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Signal Update |
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Current
Signal Performance as of
Signal
Type |
Trade
Date |
Return
since issued |
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World |
U.S. |
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Nasdaq
100
(QQQQ)
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Russell
2000
(IWM)
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S&P
500
(SPY)
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Market Update |
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It has been a volatile week for stocks, marked by low trading activity
ahead of the Labor Day week-end. Renewed weakness in the financial
sector dealt the markets a blow Monday, causing a 2% drop for both the
Nasdaq Composite and the S&P 500. The major indexes were able to
stabilize Tuesday following a better-than-expected reading on consumer
confidence for August and news from the Commerce Department of a 2.4%
increase in new-home sales for July. Stocks then posted solid gains the
next day on the back of a positive report on durable goods orders: the
government announced a 1.3% jump in July, well ahead of the unchanged
reading economists had expected. The main indexes continued their march
forward Thursday, with the Dow Jones Industrial Average leading the way
with a 1.8% daily gain. Stocks were boosted by lower oil prices and a
strong GDP report for Q2 that showed a 3.3% increase, well above the
projected 2.7% reading. The major averages finished the week Friday on a
negative note, moving lower after the government announced that personal
incomes fell last month by the largest amount in nearly three years
while consumer spending slowed. The technology sector was also affected
by a disappointing earnings report from Dell. The combination of bad
news caused the Nasdaq 100 to retreat 2.2% during the session.
For the week, the Russell 2000 (IWM) gained 0.26% while the S&P 500
(SPY) lost 0.66%. The Nasdaq 100 (QQQQ) did not fare as well, as it
posted a 2.88% loss. the Russell 2000 remains located above both its
50-day and 200-day exponential moving averages (EMAs), while the Nasdaq
100 and S&P 500 are now situated below their two EMAs.
For its part, our World portfolio posted a
1.46% loss this week.
The portfolio consists of the 5 top-ranked world ETFs as of
August 15, which marked the beginning of the current 4-week
holding period. Please go to the "Our
Service" page for all the details.
Our current Buy
signal remains in effect.
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Trend Timing School |
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Short
and leveraged ETFs
Since our Model has us in a Buy
phase, now is a good time to prepare for what is likely to come
next, a Sell signal.
Do not attempt to read any subliminal message in the timing
of this editorial, there is none. Instead of predicting the
future, this article concentrates exclusively on our collective
readiness for the likely next step of our Long and Short
investment strategy. We know that too often when a signal is
issued, subscribers are caught off-guard and have not yet established
exactly what to sell and what to buy. Trend changes can be stressful
times for unprepared investors and the need to research, analyze
and make decisions at such critical junctures often leads to
significant delays, or worse, inaction. With this in mind, let
us each use this as an opportunity to decide exactly what trades
we will make when the time comes, and write it all down so we
don't forget!
In the early days of our service, many years ago, the decision
was simple. We would buy the QQQ (yes, it used to have only
3 Qs back then) on a Buy
signal and short the QQQ on a Sell.
There are many ways to implement the short leg of the strategy
which, in addition to selling short, include trading options
or index futures, or buying bear mutual funds, but nowadays
many of us have adopted ETFs for all our trading needs. Ever
since the first short and leveraged ETFs started trading on
the American Stock Exchange (Amex) a little over 2 years ago
(see "What are ProShares ETFs?"),
many have found them the ideal investment vehicles to implement
our trend following strategies.
Traditional index ETFs have as objective to match the daily
performance of the index which they track, but a new generation
of ETFs provides the ability to approximate the effects of shorting
that index and/or trading it on margin. Since you can buy and
sell these short and leveraged ETFs like any other stocks, they
help simplify trading, lower costs, and also help circumvent
the "no shorting" and "no margin" trading restrictions placed
on most qualified retirement accounts. The table below provides
a simple explanation of what the four categories of ETFs actually
do:
Table 1: Daily performance objectives of various types
of ETFs
ETF
Type |
Daily
objective |
Regular |
1x |
Leveraged |
2x |
Short |
-1x |
Short and Leveraged |
-2x |
Ideally,
for complete investment flexibility for a given index we want
to cover the long and short as well as the leveraged and non-leveraged
choices, which results in groups of 4 ETFs. Using the Nasdaq
100 related ETFs for illustration, to complement QQQQ which
provides a long, non-leveraged exposure to the index (1x),
there is QLD for double exposure (2x), PSQ for short exposure
(-1x), and QID for double short exposure (-2x).
