Follow the market s trend for investment success

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1 Follow the market s trend for investment success Abstract: The study of stock market history exposes the grave risks that buy and hold investors face during significant downturns. Few of us could take the losses that markets have and will continue to deliver from time to time. Because markets move in trends and cycles, it is possible for an investor to avoid these damaging downturns and ultimately beat the market. This white paper reviews practical approaches to identify broad market trends and use these trends to profit from both up and down-trending markets. The specific strategies presented here provide investors with an effective "all-weather" alternative to buy and hold investing that can be easily implemented with cost-effective ETFs. For many decades, investors have been told that buy and hold investing is the best path to investment success. Buy-and-hold is a simple strategy that is a favorite of Wall Street brokers and large segments of the investment industry. The key tenet of buy and hold are to remain fully invested in the stock market, all the time, for the long term, regardless of what happens. Supporters of the strategy base their conviction on several arguments: In the long run markets go up, with stocks averaging a 10% return over many decades Markets spend more time in bull markets than bear markets (40 months, on average, for bull markets versus 9 months for bear markets) Taxes are lower when not actively trading (all capital gains become long term by holding our positions) Costs are lower (no active trading means few transaction fees) Buy and hold investors respond to risk through portfolio diversification - owning a broad mix of stocks. As a tacit admission that the risks during bear markets might be too severe for some investors, buy-and-hold proponents put forth the concept of asset allocation. Instead of risking your entire nest egg in the stock market, the buy and hold investment wisdom suggests we place a portion of our assets in other investments such as bonds, because they are not affected by stock market vagaries. The result of such asset allocation is that you increase your odds of achieving average results, but never realize exceptional results. On the other hand, younger investors are usually told they have plenty of time to let their investments grow and, therefore, are left exposed entirely to the whims of the stock market. What really kills the buy and hold argument are the losses incurred during bear markets; and the subsequent amount of time it takes to recover from those losses. Over the past decade, stock markets have dealt investors two periods of 50% or greater losses. Stocks have indeed recovered these losses, but it s taken years to do so. Looking at the 14 bear markets since 1929, the buy and hold investor would have lost an average of 39% and waited an average of 5.2 years to recoup her/his money. And if that sounds bad, how about the 87% loss incurred by the faithful buy and hold investor after the 1929 crash; a crash which took over 25 years to get back to even. While we once thought such a crash was relegated to history, market events of 2008 reminded us that markets remain as fragile and dangerous as ever. Avoiding these major market downturns is THE KEY to becoming a successful investor and building our wealth. To improve our ability to sidestep bear markets, let s take a look at some important market characteristics: Markets move in trends Anyone looking at a graph of the stock market can readily see that stocks do not bounce around in random fashion but display clear organization and patterns. Stock market prices move in trends. These trends can be up, down, or sideways. They can be of short or long duration. Looking at the last twenty years on Chart 1 below clearly reveals the long-term up trends and downtrends corresponding to the major cyclical bull and bear markets. There are also longer duration trends called secular, or

2 generational, bull and bear market cycles lasting between ten and twenty years. Within the cyclical market moves are shorter trends too. There are pullbacks, generally defined as declines of up to 10%, with more severe declines between 10% and 20% referred to as corrections. Rather than only profiting when stocks are rising and just enduring losses when the stock market is falling, savvy investors can exploit these major trends, be they up or down, by investing WITH the trend. By investing with the trend, we can make money both when stocks are rising AND when they are falling. The challenge is to recognize the significant trends at the earliest possible moment without getting tripped by the innumerable false alarms along the way. Chart 1: Long-term trends Finding the dominant market trend The two main schools of investing research are fundamental analysis and technical analysis. With fundamental analysis, economists and market strategists seek to determine future economic trends which might drive the market as a whole, or more specifically, a sector or company. Broad economic measures such as employment levels, store inventories, aggregate corporate profits, and interest rates can all be indicators or catalysts for stock market movements. Analysts use these indicators to try and determine a theoretical value, also called an intrinsic value, which serves as a target price for the investment. We buy the investment holding it until the target value is reached, at which point we either reassess our target, or sell the investment. To some degree, buy and hold investing argues that we are just buying the economy and that steady economic growth will drive stock prices ever-higher. The main issue with fundamental analysis is that the markets are influenced by so many other factors that market movements may or may not track the fundamental economic trends. A larger issue with relying on economic trends as an investment tool is that markets are discounting mechanisms. This means that markets are always looking forward with investors trying to anticipate the future. This forward-looking nature makes the stock market itself one of the most reliable leading indicators of the economy's future direction. Thus, stocks often predict the economy, not the other way around. Instead of attempting to measure a market or a security's intrinsic fundamental value, technical analysis strictly looks at past and present market data. The theory being that markets move in somewhat predictable and repeatable patterns of supply and demand. The reason for these recurring patterns is that investors are driven as much by emotion as by fundamental

