Our Terminology

We’re not your father’s Wall Street research firm. That’s by design—we do things differently here. Because of our unique process and non-consensus approach, there’s a good chance that if you’re new to Hedgeye, you occasionally find yourself wondering what our outspoken CEO or one of our +30 analysts said in a research note, on HedgeyeTV, Twitter, or one of our research products.

We get it. That’s why we went ahead and created this “Terminology” section—to help you clearly understand what we mean when we use terms like “Trade,” “Trend” and “Tail” or (gulp) “”Multi-Duration Model.” The reality? It’s really not that confusing. Take a look below, we’re confident you’ll get up to speed with our way of looking at markets in no time.


Duration

Duration

Duration - edu duration cartoon1

 

Duration is your time horizon: how long do you intend to hold a particular investment?  Since risk happens over time (sometimes slowly, sometimes all at once!), risk managing duration is key to any dynamic investment process.

 

In Wall Street-speak, “duration” expresses the expected volatility of your investment, as a function of your holding period. Generally, the longer your time horizon, the greater volatility an investment will experience, and different Durations imply different levels of expected volatility – that’s obvious. 

 

What’s not obvious is that each investment reacts to multiple risk factors across multiple durations. This non-linearity can lead to what we call Duration Mismatch, one of the main reasons investors have negative surprises.

 

For example, if you invest in a foreign iron ore producer, you might be excited to learn that they strike a major deposit of ore at a time.  But what if that happens at a time when the currency in which the stock trades is declining against the dollar? And at a time when China, the world’s major customer for iron ore, is experiencing an economic slowdown?  The answer: good company news, but duration mismatch in the currency markets, as the strengthening dollar causes their stock price to deteriorate, and macro-economic mismatch: the decline in the economy of their #1 customer will stick the company with excess unsold product. 

 

How do you risk manage that?  By embracing the uncertainty of constantly colliding, non-linear, factors, your plan should always be that the plan is going to change.

 

In order to proactively prepare for change, Hedgeye focuses on three core durations. We call them TRADE, TREND, and TAIL, to delineate between the immediate, intermediate, and long-term.

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Hedgeye Multi-Duration Model

Hedgeye Multi-Duration Model

Since risk is non-linear (it happens fast, and slow, and episodically), it makes sense to attempt to contextualize changes in price and volatility across time.

 

Mainstream “technical” measures consider time/price relationships using a one-factor price momentum model (like a simple moving average). That doesn’t work.

 

You might be familiar with the “200-day moving average” and its feisty sibling, the “50-day moving average.”  It’s amazing how many market pros base their investment decisions on nothing more than two lines on a graph, each measuring a simple linear process. 

 

These consensus metrics have become the Received Wisdom of Wall Street. Every “chart” is crystal clear, in hindsight. But these charts tell you nothing about power laws and/or phase transitions. No single-factor linear model does.

 

Hedgeye’s proprietary system breaks the investment time horizon into three core durations:

 

TRADE – the next three weeks or less

TREND – the next three months or more

TAIL – the next three years or less


At any given moment, every position in your portfolio will exhibit characteristics in each of these three durations, depending on a broad range of factors ranging from company-specific, to sector-specific, to broad market, to the global macro level.  If it’s starting to feel like risk management is a voyage to Infinity and beyond, you’re starting to get the hang of it.

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Hedgeye Multi-Factor Model

Hedgeye Multi-Factor Model

Hedgeye CEO Keith McCullough spent a decade in the hedge fund world.  During that time he consistently refined his risk management model, both in the day-to-day management of his portfolio, and in rigorous back-testing against historical market data.

 

After leaving the business of managing money in 2008, he kept running the model, and he continues to refine it as he uses it daily to set risk ranges and price levels for Hedgeye’s research calls. 

 

Our institutional subscribers routinely ask for Keith’s risk management levels on stocks covered by Hedgeye’s Research Team, and they often ask him to take a look at other holdings through the lens of the multi-factor, multi-duration model he built.

 

This Model is what drives our Real-Time Alerts, throwing off red and green Bullish/Bearish risk management signals throughout the course of the trading day. 

 

During market hours, the Model updates fully every ninety minutes, which means you get four refreshes each day, bringing the multiple risk metrics in line with the latest non-linear and dynamic moves in markets.

 

Keith developed the Model out of frustration with everything that he was being told by more seasoned pros – stuff that sounded great, but that didn’t work. 

 

He developed the Model so he wouldn’t have to rely on using other people’s outmoded thinking, and especially so he wouldn’t have to rely on his “gut” – which is to say, as a discipline for removing emotions from the decision making process. 

 

“Gut instinct” assumes that you are smarter than the average market investor.  But let’s face it: the word “average” almost certainly includes you.  The Model offers a disciplined tool to guide your decision making, hopefully to lift you above the “average.”  It has worked for Keith.  Now let it work for you.

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Mo Bros

Mo Bros

Closely related to the #MovingMonkeys are the traders who chase price momentum.  The idea is that a stock that has had a big up-move will continue higher is not unique. It’s been sold to you by bucket shop brokers since the beginning of time and becomes a self-fulfilling prophecy the more people believe it.

