FundVision Classic Collection - Art's

Author: Art

Hi Mike

As promised, I thought I'd share a few points and lessons learned with regard to trading leveraged funds at Profunds. Most of this is generic but if their are differences between Profunds and Rydex, I'll trust Carl or Jerry will make known any differences.

Advantages:

1. It's obvious that when the market is strongly trending up, like it did last fall, leveraged funds can make you a lot of money very quickly. That's obvious so I won't belabor the point other than to say that Ultra Mid-Cap is in a fairly nice up trend and I have owned it off and on (I do now) but I should have held this one longer than I have.

2. For those investing within an IRA, there are some real advantages since, as you know, you cannot use margin from within a retirement (IRA,401k) account. With proper money management techniques, however, you can use the leverage feature like margin since you have the potential to be 150% (sector funds) or 200% (broad market funds) from within an IRA. That's a real advantage.

3. As you know, you cannot short a stock/fund within an IRA or other retirement account. Yet, you can go long a short fund such as Bear, Ultra Bear or Ultrashort OTC. That's a real advantage under certain circumstances.

4. Administratively, there are no limitations on the number of trades or how often you can trade at Profunds which has a major effect on your strategy. Since there is no cost nor limitations on trading, you can concentrate on the market, individual sectors and your portfolio. This also is a real advantage because you can afford to take a chance, get in early and take advantage of potential opportunities as they arise. If you are wrong, simply exit. No problem at all.

Disadvantages:

1. The obvious first disadvantage is that if you are long leveraged funds and you hold them, you can lose a lot of money very fast. Even faster than you can make it in an uptrend.

2. Leveraged funds are different than ordinary funds in several other significant ways. You will find that if you own a 200% leveraged fund and the index goes up 1%, your fund will normally go up 2%. No surprise there, that's what it's supposed to do. Yet, if your are long the leveraged fund and the index goes down 1%, you be show a loss not of 2% but often 2.25%-2.50%. That's the nature of leveraged funds. You don't want to be on the wrong side of the trade. Of course, you can't avoid it completely but you can minimize it. Don't take my word for this, however, but check it out yourself and see if you don't come to the same conclusion. One way to check is to observe the gains made in Ultra Bull which tracks the S&P500, for the last few years. If the S&P500 made 25% (for example), Ultrad Bull should gain 50%, correct? Yet it never does and is more likely to gain in the neighborhood of 38% instead. Losses always count more than gains with leveraged funds. It's important to understand this as it will/should affect the strategy you develop to trade these funds in an optimum fashion.

3. With the above in mind, consider trading ranges and the following example. As you know, Ultra OTC tracks the NDX or Nasdaq 100. Suppose the NDX entered a trading range for a month bouncing between 49 and 50. No problem right? Well, not quite. Remember, every time your leveraged fund goes down it loses a little more than when the index goes up a similar amount. So, if you are in a trading range for an extended period of time and you decide to hold a leveraged fund, don't be surprised if you find you are losing money in your leveraged fund although the index is flat. I tried to find an obvious example of this but with the makret this year it was hard to find a good one. Yet, consider the NDX between 6/2/00 and 7/6/00. On 6/2/00 the index closed at 3756 and on 7/6/00 it closed at 3793 for a gain of about 1%. Profunds OTC, on the other hand, was at 83.06 on 6/2/00 and closed at 82.62 on 7/6/00 for a loss of .53%. Therefore, there was a 1 1/2% difference the index and Ultra OTC during that period. That doesn't seem like much but it makes the point that, if you hold leveraged funds, you can be losing money even while the index it tracks is making a gain. This is an important element to be aware of when designed a trading system for leveraged funds, IMO. Being invested the whole time would have netted a loss of about 1/2%. Yet once you observed the trading range patterns (2 down, 2 up), it was not difficult to wait for 2 down days and then invest for 1 day. Had you done that just once, you would have come out of the month with a nifty profit instead of a loss of 1/2% and there were multiple opportunities to make that trade. In addition, it spiked up on one occasion but when it started to regress, you could immediately tell that it was heading back to the trading range whcih presented a short opportunity. Now, you know why I call these funds opportunity funds.

