The RSI measures if a stock is “overbought” or “oversold.” The indicator ranges from 0-100, and a rating under 30 signals that a stock is oversold whereas a rating over 70 signals overbought conditions. The default RSI settings measure a stock’s relative strength over a 14-day trading period, although this can be changed to any period.
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Generally, traders like to think that buying an oversold stock is a good idea because it will bounce higher in the short term. Similarly, they’d sell overbought stocks thinking that they return to the mean.
Here’s what it looks like (the blue area at the bottom of the chart). Right now, the S&P 500 is almost at oversold levels. Should you be gearing up to buy?

Strategy #1: Buying when the RSI reaches 30 or lower, selling when it reaches 70 or higher:
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​Ticker: SPY — Timeframe: Daily

The strategy tested below simply only bought the SPY when its RSI reached 30 and only sold after it got to 70. As you can see below, it was profitable over a 27-year period, but it wasn’t all that great. It caught a max drawdown of over 60%, as it did horribly in the 2008-09 recession. Also, it had an average loss of 21% and only returned 146% vs 615.58% for buying and holding the SPY. The goal of trading is to minimize risk and maximize profits. This strategy didn’t seem to do that.

Now, let’s try the same strategy from above but on the 65-minute timeframe.
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This one performed slightly better overall and had less drawdown. However, it still isn’t ideal and doesn’t seem worth pursuing.

Strategy #2: Buying when the RSI reaches 30 or lower, selling when it reaches 70 or higher, OR automatically selling after 5 candle closes
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​Ticker: SPY — Timeframe: Daily

The strategy below is the same as the strategy above except it will automatically sell the position after 5 candles have passed in the specified timeframe. This helps reduce drawdown and follows the idea that a stock should bounce relatively quickly after being oversold.

​As you can see, the max drawdown was reduced to only 18.8%, but overall, the strategy still isn’t impressive. The overall returns are also low, at 48.5% over a 27-year period.

Let’s add another variation to the original strategy to see if it works better that way.

Strategy #3: Buying when the RSI reaches 30 or lower, selling when it reaches 70 or higher OR selling after a 2% gain:

Ticker: SPY — Timeframe: Daily

The strategy shown below is the same as the first one, except it also sells when your trade hits a 2% gain. This ensures that you’re taking profits when given them. While it had a staggering 100% success rate and decent performance, it’s still a bit of a risky strategy since it doesn’t have a true risk-minimizing exit condition. It was completely unable to avoid the 2020 crash, which is where it saw the -27% drawdown. Overall, not the best, but it still did better than the original strategy that didn’t include the 2% take-profit exit condition.

Strategy #4: Shorting SPY when RSI crosses over 70, covering the short either after a 2% gain or after 5 candle closes
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Ticker: SPY — Timeframe: Daily

As expected, shorting an uptrending SPY chart using a simple RSI indicator didn’t really work out. The net loss was 11.3%. The 65-minute and 30-minute timeframes had negative results as well, but at least the max drawdown of 14.9% wasn’t horrible.

However, if you change it to shorting after the SPY hit 75 RSI instead of 70, the results are slightly better.

Strategy #5: Shorting SPY when RSI crosses over 75, covering the short either after a 2% gain or after 5 candle closes

Ticker: SPY — Timeframe: Daily
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When using 75 RSI as the overbought level to short SPY, the strategy actually has a positive return despite shorting into uptrends. Also, the max drawdown of 6% is surprisingly low. Therefore, a strategy of this nature may be worth looking into. If you don’t like shorting, you could use this as your take-profit strategy for long positions (take profit over 75 RSI).

Using the 65-minute time frame for the same strategy also had positive results. Nonetheless, neither of these results are that impressive except for the very minimal drawdown.

You may be wondering, if 75 RSI was an improvement over 70 RSI, then 80 RSI would be even better, right? Well, not really.
​
Here’s an example:

Strategy #6: Shorting SPY when RSI crosses over 80, covering the short either after a 2% gain or after 5 candle closes:

Ticker: SPY — Timeframe: Daily

Compared to using the 75 RSI, the net gain got smaller, and so did the max drawdown. So, it balances out. Also, there were only 10 trades taken in 27 years, and it’s not really enough data to make a conclusion out of it. Also, the 65-minute time frame saw slightly negative results using this strategy and the 30-minute time frame was about flat. Not worth pursuing.

As the heading states, the RSI indicator isn’t exactly the greatest when used by itself. At least that’s what the backtest results showed. However, there is some hope for the RSI if you can combine it with other indicators or find other ways of using it that yield better results. After all, that’s what backtests are for, you can check it all out for yourself to see what works for you.

Please note: Past performance is not indicative of future results, backtests are for informational purposes only. Just because a strategy worked well in the past, doesn't mean it will work well now. Keep this in mind when testing a trading strategy.

Read: How to Backtest a Stock Trading Strategy - No Coding Required
Read: Shorting Growth Stocks - Backtesting a Moving Average Strategy on ARKK

Thanks for reading. Hope you found this article helpful!

Hey everyone,

We’ve been having trouble with sending emails this week for our bullish ratings, so here are a bunch of our recent buy ratings in one email, which are free to read.
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Besides the buy ratings, you should check out our JPM article from last week titled “Using JPMorgan's Earnings Call For Recession Clues” where we break down the biggest bank’s earnings to determine if a recession is coming soon or not.

Note: This is NOT professional financial advice, do your own research before buying.

Most of these Buy ratings are in downtrends, meaning that the chances for more short-term downside are high (as traders, we know this to be true). The ratings are not based on technical analysis. They are meant for long-term investors that have a long-term time frame.

​Anyways, here they are:

RH, also known as Restoration Hardware, sells furniture, lighting, textiles, decor, and more. It has been beaten down as well, currently 57% off its highs. This offers a decent entry point for long-term investors.
​
Read our article to find out why:

Innovative Industrial Properties (IIPR) is a triple-net-lease cannabis REIT. Essentially, it makes money from owning cannabis properties and leasing them out to other cannabis companies. It is HIGHLY profitable and pays a nice, quickly- growing dividend.
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This stock has done very well historically, but now, it is about 45% off its highs. It got pushed down even lower by a short-seller report that is likely to not have much merit to it (similar to a 2020 short-seller report on the company).

