Risk Management: Benefits of the ITA Risk Reduction Model

Platinum members who employ the ITA Risk Reduction model will find the following guidelines of interest.  When your portfolio comes up for review, and I recommend using a 32-Day review period, run through a number of steps.  Before I get to the steps, here are the reasons for selecting the 32-Day interval.

  • It slowly rotates the review through the month rather than always having it occur at the end of the month, or some other fixed date, as is the case with the Faber-Richardson model.  One might even increase the number of days between review periods to something as high as 35 days.
  • Extending the period to something over 30 days avoids possible wash sales.
  • The frequency is sufficient to not let the market walk away from the investor before action is taken, but long enough to avoid numerous whipsaws.
  • The short-term trading fees are avoided for TDAmeritrade customers.  I am one of their customers so this is very important for the portfolios using the ITARR model.
  • The ITARR, while a timing model, is all about risk management.

And now for the steps I walk through when a portfolio comes up for review.

For each holding in the portfolio I check the price of the stock or ETF and compare it with its 195-Day Exponential Moving Average (EMA).  The critical ETFs I examine are the following:  VTI, VTV, VOE, VBR, VO, VB, VUG, VOT, VBK, VNQ, RWX, VEU, VEA, VWO, DBC, PCY, TLT, TIP, and BND.  For larger portfolios there may be other commodity holdings such as SLV and GLD.  In some portfolios I may let some ETFs ride regardless of market conditions and activate the ITARR model with specific ETFs.  For example, an investor may want to always hold VTI so as to always be invested in the U.S. Equities market.  These are decisions each investor needs to make.

Here are the two sites I check when going through my list of ETFs.  Be sure to bookmark this site.  I am saving it as the Linkable Version so you have it available to use.  If you share this site with a friend, be sure to activate the Linkable Version.

http://stockcharts.com/h-sc/ui?s=VTI&p=D&yr=1&mn=0&dy=0&id=p16286589161

The above link also contains valuable information from the Relative Strength Indicator (RSI).  Be sure to give the RSI proper attention.  Be wary when the RSI moves above the 70% line and doubly careful when it crosses above for the second time in a very short time span.  Buying opportunities show up when the RSI crosses below the 30% line.  Use this signal to your advantage.

Another site I use when going through the list of ETF holdings is the following, and it is best to check this one after the markets are closed and have time to report any changes.

http://stockcharts.com/def/servlet/SC.pnf?chart=vti,PWPADANRBR[PB20!E20,2!A][D][F1!3!1.0!!2!20]&pref=G

In the above Point and Figure (PnF) graph, always take a little time and read the description.  Is a new pattern developing such as a breakout to the upside or downside?  Is the graph showing some sort of warning?  I use the PnF graph as a backup to the Price-EMA relationship.  I’m reluctant to sell when the trend is positive, regardless whether or not there are X’s or O’s in the right-hand column.  Once more, pay attention to the description attached to the graph at the time you activate the PnF graph.  As I show in the above link, always use the Percentage Scaling Method instead of the Traditional default Scaling Method.  The Traditional method only makes sense if one is generating these charts by hand.  I use a computer so take advantage to the sophisticated percentage scaling method.

The ITA Risk Reduction model does not take much time each cycle.  The monthly or 32-Day review process keeps one attuned to the needs of the portfolio.  For example, yesterday I was looking at the Kepler Portfolio and realized how much attention this portfolio needs to bring a number of asset classes back into balance.  That would not happen if I simply forgot the portfolio.  From experience, I find that if I don’t pay attention to a portfolio it can easily go off the “asset allocation rails” and when this happens the IRR of the portfolio begins to drift away from the IRR of the ITA Index, our customized benchmark.

Take the time to review your portfolio every 32 to 35 days, and be consistent in your approach to risk management.