Simple Timing system

[Hamlet]

What if the market gaps down on you?

In 1987, you wouldn't have been able to sell when the market dropped to your number, because the market opened well below it. You could well have a day where the DOW opens 2000 points lower than where it closed (Imagine a horrible scenario like Fannie and Freddie defaulting and the government NOT backing their bonds).

You can't remove the risk of losing a lot of money in the stock market without removing most of the upside too.

All you can do is try to buy solid businesses at good prices and hope for the best.

All great points. On the last point, that its true. But isn't that superior to possible financial ruin at what feels like a highly risky time in the market? (I see Financial institutions tanking and read there may be much more in losses to come.) May a little dirty but very simple market timing be in line?

 

[2B]

RockOn,

If you are being scared out of the market, get out and sleep better. The big question is will you have the courage to get back in when it moves back over your target? The market had fully recovered its 2008 losses in mid-May. We're now down below the earlier lows in just 6 weeks. We can be back up 20% in another 6 weeks or less. Yes, we may still fall another 30%. We might go to zero.

Why didn't you put all of your money into annuities when you were talking about them before? You wouldn't have lost anything.

 

[RockOn]

What if the market gaps down on you?

In 1987, you wouldn't have been able to sell when the market dropped to your number, because the market opened well below it. You could well have a day where the DOW opens 2000 points lower than where it closed (Imagine a horrible scenario like Fannie and Freddie defaulting and the government NOT backing their bonds).

You can't remove the risk of losing a lot of money in the stock market without removing most of the upside too.

All you can do is try to buy solid businesses at good prices and hope for the best.

You have to admit you are cherry picking the one day in history where the black swan would have hit. It could happen again in the next year (or ?) until the next bull market comes, but really how likely is that?

On the last point, I know you believe that and that is fine.

I think there are ways to remove some of the risk, you do not. Many people agree with both of us.

 

[RockOn]

RockOn,

If you are being scared out of the market, get out and sleep better. The big question is will you have the courage to get back in when it moves back over your target? The market had fully recovered its 2008 losses in mid-May. We're now down below the earlier lows in just 6 weeks. We can be back up 20% in another 6 weeks or less. Yes, we may still fall another 30%. We might go to zero.

Why didn't you put all of your money into annuities when you were talking about them before? You wouldn't have lost anything.

I know following even a simple system is very hard. I also know markets can change quickly. I also know that when I see the financial problems in this country, things "could" be on the verge of getting very serious. Please tell me if you know otherwise.

On the annuities, I still might buy them. I already might have been better off ultimately if I had. I didn't because I haven't fully retired yet and can still handle some lower risk investments for now, at least I thought I could . Hopefully if I pull the plug on annuities which will be in about 6 years or so, they will still allow me to get a 6% IRR if I live to the mid to late 80's. Maybe they will be dropping the IRR if the markets don't do well in the next few years. That would s*ck.

P.S. by the way, the Preferred Stock funds I own lost about 17% in the last 8 weeks, so much for that being a much better plan than a guaranteed 6% annuity.

 

[FIRE'd@51]

Options are another option to excute the system, the trouble is they have cost and that cost isn't really minimal in percentage terms. If one can trade without fees, my way is a cheaper way to go as I calculate it. Options are a close second since the whipsaws might be less slightly less costly, maybe a tossup.

This is the "trap" that the dynamic portfolio insurers fell into. They thought they could create the option more cheaply by trading the underlying asset, in that case, the S&P 500 futures, which were relatively cheap to trade.

When you say your way is cheaper, what you really are saying is that you think the subsequent realized volatility will be less than that implied by the option price. So you are making a volatility bet.

Think of an at-the-money option with one day until expiration. You buy it today, and tomorrow it pays off your desired return pattern. You're 100% in if the market is above the strike, and 0% in if below. You are correct that this option will be relatively expensive in percentage terms - I calculate a Black-Scholes value of 0.63% for a one day at-the-money option with an implied volatility of 30% (roughly the current VIX value). But you have to think of the cost of creating that option dynamically. If the realized volatility is 30% over the next day, your actual cost of creating this option will be roughly 0.63%, and that's assuming no gap moves. If the market whipsaws back and forth through the strike price so that your trading volatility is greater than 30%, then your dynamically-created option will cost more than 0.63%. Wall Street is littered with the carcasses of people who thought they could create an option more cheaply by trying to replicate it with the underlying asset. The dynamic portfolio insurers of 1987 were the textbook example.

