There were no position changes in the Country models this week. Both China and India pushed to new recent highs. TMF had a volatile sideways range week, and while it ended squarely in the range, there were times that it looked like it was going to fall hard out of that range. Continued weakness in Europe and other regional economies makes the U.S. markets and treasuries an attractive place for the world’s capital.
This Week’s Strategy Lesson: Rebalancing (Part 2)
Last week we spent some time going over the general concept of rebalancing a portfolio. From our analysis, we saw that over time, if a portfolio isn’t rebalanced, its can have a negative effects on your diversification, single position risk, as well as performance.
However, the effect only becomes significant when the portfolio position sizes start to really differ. Where you draw the line on when to rebalance will ultimately come down to the capital you are trading with the cost of your trading commissions.
The one thing we didn’t get to was walking through the mechanics of how one would rebalance—which will be the subject of this week’s article. We are going to go through a hypothetical rebalance scenario using a three ETF portfolio similar to any our individual models.
For now, we are going to assume that you purchased three equal dollar positions of CURE, DRN, and SOXL on January 2nd, 2014 and held them until July 1st 2014.
If you had a $30,000 portfolio (starting size doesn’t really matter for this illustration) and put approximately $10,000 into each, based on opening prices January 2nd, you would have purchased 147 shares of CURE, 267 shares of DRN and 149 shares of SOXL.
From the chart above, you can see that all three holdings performed well over this period, however, there was a big difference in performance between the +30% in CURE and the +70% in SOXL.
Our original $10,000 position in CURE would have grown to $13,200, the $10,000 in DRN would be $16,140, and the $10,000 in SOXL would have grown to $17,015. The dollar value of the largest position is almost 30% bigger than the smallest position.
To begin our rebalance, we must first determine our new total equity. If you add the three positions together, you get a value of $46,355. Since we have three positions, we will divide that total by three to get the new “balanced” position size. Performing that calculation we come up with a value of $15,450.
The next step is to figure out how many shares of each of the ETFs we should own such that each of our three positions have a dollar value roughly $15,450. To accomplish this, you simply take the current price of each and divide it into the $15,450.
The “Current Allocation” above is the number of shares for each position in our portfolio based on our January 2nd entry. The “New Correct Allocation” is the number of shares we want to have today so that our portfolio is balanced. And the “Actions to Take” details the three steps we have to take to bring the portfolio into balance.
Specifically, we would sell 13 shares of SOXL (149 minus 13 equals 136) and sell 11 shares of DRN and use those proceeds to buy 24 additional shares of CURE. Since you won’t always know exactly what price you will get and the number of shares don’t always evenly divide into your allocation, you shouldn’t worry about getting the number precisely correct—for our purposes here “close enough” is “close enough.”
So to sum up the steps: 1) Find your current total equity position. 2) Divide that by the number of positions. 3) Calculate the number of shares you should own based on the number you found in step 2. 4) Buy or sell shares of each position until your holdings all match the number of shares for each position that you found in step 3.
Keeping your ETF portfolio balanced plays an important role in how you manage the system for the long-term—especially if you follow our position sizing methodology (1/3rd in each position). We recommend checking and rebalancing if necessary twice a year, in January and July.
These are the steps for balancing a “Basic” version of the models where you have only three positions and you are 100% invested in each. Next week we will wrap up this series and cover how to rebalance a portfolio with additional positions or if you have taken profits in a position.
The Current Condition of the Model
For the country model, we are in FXI, IFN, and TMF. IFN is about a dollar away from hitting its final target in the Stops & Targets model. We will be keeping an eye out for that next week. We also have a live coaching scheduled for Monday and a replay will be available on the website.
Stay tuned to daily updates for any position changes.
Here is a summary of the weekly performance of all the ETFs that the strategy monitors:
Best wishes for your trading,
James Kimball
Trader & Analyst
MarketGauge