Breakout

There’s a new kid on the block. Innovator’s IBD® Breakout Opportunities ETF, ticker BOUT.

The goal of this fund is to identify stocks before they break out. Basically, they’re delivering on a style of technical analysis via machine, which I find intriguing.

When I was trading stocks, I would often buy on the breakout and then sell on the retest. Over and over I would let my emotions get the best of me. Needless to say, it was not a profitable strategy.

Theoretically, an algorithm will eliminate some of these biases that all traders have to overcome. Below is how they plan on doing this.

When a stock reaches a recent high in price and at least four weeks elapse without that high being surpassed, this price is identified as the base price. This base is used to determine those stocks nearing breakouts and those stocks experiencing breakouts. In making this determination, the Index utilizes an algorithm that analyses the following trends for each stock:

1. The length of time from the establishment of the base to the current date.

2. The difference in price between the base and the lowest subsequent price for the stock.

3. The percentage difference between the current price and the high at the start of the base.

4. The percentage difference in price from the stock’s lowest price subsequent to the establishment of the base and its current price.

5. The percentage change in the stock’s price in each of the last three weeks

You might be wondering what happens if stocks are in a lousy environment where they’ breaking down instead of breaking out. They have an answer for that too.

The Index is also designed to be responsive to equities market conditions that provide fewer opportunities to invest in stocks with breakout potential. Upon the occurrence of certain market signals identified by the Index Provider as forecasting a downturn in the equities market, the Index will allocate 50% of its weight to a portfolio composed of U.S. Treasury bills with maturities of one- to three- months (“cash positions”) to approximate an investment in cash.

Okay, very interesting. However, when I took a look at the holdings, I was reminded that while a quantitative process can mitigate human biases, a rules based strategy in and of itself is not necessarily enough. The rules have to, for lack of a better word, be good.

The idea that a stock has resistance is based on the fact that it has failed to get above a certain level multiple times, and every time it approaches that level, willing sellers dominate eager buyers. Ipso facto, a stock needs history to develop resistance. Which is why I was very surprised to see that six of BOUT’s top ten holdings, or 20% of the fund, are stocks that IPOd this year.

I cannot imagine a stock without a 50-day moving average can breakout because there is not enough history to break out of.

I’m all for innovation in the ETF space, and any time you can quantify what humans do, then even better, but this is a good reminder that there is a human behind every machine, and the output is only as good as the input.

Source:

Summary prospectus

 

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