be reproduced or transmitted in any
form or by any means without the express written consent of Waverly Advisors.
 Risk Management
 Risk management is a broad and complex topic
– Position sizing (allocation)
– Directional risk (risk the idea is wrong)
– Volatility risk
– Correlation risk
– Tail risk
– Regulatory risk
– Execution risk
– Behavioral risk
 The job of a risk management system is to reduce
“degrees of freedom.”
 What can be addressed technically?
© 2013 by Waverly Advisors, LLC. All rights reserved. No part of this document may be reproduced or transmitted in any
form or by any means without the express written consent of Waverly Advisors.
 Risk Management: Rules
– Position sizing (allocation)
– Directional risk (risk the idea is wrong)
– Volatility risk
– Correlation risk
– Tail risk
– Regulatory risk
– Execution risk
– Behavioral risk
 Simply having a set of rules will address these issues.
 Rules are pointless unless they are followed.
 Iron-clad discipline is essential.
© 2013 by Waverly Advisors, LLC. All rights reserved. No part of this document may be reproduced or transmitted in any
form or by any means without the express written consent of Waverly Advisors.
Risk Management: The Unknown
– Directional risk (risk the idea is wrong)
– Volatility risk
– Correlation risk
– Tail risk
– Regulatory risk

 These risks are essentially unquantifiable and

unpredictable.
 Over a large sample size, some of these will likely cancel
out, especially for long/short investors.
 One way to think of these risks is that they are the cost of
being involved in financial markets.

© 2013 by Waverly Advisors, LLC. All rights reserved. No part of this document may be reproduced or transmitted in any
form or by any means without the express written consent of Waverly Advisors.
 Technical Risk Management:
Directional Risk
 One of the problems facing fundamental (or macro)
investors is where to set stops.
 Percentage based stops (i.e., 10% on each position)
are better than no stops at all, but they do not
respect the volatility of the market.
 Volatility-based stops (ATR, standard deviation, etc.)
may be a better solution in many cases.
 Tactical tools can at least be used to filter out strong
trends against positions.
– Why buy in a strong downtrend? At least look for potential
inflection points.
© 2013 by Waverly Advisors, LLC. All rights reserved. No part of this document may be reproduced or transmitted in any
form or by any means without the express written consent of Waverly Advisors.
 “Crash Risk” in Equities
 Historically, the major crashes or selloffs have been preceded
by technical signs of weakness.
– Large standard deviation moves down.
– Trend change on multiple timeframes.
– (Other commentators would note that many moving averages have
been broken.)
 There has never been a large, sudden crash in a “healthy
market environment.
 However
– This does not mean it will always be that way.
– There are false alarms.
 This is information that can be used in the risk management
and risk-assessment process, but may be difficult to use in a
stand-alone capacity.

© 2013 by Waverly Advisors, LLC. All rights reserved. No part of this document may be reproduced or transmitted in any
form or by any means without the express written consent of Waverly Advisors.
 Technical Risk Management:
Volatility Risk
 Tomorrow’s volatility may not look anything like
today’s.
 Seemingly quiet markets can have sudden, large
moves.
 If you’re sizing positions by volatility, this is a serious
risk.
 The good news is that volatility is somewhat more
predictable than price.
– Understand the difference between implied and historical
(statistical) volatility.
© 2013 by Waverly Advisors, LLC. All rights reserved. No part of this document may be reproduced or transmitted in any
form or by any means without the express written consent of Waverly Advisors.
 Seasonality Is Important

© 2013 by Waverly Advisors, LLC. All rights reserved. No part of this document may be reproduced or transmitted in any
form or by any means without the express written consent of Waverly Advisors.
Markets Price Risk Differently

© 2013 by Waverly Advisors, LLC. All rights reserved. No part of this document may be reproduced or transmitted in any
form or by any means without the express written consent of Waverly Advisors.
 Modeling Volatility
 Volatility tends to be mean-reverting in the short
term, and trending in the intermediate-term.
 Implieds can sometimes predict market shocks.
 Two specific tendencies to consider:
– Volatility contraction leads to volatility expansion
– Volatility clustering often leads to persistent high vol
conditions after a volatility shock.