Conclusion:

I've had my best luck this year waiting for the right opportunity and then investing even if it's only for 1 day a week. On some of those up days the index goes up 2%-3% which means you make 4%-6% which for most funds is a good month and you did it in a day. The key is to wait for a good opportunity and then take advantage of it. A good opportunity is when you observe the index hit support or resistance and the odds are with you that the index will move a certain direction. Another opportunity occurs when you see a pattern develop. Carl and I played the down Monday pattern for months. I keep playing it as long as it repeats. When it stops, I stop. Will you takes some losses? Of course but the idea is to minimise the losses. Of course, that's important in all funds but even more important in leveraged funds, IMO, for the reasons mentioned above.

One additional point:

The addition of Sector funds to the Profunds/Rydex lineup is a huge advantage from a strategy persepective. If you consider that there are times when certain sectors may do well even while the broad market regresses, you can use that to your advantage. That is, if you think the broad market is going to regress yet energy, telecom and utilities (for example) will go up, you can be long those sectors and at the same time use Bear, Ultra Bear, or Ultrashort OTC to short the broad markets. Ideally, you can have your sector funds making you money (150%) while the short position (200%) also makes money or at least protects your long positions against a reversal. Obviously, proper money management is a very important part of any investor's strategy but because of the latitude leveraged funds give you, it's even more imperative to incorporate sound money management principals into leveraged fund investing. During low risk situation you can be 200% invested yet when the market is at risk, you can be anywhere from 0% invested to 200% short. That's a huge range in which to make risk/reward decisions. The advantage of Profunds, Rydex and others is that you can concentrate on the levels of exposure and the sectors you may want to be invested in and completely ignore such mundane things like ERFs or the number of trades you made in the last 30,60,90 or 180 days. Such thing should never enter into a decision to trade.

Hope this gets you thinking about a few of the elements involved in trading leveraged funds. As I said, don't take my word for any of this but check it out for yourself and then develop a strategy to take advantage of the strengths and weaknesses of leveraged funds. The point of all of this was simply to get you looking at a few thing that are different from investing in regular funds. You may decide to ignore any or all of these points when you develop your strategy which is fine. At least you are aware of them and have taken them into consideration and that was the point. The point is, if I can make 1 or 2 good trades a week using leveraged funds, I can make a heck of a return over a month. It takes patience to wait for it but opportunities are always presenting themselves.

Hope this helps.

Cheers

Art

Author: Art

In Reply to: Re: Thanks and Opinions posted by Ed Parlier on September 11, 1998 at 00:30:19:

Hi Ed/ gang

I always look forward to your cogent posts and I'm personally glad you decided to share some of your experience here.

"I used to think I could read a trend ("the trend is your friend"), however, lately it seems that the moves are so large, so quick, that it's more likely to be whipsawed than to make any money."

I agree. In fact, my strategy was to trade trending markets only or ,at least individual funds that were trending. My TA indicators, strategy and money management techniques were all set up for trend following. I never had much success when trading outside the trend environment either. Then a 3-4 months ago jerry, Sid and I were talking about trading Rydex funds which were in a trading range so we did a little preliminary work on trading ranges. It because apparent that new strategies and parameters would have to be devloped as my "trend following" system was inadequate to pick up the reversals. Keep in mind, the market was only moving up or down within 50 points (almost nothing *smile*) at that time. Then I read a book called Trading as a Business that hit a cord. It was very consistent with what successful traders were writing about trading multiple markets. I have heard many successful traders conclude that an investor must be able to trade multiple markets but I wasn't exactly sure what was meant by that statement. My initial impression was that successful traders might trade the commodities or currency markets as well as stocks but this book and the current market clarified the issue for me. It isnt trading different things, multiple markets actually means trading three different types of what we call "the market". If you think about "the market" as three separate markets, the reason for the current difficulties become clear. The reason you were getting whipsawed is because the market changed to a different market but you didn't change with it. That was the point the author was making with his multiple markets comment.

First, let me say that Omega gives this book away because they are trying to get you to buy Tradestation. In the process, they explain the steps required to build successful trading systems for multiple markets. They discuss, indicators, strategies and money management techniques that you can program into Tradestation to build a trading systems that work in multiple markets. No single trading system, according to the author, will work in all three markets, I agree. The current market seems to clearly illustrate that fact as reflected in your comments and my own experience.

BTW, I agree with much (not all) of what the author has to say but disagree that Tradestation is necessary to accomplish them. After all, developing a trading system is no more than sitting down and deciding on what technical indicators, strategy and money management techniques you will use to trade the current market. Tradestation may automate the process and assist in back testing but investors must still design the system to program into Tradestation based on the current market. You may have to decide when to implement the different strategies but you can do all those things with a much less expensive program like Supercharts, IMO.