Focusing on the list of 8 World ETF Rankings
U.S. markets, the Table 2 below lists all
the available ETF choices. We can see that 5 of the markets
have complete sets of 4 ETFs, but 3 of them (the Wilshire
5000
, the Nasdaq Composite and the Russell Micro
Cap) have only a regular ETF (1x) and no short or leveraged
counterparts.
Table 2: Short and leveraged ETFs
Market |
Long
ETF Ticker |
Short
ETF Ticker |
Large
Cap Dow Jones 30 |
|
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Wilshire
5000 |
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---
--- |
Large
Cap Nasdaq 100 |
|
|
Nasdaq Composite |
|
---
--- |
Small
Cap Russell 2000 |
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Mid
Cap S&P 400 |
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Large
Cap S&P 500 |
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Micro
Cap Russell |
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---
--- |
We would
be remiss not to spell out our reservations about the use
of leverage. Most of us get enough volatility investing in
the main U.S. markets and strongest world markets, without
leverage. Few are those who can stomach the volatility, risk
and drawdowns that full leverage can deliver. Should one be
tempted to increase the risk/reward stakes, we do not recommend
exceeding an 80/20 ratio, or an 80% margin (which means 80%
your capital, 20% borrowed capital). Besides leverage per
say, leveraged ETFs can provide other benefits (see "How
can leveraged ETFs reduce my costs?".
When looking at the ETFs we list for shorting purposes, new
subscribers wonder why we do not apply the same approach as
we do during Buy
signals, which is to follow the World ETF Ranking
to decide which markets to short. The primary reason to not
recommend shorting the ETFs in the rankings is that our relative
strength based system is designed exclusively to identify
forward momentum, and not which funds are likely to go down
the most. Some assume that, having risen the most, the strongest
markets during an upswing should also be the ones to drop
fastest and furthest during downturns. More often than not
this is not what happens. The strongest economies are frequently
the ones that weather storms best or even prosper.
Neither is the system symmetrical. You cannot assume that
shorting the weakest markets during Sell
signals will produce superior results, because it would not.
The markets already at the bottom of the rankings do not have
much downside left in them, and are quite often screaming
buy opportunities for the speculator rather than good shorting
picks.
For down market legs it only makes sense, and has proven most
effective, to short the instruments most closely correlated
to the Nasdaq Composite index which drives the TimingCube
Model. The markets and ETFs listed in the table have demonstrated
excellent correlation in the past.
We know there are now short and leveraged ETFs for just about
anything from commodities, to currencies and foreign markets.
And what about industry sector funds? Make sure to read the
answer to that question in the FAQ of the Week
below.
Our aim was not to provide an exhaustive list of short and
leveraged ETFs but rather to focus on those best suited for
our investment strategy. You can find all the funds directly
from the companies that offer them. The vast majority are
sourced by:
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FAQ of the Week |
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Question:
Can I trade industry sectors with the signals?
As we review the topic of short and leveraged ETFs in this week's
Trend Timing School editorial, we do not
doubt that some astute subscribers will question why we left
out the funds specializing on industry sectors. For example,
the ProShares ETF
family at last count included 14 short and "ultrashort", their
terminology for short and leveraged (-2x), industry sector ETFs.
These sector ETFs allow you to bet against specific industries
ranging from Basic Materials to Utilities. We use the word betting
intentionally because the TimingCube
signal does not provide any trend guidance for individual sectors.
The TimingCube
Model and signals track the broad diversified stock market trends,
U.S. and International, not narrow and specialized segments
of the stock market. It is well known that industry sectors
are poorly correlated with the broader markets and have their
own cycles. We do not recommend applying the Buy/Cash/Sell
timing signals to industry sectors.
Warm wishes and until next week.
The TimingCube
Staff
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