Knowing the results and understanding how returns are calculated is important to everyone. The sad reality is that many (most?) of us are math challenged. We have explained how to read the results tables in the October 31, 2003 FAQ of the Week, and in the July 9, 2004 Trend Timing School article we dumped more performance related terms and formulas than you ever wanted to know. Instead, this week, we take the very simple, step-by-step route to crunch the basic numbers.

What is the gain on a trade?
The gain is calculated by dividing the "ending price" (the open price on the next trade date) by the "initial price" (the open price on the trading date) and subtracting one. Let us refer to the "Trades and Cumulative Returns" table on the "Results" page for specific examples.

Example 1: Buy signal, Nasdaq 100, trade of 4/3/2003 to 4/30/2004
The "ending price", open price on 4/30/2004, was 1435.16
The "initial price", open price on 4/3/2003, was 1070.51
Gain = 1435.16 / 1070.51 - 1 = 0.3406 or 34.06%

For Sell signals during which we are short the market, the calculation is the same but we take the negative of the result (multiply by minus 1) to get our real return.

Example 2: Sell signal, Nasdaq 100, trade of 4/30/2004 to 10/28/2004
The "ending price", open price on 10/28/2004, was 1473.41
The "initial price", open price on 4/30/2004, was 1435.16
Gain = - (1473.41 / 1435.16 - 1 ) = - 0.0267 or a 2.67% loss

How do I compound two or more trades?
The easiest trick to remember is that the results of successive trades or time periods multiply instead of adding. The compounded gain is calculated by multiplying the "multipliers" of each trade or period. The "multiplier" is simply one plus the gain.

Example 3: Compounding of 4/3/2003 and 4/30/2004 trades, using Nasdaq 100
The "multiplier" for the 4/3/2003 trade is 1 + 34.06% or 1.3406
The "multiplier" for the 4/30/2004 trade is 1 + ( - 2.67%) or 0.9733
Compound gain = 1.3406 x 0.9733 = 1.3048 or a 30.48% gain

The rest is but repetition.

This question comes up frequently but alas the answer does not help those who do not already know the answer. Yes, you can use options and futures, if you know exactly what you are doing. We are not options or futures traders ourselves and have not discussed the use of such investment vehicles in our service. Because the options field is quite complex and specialized, it is also fraught with risks and dangers for the novice and therefore not suitable for the majority of our subscribers.

In a nutshell, an option is a contract that endows the holder with the right to buy (called a "call") or sell (called a "put") a security at a specified price on a particular date, or during a stated period of time. An option is a bet about the future price of the "underlying" (a security or an index). Futures are similar contracts for commodities and indices. LEAPs are a longer-term type of option with expiration over nine months and up to two years out.

Since they are such versatile instruments, options can be used in very creative ways, from very conservative application of options to protect a position, to making outright bets, possibly with extreme leverage, on the future movement of the security or index. It just so happens that our signals being good indicators of the predominant market trend makes our service a good tool for options traders. We hear from several subscribers who say they achieve great results by applying the signals to their options strategies. Maybe some day we will dig deeper into such strategies.

Warm wishes and until next week.

The TimingCube Staff