Weekly Grail Report

“The basic math shows that the vast majority of up AND down days occur when the market has already been declining.”
– Mebane Faber

Mebane Faber has a post from April of last year titled, “Where the Black Swans Hide.” He makes the point that most of the big up and down days in stock market history have occurred below the 200-day moving average.

He also posts this table:

Since 1929 the annualized median return for the Dow when it was above the 200-day moving average has been 13.98%. The annualized median return below the 200-day moving average has been zero.

Even though the fact that the market does much better when it’s trending up than when it’s trending down is not exactly breaking news,  it did cause me to think about how it applies to market history and to our strategies.

It occurs to me that all the really bad things that have ever happened (at least since 1929) in the stock market have happened below the 200-day moving average. The Crash of 1987? Below the 200-dma. The 1998 Russian bond default? Below the 200-day moving average. The  big sell off after the 9/11 attack? Below the 200-dma. The 2008 asset meltdown? The entire year was spent below the 200-dma. Even the 1929 crash occurred below the 200-dma.

It’s not that only bad things happen in the world when the stock market is below its long-term trend line, it’s just that the market has a much more extreme negative reaction to unfavorable world events when it is already trending down. For example, the Kennedy assassination occurred while the Dow was above the 200-dma. The result was that terrible event had a surprisingly mild effect on the market. The Dow sold off about 5-10% and was making new highs within weeks.

It affects our strategies as well.  For example, with the RSI Reversal Strategy I wondered if it does better above the 200-dma than below. And if it does better above, is the difference significant?

Using the S&P 500 index as a test I went back to 1980 and separated buy signals that occurred when the S&P was above its long-term average from the ones that occurred when the S&P was below the average. So far I’ve back tracked every trade from the beginning of 1980 to the end of 1993.

There were 75 RSI reversal trades that occurred when the S&P was above the 200-day moving average and there were 40 trades that occurred below the average. The results were an eye-opener. As I expected the strategy was very profitable, but all the profits resulted from trades that began above the average — all of them. The trades below the average basically broke even.

I stopped at the end of 1993 simply because I ran out of time. But I’m interested enough in this that I’m going to complete it all the way to 2010. And when I’m finished I’ll post the details for members. But I don’t expect the results to be much different than what I’ve completed so far. The profits occur above the long-term moving average.

So, beginning immediately, with the RSI Reversal Strategy I’m only going to take the buy signals that are generated when the ETF is above the 200-day moving average. I’ll ignore all signals that happen below the average.

The strategy is currently tracking 17 leveraged ETFs. As of Friday’s close, the following are above the 200-day moving average: BGU, DGP, EDC, ERX, FAS, MWJ, TNA, TYH and UCO.

The following are below the average: AGQ, DZK, TMF and TYD.

The following haven’t been trading long enough to have a 200-day moving average: CZM, DRN, LBJ and UPRO.

With the ones that don’t have a 200-dma yet I’m going to take buy signals anyway. And then when they have a long-term average I’ll treat them just like the others.

I’m going to keep back testing and studying the results to see how they affect, not only the RSI Reversal strategy, but other strategies as well. For example, with RSI Reversal — as long as ETFs are above the average — it appears that it may be worthwhile to hold positions for greater profits rather than selling when they move above RSI 50. This has exciting implications.  But I have a lot more work to do on that, so we’ll see.

Update: I almost forgot something important. By only taking RSI Reversal signals above the 200-dma it will no longer be necessary to sell half of the position on the first profitable day. The only point in doing that was to take some money off the table early during times when the market really tanks. But since the great majority of those instances occur below the moving average we can now just sell the entire position on an RSI close above 50. That one change alone should add to profits.

Let’s look at what’s going on with the other strategies.

ATR Reversal Strategy

The portfolio is currently about 37% invested, owning GDXJ and DGP. I think silver is close to breaking out to the upside again. If so, it will probably be the next position I buy for this portfolio.

Magic Formula Strategy

MF is a little over 50% invested at the moment. I’ll probably add one or more positions this week.

COT Strategy

The Commitments of Traders strategy is about 72% invested. There is nothing to do but wait until the Blees numbers give buy signals.

Long Term Timing Strategy

The end of the month was Friday. All positions — GLD, SLV, EEM, and SLW — closed above the 10-month moving average (which, by the way, is tantamount to the 200-day moving average). The portfolio is 71% invested. I don’t see any reason for this portfolio to be in cash. So I want to add a couple of more positions. I’ll probably do that this week.

Gold/XAU Ratio

The ratio closed on Friday at 6.92. As long as gold mining stocks are this cheap I’ll continue to buy them. In fact, since GDX closed the month above its 10-month moving average, it’s a prime candidate buy it for the Long Term Timing strategy.

Have a prosperous week,

Larry