Since the option premium grows slower than linearly with time (more like the square root), you can reduce the percentage cost per unit time by purchasing longer dated options, e.g one week, or one month. If you hold it until expiration, the payoff will be the same binary one that you are looking for. At least with the purchased option your cost is known up front, and the payoff pattern at expiration is guaranteed

 

[RockOn]

This is the "trap" that the dynamic portfolio insurers fell into. They thought they could create the option more cheaply by trading the underlying asset, in that case, the S&P 500 futures, which were relatively cheap to trade.

When you say your way is cheaper, what you really are saying is that you think the subsequent realized volatility will be less than that implied by the option price. So you are making a volatility bet.

Think of an at-the-money option with one day until expiration. You buy it today, and tomorrow it pays off your desired return pattern. You're 100% in if the market is above the strike, and 0% in if below. You are correct that this option will be relatively expensive in percentage terms - I calculate a Black-Scholes value of 0.63% for a one day at-the-money option with an implied volatility of 30% (roughly the current VIX value). But you have to think of the cost of creating that option dynamically. If the realized volatility is 30% over the next day, your actual cost of creating this option will be roughly 0.63%, and that's assuming no gap moves. If the market whipsaws back and forth through the strike price so that your trading volatility is greater than 30%, then your dynamically-created option will cost more than 0.63%. Wall Street is littered with the carcasses of people who thought they could create an option more cheaply by trying to replicate it with the underlying asset. The dynamic portfolio insurers of 1987 were the textbook example.

Since the option premium grows slower than linearly with time (more like the square root), you can reduce the percentage cost per unit time by purchasing longer dated options, e.g one week, or one month. If you hold it until expiration, the payoff will be the same binary one that you are looking for. At least with the purchased option your cost is known up front, and the payoff pattern at expiration is guaranteed

If I cn buy a million dollars of a mutual fund for $0.00 and sell it the next day if I need to for $0.00. How can I beat that?

 

[FIRE'd@51]

If I cn buy a million dollars of a mutual fund for $0.00 and sell it the next day if I need to for $0.00. How can I beat that?

But how do you know it will be worth $1 million the next day? That would only be true if the realized volatility were zero. Otherwise, you would still be subject to whipsaws.

 

[RockOn]

But how do you know it will be worth $1 million the next day? That would only be true if the realized volatility were zero. Otherwise, you would still be subject to whipsaws.

I'm not following, sorry. If I buy a million dollars of a Dow fund when the Dow was 11501 and sold it in two days when the DOW was 11499 and didn't have to pay any commisions, my total loss for that whipsaw was 0.017%. Almost a free trade that time. I understand those prices are not reality and I would be subject to greater losses (whipsaws).

Now how would that work with options? I'd pay the premium for 1 million dollars worth of the DOW index. If the DOW went down below "my number" two days later and I sold my options, my option loss would be much more than 0.017% and I would have paid two commisions. What don't I understand? Are you saying not to sell the options and invest as if I were buying longer term isurance?

I'll go back and reread your post, I am talking about something way more basic than dynamic portfolio insurance. Simply getting in and out of the market through indexed mutual funds. I am not trying to create an at-the-money option. I am just placing a buy stop order above the market, and selling on the day of first loss after the buy stop was triggered. I understand I will be whipsawed as many times as necessary to insure I am totally invested for a bull market, and safely out during a continued bear market. As I see it the same could be done with options, higher trading costs, but "possibly" slightly less painful whipsaws. I am trying to keep it very simple but avoid a possible serious sell off that could be coming. I would be giving up some upside and suffering potential whipsaws to accomplish that. In this environment, it seems to me to be worth it.

 

[haha]

I'm not following, sorry. If I buy a million dollars of a Dow fund when the Dow was 11501 and sold it in two days when the DOW was 11499 and didn't have to pay any commisions, my total loss for that whipsaw was 0.017%. Almost a free trade that time. I understand those prices are not reality and I would be subject to greater losses (whipsaws).

