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

Market Update

Buoyed by positive earnings reports, the major averages posted more gains this week, allowing the Dow Jones Industrial Average to clear the 13,000 mark for the first time and close the week at a new all-time high. Stocks moved modestly lower Monday on rising oil prices. Action picked up the next day after Texas Instruments reported better than expected quarterly results and issued bullish guidance for the current quarter. The news helped the semiconductor SOX index jump to finally break out of its multi-month range. This is significant because more often than not, the SOX leads the Nasdaq Composite and the overall market. Positive action for this index is therefore good news. IBM also helped boost the market Tuesday by announcing a $15 billion stock buyback plan and an increase of its dividend. Trading volume was heavy on the day, but it increased even more Wednesday as a batch of strong earnings reports pushed the major averages to new highs, with the Dow Jones Industrial Average closing above the 13,000 milestone.
The bullish action, coupled with increased volume since last week caused our Model to issue a Buy signal after the close Wednesday. Some new trends arrive with a bang and others with a whimper. Bullish price action has been predominant and markets have crept forward for over a month, yet strong volume on up days had been the missing ingredient up to now. We are less than 6% from where our Cash signal was issued. If it is going to approach historical averages, this rally is just getting started. Stocks were able to hold onto their gains for the rest of the week, as Friday's release by the Commerce Department of a weaker-than-expected GDP report was counterbalanced by a blowout earnings report from Microsoft.

The Nasdaq 100, S&P 500 and Russell 2000 respectively gained 2.45%, 0.65% and 0.10% on the week. All 3 indexes rest above both their 50-day exponential moving average (EMA) and 200-day EMA.

For its part, our World Index Ranking portfolio underperformed the US averages as it posted a 0.05% loss this week. The portfolio consists of the 5 top-ranked world indexes as of March 30, which marked the beginning of the current 4-week holding period. The World Index Ranking portfolio is being rebalanced today, as the current 4-week holding period is now over.

We now have a Buy signal in effect.

Trend Timing School

Leverage beyond margin

Imagine you have the ultimate market timing system which tells you precisely when to be long and when to be short; why wouldn't you bet all of your money, and as much of someone else's money as they let you borrow? The main reason is that no one has found the ultimate market timing system yet - we humbly recognize that ours is not perfect and probably never will be. Still, many investors are attracted by the lure of higher potential profits associated with leverage. Leverage can be defined in the investing lingo as a factor by which market gains (and losses) are multiplied. In this article we will review the array of leverage instruments and techniques at our disposal, and compare their respective merits and weaknesses.

Before we get to the main topic we must deliver a public service message which is: not to use leverage beyond reason. As always we encourage strategies that place financial security first through balanced approaches. Many are tempted by the impressive long term return figures for the Long and Short with Margin strategy, but no one wants to look at the downside. How much drawdown can you take? With margin you theoretically stand to lose more than you invest. For the majority of investors we do not recommend leveraging more than 20% of their investment. The Long and Short with Margin strategy in contrast, if applied to your entire capital, represents 100% margin, 5 times more than we advocate. Moreover, many investments such as the top ranked World Indexes are typically volatile and risky enough without applying further leverage.

For those not familiar with margin investing we would suggest reading "Margin trading explained". For those in more of a hurry we quote:

"To understand how margin trading works, let's look at a specific example: if you have a margin account with $10,000 of your own money, you could borrow up to the same amount from your broker to purchase stock for a total portfolio of $20,000. That's what's called being on full margin because from your perspective you have borrowed a full 100% of your own capital. From your broker's point of view you meet the maximum 50% initial margin rule because you are on margin for 50% of your overall account value. If the stock you purchased has increased by 30% in value by the time you sell, your portfolio is now worth $26,000 and $16,000 of that is yours ($26,000 minus the $10,000 you borrowed from your broker). This represents a net gain of $6,000, or a 60% return on your $10,000 investment. Without the margin trade you would only have gained $3,000.

As with short selling there are costs, restrictions and risks. The costs are mostly in the form of broker fees and interest on the borrowed money. You will first need to open a margin account or convert an existing account depending on the broker. In addition to the maximum 50% initial margin rule discussed above, the SEC also defines a maintenance margin of at least 25%. Your broker may be more restrictive than that and require a maintenance margin of 30% or even 35%. The maintenance margin is the minimum account balance you must maintain before your broker issues a margin call. Whenever the equity in your account (value of the stock minus what you owe the broker) falls below the minimum maintenance amount (value of the stock multiplied by the maintenance margin) your broker will force you to either liquidate your stock position or add more cash to the account.