Royal Bank of Canada (RY) is Canada’s largest bank in terms of market capitalization. We believe that big Canadian banks have competitive advantages due to the oligopoly they enjoy, and we believe that RY stock is undervalued.

Williams-Sonoma (WSM) sells home products like furniture, bedding, lighting, rugs, and more. Currently 39% off its highs, we believe this is another good stock for the long term. Its low valuation allows the company to buy back many shares on top of having a respectable, growing dividend.

​It also has high returns on capital, steady growth, and record profit margins despite high inflation.

Thanks for reading. Hope you found this article useful!
​
Be sure to check out simplywall.st, TipRanks, and Finbox for fundamental analysis, and TrendSpider for charting software!

If you use our special link for simplywall.st, you will get a 14-day extended free trial and unlimited company views, meaning you can analyze all the stocks you want using their tools (which we use all the time).

If there are any stocks/topics you’d like us to cover, hit us up!

Email: info@stockbrosresearch.com
​
Twitter @StockBrosTrades

At current prices, we are very bullish on the stock for a few key reasons that we go through in our TipRanks article below. These include its competitive advantage and intrinsic value (juicy dividend, high buybacks, and more) that the market seems to have mispriced. Click below to check it out!

Thanks for reading. Hope you find this article useful!
​
Be sure to check out simplywall.st, TipRanks, and Finbox for fundamental analysis, and TrendSpider for charting software!
​
If you use our special link for simplywall.st, you will get a 14-day extended free trial and unlimited company views, meaning you can analyze all the stocks you want using their tools (which we use all the time).

Thanks for checking this out!
​
Be sure to check out simplywall.st and Finbox for fundamental analysis, and TrendSpider for charting software!
​
If you use our special link for simplywall.st, you will get a 14-day extended free trial and unlimited company views, meaning you can analyze all the stocks you want using their tools (which we use all the time).

Read our full Seeking Alpha article by clicking the button below:

Thanks for checking this out!
​
Be sure to check out simplywall.st, TipRanks, and Finbox for fundamental analysis, and TrendSpider for charting software!
​
If you use our special link for simplywall.st, you will get a 14-day extended free trial and unlimited company views, meaning you can analyze all the stocks you want using their tools (which we use all the time).

There's currently a lot of commotion regarding the yield curve. With large investors focusing on the inversion of the 2-year and 10-year government bond spreads, it's worth discussing the importance of this event because the yield curve has been used for decades as a leading indicator of economic outlooks.

The inversion of the 2-year to 10-year spread – which is when the 2-year government bond yields a higher return than the 10-year government bond – is seen as a harbinger for recessions. This is because the inversion has predicted the previous recessions of 1981, 1991, 2001, 2008, and 2020 (although COVID-19 was the catalyst for 2020). Nonetheless, investors watching the curve would've been ready for a recession despite whatever the true catalyst was.

An inverted yield curve is an unusual event because, logically, investors should want to receive a higher return on long-term investments than on short-term ones.

However, when investors begin to have a negative outlook on the economy, it causes them to start parking their money in bonds which pushes the yields down. More specifically, investors start buying up longer-term bonds. The logic behind this is that recessions last an average of 18 months. Therefore, investors can at least theoretically guarantee an income over that period.

Furthermore, when looking at lending activities, financial institutions "borrow short and lend long," meaning they will borrow a short-dated loan because it should have a lower interest rate and lend at a longer time frame at a higher rate. The spread between the borrowing and the lending is the profit. A flattening yield curve reduces lending profits, which may lead to reduced lending activity.
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Does an inverted 2-year and 10-year spread guarantee a recession? The answer is no because the yield has inverted twice without it being followed by a recession.

Although most investors continuously watch the 2-and-10 spread, they often overlook the spread between the 3-month and the 10-year bonds.
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Unlike the 2-10 spread, which has been wrong twice, a 3-month and 10-year inversion has never been wrong so far. All 8 of the recessions in the US since 1970 (up through 2020) have been preceded by an inverted yield curve (10-year vs. 3-month).

The reason for this is likely because the 3-month yield closely follows the Federal Funds Rate, which is the interest rate that banks charge each other to borrow or lend excess reserves overnight. For the 3-month yield to climb higher than the 10-year yield, it means the Federal Reserve has raised the Federal Funds rate above the 10-year yield.

Since the 10-year yield is often used as a proxy for long-term growth expectations, an even higher Federal Funds rate means that the cost of borrowing is higher than the expected growth rate. In our view, this would suggest that the Federal Reserve has tightened too much, thus, eventually leading to a recession.

This leads to the expression, "Bull markets don't die of old age, but rather they're killed by the Federal Reserve."

Currently, the spread between the 3-month and the 10-year is very wide since the Federal Funds Rate is still 0.25-0.50%. At the time of this writing, the 3-month yield is 0.53%, while the 10-year yield is 2.38%. However, the market is expecting the Federal Funds Rate to climb very quickly based on the Fed Funds Futures contracts.
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The market expects it to be 2.49% by January 2023 (calculated as 100 - 97.51), which is less than a year away.

As a result, we currently don't see a recession in the cards for 2022. A more likely scenario is that we simply see a slowdown in growth, and that high-quality stocks that can perform well in all market conditions will likely outperform.

Thanks for reading. Hope you found this post useful!
​
Be sure to check out simplywall.st, TipRanks, and Finbox for fundamental analysis, and TrendSpider for charting software!

​If you use our special link for simplywall.st, you will get a 14-day extended free trial and unlimited company views, meaning you can analyze all the stocks you want using their tools (which we use all the time).

Our other fundamental analysis articles here:

In a previous article, we mentioned why we thought it might have been a good time for investors with a shorter time horizon to take profits on Adobe. Since then, the price of the stock has dropped significantly, shedding 34% of its value.

However, long-term investors who have held on through the volatility shouldn't worry, as we believe the stock can easily return to over $600 eventually. Thus, we are now very bullish on Adobe stock.

