TimingCube - Wash sales - wash sale,taxable trade,cost basis,loss deduction,non-equity options,tax implications

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Signal Update

Current Signal Performance as of

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

Cumulative Returns since First TimingCube Live Signal () as of

Index	Long Only	Long Only with Margin	Long & Short	Long & Short with Margin	Buy & Hold
Nasdaq 100
Russell 2000
S&P 500
QQQQ

Note: QQQQ returns are included for continuity sake.

Market Update

It's been a punishing week for the markets, but a great one for us thanks to our active Sell signal. In a continuation of last Friday's negative action, stocks started the week by moving sharply lower until 2pm EST on Tuesday. Then, markets zoomed back up after the release of the last Fed meeting's minutes signaled that the central bank has no intention to be more aggressive in its pursuit of higher interest rates. The sigh of relief did not last, though, as selling pressure again picked up on Wednesday, pushing the major indices lower yet. The final blow came on Friday, after IBM announced two days early that it had missed both its earnings and revenue targets. Coupled with weak economic reports, the shortfall caused a heavy sell-off in stocks and a bond rally, in typical flight-to-safety fashion. In just a matter of days, investors' concerns seem to have switched from higher oil prices and an inflation-generating economy to a sense that the economy might not be so strong after all and may in fact be weakening. All major indices closed at new lows for the year and are now well below their 200-day exponential moving average (EMA).

Of the three major indices we follow, the Nasdaq 100 was the hardest-hit this week, losing 5.18%. The Russell 2000 and S&P 500 were not far behind, with respective losses of 4.91% and 3.27%. Needless to say, the week's action has reinforced our current Sell signal. However, markets are now very oversold as a result of the heavy losses, thus it is likely that we will experience a bounce in the coming days, however short-lived it may be.

Trend Timing School

Wash sales

In case you forgot, today is tax day (in the U.S. anyway), and instead of reading this article you might be better off finishing your tax return before the midnight deadline.

As is becoming a tradition at TimingCube, the Weekly Update topics during "tax week" tend to be heavily tax-oriented, and while we cannot fill your tax return for you, we feel it is important to address the tax implications of Trend Timing. To that effect it might be beneficial to (re-)read the "Tax considerations" article we published this time last year. This week we deal with wash sales, a little known tax rule which had some of you worried recently.

The essence of the rule is that you cannot deduct losses from stock or security trades in a wash sale. A wash sale occurs when you sell or otherwise dispose of stock or securities (including a contract or option to acquire or sell stock or securities) at a loss and, within 30 days before or after the sale or disposition, you directly or indirectly:

Buy substantially identical stock or securities,
Acquire substantially identical stock or securities in a fully taxable trade, or
Enter into a contract or option to acquire substantially identical stock or securities

By "indirectly" the IRS means that if you sell stock and your spouse, or a corporation you control, buys substantially identical stock, you also have a wash sale.

Where many people interpret the rule strictly as "cannot deduct", the IRS is actually more generous than that because they only call for the deduction to be postponed. If your loss was disallowed because of the wash sales rule, you can add the disallowed loss to the cost of the new stock or securities. This cost basis adjustment effectively postpones the loss deduction until the disposition of the new stock or securities.

An even more obscure exception to the rule which could assist subscribers utilizing certain index options is that the wash sales rule does not apply to so-called Section 1256 contracts, which include non-equity options and broad-based stock index options (also see the related "FAQ of the Week" below).

You may ask why TimingCube subscribers should care about wash sales in the first place. Let's take a hypothetical example to illustrate how a wash sale could occur. Say you became a new subscriber mid-signal during December of 2004 and to get in sync with the then active Buy signal you purchased 100 shares of QQQQ at $40.03 at the open on December 31, 2004. By the time you sold at the open on March 17, 2005 following the Sell signal, QQQQ had dropped to $36.61 and your trade would have resulted in a loss of $342 ($4003 minus $3661), not counting commissions. The IRS normally allows such investment losses to be deducted from your income. However, if within 30 days of March 17 our Model had detected a trend reversal and issued a new Buy signal, you would then have purchased QQQQ shares again, and in the process created a wash sale. Luckily, the 30 days went by and our Sell signal remains in effect, and this time around no one experienced a wash sale.

As always, we need to point out that we are not tax advisors and for more details on wash sales or tax questions in general you should go to the Internal Revenue Service web site at http://www.irs.gov/ or consult a professional tax advisor.