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Explaining directional and market neutral indicators

A few days ago, we went ahead and launched the AgoraOpus Insight platform. Now comes the time to start explaining the power of this platform, and I’m going to do that below using our current view on Apple (AAPL) and NVIDIA (NVDA) as an example.

In the above picture, you will see a few different things, so let’s label them first:

These three lines represent the directional (red), combined (blue), and market neutral (green) indicators. These indicators should be read as weightings or exposure gauges, telling us to own (be long) the company when they are positive. Or to not own (be short) the company when negative.

You could easily look at this graph and say, “the green line has been negative from early June, but the price has continued to go up, it doesn’t work!” And I’d agree, if viewed like that. But that’s where I need to explain some of the details.

What does directional mean?

Our directional indicator will show our view on the direction of an instrument. Do we believe the price will go up? If so, the directional indicator will be positive. Do we believe it’s highly likely that the price will go up? Then the directional indicator will be more positive than if we weren’t so sure.

That’s pretty easy to reason about. And we’ve been positive to AAPL the whole year, with increasing confidence about the direction.

What does market neutral mean?

Our market neutral indicator is a little bit more difficult to get your head around. That’s because the market neutral indicator doesn’t care about direction. We can have a very positive market neutral indicator, but the price might be going down. Or as we’ve had for AAPL, our market neutral indicator has been negative since early June.

What that does mean is that we think AAPL is going to underperform the rest of the market. Yes, AAPL’s share price has been going up, but we’ve been indicating that we think you might get a better gain elsewhere.

As an example of a different case we can look at NVIDIA, which over the year has more or less doubled in value, a lot better than Apple’s 50% gain.

We see for NVIDIA that the market neutral indicator has remain positive and mainly stable throughout, with the directional gaining strength. As was shown by the market neutral indicator, better gains could be had in NVIDIA than in Apple.

What does the combined do then?

The combined indicator attempts to capture both the directional and the market neutral into one indicator. In our Apple example, we are currently neutral to the company on the combined indicator, and would not put much portfolio exposure in on it. We are neutral because the directional and market neutral indicators are pretty much the exact opposite of each other.

As we do however see on the NVIDIA chart, the combined indicator is not just the average of the directional and market neutral, as you’d might think when looking at the Apple chart. Instead, it is the combination of the directional and market neutral taking into account the overall picture with all other instruments as well.