Phase Transitions

Phase transitions is a commonly considered term to describe the change in the state of matter from solid to liquid or gaseous. In the investment or trading world, we consider these changes in trend. We want to pay close attention to these on a short, intermediate or long term basis in making investment decisions or allocating funds in our portfolios.

For decades we have been taught the old ‘buy and hold’ mantra as the best way to invest. Our mentors rolled out 80 and 90-year old equity charts with performance from the 1920’s forward, emphasizing the magic of this approach. However, closer inspection would suggest it also makes sense to own investments which can profit in not only up markets but choppy and downward markets, too.

For example, consider the stock market peak of March 2000 and the bear market which followed in 2001-2003. Then, several years later the stock market experienced another dislocation in 2007-2009. The average investor which entered the equity markets in 2000 took 10-years to return to break even using a buy and hold strategy only. Over the aforementioned decade financial and commodity markets experienced numerous phase transitions or trend changes. It would have made sense to allocate capital to programs with the flexibility for profit potential in these environments, which is the foundation of Modern Portfolio Theory. There is however, no guarantee this would protect against future portfolio losses.

So how does this apply today? We are witnessing phase transitions in many global markets. China, Europe and many Emerging Markets are slowing and it is reflected in their stock markets and currencies. Another example would be the Dollar price movement since the March 2018 lows. This has led the U.S. domestic equity indices to make new highs, i.e. the Nasdaq 100 and Russell 2000, while the S&P 500 index is currently making lower highs.

Where do we go from here? I do not believe anybody has a crystal ball but the lesson is to identify investment programs with the ability to adapt to changing market conditions and add them to your portfolio. We believe it is an approach which will pay dividends over time.

The content of this article is based upon the research and opinions of Robert Spears, Managing Partner,  Optimized Trading LLC. 

There is a risk of loss in trading futures. Futures trading is not suitable for all persons. While managed futures can help enhance returns and reduce risk, they can also result in further losses in a portfolio.

Studies conducted of manage futures as a whole may not be indicative of the performance of any individual CTA or CTA index.
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