I think what he is saying is that this is in fact dynamic portfolio insurance, no matter what you choose to name it. And it has been tried by well informed people with large resources- and they got kicked in the butt, good and hard.

Still, although I would never try it, I think it would be peachy if you gave it a shot. After all, it's only money.

Ha

 

[FIRE'd@51]

I understand those prices are not reality and I would be subject to greater losses (whipsaws).

That is my point, and those losses could be significantly greater than the 0.63% I used in my example. A 30% annual volatility (standard deviation) translates into 1.8% per day, which means that there is a probability of 16% that the market could be down more than 1.8% in one day. If I worked out the arithmetic from the standard normal distribution properly, the probably of a decrease by more than 0.63% would be 36%. If the volatility turns out to be lower, you will come out ahead. I'm just trying to point out the bet you are making if you do it your way.

I know many traders who thought they could sell "overpriced" options (high implied volatility) and hedge them dynamically. Often they were right. But when they were wrong, they blew themselves up.

 

[RockOn]

That is my point, and those losses could be significantly greater than the 0.63% I used in my example. A 30% annual volatility (standard deviation) translates into 1.8% per day, which means that there is a probability of 16% that the market could be down more than 1.8% in one day. If I worked out the arithmetic from standard normal distribution properly, the probably of a decrease by more than 0.63% would be 36%. If the volatility turns out to be lower, you will come out ahead. I'm just trying to point out the bet you are making if you do it your way.

I know many traders who thought they could sell "overpriced" options (high implied volatility) and hedge them dynamically. Often they were right. But when they were wrong, they blew themselves up.

Ok, I get it.

I am looking at this as being a one time thing, just for this single environment (the current possible financial crisis) not a full time trading system. I do understand how the whipsaws could be minimized somewhat with options and that would be a worthwhile thing to do. If I am only planning on suffering through a few whipsaws, I see the size of the whipsaw as less of an issue. I see suffering a few whipsaws and going with a delayed buy stop as fairly cheap insurance in case things really start to fall apart. (Granted, doing it with options might be a little cheaper, especially if things take a long time to resolve). If things don't fall apart, I have lost a little upside but am back in the game.

 

[samclem]

I just wonder why an individual who believes he has the ability to discern that the great meltdown is upon us AND that he can detect when it is time to get out off the market AND that he has the ability (or a system) to know when to get back in . . . why would such an individual ever have spent time considering the purchase of an annuity? Seems like squandering a special gift.

 

[RockOn]

I just wonder why an individual who believes he has the ability to discern that the great meltdown is upon us AND that he can detect when it is time to get out off the market AND that he has the ability (or a system) to know when to get back in . . . why would such an individual ever have spent time considering the purchase of an annuity? Seems like squandering a special gift.

You are not reading me correctly.

I believe a great meltdown "could be" upon us, the signs of it are apparent.

I believe it is better to be safe right now as the financial institutions are crashing around us. I am not sure this is the end but when was the last time this took place? Also hyper-inflation is not completely out of the question.

I believe I do not know when to get back in so I prefer to set a price level to make sure I am back in if this all passes without much more damage.

I might buy an annuity because all of investing is so uncertain and risks are actually really risks when investing in risky markets. Also a guaranteed 6% steady IRR (if it is indeed really safe) is about as much as many knowledgeable people tell me to expect from a 50/50 or 40/60 portfolio which is my maximum stock risk tolerance.

See I really don't have a special gift, I just do not like losing money and think about timely ways to avoid it. I am just throwing this idea out there, to see whether I can learn something. I may follow it or may not, I haven't decided yet. I understand its risks and rewards I think. So far, I haven't really heard much downside to this idea though. Other than the usual "timers will lose all their money and burn in hell".

 

[al_bundy]

the best buy and sell signals i've seen are finding divergences in MACD and other indicators and the market indexes. the market is supposed to trend the technicals. MACD will give warning of a rally or correction that will last a month or more and other indicators depending on the length of time they cover

the rally that started in mid-march had a 2 month long bullish divergence in the MACD and RSI. basically the market kept falling while the average closing price started rising. the reason this happens is you can have a bunch of up days and a few big down days to drop the price really low, but the average will still be trending up.

early june there was a bearish divergence on the MACD for the SP500 and nasdaq. it started trending down while the market was still rising.

the length usually gives you an idea how powerfull the rally is going to be. in 2002 the bullish MACD divergence was around 3 months long. if you see it on a weekly chart as well than it carries a lot of significance.

another leading indicator i've read about is the Dow Transports. they lead the rally that started in march and started falling in early june with the market

doesn't mean it's the start of a new bull market, but a chance to buy and hold for a few months to make some cash and then see how things are going.

