A lot of Wall Street-types wake up in the morning and try to tell Mr. Market what they think it should be doing. Our Risk Range™ Signaling process is designed to measure and map what the Market is actually doing. This provides investors with a repeatable risk management process which complements our rigorous fundamental research views.
CEO Keith McCullough's quantitative Risk Range™ Signaling process was developed during his years as a hedge fund manager. This Risk Range™ Signaling process generates a probable range to make better buying and selling decisions.
“It's simple. At the top end of range you sell. At the bottom end of the range you buy," Keith explains in the video below. "You’re fading the market. That’s a great way to do it. When the market is going down you’re buying. When the market is going up you’re selling.”
Keith's quantitative Risk Range™ Signaling model was designed to incorporate the “reflexive” and behavioral nature of financial markets. The model uses three core inputs – price, volume and volatility – to determine the likely daily trading range for any publically-traded asset class.
Bottom Line: This is a "multi-factor" proprietary model (not your grandfather's 50-day moving average!). These immediate-term Risk Range™ Signals are dynamic. In other words, the immediate-term Risk Range™ Signals change as the underlying price, volume and volatility of a particular asset changes.
To break it down conceptually, if an asset's price and volume are rising while its volatility is falling, generally its Risk Range is bullish. It means investors are buying with conviction. In this scenario, an asset's Risk Range™ Signal generally narrows as the probable outcome of that asset heading higher goes up.
On the other hand, if an asset's price is falling, while volume and volatility are rising, that's bearish. It means investors are selling with conviction. In this scenario, an asset's Risk Range™ Signal generally widens as the probable outcome of that asset heading lower goes up.
This is an overly simplistic explanation but conceptually sound.
At its core, our Risk Range™ Signaling model is designed to be intuitive: You sell at the top end of the range and you buy at the low end.
Hedgeye CEO Keith McCullough’s quantitative Risk Range™ Signaling model was also designed specifically to be multi-duration. This means our Risk Range™ Signals dynamically adjust to suggest critical thresholds over three different time periods:
- Short-term = Trade: 3 weeks or less
- Medium-term = Trend: 3 months or more, and
- Long-term = Tail: 3 years or less
The idea is to give investors a clear framework for understanding how an asset is trading over short-term, medium-term, and long-term time horizons. Assets above the immediate-term "Trade" threshold are said to be "Bullish Trade" (and so on up the duration thresholds).
Within this "multi-factor, multi-duration" framework, there are also critical market set-ups of which to be aware. Here are two important ones.
#1. "Bullish & Bearish Formations"
“When you have something that’s bullish over the Trade, Trend and Tail durations, that’s called a ‘Bullish Formation,’” Keith explains in the video above.
Simply put, assets where last price is greater than all three durations (Trade, Trend and Tail in ascending order) are said to be in a “Bullish Formation” and all dips should be bought, insomuch that assets in the converse “Bearish Formation” should be repeatedly shorted on strength.
#2. "Bullish & Bearish Phase Transitions"
Another important market set-up to watch: Assets that transition from Bullish to Bearish Trend and vice versa. “When you have something that goes from Bullish Trend to Bearish Trend, that’s called a 'Bearish Phase Transition,'” Keith explains.
“Be careful of those," Keith continues. "That set-up is where you’re going to find your best shorts. Similarly, when something goes from Bearish Trend to Bullish Trend, that’s called a Bullish Phase Transition (and where you find your best longs).”
Furthermore, spotting fundamental catalysts that ultimately lead to bullish or bearish phase transitions are a great source of alpha-generation. “The biggest winners you’re going to have are things that are breaking out on a trending basis, so on the long side it’s assets that have just gone from Bearish to Bullish Trend," Keith explains. "Those are the assets that consensus isn’t long enough of yet and people have to chase them.”
This is an important point about our Trend threshold. As an asset's price falls and breaches the Trend line, it signals a major shift in sentiment and momentum from bullish to bearish (according to the model’s measurement of price, volume and volatility).
Make no mistake, when an asset dances around its Trend line, we’re monitoring it closely for confirmation that it either it maintains its Trend or we see a sustained breakdown confirmed by the asset’s price, volume and volatility. When an asset confirms a Bearish Trend breakdown, and you're long, you get out! (Conversely, if you're short a Bearish Trend that confirms its Bullish Trend, you get out!)
A FINAL NOTE ON TRADING USING RISK RANGE™ SIGNALS
The smart trader is highly incremental in their trading using our Risk Ranges. Here's a key excerpt transcribed from the video above with Keith.
"If you have a bullish trend, you buy that asset incrementally at the low end of the Risk Range. Unless the Bullish Trend breaks, you buy and get bigger incrementally at the low end of the Risk Range.
I like to buy 25 to 50 basis points at a time into a position as it approaches and even goes through the low end of my immediate-term Trade Risk Range™.
Put another way, as that asset approaches the low end of the range your position size grows toward your max position size,” Keith says. “The same thing is true at the top end of the Risk Range. As the asset goes up toward and through the top end, you sell incrementally again toward you minimum position size.
I highly suggest you do things incrementally. Don’t look at dollar amounts of your capital. Look at percentage of capital deployed or at risk.”
For more, we highly recommend checking out Keith's detailed primer on "Position Sizing."