What’s good about Adobe is that it remains minimally impacted by macroeconomic events, and it generates reasonably predictable cash flows despite an uncertain backdrop. We also believe that the market is significantly undervaluing ADBE stock.

It is currently in a downtrend, so there may not be immediate upside, but we believe it will recover over the long term.
​
Find out why we like ADBE by clicking below:

Autodesk (ADSK) is an industry leader that has seen its valuation drop significantly in the past few months, from a high of ~$344 to a low of ~$186 recently. It is currently at $212.

As we begin to enter the middle portion of this new business cycle, high-quality companies with high margins and returns on capital are likely setting up to outperform going forward (we explain this more in the full article linked below). As a result, we are bullish on Autodesk at these levels.

Quality-Factor Investing During the Mid-Cycle

In the world of finance, investors like to break down stocks into groups called factors. These factors include value, growth, momentum, and quality, to name a few.

The iShares MSCI USA Quality Factor ETF (QUAL), which we reference in the full article, defines quality as having a high return on equity, stable year-over-year earnings growth, and low financial leverage. ADSK is a holding in the QUAL ETF.

Also, Autodesk is likely a good hedge against inflation and its current valuation is attractive.

Again, this is not necessarily a short-term play. The trend is still down for Autodesk, so it can see some short-term pressure, but the long term looks good.
​
See why we like Autodesk by clicking below:

Thanks for reading. Hope you found this post useful!
​
Be sure to check out simplywall.st, TipRanks, and Finbox for fundamental analysis, and TrendSpider for charting software!

If you use our special link for simplywall.st, you will get a 14-day extended free trial and unlimited company views, meaning you can analyze all the stocks you want using their tools (which we use all the time).

Our other fundamental analysis articles here:

The market can be very volatile at times leading investors to get caught up in all the noise. However, we hope to cut through all the rhetoric by looking at the numbers in an attempt to simplify our decision-making process. We don't try to predict, but rather, we try to react to the current state of the macroeconomic situation. Hopefully, you find this article helpful in your decision-making process.

As we can see from the chart above, there were periods of time when the spread was actually negative, meaning investors were getting a better yield from risk-free assets than from stocks.
What's interesting is that these negative readings came before the significant market declines of Black Monday, the 1990 recession, and the Dot-com bubble. In addition, it came very close to turning negative before the Great Recession.

Thus, it appears to be a very good gauge of when markets become out of control and also helps explain why 2020 and 2021 saw strong upside after the COVID-19 crash. With bond yields being so low, there was nowhere else for money to go except into stocks.

What's also interesting to note is that the periods of market declines were preceded by a sharp increase in the 3-month Treasury yield. This is important because T-Bills follow the Federal Funds Rate very closely and thus would imply that the Federal Reserve had hiked rates too fast during those time periods.
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Therefore, investors need to monitor what the Federal Reserve does because it could potentially push yields high enough to the point where risk-free assets provide higher returns than stocks.

Thus, the forward spread is 2.19%.

​However, keep in mind that the spread between the 3-month T-Bill and the actual Federal Funds rate tends to be within 1% of each other, at least for the most part, as pictured below:

Therefore, we can estimate that the forward spread will likely range between 1.19% to 3.19%.

​Although we call it the "forward spread," it's important to distinguish that we ourselves are not really forecasting because we are simply looking at what the market is expecting at the current time and reacting to the changes in its expectations at the end of each trading day.

The bottom line of this article is that investors should consider how much more they are theoretically getting paid over risk-free assets to take on the additional risk of equities. Although markets can become irrational at times and lead to outsized gains in price appreciation, they tend to eventually revert back to the fundamentals.

The key is to logically and objectively assess when markets have become too irrational and reduce exposure to speculative stocks when it happens. Furthermore, because the market is forward-looking, it is also important to stay on top of the market's continuously changing expectations and adjust your positions accordingly.
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Although it's impossible to perfectly time the market, there are always clues for avoiding the worst parts of a large downside move. Nonetheless, as things currently stand, stocks are still attractive at the time of this writing as there really is no other alternative for investors, and the spread is still relatively high.

​Thanks for reading. Hope you found this post useful!
​
Check out simplywall.st, TipRanks, and Finbox for fundamental analysis, and TrendSpider for charting software!

Of course, those results are from a low point; you’ll never catch an exact low. Also, BBY was a different business back then (declining revenue, lower profitability). However, in the past few years, it has started to grow steadily while increasing its return on invested capital.

It even has higher returns on invested capital than many investors’ favorite mega-cap tech stocks like Alphabet, Microsoft, and Meta Platforms (Facebook).

Currently, Best Buy is about 29% off its highs. So, we could be closer to a low point than a high point. This is especially true when considering its already-low valuation (about 10x P/E ratio) and expected future growth. This isn’t like one of the unprofitable, high-flying tech stocks that got beat up after increasing 5x in a year.

This is a real company with real earnings that has been able to remain competitive in a world where companies like Amazon exist.
​
Read our full TipRanks article below to see why we like BBY stock at its current valuation!

Thanks for reading. Hope you found this post useful!
​
Be sure to check out simplywall.st and Finbox for fundamental analysis, and TrendSpider for charting software!

Thanks for reading. Hope you found this post useful!
​
Be sure to check out TipRanks and Finbox for fundamental analysis, and TrendSpider for charting software.

Although there is long-term upside potential with FTNT, we’d like to see it potentially drop more or at least form an uptrend before buying in. So we’re neutral on FTNT, for now.
Regardless, both GOOG and FTNT are companies with high returns on capital that create value for shareholders.

When looking at FTNT compared to other players in its industry, such as popular stocks like CrowdStrike (CRWD), Zscaler (ZS), and Cloudflare (NET), FTNT comes out on top, with great fundamentals.
​
Check out our articles to see what makes these companies so good:

Thanks for reading. Hope you found this post useful!

Here’s another recent bullish rating of ours in case you missed it: Meta Platforms Stock: Oversold and Undervalued
​
and be sure to check out TipRanks and Finbox for fundamental analysis, and TrendSpider for charting software.

