Reader Feedback: Short Selling With The Trend Tracking Index

Ulli Uncategorized Contact

Judging by the emails I have received over the years, selling short when the markets tank has quite some attraction for aggressive investors.

I have commented before that looking at historical price points with the benefit of hindsight and determine that some of our sell signals would have provided a good shorting opportunity, does not tell the entire story. It does not account for the tremendous volatility, which would have stopped you out on several occasions assuming that you used a sell stop in the first place.

Reader Larry took it upon himself to test the shorting theory by using some of my sell signals to enter a short position and exit upon receiving a new buy signal. This is what he found:

I can’t say thanks enough for what you share with us readers in your weekly letter and daily blog.

Below is a back test I did for my own curiosity regarding using bear funds during your T.T.I. sell signals.

Using the sell dates on your chart that you publish each Friday and Yahoo Finance historical adjusted prices for splits and dividends I came up with the following results. A $10,000 original investment for example only was used in this back test.

Compounded annual growth rate 2.71% over the approx. 8.65 years.

While some cycles produced good results, others did not. Of course, Larry did not use any sell stop discipline, so it’s unknown if the weaker results might have turned out better or if the better results would have turned out worse.

In other words, he strictly used buy and hold in between the sell and buy dates. As I mentioned above, the results do not show the volatility or the DrawDown your portfolio would have experience to get to some of these gains.

Overall, the losses were fairly small, although three in a row over several years might have discouraged an investor to continue with this strategy. Nevertheless, I found Larry’s test very interesting and the overall positive result surprising.

Thanks for your efforts, Larry.

Sunday Musings: Reasons To Worry

Ulli Uncategorized Contact

Jim Jubak wrote an article recently that caught my attention. It’s titled “8 Reasons For Investors To Worry.” Let’s listen in:

Has economic volatility in the US and abroad left you somewhat twitchy? That isn’t necessarily a bad thing. The trick is figuring out how best to expend your anxiety.

This is my fourth take in less than six months on how to worry.

I wrote the first one in October, when the Dow Jones Industrial Average had poked its head above 10,000 for the first time in a year and the Standard & Poor’s 500 Index was just about to kiss 1,100.

Now I’m writing on the topic just days after the Dow industrials touched 10,000 again, but this time headed in the other direction. The Dow closed at 9,908 on Feb. 8.

In October, the worry was that the stock market had gone up too far, too fast and was ready for a fall. Now the worry is that the long-feared decline has finally arrived and that it will be much worse than the correction that investors have been waiting for. Or at least that’s the fear.

All this history tells you something about how tough the past four to five months have been on investors, who have been through two bear markets in less than 10 years and are justifiably inclined to jump at every bit of news, good or bad.

Jumping at every bit of news is actually not bad behavior. The lesson of the past decade is that investors can easily get too complacent.

Remember the saying: You’re not paranoid if they really are out to get you.

Buy-and-holder beware

I just came back from an investment conference in Orlando, Fla., where I heard a number of speakers proclaim that the 60% rally off the March bottom proves that buy-and-hold investing is alive and well. Well, frankly, I think all that remark proves is that complacency is alive and well even after two bear markets have left many buy-and-hold investors looking up at 0% for the decade.
…

The challenge now is to pay attention as you should — but to separate the real worries you need to act on from the day-to-day flow of noise. If you act on every bit of noise that causes a moment’s worry, you’ll do a good job of turning your portfolio into a profit center for your broker. But you won’t be doing your own returns any favors.
…

That still leaves us all with an important question: If some of this news is just noise (and not worth acting on) and some is important in the real world (and worth acting on), then how do we tell the difference?

And that’s where my “how to worry” list of what’s real-world important to worry about and when comes in. By listing the potential turning points in the stock market over the remainder of 2010, “how to worry” indicates what news might be worth acting on because it has a good chance of moving stock prices for more than a day or two or three.

The goal is to put together a list that tells you 1) what the chances are that something will go wrong, 2) how bad it might be if something does go wrong and 3) when things might go wrong.

Jim goes on to list 8 major worries that are all valid. Please see the above link for details. While the underlying theme makes sense and can provide hours of discussion, I don’t see a good way how you can use these 8 worries as a tool to manage your portfolio. Some of these events may very likely happen sooner or later, but the timing is the big unknown. This is a perfect example of making a good economic analysis yet not being able to utilize that knowledge to stop worrying about your investments.

To me, using trend tracking is a far easier and effective way of cutting through all the fundamental noise and actually seeing where the direction of the market is headed. Sure, as we’ve seen recently, a whipsaw will be part of the equation but in my mind it sure beats the alternative, which is wading through reams of economic facts and still not knowing when to sell, buy or head for the sidelines.

Bottom line is that while Jim’s article was well written and researched, it does not alleviate the fears or worries many investors have. Only by having a clearly defined plan of action, which includes specific entry and exit points, will you be able to sleep better at night. At least that’s how it works for me.