 

Not to be confused with the chart chasers of 2000 or 2007, these are the “Mo Bros” of 2014 vintage. They are all over Twitter. They travel in crowds, and get very sensitive as momentum chasing #bubbles begin to crash.

 

The Mo Bro is like a surfer: he looks for a wave that’s just right, then tries to ride it all the way in to the shore.  While there are many obvious things that can go wrong with any market strategy, we think one of the biggest threats to momentum investing is that old standby of the academic science of Wall Street known as the Greater Fool Theory. 

 

This Theory states that in order to sell your overpriced stock at a profit, you need to find a buyer who – by definition – is an even greater fool than you.  If you buy a stock that has just broken out to a new high, you have to be pretty sharp to be the guy who buys it at the newest, highest price, and then sells it at the newer highest, really much higher than it deserves to be price.

 

The markets, of course, are full of fools, greater fools, and larger-than-life fools.  And then of course there’s the Federal Reserve, the Greater Fool of Last Resort.  Mo Bro to the max! 

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Moving Monkeys

Moving Monkeys

Watch any financial program and sooner or later you will hear about the “the 50-day” or “200-day moving average” signaling something prophetic about markets.

 

Some “technicians” have gone so far as to slice-and-dice this down to 10, 25, and 150 day moving averages.  Forgive us if we point out that this is not an analytical exercise: anyone whose computer can count to 200 can replicate these, and many other such “analytical tools.”

 

Before there were computers and complexity theory, this type of straight-line analysis was deemed to be very valuable information. On Wall Street 2.0, not so much. That’s why we lovingly call them #MovingMonkeys.

 

In all seriousness, using simple moving averages gets more dangerous, the closer you study market history. There is no credible back-test that shows it actually works. At momentum chasing market tops, they look genius. In sideways to down markets, the monkeys get eaten.  Put differently: these straight-line models have one way to be right, and a near-infinite number of ways to be wrong.

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Old Wall

Old Wall

“You gotta be in it to win it!”  How often have your heard that? Wall Street has consistently told customers they need to be invested in the US stock market.  But investors need to know there are plenty of markets, risks, and asset allocations to think about above and beyond that.

 

“Success” on Wall Street has traditionally been defined as success for the brokers (in trading commissions), success for the traders (in trading spreads), success for the bankers (in fees), and success for the analysts (who participate in commissions, spreads, and fees).

 

What about your success?

 

If you were “in it to win it” at either of the 2000 or 2007 #bubble tops, we think it’s safe to say that your definition of success may vary from theirs. As a result, most have awakened to the fact that Wall Street’s longstanding business model is inherently conflicted, compromised, and constrained.

 

We call that, the #OldWall.

 

It’s time you self-direct yourself to do what #OldWall people have never had to do: put your interests first. It’s time for you to be the change you want to see in your wealth management.

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Price

Price

What does a security’s last price tell you?

 

The most popular price-based answers to that question are the 50 and 200-day moving averages, based on closing prices of an index or an individual stock. 

 

Other systems, such as Candlestick Charts, track daily open, high, low and closing prices.  But they still work off only a single factor, and thus do not present a full risk management picture. 

 

Price charting is based on the assumption that forces beyond mere Supply and Demand set the price of goods or securities.  We don’t disagree with that. We disagree with how consensus tools contextualize it.

 

Candlestick charting was developed in Japan in the 1700s to gauge the impact of merchants’ and traders’ emotions on the price of rice.  It has since become a favorite tool of short-term stock chartists. If you’d like to use these single-factor methods, go ahead – on Wall Street 2.0 they are free for a reason.

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Tail (Duration)

Tail (Duration)

The TAIL duration measures risk over the longer-term (3 years or less). After more than 15 years of trial/error developing this model, we’ve been humbled into submission on this front. It’s very difficult to dynamically risk manage investment ideas beyond that time frame.

 

Not to be confused with the popular definition of Black Swan “tail risks” that can often be qualitatively defined, we’ve submitted ourselves to Mr. Macro Market on this front and decided that TAIL risks are manageable, if you subject yourself to change and uncertainty.

 

Across all of our core risk management durations, the fulcrum point in the analysis is the rate of change. This is a critical difference compared to other modeling approaches.  The key questions aren’t about whether things are good or bad – they are all about probability weighing whether risk factors are getting relatively better or worse.

 

Mathematically speaking, we’re talking calculus here (2nd derivatives). Physically, you can also think about it in thermodynamic terms. What factors are undergoing “phase transitions” (from one state to another)? Because once something has moved from bullish to bearish TREND, it’s often too late.

 

Put simply, TRADEs often educates us about the stability/fragility of TRENDs, whereas the direction of longer-term TAILs can be shocked when a TREND undergoes a phase transition.

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Timestamp

Timestamp

In a word, that’s how we manifest our principles of Transparency, Accountability, and Trust. Everything is time-stamped.

 

Every signal we’ve issued since founding the firm in 2008 has been #timestamped. We don’t hide our history.  When we’re wrong, it’s right there for all to see – every win, loss, and tie.