3 economic information. They move back and forth between bouts of fear and greed which lead to buying and selling cycles in stocks. Because of this focus on cycles, trend lines are among the most widely used technical analysis tools. Trend lines allow us to easily spot trends and changes in trend. Trends can be long-term, multi-year cycles, or short-term cycles lasting days or weeks. One popular approach uses lines calculated from varying moving averages to detect changes in trend. Whenever the shorter-term moving average line is above the longer-term moving average line, we are in a predominant bull market; otherwise we are in a bear market. An example using these moving average crossover signals is shown in Chart 2 below. The chart combines longer simple moving averages (125 and 250 days) to issue Buy and Sell signals for the S&P 500 ETF (SPY). When the short-term average crosses the longer-term average to the downside, we have a Sell signal. When it crosses back above, a Buy signal is issued. The trouble with moving average systems can be that signals will lag the market and perhaps by quite a bit of time and movement. Thus, our signal would be fairly ineffective, getting us out of the market after much of the downside has already occurred. If faster parameters are selected, excessive false signals can be generated leading to frequent, back-andforth whipsaw trading. The same parameters will not work equally well at all times and for all markets. Chart 2: Trend based Buy and Sell signals The trend detection techniques referenced so far, such as moving averages, focused primarily on price and how it evolves over time. There are other techniques applying volume as an indicator of acceleration, momentum and money flow, which can assist greatly in pointing out trend changes. Many in the investment community have come to recognize institutional investors as a force behind substantial market movements. Institutional investors including banks, insurance companies, mutual funds, and pension funds, are often collectively referred to as "the big money" or "the smart money". They are the elephants (the big, heavy investors) in the swimming pool (the market). The more elephants jump in, the more the water level (the price) rises. When the elephants go home, the water level (price) drops sharply. Numerous studies have shown that as a group the institutional investors have a huge influence on individual stocks and the market in general, which is why so many try to understand and emulate what institutional investors are doing. It s not so much that the institutional investors are necessarily that much better at investing. After all, almost all mutual funds suffer heavy losses in bear markets too. But their actions drive prices, do so in high volume,