Nothing Learned

Ulli Uncategorized Contact

A couple of weeks ago, MarketWatch featured a story titled “Don’t Just Do Something; Sit There.” Here are some highlights:

You learn in grade school that a correction fixes something that is wrong.

That’s why “correction” is such a difficult term when it comes to the stock market and investing, because the market is said to be in a correction when it is moving backwards after a big advance. But if the market is “correct” when it goes down, then it must have been “incorrect” when it was on the rise, and no investor likes that idea.

Confused? Well, stock market corrections have that effect on people.

Right now, judging from emails and message boards and letters I get from ordinary investors, there’s a real fear that what’s happening now is no mere correction, but the first step back toward the abyss, another leg down, the dreaded “double-dip recession” and more.

While I don’t know many investment pros who read the tea leaves that way, it’s important to know what to look at and think about if current conditions make you nervous and you suddenly believe that what is “correct” is to give up on what has been working.

Excuse me for asking, but what has been working? Most investors have been faced with a lost decade of buying and holding and are still reeling from the meltdown of 2008. It’s about time that people finally wake up and question old paradigms.

“Corrections are rogue; you don’t know where they are going to wind up and how long they will go on for, and that’s a big reason why they are scary,” said Walter S. Frank, chief investment officer for Moneyletter. “I don’t see what we’re going through right now as a reason to change allocations, but it’s hard for a lot of people to just stand still when they get scared.”

Famous last words! After two devastating bear markets in 10 years, a current rally based on smoke and mirrors, and this chief investment officer does not see a reason for changing allocations. That would be acceptable as long as an exit strategy exists to avoid a repeat disaster, but that is probably a foreign word to Walter Frank.

Indeed, when it comes to making portfolio changes, the underlying reasons to make a move typically can be linked to one or more of three root causes:

1) The market has changed.

2) The investment has changed.

3) You, the investor, have changed.

Most observers will tell you that market changes are the least important reason to make a move, but they are the one most investors react to. This is how an investor can have a financial plan, throw it away when the market takes a dive, and then miss out on the recovery.

Missing out on a recovery? Has it ever occurred to this writer that if you don’t participate in a downturn in the first place, you don’t need to recover? I have made this point numerous times after the meltdown of 2008. As of this writing, the S&P; 500 still needs to rise almost 20% to get to the level of our sell signal effective 6/23/08.

Everything is in place to make the current correction a short one. Corporate earnings may not be great, but they were so bad at the end of 2008 that the fourth-quarter numbers from 2009 only have to hurdle a low bar.

“I don’t know that things have gone down to turn this into a buying opportunity, and I won’t be surprised if things go down further before they look better,” said Frank. “But I know I wouldn’t be too worried about a correction when it happens in a bull market that looks like it will continue for awhile.”

Sure, corrections happen all the time; the problem is that you can never be sure whether they turn into something worse, like a move back into bear territory. Given what has happened in the market in 2008 along with a stock market recovery in 2009, odds are increasingly high that the downside will come into play again.

Unlike the recovery in 2003, economic fundamentals are horrible, debt on all levels is unsustainable and unemployment, a lagging indicator, shows no signs of improvement. Actually, unemployment will get worse as states, cities and municipalities struggle with budget shortfalls. Those potential layoffs have not been factored in current unemployment figures.

Be that as it may, the market could very well ignore all bad news and continue to climb a wall of worry. If it does, we will follow the trend until the end when it bends and stops us out of our positions.

To me, not having any exit strategy at all is asking for trouble and simply confirms that nothing was learned from the past.

No Load Fund/ETF Tracker updated through 2/18/2010

Ulli Uncategorized Contact

My latest No Load Fund/ETF Tracker has been posted at:

http://www.successful-investment.com/newsletter-archive.php

No negative front page news was good news, and the major indexes closed higher again for the second week in a row.

Our Trend Tracking Index (TTI) for domestic funds/ETFs has now crossed its trend line (red) to the upside by +3.78% keeping the current buy signal intact. The effective date was June 3, 2009.



The international index has now broken above its long-term trend line by +3.24%. A Buy signal was triggered effective May 11, 2009. We are holding our positions subject to a trailing stop loss.



[Click on charts to enlarge]

For more details, and the latest market commentary, as well as the updated No load Fund/ETF StatSheet, please see the above link.

An Experiment With Shorting The Market

Ulli Uncategorized Contact

The WSJ featured an interesting story with the intriguing title “An Experiment Shows The Risk Of Shorting.” Let’s listen in:

Back in late October, with stocks rallying, I decided to hedge some of my exposure by buying a “short” exchange-traded fund—an ETF designed to rise when the market falls. At the time, based on historical norms, the market was overdue for a correction.

After all, stocks had gone up nearly 57% without any correction of 10% or more since March, despite a sluggish recovery and rising unemployment. So I bought shares in the ProShares UltraShort S&P; 500 fund, which aims to double the inverse return of the Standard & Poor’s 500-stock index. In other words, for any given day, if the S&P; 500 fell 10%, this ETF would be expected to gain 20%. I wrote then, “I’m deliberately calling this an experiment, not a recommendation. I suggest that conservative investors let me be the guinea pig.”