 

Every day our CEO, Keith McCullough, puts up his Real-Time Alerts.  These are risk management signals indicating immediate-term calls on the stocks and ETFs we follow here at Hedgeye.  Every Alert is time stamped, and the entire history of the Alerts resides on our website.  Fully #Transparent.  Fully #Accountable.

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Trade (Duration)

Trade (Duration)

The TRADE duration measures risk over the very immediate-term (3 weeks or less), and it shouldn’t surprise you to realize that an awful lot can happen in that time frame. 

 

TRADE is the point of departure for measuring risk in the immediate term.  And TRADE is the first signal you might look at if you are an active short-term trader. 

 

The TRADE duration keys off of current events and macro correlations.  As an example, a good earnings report may drive a lot of buying, causing the stock to look overbought on an immediate-term TRADE basis.  Whereas a bad one might signal immediate-term TRADE oversold.

 

If you are a longer term holder, you can use the immediate-term TRADE duration to help you risk manage (sell some high, so that you can buy more low) your best ideas. 

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Trend (Duration)

Trend (Duration)

The TREND duration in the Hedgeye model measures risk over the intermediate-term (3 months or more) and back-tests as the most manageable in our model.

 

That shouldn’t surprise you as this is the duration where many investment strategies purport to live. Three-months or more captures Institutional Investors trying to handicap “the quarter.”  It also covers the 50-day moving average and finesses into the 200-day. 

 

While immediate-term TRADE volatility can present you with buy/sell opportunities, contextualizing TRENDs, and whether the probability that they continue is rising or falling, is the most important skill set within the longer-term risk manager’s game.

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Volatility

Volatility

Does it matter? Immensely. But how many people proactively solve for it?

 

Many Institutional Investors analyze the relationship between Price and Volume – the ones who don’t respect both factors wouldn’t last long trying to execute institutional orders. Analyzing volatility is far less trivial – and for some reason, far less common.

 

Volatility is the statistically dispersion of prices of a security or index; the variance, or the standard deviation of prices for the security. 

 

The higher the Volatility, the greater the price uncertainty of a position.  That doesn’t mean that Volatility is bad.  It means that you have to take it into account if you want to make good buy/sell decisions, across durations, in what we call the Risk Range.

 

If you don’t incorporate an analysis of volatility in your buy/sell decision making process, you will have to get used to “averaging down” to offset your timing mistakes.  And as any seasoned trader can tell you, averaging down presupposes two things, both of which are unreasonable: an endless supply of money, and a stock price that finally goes back up.

 

Volatility is measured against other positions in your portfolio (relative Beta), and against broad market averages (market Beta).  A “high Beta” stock is more volatile than the broad averages and is likely to both fall and rise by a greater percentage than the market does. 

 

Risk-oriented investors are drawn to Volatility because they generally believe they can get in and out at the right time, and they believe they are better at timing Volatility than most other traders. 

 

This is often based on a small number of lucky trades, or on forgetting unsuccessful trades.  This common psychological trap is called Confirmation Bias.  There’s also the adrenaline factor, which is great if you want thrills at a casino, but it has no place in a risk management strategy.

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Volume

Volume

Since most investors care about the price of their holdings, shouldn’t they care about liquidity? 

 

If the price of your stock goes up, did you make money?  The reality is that you only make the money when you sell at that higher price, and in order to do that, you need liquidity.  If there is not sufficient volume traded, you will not be able to sell at your price – maybe not at all. 

 

Price moves perpetuate TRENDs.  Volume either confirms (rising volume) a bullish TREND, or calls it into question (decreasing volume). 

 

Strong overall volume is generally seen as a sign of health in the markets, though isolated moves in Volume can signal turning points. 

 

Stocks moving UP on decelerating volume have the potential to create a Liquidity Trap and could signal a coming correction, while an outsized burst of volume on a strong UP move in a stock could signal a breakout to new price levels. 

 

If you are combining VOLUME with PRICE, you’re already well ahead of the single-factor technicians.  But you’re not quite there yet.  Hedgeye’s Model tracks multiple factors in three categories: Price, Volume, and Volatility.

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Wall Street 2.0

Wall Street 2.0

Hedgeye is the change. Our founding principles are Transparency, Accountability, and Trust. Our mission is lift the veil of mystery from the investment process, to educate and empower your decision making.

 

We provide research and insight for a subscription fee – not against trading commissions, not to participate in banking deals.  We don’t manage money, we don’t trade our own account.  Our sole focus is to provide guidance for you to risk manage your own portfolio, using the same tools and research we provide to the top professionals in the industry.

 

While our main objective is to be right, sometimes we aren’t. But we make that trivial for you so that you don’t have to guess. 

 

We #Timestamp all our calls – research, trade signals, etc. It’s all there for you to see, in real-time.

 

We also tend to be kind of loud in public places.  But that’s ok (the guys are pretty loud too!). We want to give you a voice. We want to give you the truth.

Wall Street 2.0 is about the democratization of investment and risk management research.  There are no “first calls” or “secret huddles.” 

 

We play favorites with everyone.  For the first time, the individual investor has a fighting chance.

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