4 TimingCube and investors react to those changes in price and volume. Thus, the collective movements of institutions can make the markets and create a stampede effect in prices. Changes in trading volume, and the direction of price movements during these changes, can be telltale sign of what institutional investors are up to. The theory behind volume indicators is that quite frequently high volume trading precedes major price moves. We measure these high volume moves by counting accumulation and distribution. An accumulation occurs when the price of a stock or index closes higher AND with increased volume. Conversely, a distribution takes place when the price of a stock or index closes lower AND with increased volume. One-day accumulations and distributions are not significant by themselves. But a flurry of accumulation or distribution over short periods of time indicates a collective decision by large investors. These collective decisions are enough to define or change a market s trend, bringing in other investors in an almost self-fulfilling herd mentality. TimingCube's Trend Timing approach For the reasons outlined above, TimingCube has developed innovative investment systems that seek to read broad stock market trends. Our Trend Timing approach offers directional guidance for investors. At the heart of the system lies our 100% mechanical, unemotional models that are powerful and simple to use. Our models issue clear, definitive Buy and Sell signals. The result is an effective "all-weather" alternative to buy and hold investing. Our Classic Model serves longer-term investors who are interested in where the market is likely headed in the next 3 to 6 months. Classic gives us an average of 3 to 5 signals per year with average signal duration of 3+ months. We are trend followers and cannot predict how long a trend will last, nor how strong it will be. No one can. We are strong believers in listening to what the market is telling us, recognizing the predominant trend, and following it. While our proprietary Classic Model does look at various indicators such as moving averages, it leans most heavily on the relationship between price and volume action. The Turbo Model applies our proprietary methodology to shorter-term market movements. Sometimes Turbo is content with following the market s broad trend, lingering in a signal for weeks or months at a time. In more volatile market times, however, Turbo becomes a high-powered trading engine seeking any opportunity to squeeze profit from the market s gyrations. Thus, our Turbo Model offers an excellent companion to our Classic Model in addition to being an outstanding standalone investment tool. Whether your preference is to simply protect your portfolio from bear markets, or to more actively trade market directions, TimingCube offers a compelling solution. Our primary Long and Short Strategy is designed to profit whether the market is going up or down. We believe this strategy offers the best risk/reward ratio for most investors. It keeps you invested whether our models tell us that the predominant market trend is up or down. Both of our models are built around the Nasdaq indexes, though investors can apply the signals to the index(es) of their choice. On our website, we actively track and report on the ETFs tracking the Nasdaq 100, Russell 2000, and the S&P 500. But there are many other choices. The majority of market indexes have ETFs to go long or short (via inverse ETFs). Our Classic Model also offers the potential to drive better gains through building a portfolio around the strongest world markets. During Buy signals you invest in the Top 5 world ETFs from our proprietary World Ranking list, rebalancing every 4 weeks. During Sell signals you simply short the Nasdaq 100 by purchasing the PSQ or other inverse ETF of your choosing. A somewhat more conservative Long Only strategy follows all the same steps on Buy signals while simply going to cash during Sell signals. Our investment selections

5 We focus on broad stock market indexes, and believe our strategies work best when implemented with ETFs. There are several advantages of investing with ETFs. They are one of the most low-cost investment vehicles. They provide built-in diversification, excellent transparency, and, for the major index ETFs, have substantial liquidity so that you get good pricing. Still, all ETFs are not created equal and we strongly recommend staying with true equity index ETFs. When we refer to ETFs we are NOT talking about using closed-end funds, or Exchange Traded Notes (ETNs), or HOLDRs. These special types of funds all have drawbacks which make them unattractive for our purposes. If your preference is to simply time the U.S. markets with a Long and Short strategy, you can buy the many ETFs tracking the broad U.S. stock market indexes such as the Nasdaq 100 ETF (QQQ), the Russell 2000 ETF (IWM), and the S&P 500 ETF (SPY) during Buy signals. During Sell signals you dispose of these ETFs and replace them with their inverse counterparts PSQ, RWM and SH respectively. TimingCube Results We introduced the original TimingCube Classic Model in For illustration of the effectiveness of our investment approach in all market phases (bull, bear and trendless), we show the hypothetical growth of a $10,000 investment since the inception of QQQ (March 10, 1999) in Chart 3. Our recently launched Turbo Model offers even more dramatic potential returns. We believe such returns make a strong case against buy and hold and demonstrate the compelling value of our investment strategy. Chart 3: TimingCube Turbo and Classic Model equity curves as of February 2011 Turbo Model Long & Short QQQ strategy vs Buy & Hold QQQ Classic Model Long & Short World strategy vs Buy & Hold QQQ To conclude, we want to emphasize again the simplicity and power of the TimingCube approach. Through our menu of two completely independent models with very different personalities, TimingCube provides unique tools designed to help investors achieve outsized returns while avoiding the damaging effects of bear markets on our hard-earned wealth. We think you can see why we feel that our TimingCube systems offer a Better Approach to Investing! For more information, please visit TimingCube at or contact us at: support@timingcube.com for any questions you may have about this Free Report or about our service.