TimingCube - Margin trading explained - Margin trading,highest performance,boost your gains,investment,portfolio

November 14, 2003 Update

Renewal process update:
Following growing demand from our subscribers, we have started sending e-mail notifications for all automatic renewal transactions.
The e-mail subject line reads: ”Your purchase from TimingCube”.
The Order Description inside the e-mail reads: “TimingCube Individual Subscription Renewal”.

There is no action required on your part, the e-mail notifies you that your subscription has been renewed. It is sent for your record keeping and acts as a receipt you might need, for example for tax deduction purposes.

Signal Update

Current Signal Performance as of 11/14/2003
Signal Type	Trade Date	Return since issued
Buy	04/03/2003	+31.53%

Cumulative Returns since First TimingCube Live Signal (06/18/2001) as of 11/14/2003
Long Only	Long Only with Margin	Long & Short	Long & Short with Margin	Buy & Hold
+82.72%	+196.49%	+237.77%	+800.10%	-17.82%

Note: Performance and Returns above are obtained by using QQQ as the investment vehicle.

Market Update

Despite a big run up on Wednesday, the Nasdaq Composite finished the week 2.05% lower while QQQ lost 1.66%. Almost all of the losses occurred on Friday on lower volume, as it appears that some investors were disappointed by the latest economic data. The markets seem to have a hard time overcoming two important psychological hurdles, 10,000 on the Dow and 2,000 on the Nasdaq Composite. This week's action did not affect our signal and the current Buy is still active.

Trend Timing School

Margin trading explained

This week we will complete the review of ingredients that make up our four strategies with an explanation of margin trading. A quick glance at the returns for our four strategies shows that for most periods the leveraged "Long & Short with Margin" strategy exhibited the highest performance. Put simply, margin trading lets you boost your gains - and losses - by investing borrowed money in addition to your own. When buying stock on margin, the 50% initial margin rule lets you double the size of the investment. This multiplies all gains or losses by two, and is what we use to calculate "Long & Short with Margin" returns on the "Results" page.

To understand how this 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%. Hopefully, we would have issued a new signal long before that happened! One way to simplify all of this and side-step many of these issues, and circumvent the no margin trading in retirement accounts rule, is to instead use one of the numerous mutual funds that seek to achieve the same results - for more details see the "Our Service" page.

Last week's cautionary notes apply to margin trading as well. While many of the risks of margin trading are mitigated by the rigorous Trend Timing discipline we practice, many investors will allocate only a fraction of their assets to the most risky investments. An example of portfolio diversification could be 80% for the "Long & Short" strategy and 20% for the leveraged "Long & Short with Margin" strategy. As always, you need to decide what is right for your individual situation, but you should only engage in margin trading if you thoroughly understand what you are doing and what you are getting into.

FAQ of the Week

Question: What is a Cash signal and is it like a trailing stop?

New subscribers often ask this question to better understand how the Model works. Recently, with the heady gains we've experienced since the Buy signal was issued a little over 7 months ago, many are starting to think about drawdown, trailing stops and the Cash signal. 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. This is designed to keep any losses to a reasonable minimum from the entry point when we are most vulnerable, as no timing Model will always be 100% right. Once the Nasdaq Composite Index has advanced 7% or more from our entry point, the maximum drawdown limit is ratcheted-up to 15% and the Cash signal becomes a trailing stop. This means that from then on, if the Composite declines 15% from its most recent top on an active Buy signal, or moves up 15% or more from its recent low on an active Sell signal, a Cash signal will be issued. When a Cash signal is generated, you should liquidate your current long or short investments and keep the proceeds in cash or in a money market fund until a new Buy or Sell signal is issued. With the weekly Trend Timing School topic being margin trading we would be remiss not to mention that the theoretical decline when investing on margin could be approximately 18% from entry or 30% from the most recent paper gain top as measured on the Nasdaq Composite which triggers the Cash signals. Depending on the investment vehicle and strategy used your actual losses could be higher or lower and there is no hard limit on how much stock investments could fall in a single trading day. You will notice that the Model we use has never triggered a 9% entry level Cash signal (Editor’s note: The 15% trailing stop Cash signal has only been introduced on March 12, 2004).

We recommend to our subscribers not to view any intermediate gains as real gains. Until the current position is closed we only have "paper gains". Thinking in terms of drawdown, which is the measure of how much an investment goes down from peak to trough, is emotionally draining and counterproductive. Instead of thinking in terms of losses from an intangible peak, think positive in terms of the gains since the current signal was issued.

Warm wishes and until next week.

The TimingCube Staff

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