Signal Type	Trade Date	Index	Return since issued
		Nasdaq 100
		Russell 2000
		S&P 500

Market Update

The major stock averages moved lower this week, largely thanks to Friday's sharp retreat. After two quiet sessions, a better-than-expected earnings report from Cisco Systems propelled the Nasdaq Composite and technology stocks higher Wednesday. Cisco's announcement was a welcome relief to investors as several high-profile tech companies had issued disappointing earnings reports so far, casting doubts on the tech sector's growth prospects for the year. In a sound market, one could have expected to see the main indexes follow-through and add to their gains. It was not the case, however, as the markets were essentially flat Thursday. Friday's trading started quietly again, until two pieces of news derailed the markets and caused all major averages to close sharply lower. First, Fed officials said that additional rate hikes may be necessary to cool down an economy that may be too strong for their taste. Second, Micron Technology said that it sees memory chip prices plunging over 30% this quarter, rekindling investor's fears concerning tech stocks' profit potential. Coupled with oil prices over $60 a barrel, this convergence of bad news caused the markets to close the week on a sour note.

The Nasdaq 100 and S&P 500 respectively lost 0.70% and 0.71% on the week. The Russell 2000 did slightly better, posting a smaller loss of 0.29%. All three indexes still remain above both their respective 50-day and 200-day exponential moving averages (EMAs).

For its part, our World Index Ranking portfolio continued to outperform the US averages as it posted a 1.04% gain this week. The portfolio consists of the 5 top-ranked world indexes as of February 2, which marked the beginning of the current 4-week holding period. Please note that since we now have an active Sell signal, the World Index Ranking approach calls for selling your holdings if you follow the "Long Only" or "Long and Short" strategy. You should remain invested in the top 5 indexes only if you follow the "Buy and Rebalance" strategy, which remains invested at all times. Please go to our "Strategies" page for all the details.

Our active Sell signal remains in effect.

Trend Timing School

Investment vehicles

Continuing with the fifth article in our review of Trend Timing basics, it is only logical that the strategies we examined last week be followed with a presentation of investment vehicles we have in our arsenal to implement them. While it is true that with the use of tools such as "Performance with individual security or index" on the "Results" page numerous investors have successfully timed well-correlated stocks. However, overarching purpose of Trend Timing remains to achieve superior returns by timing the broad market indexes. A rapidly evolving and growing number of investment vehicles ever rival to become our favorites, so it is critical we stay on top of the choices at hand.

Specifically, we want to review our various investment alternatives and find out how the tradeoffs between ETFs, mutual funds and options work for us individually.

Exchange Traded Funds (ETFs)
Instead of last but not least, we should make it clear that in our judgment ETFs are increasingly first and foremost.

Since the beginning of the TimingCube service in 2001, ETFs have been the central investment vehicle for our non-retirement moneys (and we even owe our name to one of them, QQQ aka "the cube"). We have always loved the convenience, diversification, liquidity, transparency, and low costs of the largest ETFs such as the now renamed QQQQ and SPY. Maybe we should spell out more clearly that we mean not just any ETF, but the index-based and open-ended variety of ETFs.

The reason we used to narrow down the ETF field of applicability to non-retirement accounts is that Federal laws prohibit any margin trading in qualified retirement accounts, which in turn prohibits any shorting as well. Until recently this meant that an investor looking to implement one of the short or margin strategies would be forced to look at other investment vehicles, such as the mutual funds and options described below. Since 2006, which saw the advent of short and leveraged ETFs, the limitation does not apply anymore. Now, you simply buy the ETF with the objective you want: 1x, 2x, -1x, or -2x. The funds effectively circumvent the Federal rule because they involve no borrowing on your part, but they still provide a very good approximation of shorting or applying margin. And this can be done in any retirement account where you have access to these funds.

Another dimension in which ETFs have exploded recently is in geographic coverage, with many foreign country and regional funds now available. Without such funds our new World Index Ranking based strategies could not be practically implemented. Many of these funds are still young, trade lightly and do not have the full complement of long, short, double and double inverse funds that their U.S. counterparts have. In contrast to these ETFs, most geographic mutual funds are actively managed regional funds which lack transparency by not following a published index.

Mutual funds
Not even 12 months ago, bull/bear mutual funds were just about the only choice to implement the short and margined strategies in retirement accounts. ProFunds and Rydex, the pioneers of bull/bear index mutual funds, made Trend Timing possible for countless investors and for a sizeable chunk of our collective wealth: our retirement savings.

In the 2004 article "Am I better off using ETFs or mutual funds?" ETFs still had a number of significant disadvantages, especially in retirement accounts. With short and leveraged ETFs added to the mix most of these limitations have disappeared making them formidable competitors for the mutual funds.

Unless you opened an account at a firm like Direxion, ProFunds, or Rydex, you have little incentive to trade with these mutual funds anymore. The reason it might still be attractive within the fund families is that there are virtually no costs or limits to how much and how frequently you can exchange between the funds, shorter settlement periods, etc. Still, do not forget that the downside of having accounts at these fund families is that they are your entire choice of investments. For that reason alone most investors prefer a brokerage firm where they can trade the same fund families plus anything else they might want to invest in.

The bottom line is that in most instances, the simple realities - the fact that the mutual funds are only priced once a day, that most brokers limit the amount of trading that you can do with them, and their relatively higher costs - make mutual funds obsolete.

Options
We introduced options to offer alternative strategies to ETFs and mutual funds. The fact that some brokers allow their use in retirement accounts makes them another effective way to circumvent the "no margin and short selling in IRAs" rule. We used to favor options because of their flexibility relative to leveraged mutual funds, and their low cost relative to using margin. Also, by implementing an option strategy we can obtain the same performance as the equity based strategies with less capital at risk.

To implement our trend following strategies we can use options in two ways:

Given that options are like concentrated forms of stock, you want to use them in small doses. Thus, if you go with an options-only strategy, only about 10% of the portfolio goes into options with the balance remaining in a conservative, interest-generating bond fund. That blend substantially tempers the volatility inherent in the options. In summary, while we believe that options are probably the most flexible way to implement the Long and Short strategies, that very flexibility leads to complexities which can only really be mastered by very experienced traders. For more details on trading with options read the following Weekly Updates: January 21, 2005, January 28, 2005, February 4, 2005 and February 11, 2005.

FAQ of the Week

Question: Do you recommend using stops, and at what level?

Generally we do not recommend them, but as always, it is of course for you to decide if you want to apply your own stop-loss orders. Our Model in essence has built-in stops with the 9% and 15% Cash signals. As a refresher, a Cash signal is automatically issued by our Model if the Nasdaq Composite Index moves against our current position by more than 9% from our Buy or Sell entry point, on a close. Once the index has advanced 7% or more from our entry point, the maximum drawdown limit is ratcheted-up to 15% and the Cash signal effectively becomes a trailing stop.

Admittedly, the Cash signals are not the same as setting stop-loss orders with your broker. The particular investment vehicle you use might be more volatile than the Nasdaq Composite, and if you set them too tight even an intra-day spike could stop you out. The risk then is to be stranded on the wrong side of the trend if the market resumes in the direction of our signal. For more volatile funds such as many of the international ones in the World Index Ranking, wider stops than our Cash signals are justified.

The advantage of a stop-loss order is that it could protect you better against fast and significant drops, although stops are no guaranties of minimum share price. The price you pay for such downside protection is that, as our research shows, the addition of stops (including our Cash signals) increases the amount of trading and reduce overall performance.

Warm wishes and until next week.

The TimingCube Staff