​The article came out when FB was ~$190 a share, which we think is an attractive price for long-term investors. However, short-term momentum traders may want to stay away from the stock until it reverses its downtrend.

Thanks for reading. Hope you find this article useful!

Also, check out: How to Find and Pick High-Quality Stocks to Invest In
​
and be sure to check out TipRanks and Finbox for fundamental analysis, and TrendSpider for charting software.

INMD stock: InMode is a medical aesthetic devices company. It sells minimally invasive aesthetic medical products for procedures, such as liposuction with simultaneous skin tightening, body and face contouring, skin rejuvenation treatments, and more.

People that have followed our work in the past may have seen our past bullish ratings on INMD stock. We were mainly buyers in mid-2020 to mid-2021. When the share price started really going parabolic in late 2021, we trimmed a bit of our position.
 
Then, the market dipped, and so did INMD stock. We weren’t rushing to buy the dip, though, until we figured it was starting to get too oversold. We now believe it is starting to get overextended to the downside, and we have started buying again in the $37-$41 area.
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Click the button below to read why we’re buying INMD stock:

Thanks for reading!

Also read: How to Find and Pick High-Quality Stocks to Invest In

However, we don’t believe it is the best-quality stock in this market right now, even despite the huge pullback in price. This is especially true considering that LSPD is not the only stock that is well off its highs. There are many “cheap” stocks to choose from.

There are some concerning financial trends that we don’t really like about LSPD (besides the fact that it isn’t profitable).

We wrote a free article for TipRanks.com that you can view here. It explains some of the problems that we see with LSPD.

Despite this though, the stock itself remains in a downtrend, and downtrends can last for a while. So, if you are a bull, you may want to wait for a trend reversal to minimize drawdown (not financial advice).

Click the button below to read our full article. Good luck to all!

​Our LSPD article mentions the rule of 40, so if you want more info on that, here’s our article on the rule of 40 and how it can help you beat the market.

Also, check out: How to Find and Pick High-Quality Stocks to Invest In

AND be sure to check out TipRanks and Finbox for fundamental analysis, and TrendSpider for charting software.

​Thanks for reading!

Back on October 1st, we wrote a post here, where we explained a valuation method that we came up with for valuing the S&P 500 (SPY). The fair value we came up with for the S&P 500 then was $4,530.

At the time, it was trading at $4,310. Then, it recently hit a high of $4,820 on January 4 before pulling back. Interestingly, the market had shown support near the $4500-4530 level in Nov-Dec. Coincidence? Probably. But, it’s cool to note regardless.
​
Anyways, we suggest you read that post if you’re interested because it will familiarize you with the valuation method we’re about to show. We aren’t really going to go into detail about it here, we’re just gonna get to the calculations. Here’s our newest fair value calculation on the S&P 500.

Spoiler: The fair value we calculated this time was $4,996. Current price = $4,674

But, keep reading to see the calculations! Also, note that this is just one quick method of analyzing the market. This is not set in stone. Here we go:

So, the fastest way to value companies is by using multiples. Thus, we need to figure out what the right multiple should be. We will begin by setting earnings to 1 to represent 100% of all the profits earned by companies in the S&P 500.

Next, we will need a discount rate. As discussed in the post we linked above, the CAPM formula can be simplified as follows:

Risk-free rate + Equity risk premium

At the time of this writing, the 10-year yield is 1.79% and the equity risk premium is 4.4% as per S&P Global, which equals a discount rate of 6.19%.
If we didn't want to factor in growth, we could simply say that the fair value of the S&P 500 is 16.15 times earnings:

1 ÷ 0.0619 = 16.15

However, that's incomplete because growth expectations are important. Since the market tends to look 6-12 months ahead, we will incorporate growth for the next 12 months.

For growth estimates, we will use analyst estimates which can be found here. The latest reporting period for S&P 500 earnings is September 30, 2021. As of that date, the trailing twelve months’ EPS for the S&P 500 is $175.37. Looking forward to September 30, 2022, EPS is expected to come in at $201.88 on a NTM basis. This represents an expected 15.1% growth rate.

The forward estimates are bound to change as more info comes out. This is especially true now as earnings season is starting. So, keep an eye on the estimates using that link provided in the numbers above.

You can’t just stop at next year’s forward earnings though because earnings are likely to continue growing in the long run. Therefore, we will need a perpetual growth rate, which we set to 2.125%.
We arrived at this number by using the 30-year Treasury yield as a proxy for long-term growth expectations. This number fluctuates constantly, you can check the current 30-year yield here. Since 30-year bonds are the longest duration bonds, it makes sense to use their yield as the perpetual growth rate.

Fair Value = (1 + NTM growth) ÷ (discount rate - perpetual growth rate)

28.49 = 1.151 ÷ (0.0619 - 0.0215)
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At the time of writing, the S&P 500 is trading at about 26.65x earnings (calculated as follows: 4674/175.37 = 26.65) which means it's still below the fair value of 28.49x that we just calculated.

A multiple of 28.49x implies a fair value price of about $4996 for the S&P 500.

Will the S&P 500 get near $5,000 relatively soon? It’s possible, but then it’d have to be renamed the S&P 5000; it only makes sense.
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However, we’re not making any predictions here, so don’t tell us that we told you it’s going to $4,996, unless it actually goes to $4,996, then feel free to give us credit ;). But really, we’re just presenting you the numbers based on analyst estimates.

The beauty of this approach is that you can automate the inputs on Excel or Google sheets and see the fair value change in real-time and thus be ready for sudden changes in market conditions.

The Trend:

Despite some bearish macro developments recently, such as 7% inflation for December, the S&P 500 remains in an uptrend. Here’s a weekly timeframe chart.

The market is still above its 30-week moving average (the green line) and it has trendline support and horizontal support below. Therefore, it still has potential to continue rallying. If it breaks down under the 30 SMA, then we’d start getting more concerned for sure.

There are limitations to our valuation approach, which we outline here. Rising interest rates and equity risk premiums could drag the fair value multiple down, so that’s something you’d ideally want to factor in.

