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RADAR (Rotation Analysis Designed to Assess Risk)

A product of Simon Economic Systems, Ltd. – Steve Simon, president

Portfolio managers and analysts generally rely on three types of market analysis:

  • Fundamental: tracking of earnings, dividends, price-to-earnings ratios
  • Technical: quantitative evaluation of price patterns, volume characteristics and market trends
  • Sentiment: assessment of the expectations and convictions of the market

RADAR, which falls into the latter category, encompasses the emotional or psychological component of the investment process. It is best used as an instrument to determine if and when the market agrees with an analyst’s fundamental and technical conclusions.

Steve Simon’s RADAR (Rotation Analysis Designed to Assess Risk) has been developed around the theory that market psychology is a major force in the pricing mechanism of the market. The key to his work is the analysis of risk – RADAR monitors the risk cycle, which is based on the emotions that drive the market.

Risk is the speculative excess in the market, a point at which perception and reality reach unsustainable limits. Investments become vulnerable when this excess unwinds. Through its evaluation of absolute and relative risk, RADAR points to those areas that have the highest probability of outperforming the market at a specific point in time.

RADAR can help reveal investment opportunities by identifying when perception and reality are at extremes. RADAR measures the probability of a trend continuing.

The Framework of the RADAR Scoring System

Designed to be most effective over a three-month time frame, the RADAR scoring system is based on two factors: the Buy Side Demand Index (BSDI) and trend identification. The BSDI is the core indicator of the model and is used to identify when investors expectations are “stretched out” beyond normal limits.

The second component, trend identification, is a forward-looking alpha model that ranks sectors, industries, and individual securities according to their future performance versus a benchmark. Together these indicators have great predictive ability to identify when:

  • Volatility in the market, as well as volatility premium, will be increasing over a 30-day period.
  • Market risk is much higher than normal due to investor’s misinterpretation of risk.
  • Liquidity is drying up and, therefore, a violent trend reversal is likely.

Why RADAR Works

History repeats itself. Sell side analysts tend to be the most enthusiastic and optimistic when they should be cautious and most fearful when it is time to be aggressive. RADAR helps prevent unwise investment decisions that can be made when self-discipline is replaced by over-enthusiasm and a reckless ego. It can also point to investment opportunities that occur when perception and reality are at extremes.

Best Used as a Complementary Tool

By adding RADAR to the stock selection process, an existing valuation model becomes scaleable and, therefore, a more robust, accurate, and predictive tool. In turn, analysts have more time to spend on material valuation issues and strategic forecasts.

Simon Economic Systems, Inc.