In addition, I believe there are always 4 considerations when trading any market. These elements are mentioned over and over by those who trade for a living and are rather intuitive. There is 1 constant and 3 variables to consider when making a trade. Fundamentals are a constant across all markets and while I certainly think they are important, I don't consider fundamentals a variable since it is common to all three markets. It simply means, knowing what is happening in the market. The variables Include: Technical Analysis techniques, Strategy and Money Management Techniques (MMT). Using the same trend following indicators, strategy and money management techniques in multiple market scenarios will simple not work, at least for me. Others may have more expertise than I.

The Three Markets: The author makes the case that the 3 markets are Trending Markets, Directionless Markets and Volatile Markets.

1. Trending Markets: All of us know what a trending market is so I will address just some of the less obvious points. The first point is that trend says nothing about direction. It could be trending up or down. Historically, the market only trends 30%-40% of the time but this is where 75% of an investor's ROI is made or lost. It is as important to be "in" the market near the beginning of a trend as it is to be "out" or "short" the market near the end of a trend.

2. Directionless Markets: This is the author's term so he can differentiate it from Volatile markets but I still call it a trading range market. If it is true that the market only trends 30%-40% of the time, then it is logical that from 60%-70% of the time, we face a "Trading Range" or "Volatile" market. This can often be a simple consolidation after which the trend will resume or it can pre-announce a decline as buyers are unwilling to pay higher prices for stock. These can be lengthy as in 1994 or relatively short as the 3 month period prior to the summer rally. In a trading range market, the day to day variations in price are considered to be within normal day to day parameters.

3. Volatile Market: This can be mistaken for a trading range market because it often occurs within a specific trading range which is why the author distinguishes the two by calling one a "Directionless" market and the other a "Volatile" market. A popular misconception is that the market is volatile just prior to a major correction. This is not normally true. Historically, volatility increases "after" a major correction or bear market has begun or during a flag (interuption in a trend) pattern. Also, they can and do occur in series. In other words, you can have a steady decline, followed by a period of volatility while the fund or market is in a volatile trading range and then it smoothly declines followed by another trading range and another period of volatility as a new support and resistance level is achieved. There are two major differences between Directionless or trading range markets and volatile markets however, The first is duration. "Trading range" markets can last a fairly long period of time, often from a few months to as long as a year. "Volatile" markets usually occur with much shorter duration, usually no more than 1-3 months. The second difference is the large single day percentage increases or decreases that occur in a "Volatile" market. Consider that you can have a 3%-8% increase or decrease in 1 or 2 days when the market is Volatile. An 8% gain, under normal circumstances would be a very good month. This alone requires a different strategy than a trading range or trending market. Out of the last 8 trading days (prior to today), 7 had moves of 300 Dow points or more. This means that the market either went straight up/down 300 points or dropped 100 points, reversed and gained 300 points with a resultant 200 point gain in the DOW. That's incredible, IMO.

Indicators, Strategy and MMT:

I started to respond with the indicators, strategy and MMT I was using in the three markets but decided that this was getting to be a book. It can be covered in more detail later and everyone should use the indicators, strategy and money management techniques they are comfortable with anyway. Besides, I wanted to discuss the 3 market concept. If members don't believe in this 3 market concept, a discussion of the indicators, strategy and MMTs you might use is a moot point anyway *smile*. So, for this discussion, let me stick to the main issue, yet still attempt to answer your original question, How is my experiment doing?

I cannot call my experiment successful. Although I did make a small profit, the reason I was not successful in the 2 weeks I used the system is that I was using trading range parameters to trade a volatile market and got the results I deserved. Most of the gains were gone on the transitions because of high day to day price variation. It was a relatively safe approach but it didn't work well from a profit perspective and definitely wasn't worth the effort so I stopped and went back to neutral until last week (week ending the 4th). Keep in mind, I back tested my system on the same S&P500 fund using the early summer trading range and a trading range from last year. The system worked great as long as the fund was in the trading range but it didn't call breakouts well so I added a normal trend following indicator to identify the breakout if there was one. I back tested the system and it worked great but it didn't work in this environment so I went to back to cash after 2 weeks. Then I read the book, Trading as a Business and it was as if a light was turned on. The reason it didn't work this time is because we were not in the Directionless or trading range market I tested it on, we are in a volatile market. No small wonder it didn't work.
I want to be able to trade all three markets but what do I do for indicators, strategy and MM techniques. I can deal with trending markets and I'm getting better with trading range markets, Volatile markets, such as we have now are a different matter all together. I honestly don't know the best way to trade a volatile market with mutual funds. It would seem easier if you are able to trade intraday but I don't have the option to short SPY within an IRA. The Bull/Bear funds available at present are EOD funds so it is obvious that if I was going to trade at all in a volatile market, a new strategy would have to be devised.