The guinea pig is back with his report.

It’s long been my policy to avoid bets on short-term moves in the stock market. There are good reasons for this. No one else has been able to predict the market’s short-term direction with any consistency, so why should I? I only expected to hold the short ETF until a correction materialized, then sell.

And indeed, despite my expectations for a correction, none came. On Oct. 27 the S&P; 500 was at 1063; by Christmas it was 1126, a gain of 63, or 6%. My ETF, as expected, went the other way and lost more than twice that much, or 13%. So, as I reported on Dec. 23, I figured the market was even more ripe for a correction. I bought the ProShares UltraShort QQQ fund, which aims to achieve twice the inverse return of the Nasdaq 100 for a single day. At that point, the Nasdaq Composite was at 2253. Still, the market kept rising; the Nasdaq hit 2320 on Jan. 19.

Then I was vindicated—somewhat. By Feb. 5, the Nasdaq Composite had dropped as low as 2100 intraday, or just under 7% below its level when I bought the short ETF. The Nasdaq 100 had fallen similarly. I was looking at a gain of over 8% in my UltraShort QQQ shares. Coincidentally, the S&P; 500 fell to 1063 the previous day, right where it had been when I bought the UltraShort S&P; 500.

But then what? I hadn’t developed a clear-cut exit strategy. I had the idea I’d sell the short funds when the Nasdaq Composite had dropped 10%, a standard correction. But it never quite hit that threshold. Still, I no longer had the sense that stocks were so overvalued. Much had changed since October. Corporate earnings were rolling in, and they were strong. Multiple indicators suggested the economy was indeed improving. Despite the decline, the market seemed remarkably resilient considering all the bad news, such as worries about Greece defaulting. And then, the markets resumed their climb. Last week the S&P; 500 was back to 1076 and the Nasdaq to 2184.

I bailed out, a modest gain in my UltraShort QQQ shares offsetting a small loss in the UltraShort S&P; 500. With transaction costs, I pretty much came out where I would have been had I held cash.

The short ETFs performed as advertised, but I doubt I’ll be buying them again anytime soon. It may turn out I sold them prematurely, and that the long-awaited correction of more than 10% is just around the corner. But who knows?

The problem with selling short—which is really just the problem of selling, magnified—is you have to be right twice. You have to know when the market is overvalued, and then you have to know when a correction has run its course. I know there are many successful short sellers, but I don’t like those odds.

It’s obvious that the idea was to simply experiment with no clearly defined entry and exit points, so for that I appreciate the author being the guinea pig.

However, it brings up an interesting question, which has been asked by readers many times. How about selling short when the domestic TTI (Trend Tracking Index) crosses its long-term trend line to the downside and into bear market territory?

If you are an aggressive investor, you can allocate a portion of your portfolio to this approach. I found that there is a world of difference in looking at a chart with the benefit of hindsight and acknowledging that this point would have been a good one to short and actually implementing such a discipline.

What the chart does not tell you is the incredible volatility that you may have to face when taking a short position in bear market territory. Several readers shared their experiences with me back in 2008 when the bear struck and they went short. Violent market swings in both directions made that an endeavor for only the gutsiest of investors.

Nevertheless, I liked the author’s willingness to share the good with the bad, and it gave me the idea to do the same. My plan is that, once the domestic TTI breaks below its long term trend line and moves into bear market territory, I will take a position in SH (only for my personal account) and share my experiences with you.

To me, it’s not a question if we get to the bear market territory but only when.

Vanishing Fears

Ulli Uncategorized Contact



It’s not that the Greek debt crises disappeared over the Holiday weekend, but soothing words and lack of front page news were enough to alleviate or at least postpone fears of an imminent crisis. For the past 1-1/2 weeks, the market was headline driven and kicked around depending on the news from Europe.

No news was good news yesterday, and the major indexes, supported by a better-than-expected manufacturing index, along with a weaker dollar and a rally in commodities, did not hesitate and off to races we went.

While the rally was indeed impressive, we have to wait and see if this was a one-day wonder, or if short-term momentum has actually reversed. Major resistance for the S&P; 500 lurks around the 1,100 level, give or take a few points.

Mish at Global Economic Trends featured an interesting piece this morning, which resonated with me. It’s a lengthy article, but here is the summary titled “Something Is Brewing:”

Pressures mount as China attempts to walk a fine line between overheating and an economic bust accompanied by massive social unrest.

Elsewhere, central bankers assume the global economy is in recovery. In reality, the global economy is in another speculative binge fueled by reckless global stimulus, with China at the head of the pack.

Meanwhile, global imbalances grow with most eyes on Greece and Spain. Let’s not forget the massive property bubbles in Australia and Canada, and massive speculation in China. In the US, cities and states are on the verge of bankruptcy.

Something is brewing alright. That something is “trouble”, and not just for China.

That’s been my feeling for some time, which is why I don’t mind having a reduced exposure to the market due to some sell stops having been triggered last week. Once I can indentify that the major trend has in fact resumed, I will reconsider and add to my current positions.