Overall though, it’s a quick way to get a sense of market valuations. Although people will have their beliefs about valuations, sometimes it’s better to listen to what the market is telling you rather than trying to tell it what to do. This is one of many ways of listening to the market.

We don’t solely rely on this; we use chart analysis a lot as well, as shown above. But, we want to reiterate here: this is not financial advice and we are not claiming the S&P 500 will hit near $5,000. Do your own due diligence and come to your own conclusions.

Thanks for reading! If you enjoyed this post, consider sharing it or giving us a follow on Twitter.

And here’s 10% off TrendSpider using code TS10 when signing up. Good luck to all!

​Also read: How to Find and Pick High-Quality Stocks to Invest In

Want to short growth stocks? Here's a moving average trading strategy we backtested on Cathie Wood's ARKK ETF (using Puru Saxena's ideas as inspiration). This can potentially help you profit on both the long and short side. Check it out!

Using TrendSpider’s backtesting tools, let’s see how that works.

​We’ll test out a few variations of this, so stick with us.

The first variation is the most simple one.

Here’s the criteria: Sell ARKK short when the 5 EMA crosses under the 7 EMA and close the short when the 5 crosses back over the 7.

​Over the past year and a bit, these are the results. It produces a positive return, but not necessarily the best return. 2.10% return vs -5.88% for ARKK.

Here are the results over a longer timeframe. Not too great. -35% return vs 143% for ARKK.

However, there are some important things we need to consider here.

This obviously doesn’t perform well because it is shorting ARKK even in strong underlying uptrends as long as one simple short-term criteria is met, without even considering any other fundamental factors. We doubt Puru would just short based off that one factor.

Not to mention, we are only exiting the trades when the moving average crosses back over (to keep the backtest simple), but in reality, the exits could be much different and could be based on key support/resistance levels.

Also, the strategy of course performs much better when ARKK is experiencing longer-term drawdowns, as you can probably tell from the charts above.
​
So, lets tweak it a bit. If we’re going to follow trends, we might as well only short when the underlying trend is actually down.

To avoid shorting into strong uptrends, this strategy adds just one extra indicator.

Criteria: Short ARKK when 5-day EMA crosses under 7 EMA, but ONLY if the stock price is also under the 200-day simple moving average. Exit conditions: cover the short when 5 and 7 cross back over (regardless of the 200 day moving average)

So, for example, if the MA’s crossed under, it wouldn’t short if ARKK is above its 200 SMA. Only if it’s lower. Here are the results since ~ November 2020.
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This is exactly what you want to see from a hedging strategy. Positive returns - and nice ones too. 16.77% returns, with a max drawdown of 7.35% and a beta vs. ARKK of -0.19.

Below are the exact entries and exits in that period (hopefully its easily visible). This strategy avoided shorting the strong run up from November 2020 to February 2021 and only shorted once the trend was already weak.
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The first short came in July 2021. In fact, if you look close enough, it signalled another short on December 29, just a few days ago.

Below are the results if you extend the backtest to start around January 2018.
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Not AS good, but still not bad. The 24% max drawdown is a bit ugly, but the returns are positive, which technically means you would’ve protected your downside by making that extra 5.56% on the short side.

Remember, you can hold long positions for the most part when you are not short ARKK. You don’t have to exclusively short. Therefore, holding long, PLUS the positive returns from hedging at the right times, would allow you to probably outperform ARKK in this scenario.

Let’s extend the testing period a bit longer.
​
Starting in ~ October 2014, hedging with this strategy gave a 27.66% return. Pretty good if you consider what we wrote above.

First, let’s test just the 5 and 7 EMA’s. The strategy will be flipped though.

Criteria: BUY ARKK when 5-day EMA crosses OVER 7-day EMA. Close long when 5 crosses under 7 EMA.
​
Here are the results: 235.75% return vs 373.6%. While you may look at this and say that it sucks because it underperformed, there are things you need to consider.

The max drawdown for the strategy was 30%. This is actually not bad relative to ARKK because ARKK’s max drawdown around this period is about ~45%+ (from the COVID-19 crash), and there was also another 44% drawdown from Feb 2021 highs to December lows.
​
Also worth mentioning, there seems to be only one major drawdown period in this strategy compared to 2 or more for ARKK. The beta is also 0.51, about half as volatile as ARKK, but with more than half of its share price appreciation (half would be a 186.8% return). So, you get less overall return, but with much less volatility as well.

Now, here’s where it gets a bit better. We’ll combine the 20 day SMA for going long (20, not 200, it’s not a typo)

Criteria: BUY ARKK when 5-day EMA crosses OVER 7-day EMA but ONLY if price is above the 20 SMA. Close long when 5 crosses under 7 EMA regardless of 20 SMA.
​
Here, the performance is slightly lower than the one tested above, but it is arguably better because the max drawdown drops to 25.26% while the return is still good at 224%. ARKK’s max drawdown of 45.5% (COVID crash) is 1.8x higher.

Unfortunately, we can’t backtest a both long/short strategy, but you’ve seen the positive returns of the short strategy (with 200 SMA combination). Therefore, if you combined both strategies, you’d most likely have even higher returns than just using one exclusively.

This will allow you take advantage of both uptrends and downtrends and since you’re not fully invested all the time, you avoid a large part of the drawdowns.

We only tested ARKK stock above because that’s a common hedge ticker that Puru uses. There are no guarantees that this strategy works well with other tickers like SPY (in fact, it doesn’t really work so well on SPY, we quickly tested that and the returns were negative for hedging).
​
Also, these are just backtests and not real-life results. Finally, past performance is not indicative of future results, so there really are no guarantees of future success here; we are simply just presenting information.

It seems as though the 5 and 7 EMA hedging strategy works on ARKK, especially recently, which is the most important part. If something is working NOW, then stick to it. It also seems to work much better when combined with another downtrend indicator like price being below the 200 SMA.

The strategy also has worked on the flip side for going long. Combine the two, and you could be golden.

If you’d like to backtest these or other strategies yourself, check out TrendSpider here. They have a 50% off new year’s sale and it ends in a few hours! TrendSpider is a great platform for charting, backtesting, and more.