 

[RockOn]

So where are we now? Any current technical readings?

 

[al_bundy]

MACD is trending down, but i see a small uptrend on the stochastics

i really don't remember the details of what each of these things is or the exact formula. all i remember is that the formulas are either simple averages over a period of time or simple statistical formulas.

yahoo offers free technicals on their charts. i prefer the look of StockCharts.com - Simply the Web's Best Stock Charts myself

 

[Zathras]

I haven't lost a dime in this market yet. Until I either sell some stock or one of the companies I own stock in go backrupt I won't.
Yes, portfolio value goes up and down yet I really don't see the gain in panicing and selling low only to come back later and buy at a more expensive level.
Actually, I do see one case. If someone did not have enough cash for living expenses for the next 12-18 months AND you believe the market will only go down from here, it might be better to sell now since you will be forced to sell soon anyways.
But if that were the case I would suggest that the investor was not properly diversified to start with.

 

[Hamlet]

There are plenty of less dramatic gaps down (and up), although they are probably not deal breakers for your plan.

I just think that there is a lot of potential for the market to move up and down over your price for the next year or two. The market was doing horrible until March. Earnings came out, and they were ok. Not great, but not end of the world bad. The market rallied, but has spent the last month or two getting terrified again.

We're in earnings season again, and I suspect earnings will be mediocre. The market will probably rally a 1000 points or so over the next month, and then start getting scared again. We may repeat that 4 or 5 times before we actually get away from 11500 for good. That may eat a fair amount of your capital.

It feels a awful lot like trying to beat the casino by doubling your bet every time.

I just think it would be simpler to just own a lower percentage of stocks, or to pick lower risk stocks.

I think that no matter what happens from this financial/housing meltdown, Coke, General Mills, Philip Morris, Kraft, Budweiser, Johnson&Johnson, McDonalds, Microsoft, and Proctor&Gamble will prosper. You won't make a killing on them, but I would bet an awful lot of money (wait, I have ) that they will be higher in 10 years.

If you do decide to go with your plan, though, I'll be very interested in hearing how it turns out. Either way, good luck.

You have to admit you are cherry picking the one day in history where the black swan would have hit. It could happen again in the next year (or ?) until the next bull market comes, but really how likely is that?

On the last point, I know you believe that and that is fine.

I think there are ways to remove some of the risk, you do not. Many people agree with both of us.

 

[2B]

P.S. by the way, the Preferred Stock funds I own lost about 17% in the last 8 weeks, so much for that being a much better plan than a guaranteed 6% annuity.

I don't remember if you were in any of the threads on closed end preferreds but one key point about them is their extreme volatility. I have a nominal 5% of my portfolio in them generating about an 11% annual return. The principle has been all over the place and most of my holdings would be losses if sold now. I agree that they have dropped significantly in the last 8 weeks but they had risen almost as much the 8 weeks prior. Because the interest rates are now bumping 13%, only my asset allocation discipline is keeping me from buying more.

I'm still getting my dividends on schedule. If I need the cash I can sell. Sometimes at a loss and sometimes at a profit.

 

[RockOn]

I don't remember if you were in any of the threads on closed end preferreds but one key point about them is their extreme volatility. I have a nominal 5% of my portfolio in them generating about an 11% annual return. The principle has been all over the place and most of my holdings would be losses if sold now. I agree that they have dropped significantly in the last 8 weeks but they had risen almost as much the 8 weeks prior. Because the interest rates are now bumping 13%, only my asset allocation discipline is keeping me from buying more.

I'm still getting my dividends on schedule. If I need the cash I can sell. Sometimes at a loss and sometimes at a profit.

I just remember you recommending Preferreds as an alternative to looking at an annuity. A annuity is a no volatility lower yielding investment. Preferreds, wow, more volatility than the SP 500 lately. Not the same animals.

