The second aspect of the work that is presented here is the choice of the rule under which timely changes in the allocations of account equity are decided upon.
The most important understanding that we can have, if we are to fully benefit from quantitative analysis of the trailing history of the markets, is that having a “theory” as to why a particular rule is better than another is neither necessary nor even desirable. Empiricism is the appropriate resort as we do not consider that a priori assumptions about a particular course of human behavior in the marketplace to be trustworthy.
For example, many academicians admit that momentum works, that to some extent advances in stock prices tend to be followed by continued gains. But they call it an anomaly because it doesn’t fit into the theoretical concept of an efficient marketplace. It’s because momentum works that it is presented here.
Secondly, all of the rules for making changes in allocations of account equity that are in use within the Traded Portfolio project incorporate what is usually called a “walk-forward” procedure— one or more parameters that affect the allocations are determined on the fly, based on the immediate trailing history. In that way we stand a chance of the program proving to be adaptive to changes in the way that the market trades and we may be afforded a major advantage over the more static approaches.
Presently the rules whose results are presented in these pages, momentum-based at present, are simply based on price histories. However, nothing about the basic structure or design of the programs in use imposes a limitation to the use of price data and there is no failure to consider factors not represented solely or particularly by price such as value, market capitalization or industry-group classification. Indeed, those factors are represented as selection criteria for candidate securities lists out of which portfolios are formed.