Also, check out this article we wrote last year where we show other moving average backtests. If you want to learn HOW to backtest, we also have another article here titled How to Backtest a Trading Strategy - No Coding Required.

​Twitter: @StockBrosTrades
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As you may know, stocks continued to rally that day.

When gauging risk assets in particular, you can take a look at the ARKK ETF. ARKK invests in many innovative high-growth stocks that are often highly valued as well. These are the type of stocks that people generally buy when there’s less fear in the market.
​
Here’s an ARKK chart below. On Wednesday (the FED announcement day), ARKK went from the low $90’s pre-announcement to the high $90’s by market open the next day. It then gave back all of its gains on Thursday, but on Friday, something interesting happened. A big bullish engulfing candle formed on high volume at a big support level. See below.

This is essentially a continuation move of last Wednesday’s “negative” news. The high volume also adds extra bullish confirmation.

Since this happened on “bad” news, big volume, and at a support level after many months of drawdown, it’s likely that the $90-ish level will hold for ARKK.

We’re not actually long ARKK right now, we have other long positions, but we were SHORT before and we closed the short at around $93 in anticipation of this news. We don’t see a good short opportunity in it now as the downside is probably limited (we tweeted all of this a few days ago).

In fact, Cathie Wood recently said that due to the sell-off in her ETFs, the upside potential (as of Wednesday) for ARK ETFs was an estimated compound annual growth rate (CAGR) of 40% for the next 5 years. That turns $1,000 into $5,378 in 5 years; not bad…if it plays out.

So are we going to go long ARKK? Probably not, yet. Besides the fact that we don’t really like all of its holdings, it’s a bit of a tricky long since it’s still in a downtrend and there are resistance levels nearby. Things are looking promising for bulls as of right now, but we don’t normally buy into downtrends.

A few small positions in “risk” stocks wouldn’t hurt too much though if you are really eager to take advantage of suppressed prices.
​
Important Side Note: If somehow the $89-90 support level breaks down, there could be some serious downside ahead for ARKK. So, that’s definitely something to watch out for and something that we may short into if it happens.

Knowing that growth stocks possibly have relatively limited downside ahead, we can start to look for opportunities in that space. We can also look for up-trending stocks in general, even if they aren’t part of the “high-growth” category.
​
Here are a few stocks we have our eyes on.

After triple bottoming near the $47 level, APPS looks it has potential. There is a pretty strong resistance level in the low $59’s that it has to get past first in order to start establishing an uptrend. We like the fundamentals and valuation of this company, but we won’t get too aggressive until it at least gets above that level, for now.

Very nice relative strength here on some heavy volume. Resistance nearby around $18.50 but if it breaks above that, the next stop is $20.50 area.

(Weekly timeframe) AMZN stock is tricky since it’s been flat for over a year. Around the current price though, it does offer a higher reward than risk, in our opinion. Key levels to watch underneath are ~3275 and ~3170. We probably wouldn’t want to buy those dips under those levels if they were to happen.

Lately, the 50 week MA (green line) has been a good spot to buy at. You could also wait for it to break the short-term diagonal resistance we drew, which is what we’re gonna look for.

​(weekly timeframe) A dip to the 50 moving average which has supported the past few times. Looks promising so far. Took just a small position since it’s too early to tell if it bottomed out. Stop loss around $209 level. Good stock for the long term as well for those the investors out there. Check out our ETSY article here.

Nice breakout on increasing volume. Stop-loss under recent wick low (under $38.36), first target previous highs of $41, second target $45.

Not something we’re buying yet, but it’s on the radar. Possibly if it breaks Thursday’s high of $92.70. Nice retest of support though, so far.

That’s mostly our watch list for now!
​
Thanks for reading! We hope the article was useful to you. If you enjoyed this article, consider sharing it and/or following us on Twitter @StockBrosTrades

Also, if you want good charting software, check out TrendSpider. We use it all the time to find stocks to trade. Cheers!

In this post, we break down diversification and how many stocks you need in your portfolio to be well rounded, based on real statistics. We also talk about the "Holy Grail" of investing, which has to do with diversification, of course. 

• Some investors prefer the relative safety of diversification while others look for concentrated bets with the aim of generating significant alpha.
• For the average person, diversification is likely the better choice. However, for specialists with deep knowledge about a particular industry, a concentrated portfolio likely makes more sense.
• You might not need as many stocks as you'd think to get most of the benefits of diversification.
• Correlation plays an important role in improving diversification.

Different investors have different styles. Some investors prefer the relative safety of diversification while others look for concentrated bets with the aim of generating significant alpha. Alpha is defined as the excess returns earned on an investment above the benchmark return.

One strategy is not necessarily better than the other because it depends on each investor's personality and skill level. For the average person, diversification is likely the better choice.

However, for specialists with deep knowledge about a particular industry, a concentrated portfolio likely makes more sense. To be clear, a concentrated portfolio doesn't necessarily mean that all stocks have to be part of the same industry. It could also be one best stock from each sector.

Nonetheless, we want to know how much diversification is actually needed in order to get as close as possible to a concentrated portfolio with most of the benefits of diversification. As it turns out, the answer is: it depends on portfolio style.

​The CFA Institute breaks it down into the following categories: small cap vs. large cap, value vs. growth, dividend vs. non-dividend, and US domestic vs. international.
​ 
The results were as follows:

Source for all pictures: CFA Institute

For large-cap portfolios, there’s little to be gained by diversifying beyond 15 stocks or so. For small-cap portfolios, peak diversification is achieved with around 26 stocks. Overall, you could generally get away with about 30 or less different stocks in order to achieve most of the diversification benefits. However, we want to take this one step further.

The results above were achieved with naïve diversification, which simply means that stocks are chosen at random without any consideration of underlying fundamentals or mathematical models. Ray Dalio, who manages the world's largest hedge fund, adds an interesting twist that he calls "The Holy Grail" of investing. He summarizes it nicely in the video below.

To summarize the video from Ray Dalio, once you factor in the correlation between the individual assets in your portfolio, the number needed to achieve peak diversification decreases. In essence, if you can find 15-20 uncorrelated return streams, then you have basically achieved peak diversification.

