Frequently Asked Questions
The systematic portion has the 35+ year historical advantage. The discretionary portion has the advantage of position sizing. We will give an example here that was a loser to illustrate the challenges of working with the model. It would be easy to give any of the many examples that were profitable but we’ve always believed that more learning comes from challenging situations. Thus on the weak November 9, 2009 buy signal, I only bought a 50% position in QQQQ. As distribution days continued to mount, the model found itself on a standby sell signal. Once the sell signal was triggered on November 19, 2009, I immediately switched to a 30% position in FAZ which is the 3-times leveraged Direxion Financial Bear ETF. I switched into FAZ because the financials had lagged the major indices for months and a 30% position in the FAZ is effectively a 90% short position in the XLF, the SPDR Financial ETF. I then bought an additional 30% position in FAZ once the NASDAQ Composite index broke below the lows of November 19, 2009. Once new lows were made again on November 27th, I bought a 30% position in TYP, the 3-times leveraged inverse ETF called the Direxion Tech Bear that is also a good inverse proxy for the NASDAQ Composite Index - it will rise when the NASDAQ falls. I decided to diversify into TYP even though I was even more bearish on the financials given the fundamental backdrop of the United States economy at the time. Having this 90% position in triple-leveraged inverse ETFs put me at an effective 270% short exposure and an average cost below where I had bought the three positions, thus I had reasonable cushion.
In practice, investors can decide whether to employ the discretionary portion using leveraged ETFs or the "plain-Jane" systematic portion where the model simply goes 100% long or short the QQQQs if it is not in cash. Also note that after November 27, 2009, the market turned back up yet again as so-called "quantitative easing" by the Federal Reserve continued to help the markets move higher, a recurring theme since March 2009. After November 27th, the model’s self-protection mechanism kicked in, which reversed profits but protected capital, so that losses were contained to less than -3%.