© 2013 by Waverly Advisors, LLC. All rights reserved. No part of this document may be reproduced or transmitted in any
form or by any means without the express written consent of Waverly Advisors.
Quantifying Volatility Contraction
 Chart patterns
– Triangles
– Narrow range bar or bars (NR7)
– Series of NR bars
– Multiple inside bars
– Dojis
 Tracking a volatility measure
– E.g., historical volatility or ATR
– Be on guard for expansion when it is “very low.”
 Using a ratio of volatility measures.
– E.g., 20 day and 100 day historical volatility. Be on guard when
that ratio is in the lowest quartile of its X year range.

© 2013 by Waverly Advisors, LLC. All rights reserved. No part of this document may be reproduced or transmitted in any
form or by any means without the express written consent of Waverly Advisors.
 Portfolio Construction
 Modern portfolio theory looks at combinations of
risky assets.
 One common approach is to look for the
combination of assets that give the highest expected
return for a given level of risk.
 This process requires inputs
– Expected return of assets
– Expected volatility of assets
– Expected correlation
 Technical tools can help
© 2013 by Waverly Advisors, LLC. All rights reserved. No part of this document may be reproduced or transmitted in any
form or by any means without the express written consent of Waverly Advisors.
 Return Assumptions
 These are important inputs into the model. (Get
these wrong, and portfolio construction will suffer.)
 One approach is to use prior history as the “baseline”
and then “tilt” projected return assumptions via
technical tools.
 Volatility can also be modeled, but it is important to
consider the periods between rebalancing.

© 2013 by Waverly Advisors, LLC. All rights reserved. No part of this document may be reproduced or transmitted in any
form or by any means without the express written consent of Waverly Advisors.
 Return Assumptions

© 2013 by Waverly Advisors, LLC. All rights reserved. No part of this document may be reproduced or transmitted in any
form or by any means without the express written consent of Waverly Advisors.
 Primary Idea Generation

Portfolio
Construction Tools as
Filters

Risk Management
• Directional
• Volatility

© 2013 by Waverly Advisors, LLC. All rights reserved. No part of this document may be reproduced or transmitted in any
form or by any means without the express written consent of Waverly Advisors.
 Summary
 Technical tools are just as effective on long and short
timeframes.
 Understand your tools, what they measure, their
blind spots, and what their limitations might be.
 Technical tools can be used to generate ideas,
manage risk, filter and manage trades, or in tandem
with portfolio construction methodologies.
 There is both art and science to incorporating
technical tools, so a proven methodology and
experience using it are important.
© 2013 by Waverly Advisors, LLC. All rights reserved. No part of this document may be reproduced or transmitted in any
form or by any means without the express written consent of Waverly Advisors.
© 2013 by Waverly Advisors, LLC. All rights reserved. No part of this document may be reproduced or transmitted in any
form or by any means without the express written consent of Waverly Advisors.
 Waverly Advisors, LLC:
Research Products
Tactical Playbook – Available on Interactive Brokers
– Written for the active trader on the daily/weekly timeframes
– Exact trade recommendations
 Hybrid systematic-discretionary methodology
– In-depth technical “drill down” into a set of markets.
– Bigger-picture overview of all liquid asset classes.
Tactical Portfolio Outlook– Available on Interactive Brokers
– Written for the longer-term manager
 Addresses both the allocator and the longer-term active trader.
– Emphasis on executing with ETFs in a long-only and long-short environment
– Focus on Equities, Equity Sectors, and other asset classes
– Macro perspective on risk factors and major economic events.
Options Market Outlook – Contact Waverly Directly
– Proprietary, quantitative analysis of options market
– Incorporates both volatility and directional analysis
– Macro risk factors and cross-asset perspective
– Actionable trade ideas

© 2013 by Waverly Advisors, LLC. All rights reserved. No part of this document may be reproduced or transmitted in any
form or by any means without the express written consent of Waverly Advisors.
Contact:
Adam Grimes
CIO, Quantitative Analysis, Risk Management
[email protected]

Andrew Barber
CEO, Macroeconomic Analysis
[email protected]
Waverly Advisors
228 Cedar Street Damon Krytzer, CFA
Corning, NY 14830 Managing Director, Portfolio Construction &
Management
(607) 684-5300 [email protected]

www.waverlyadvisors.com Chris Noye

Managing Director, Head of Sales
[email protected]
[email protected]

© 2013 by Waverly Advisors, LLC. All rights reserved. No part of this document may be reproduced or transmitted in any
form or by any means without the express written consent of Waverly Advisors.