This is easier said than done thanks to ETFs passively buying and selling a large number of different stocks in addition to many institutional investors who basically just copy each other's moves. It's also important to note that Ray Dalio is referring to return streams, meaning any asset class, not just stocks. Nonetheless, the underlying principle still applies to a portfolio of just stocks.
​ 
The takeaway from this article is that an optimally diversified portfolio should have as little correlation as possible. This allows investors to achieve the benefits of diversification while remaining as concentrated as possible.

However, you shouldn't want stocks that are uncorrelated simply because the price drops while everything else goes up. You'd want stocks that are uncorrelated to the downside only, meaning they are less likely to drop simply because everything else dropped. To do this, we sometimes like to use downside beta because we believe it to be a better measure of risk (we will discuss downside beta in future articles).

Want to improve your chances of beating the market? Check out our FREE Substack newsletter where we discuss stock market strategy, market updates, stocks to watch, research reports, and more.

Hey everyone, it’s Vince and Andre.

​As you probably already know, we’re two brothers who talk about stocks. We’ve been investing since 2014 and have been through a lot of ups and downs. We’re currently bloggers for Seeking Alpha and TipRanks, and now Substack.

We went from the beginner stages of falling for “hype” or “doomsday” predictions that got us nowhere, to where we are now; making money in stocks by following sound principles and doing research that most people are too lazy to do.

We aren’t one-trick ponies either. Generally speaking, most investors classify themselves into one of three categories: fundamental analysts, technicians, and quants.

However, we believe all three approaches are equally valid in their own ways and can complement each other when combined to create a better overall portfolio performance.

For now, we are just testing the waters, but you can expect educational posts, interesting stocks to watch, market updates, some research reports, and more (potentially).

We hope you find our future content valuable! Good luck to everyone! Oh, and nothing we say is financial advice, of course. Just our opinions.

Twitter: @StockBrosTrades
Our Seeking Alpha
​Substack Newsletter

We would like to preface this article by making it clear that we're not making any market crash predictions. Instead, we will be looking into the mechanics of the market to come up with a framework for understanding how it functions. These are simply some ideas that we'd like to share.

We're interested in reading any feedback on whether you agree or not. If you disagree, we'd appreciate your thoughts to be constructive so that we can collectively try to arrive at a better understanding.
​
A lot of the time, the market appears to wild, irrational and random. However, there's a potential method to the madness. In the grand scheme of things, the market is mechanical and influenced by a few key factors. Namely, the bond market, discount rates, and growth expectations. No surprises there.
​
But how can we organize these factors to arrive at an understanding of what is driving the markets?

We often see investors reference the historical P/E ratios to conclude that the market is overvalued. Although this is a good start, it has a flaw. When will the P/E multiple revert to the mean? Looking at history and recognizing that prices are higher than normal won't necessarily stop prices from continuing to go up. This could cause investors to miss out on solid gains, which reminds us of the quote from Peter Lynch:

- "Far more money has been lost by investors preparing for corrections or trying to anticipate corrections than has been lost in the corrections themselves."

Of course, it's probably better to be out early than late, but we want to improve our chances of getting out closer to the top. But there remains a question - why and how do stocks form bubbles? Well, the answer might be that it's not a bubble until it gets close to the top. Bear with us.
What we mean is that it's likely not mainly due to irrational investors. Although they play their part, the underlying fundamentals brought the market to a certain height and then quickly changed for the worse.

We'll start with the bond market. The bond market, in our opinion, is probably the best gauge for the stock market. Government bonds form the basis of valuation as the 10-year yield is often used as the risk-free rate. Changes in the risk-free rates impact the valuation of equities. Therefore, what happens in the bond market is a precursor to what may happen in the stock market.

The main driving forces behind the bond market are inflation expectations and the Federal Reserve. Emphasis on the word expectations because the market is forward-looking. If the market expects inflation to drop in the next 6-12 months, bond yields will drop as well. The opposite is true if inflation is expected to rise.

The Federal Reserve impacts the bond market by buying or selling. When it buys bonds, it pushes yields down and vice versa when it sells. This is how central banks print money. Essentially, they're paying investors who are selling bonds with money that didn't previously exist.
​
This money doesn't directly make its way into the economy because it goes to investors who liquidated their positions in an investment account. Because the investor just lost a source of income in the form of interest payments from the bond, it's very likely that this money will simply be reinvested.

​Since yields are low, other assets such as stocks or real estate become more attractive and money begins flowing into those asset classes. When the Federal Reserve sells bonds, it's removing money from the market and pushing yields higher. As a result, bonds start becoming more attractive.

Now that we've discussed the bond market, it's time to move on to the discount rates. The discount rate is the theoretical minimum required rate of return an investor demands from an investment. The most commonly used method to calculate the discount rate is the capital asset pricing model (CAPM for short). The formula is as follows:

CAPM = Risk-free rate + Beta (Equity Risk Premium)

We understand that CAPM is mainly used for individual stocks. However, when breaking down the theory behind the CAPM, we can see why it makes sense to use it for an index. We will start with the equity risk premium which we will refer to as "ERP." The ERP is written as the expected return of the market minus the risk-free rate. The "market" that investors use for the calculation is almost always the S&P 500.

The theory is that to compensate for the additional risk of equities as a whole, investors require a certain return over the risk-free rate to justify investing in this asset class. The equity risk premium that's most commonly used is the historical one which is calculated as historical S&P 500 returns minus the historical risk-free rates. Currently, that's 4.7% as per data from Finbox.

Now, the part that applies to individual stocks is the beta portion of the formula. The theory is that to compensate for the additional risk of investing in an individual stock versus a diversified portfolio of 500 stocks, the equity risk premium needs to be adjusted by the volatility of the individual stock. This represents the premium over the risk-free rate that investors require to justify investing in the individual stock.

Finally, the current risk-free rate is added to the adjusted ERP to get the end result (remember, ERP is the amount required above the risk-free rate). Since the required return for the S&P 500 as a whole already is part of the ERP portion, and we're not adjusting for the risk of an individual stock, the CAPM formula in this scenario can be simplified as follows:

​CAPM = Risk-free rate + Equity risk premium
​
As you can see from the formula, all else being equal, the higher the risk-free rate, the higher the discount rate which equates to a lower valuation of stocks. This is consistent with the notion that higher yields make stocks less attractive.

