Don’t Be Afraid To Change The Denominator

I’ve been meaning to write about this topic for a while. And that’s keeping an open mind to what you’re pricing your assets in. Why do they need to be in dollars? Think about it – there’s opportunity cost there.

One of the things I’m going to talk about during my presentation at Stocktoberfest Friday is changing denominators to find stronger trends, or trends in general for that matter. The first example might be my favorite of all time. We know that $AAPL is America’s favorite stock. And in case you didn’t, let me just tell you how much hate mail I received when I brought up the possibility of a decline in Apple stock last month. It’s been one of the biggest winners in a lot of people’s portfolios. But as good as it’s been, the gains were just a fraction of what a Long $AAPL / Short $RIMM trade brought home:

So in this case, we’re looking at a strong trend becoming much stronger by changing the denominator from US Dollars to the Blackberry maker, Research in Motion. The next example takes a non-trending asset and turns it into a super-trending asset. For a couple of years, Crude Oil was in a frustrating trading range that was difficult, if not impossible to trade successfully. But by changing the denominator and shorting Natural Gas against it, we see a beautiful trend that made a lot of money.

This particular trend got somewhat out of control and we liked, and continue to like, the reversion to the mean trade better. So these days, we’ve flipped it around by having Natural Gas as the numerator and Crude Oil as the denominator (see here). But the point is that we shouldn’t be afraid to play around with denominators. Assets don’t HAVE to be priced in US Dollars. You choose to price them that way. And I think there’s opportunity cost there.