I have about a 4% position and bought them this year at what looked like lows (in February and mid-June) but have still been hit pretty hard. Most funds are into financials to get the higher yields, the yields could start dropping if some of the companies don't make it. I wonder if they are worth it, maybe to much like junk bond funds, reaching to hard for yield?

 

[RockOn]

I just think that there is a lot of potential for the market to move up and down over your price for the next year or two.

It feels a awful lot like trying to beat the casino by doubling your bet every time.

I think that no matter what happens from this financial/housing meltdown, Coke, General Mills, Philip Morris, Kraft, Budweiser, Johnson&Johnson, McDonalds, Microsoft, and Proctor&Gamble will prosper. You won't make a killing on them, but I would bet an awful lot of money (wait, I have ) that they will be higher in 10 years.

The first point, yes that wouldn't be good.

The second point, it sort of takes on that feel, keep trying until the bull market really comes back.

On the last, I bet you would have included GE, maybe even BofA, or Citibank if you made the list a year ago.

 

[2B]

I just remember you recommending Preferreds as an alternative to looking at an annuity. A annuity is a no volatility lower yielding investment. Preferreds, wow, more volatility than the SP 500 lately. Not the same animals.

True, annuities have no volatility. The moment you sign and give them your check the SPIA will always have a value of $0. If times get tough, you could always see what JG Wentworth will give you for your annuity.

 

[Hamlet]

I might still include GE, although their business is so complicated that I could never truly feel comfortable owning them.

Certainly the stocks I listed are not immune to downturns, and in a year one or two might be down an awful lot, like BofA or Citibank. I would probably want to add a few more to diversify. I think that as a group they should be pretty safe if you are looking 5 or more years out.

Here is my "I bet this outperforms bonds over the next 5 years portfolio":

The ones I've already listed:

KO
GIS
MO
KR
BUD
JNJ
MCD
MSFT
PG

Some additions to diversify and gamble that banking and insurance will continue to be a viable business:
BRKb
USB
WFC

Some retailers that will likely survive (TGT or LOW could be on the list as well):
WMT
COST
HD

A good company that I just can't help recommending:
FAST

Better get a couple oil companies in there:
XOM
BP

Defense:
LMT

Never dis the mouse:
DIS

If this portfolio is down more than 20% from here on 7/13/2013, I'll give you a gun and a week's supply of my canned goods

The first point, yes that wouldn't be good.

The second point, it sort of takes on that feel, keep trying until the bull market really comes back.

On the last, I bet you would have included GE, maybe even BofA, or Citibank if you made the list a year ago.

 

[2B]

BAC is my last remaining individual stock. I'm amazed at the plunge its taken. It seems like every day an analyst comes out with the same warning that BAC will be forced to cut its dividend and recapitalize. The stock dutifully falls 5%. I thinks its about half of its 52 week high and sets new lows almost daily.

The CEO has come out twice since the carnage began and has said that he sees no need to either increase their capital or cut the dividend. Somehow he has no credibility. Over 2% of the total stock outstanding is shorted. This is monstrous for a company like BAC. There's either a safe but harrowing 11+% dividend here or a CEO than needs a good whippin'.

 

[RockOn]

I might still include GE, although their business is so complicated that I could never truly feel comfortable owning them.

Certainly the stocks I listed are not immune to downturns, and in a year one or two might be down an awful lot, like BofA or Citibank. I would probably want to add a few more to diversify. I think that as a group they should be pretty safe if you are looking 5 or more years out.

Here is my "I bet this outperforms bonds over the next 5 years portfolio":

The ones I've already listed:

KO
GIS
MO
KR
BUD
JNJ
MCD
MSFT
PG

Some additions to diversify and gamble that banking and insurance will continue to be a viable business:
BRKb
USB
WFC

Some retailers that will likely survive (TGT or LOW could be on the list as well):
WMT
COST
HD

A good company that I just can't help recommending:
FAST

Better get a couple oil companies in there:
XOM
BP

Defense:
LMT

Never dis the mouse:
DIS

If this portfolio is down more than 20% from here on 7/13/2013, I'll give you a gun and a week's supply of my canned goods

You might need the gun if that happens!

I do think your list looks pretty good, you are obviously knowledgeable about lower risk.

Good luck with it. It would be fun to keep track and see how they did in 5 years.