Therefore, we believe using CAPM to determine the discount rate of the index is a reasonable approach because the required return of the index already is part of the calculation. In addition, an S&P 500 index ETF is an asset that owns 500 profitable companies. To purchase this asset, you need to pay a multiple over the total earnings. Therefore, trying to determine a fair value is a logical thing to do.

In addition, it's important to remember that the market is forward-looking. Thus, growth expectations are an important piece of the puzzle. Market panics can arise from a very pessimistic view of future earnings. The pandemic crash was caused by the initial expectation that lockdowns would severely impact the future earnings of most businesses. Put all these pieces together and you can get a reasonable understanding of what is driving the market.

Many found it strange in 2020 when the economy was crumbling while the S&P 500 was heading straight up towards a V-shape recovery. But, when we look at the factors we mentioned above, everything lined up perfectly for that rally.

Yields went from nearly 2% at the start of the year to as low as 0.33%. This caused discount rates to drop considerably which boosted the valuations of stocks that saw minimal impact or benefited from COVID-19. In addition, the market expected the economy to eventually recover while at the same time expecting COVID-19 beneficiaries such as big-tech to see a surge in growth.

Then as 2021 rolled around, inflation expectations began to rise while growth expectations for stay-at-home stocks began to fall. As a result, the risk-free rate increased along with discount rates. During this time, tech stocks took a hit because they had higher valuations which could no longer be justified by the discount rates and growth expectations.
​
The S&P 500 Index pulled back a little bit as a result. However, it quickly rebounded because the recovery stocks were now expected to see strong enough growth from reopening that their valuations still looked attractive at higher discount rates. Since then, tech and recovery stocks have been taking turns rallying and falling depending on the changing conditions each month causing the SPY to essentially go up with only minor pullbacks.

Based on the factors mentioned above, we want to be able to answer 3 questions:

1. What's the fair value of the SPY?
2. Why does the market think the current price is justified?
3. How can we arrive at these answers quickly at any given time?

The fastest way to value companies is by using multiples. Thus, we need to figure out what the right multiple should be. We will begin by setting earnings to 1 to represent 100% of all the profits earned by companies in the S&P 500.

Next, we will need a discount rate. As already discussed, the CAPM formula can be simplified as follows:

Risk-free rate + Equity risk premium

At the time of this writing, the 10-year yield is 1.49% and the equity risk premium is 4.7% as per Finbox, which equals a discount rate of 6.19%.
If we didn't want to factor in growth, we could simply say that the fair value of the S&P 500 is 16.15 times earnings:

1 ÷ 0.0619 = 16.15

However, that's incomplete because growth expectations are important. Since the market tends to look 6-12 months ahead, we will incorporate growth for the next 12 months. For growth estimates, we will use analyst estimates which can be found here. The latest reporting period for S&P 500 earnings is June 30, 2021. As of that date, the trailing twelve months EPS for the S&P 500 is $158.74. Looking forward to June 30, 2022, EPS is expected to come in at $187.11 on a TTM basis. This represents an expected 17.87% growth rate.

However, earnings are likely to continue growing in the long run. Therefore, we will need a perpetual growth rate which we set to 2.06%. We arrived at this number by using the 30-year treasury yield as a proxy for long-term growth expectations. This number fluctuates constantly, you can check the current 30-year yield here. Since 30-year bonds are the longest duration bonds, it makes sense to use their yield as the perpetual growth rate.

Fair Value = (1 + NTM growth) ÷ (discount rate - perpetual growth rate)

28.54 = 1.1787 ÷ (0.0619 - 0.0206)
​
At the time of writing, the S&P 500 is trading at about 27.3x earnings (calculated as follows: 4333/158.74 = 27.3) which means it's still below the fair value of 28.54x that we just calculated.

A multiple of 28.54x implies a price of about $4530 for the S&P 500. This isn't too far off certain price targets that are calling for S&P 500 to hit $5,000.

The beauty of this approach is that you can automate the inputs on Excel or Google sheets and see the fair value change in real-time and thus be ready for sudden changes in market conditions.

There are some limitations to this approach. To begin with, there's some degree of subjectivity when it comes to the perpetual growth rate. Different investors might have slightly different expectations for perpetual growth which could make a material impact on the valuation. However, to add a bit more objectivity to the calculation, we think the most reasonable approach is to use the 30-year treasury yield as it can be used as a proxy for long-term expectations.

In addition, the market's expectation of earnings growth for the next 12 months can change very rapidly. Thus, investors have to stay on top of these expectations to avoid being blindsided. You could use analyst expectations like we did in our calculation. However, that assumes normal market conditions. Black swan events are therefore not factored into these estimates.

This is not a perfect solution. However, we believe it provides a reasonable framework for understanding the mechanics of the market quickly. It also provides better guidelines for when to buy and sell at a macro level so that you can capture more gains and reduce the risk of being blindsided by changing market conditions.

We understand that some people are not fans of the CAPM model. However, as investors, we must understand that what matters most are the methods that most other market participants use. CAPM is still the most popular method for determining discount rates and changes in the risk-free rate will continue to move markets.
​
Therefore, we believe it's better to listen to what the market is saying through the use of discount rates rather than trying to tell it what to do

Adobe (ADBE) is a fantastic company with strong competitive advantages which we covered in our previous articles:
​

1. Adobe Stock: Here's Why It Is Undervalued Despite High Valuation Multiples
2. Despite Inflation Fears, Adobe's Valuation Has Increased

​Our first article went into more detail about Adobe's operations and advantages and we recommend having a read if you are unfamiliar with it. Since our first article, Adobe has returned investors 31.78% compared to the S&P 500's return of 13.17%. Since our second article, Adobe has returned 20.90% versus 4.95% from the S&P 500.

​In this article, we will be updating our valuation model for the company since our previous price targets have been exceeded.

*This is a premium seeking alpha article, so we can’t fully post it here.*   ​