Frequently Asked Questions
Our observations over the years, especially over the last decade, is that a strategy we call Open Window would only take the highest probability trades in the highest probability environments, namely when the window of opportunity is wide open. The issue with this strategy is that it tends to be very difficult to execute since in less-than-ideal environments, money can still be made, so it runs counter to the trading psychology of wanting to be in the action. In practice, however, the great paradox is that profits earned by waiting for just the right times would often be greater. Of course, in trading, a 50% success rate during a strong bull market is admirable, thus position sizing, pyramiding winning positions, and being quick to cut losses is key.
Open windows are rare. On the long side, they are detected by a confluence of high quality stocks issuing buy signals such as in March 1996 when MDM was neutral but a number of excellent leaders started to break out of sound basing patterns. This also occurred in Aug-Sep 2006 with a large number of names issuing pocket pivot buy points.
On the short side, over the last 20 years, the market tends to move lower quickly, so the open window is harder to identify, though can be done if enough former leaders are forming various deleterious price/volume patterns such as PODs and weak, dead cat rallies into resistance.
In 2011, the markets were the opposite of open window, as trendless, gap up/gap down news driven volatility was the order of the day. Then in 2012, an illusory uptrend from January to March was difficult to capitalize on after such a lengthy period of seeming randomness. That said, MDM was able to outperform the general markets in 2011 by capitalizing on the few strong signals which more than outweighed losses from false signals.
Nevertheless, 2012 presents new challenges above and beyond what we observed in 2011. As we wrote in a prior report:
The trend following wizards as a whole continue to be in the red for 2012 (as of end of March):
Even the great Bill Dunn (Dunn Capital) and John Henry (JWH & Co) who were both interviewed in Michael Covel's Trend Following Wizards are down double digits as of end of March (-10.62% and -17.26%, respectively), even though the general market had been in a 3 month uptrend, with the NASDAQ Composite up +18.7% year-to-date as of end of March and up +13.4% year-to-date as of Friday's close:
There is no data as of yet for the month of April or May, but given the mushy, trendlessness in the general markets since end of March, we would imagine losses for these trend following wizards have worsened.
This speaks to the highly unusual and challenging market environment that has so far been prevalent in 2012. Such aberrant periods are not self-sustaining and have always come to an end. For example, in 2011, the model had a number of false signals, up until its series of true signals beginning on August 2, 2011, which more than made up for the small losses as tracked on the NASDAQ Composite thus MDM was able to outperform the major markets in 2011. Just as patience was required by July of 2011 after a series of false signals, we see a similar situation in today's market environment. As we have recommended in past reports, one might pyramid slowly into their ETFs/ETNs so less is lost should the signal prove false, especially in the challenging environment that currently exists.