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MLR - Q&A - Why has the model been switched more in 2011 than in prior years? What are the returns of the model year-to-date? Decay issues with leveraged ETFs?

Q: I was looking over the history of the MDM. It seems the model has given nearly twice as many signals in the last 12 months compared to most other periods. Has the makeup of the model changed somewhat or is it just due to the extreme volatility?


A: 2011 has been one of the most challenging years on record. That the model has made nearly twice as many signal switches in 2011 [as of October 27, 2011] speaks to this. The first half of 2011 was a go-nowhere, more or less trendless market environment, the most challenging of environments for position traders and trend followers. Fortunately, the model's fail-safes kept losses on false signals to a minimum during the first half, then capitalized on the drubbing the market received in August, thus the returns for 3-times ETFs using our Market Direction Model are around triple digit percentage gains so far in 2011.

Due to the trendless, volatile nature of 2011, the Trend Following Wizards have been underwater as a whole:

Trend Following Wizards Year-to-Date Performance as of September 2011




Q: What are the returns of the model year-to-date?


A: Our members usually just go here https://www.virtueofselfishinvesting.com/results and calculate the returns using various timeframes.

For example:

Since the June 30, 2010 sell signal, using NASDAQ Composite $1 would have grown to $1.34 or a 34% gain up to October 26, 2011 close.
Since the June 30, 2010 sell signal, using TNA $1 would have grown to $2.19 or a 119% gain up to October 26, 2011 close.

Year to date, using TNA, $1 would have grown to $1.75 or a 75% gain up to October 26, 2011 close.



Q: Why short a normal leveraged ETF instead of just buying an inverse leveraged ETF?


A: Shorting a normal leveraged ETF instead of buying an inverse leveraged ETF removes the decay factor. On decay issues, please read:http://seekingalpha.com/article/223261-shorting-with-etfs-3-things-to-consider?source=yahoo

As the article points out, decay works to your disadvantage in volatile markets that go nowhere, but works to your advantage in strongly trending markets. For example, if you look at the NASDAQ 100 vs it's 3-times ETF TQQQ from the low of 8/27/10 to the high of 11/9/10, the NASDAQ 100 was up 25.9% while the TQQQ was up 97.3%, or nearly 4x the NASDAQ 100!

Since the model switches signals on average between 12 to 20 times a year and usually exits after the uptrend or downtrend reverses, decay should have only a small impact if any.

That said, some may wish to take the decay advantage/disadvantage out of the equation by shorting normal leveraged (2-times and 3-times) ETFs on a sell signal instead of buying inverse ETFs provided you can get the borrow. Be careful of high fees associated with shorting ETFs. In our experience, there are enough ETFs out there that can be borrowed with little to no fees.

This should address the issue raised today on MarketWatch: http://www.marketwatch.com/story/leveraged-etfs-are-the-worst-investment-ever-2011-10-28?link=MW_home_latest_news

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