Using the previous example, if instead of increasing by 30% the stock you purchased loses 25%, the equity in your account would be $5,000 ($20,000 minus 25% = $15,000, minus the $10,000 you borrowed = $5,000). This $5,000 is about 33% of your $15,000 portfolio value, which would satisfy a maintenance margin requirement of 30%, barely."

To add to the complications and limitations of margin trading, it is prohibited in qualified retirement accounts such as IRAs. Luckily, there have been alternatives available and the table below compares them.

Leverage instruments and techniques

	Maximum  leverage	Risk	Cost	Ease of use	Other issues
Margin	2x	High	High	Low	Not allowed in IRAs
Leveraged mutual funds	2.5x	Medium	Medium	High	Slippage (end of day trading) Negative compounding
Leveraged ETFs	2x	Lowest	Low	Highest	Negative compounding
Options	10x+	Highest	Low	Lowest	Not allowed in IRAs by certain brokers

Sophisticated investors have always exploited options to create leverage. Because of their complexity and leveraging power options can be deadly for the non-initiated, which is why they earn the highest level of risk of all the alternatives. Yet, in the hands of an expert, they can yield actual risk levels substantially lower than other approaches. A series of four Weekly Updates from January 21 to February 11, 2005, described an option strategy which can achieve performance comparable with that of equity based strategies with a much smaller portion of capital at risk (say about 10%). This means options let you apply much more leverage than margin does, and by applying them wisely your overall market exposure can be decreased substantially.

For a long time, the only way to simplify all of this and side-step many of the issues, and circumvent the no margin trading in retirement accounts rule, was to instead use the leveraged mutual funds that seek to achieve the same results as margin trading. Fund families such as ProFunds and Rydex have been around for years and have made Long and Short strategies practical for hundreds of thousands of investors. Offsetting the ease of use, the leveraged mutual funds have exhibited performance discrepancies as compared to ETFs (see December 10^th and 17^th, 2004 Weekly Updates). A large contributor to their performance deficit is the lag incurred by the mutual funds for having to trade at the close on the trade date instead of at the open like ETFs, known as slippage. The remaining shortfall is mostly attributable to the negative compounding effect inherent in how the funds work (See "Why do the ProFunds and Rydex leveraged funds not consistently track their index?").

Since then we have seen the apparition of leveraged ETFs which go further in addressing investor concerns than any of the alternatives. They are by far the simplest to use and trade like stock at any time during the day. Their lower costs and risks make them the hands-down winners for most investors. The only remaining drawback is the negative compounding effect which under certain market conditions will negatively impact performance.

Note: Lists of all currently available leveraged mutual funds and ETFs can be found in the "What to trade?" section of the Resources page.

FAQ of the Week

Question: Why would I consider the World Index Ranking Buy and Rebalance strategy?

Ever since we launched the World Index Ranking service we have presented three distinct and complementary strategies: Long Only, Long and Short, and Buy and Rebalance. While the first two strategies only have us invested (long) in the market during TimingCube Buy signals, the Buy and Rebalance strategy keeps us invested 100% of the time, independent from Trend Timing.

By constantly rebalancing into the top 5 world markets the strategy manages to limit the downside risk as demonstrated in the table below by the relatively moderate losses exhibited during the most recent bear market years, 2001 and 2002. Nevertheless, because the Long and Short strategy has performed best every year for which we have results, it is the strategy most widely adopted by subscribers. They may be missing a good strategy diversification opportunity.

World Index Ranking, Yearly returns

Year	Long Only	Long and Short	Buy and Rebalance
2006	35.60%	50.95%	24.34%
2005	38.40%	50.62%	32.93%
2004	29.47%	34.59%	23.03%
2003	59.18%	61.59%	45.98%
2002	2.62%	34.84%	-12.05%
2001	20.73%	102.26%	-1.29%

To provide another perspective, and a real time demonstration of why the Buy and Rebalance strategy can have some merit and, in our opinion, a place in anyone's portfolio, we only need to look at the World Index Ranking returns since going live on September 15, 2006 (As of last Friday April 20, 2007):

• Buy and Rebalance: 23.81%
• Long Only: 10.38%
• Long and Short: 7.82%

Just as we argued that an investor might benefit from dedicating a portion of their portfolio to a stock picking strategy (see last week FAQ: "How does market trend following compare with stock picking?"), we believe that following the World Index Ranking service with the Buy and Rebalance strategy can provide a good hedge in periods when strong market trends are hard to find.

Warm wishes and until next week.

The TimingCube Staff