This document describes how to use forecasts that I am posting daily on the WWW. These stock and mutual fund forecasts are short to intermediate term in time duration. The typical trade duration is days to weeks. Occasionally, one of the stock or mutual fund trades will have a duration of a few months, but these long term trends are not frequent in recent financial markets. With an adaptive forecasting system, the forecasts will adapt to the market, and will reverse position (L to S or S to L) as needed to "stay on the profitable side of the market."
Most of my institutional-investor clients are value in investors. They do not trade frequently. Here are the ways that they use adaptive forecasts:
Capital preservation and risk reduction. Forecasts
are used as sell indicators. Value investing involves a lot
of analysis of the fundamentals prior to making a buy
decision. But often, a sell decision is not as rigorously
generated when using fundamental analysis. One of my
clients' portfolios recently benefited from having a sell
signal which preserved 85% of the capital invested in one of
the stocks in that portfolio.
When to buy. Selecting a good entry price for a
trade can be done by timing the buy decision to coincide
with a "S to L" transistion in the recommendations from
adaptive technical forecasting.
When NOT to sell. This is perhaps the most important
thing that is helpful to a value investor. Example: A
value investor is typically Long on issues that are believed
to have a long-term probability of showing an increase in
share price. A value investor's maximum acceptable drawdown
on any long position may be, say, 8%. The investor knows
the forecast has gone from Long to Short, and the
forecasting accuracy is, say, 80%. With such a high
probability of being correct (forecasting accuracy of 80% on
all recent forecasts), should the investor sell or "lighten
up" on his long position? The value investor notes the
trend forecast and observes that it is -3%, meaning that the
forecast is for a price decrease of 3%. A value investor
can comfortably decide to hold the Long position, since the
forecasted drawdown, for this leg of the price move, is only
3%, which is less than the investor's maximum acceptable
drawdown of 8%.
The most important point is that value investors can almost
always be profitable using this kind of adaptive
forecasting, because the value investor has a good forecast
of what is probably going to happen, and has a probability
(forecasting accuracy) that that forecast will be correct,
and knows when NOT to take each trade, thereby keeping the
turnover rate low.
To achieve a high FORECASTING ACCURACY, we use an AD PTIVE forecasting system, which responds and ADAPTS to changing market conditions. This is necessary in rapidly-changing financial markets. We use forecasting theory developed for engineering applications to analyze trends, coupled with learn-and-optimize techniques from the field of artificial intelligence and a filtering method to separate the orderly price moves from the random price moves.
When the markets are choppy, the forecasting system will be short term (frequent reversals in position; L to S and S to L) because the forecasting system ADAPTS to the market conditions. When the markets are orderly and trending over the longer term, the forecasting system will be long term (positions will be held for a longer period of time, and the forecasts will have INFREQUENT reversals in position; L to S and S to L) because the forecasting system ADAPTS to the market conditions.
A forecasting system is used to create a trading system. A forecasting system is not a trading system. Most of what I do for my clients is interpret the forecasting advisories and customize a trading system for their particular type and style of trading.
PRICE FORECASTS
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Charlotte, NC 28269
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