New Strategy:

1. I decided the key to making a profit quickly is a hit and run approach, from the title of the book. In this context, the entry point and exit points are key. If the market is indeed trading between 7500 and 8100, then it is necessary to wait for a reversal, confirm the reversal and then exit prior to the next reversal. After the 360 point gain early last week, I noticed that resistance held. The following day, there was no follow through on the gain and in fact it reversed direction. My strategy requires that I confirm that reversal so as to avoid going short on a breakout of resistance. The following day, the decline continued so I shorted the market using Prubear. Thursday, the market was down 250 points (Prubear was up 6.7%) but I was within 200 points of support at 7500 which required an exit by my strategy since 200 points is a normal day these days *smile*. I really didn't want to sell because Friday was the day that Star's report was going to be released and I though the market might continue down. But, if you don't follow your strategy, there is no sense having one, so I sold. Good thing, the market started down Friday and then reversed as it hit 7518 interday. Many say it was the Clinton prayer breakfast apology but I think it simply hit support at 7518 and buy programs kicked in. I should have gone long on Friday but I didn't have the guts since the market would have all weekend to contemplate the Star report. Still, 6.7% is a good month under normal conditions and I made that in one day, why get greedy? Although the market is volatile, my major concern is still avoiding losses so picking a safe entry and exit point is still critical to my strategy.

2. Technical Indicators: Most are not much use in this environment at my level of expertise. Support, resistance, channels and trend lines are all I'm using. Everything else is to slow. If I get a safe 1-2 day bump per week in this environment, that's fine with me.

3. Money Management techniques: Since this strategy is new to me, I should be using monopoly money but I don't want to miss the opportunity to trade in real time. So, I'm only investing 20% unless we see a breakout from the current trading range either up or down. I am calculating the results as if I was investing 40% to see if I would achieve my goal of 7%-8% at that level. I am also calculating what the return would be if I traded Profunds Ultra Bull/ Ultra Bear on the same days. I know this is not as aggressive as some others but hey, I'm new at trading volatile markets. For years, I was content to just be on the side *smile*.

I'm looking forward to hearing from others on their strategies and techniques in this market. As I said, mine is not aggressive at present but if it works as expected, and confidence improves, there will be plenty of time to become more aggressive. I'm just not there yet. As everyone knows, I'm chicken *smile*.

I hope this answered your question.

Cheers

Art

Author: Art

Posted by: Art on April 13, 1999 at 18:51:40 In Reply to: Re: Which fund families allow daily trading for free? posted by Paul on April 13, 1999 at 18:10:26

Hi Paul

"I am just curious, what is a reasonable number of trades an active fund trader should be targeting. Do most of you switch funds every day, or just once in a while?"

There is no correct answer to that question. You trade as often as you need to depending on your strategy. I know that sounds like a non answer but it's a fact. I went for years never trading mutual funds in less than 30 days. But, has the market become more volatile, you need to trade more often. Suppose, I suggest a number like 15 trades per year. Then assume I have 10 funds in various sectors but all my indicators say that there is a correction emminent so I sell. Sure enough, the correction does occur and you get back in after a 10% correction. How many trades did you have for the year? You had 20 trades correct? Is that too many? Not in this case it isn't. Now suppose the correction from above doesn't happen so you get back in but a few months later you again indicate a posible correction. Do you stay? In addition, what happens during the year if 4 or 5 of your funds suddenly go out of favor. Do you trade them or do you hold them and lose money hoping they will come back at some point? Only you can answer that, right? I have a low risk tolerance so I trade whenever things look dangerous to me. Others can accept a 10% correction or more without batting an eye.

Bottom line: How many trades you have during the year depends on the market and your risk tolerance. I don't know if there is an average. I tend to concentrate on the market so I try not to let the number of trades or the cost of trades interfere with the trade. As any good investor will tell you, let your winners run but cut your losers quickly.

Profund and the other funds you mentioned are fairly new and no they don't have international funds as yet. If you are new to act8ive investing (controlling your own risk) I would not recommed them for you anyway. Profunds "Ultra" funds track the S&P500 and OTC markets but at twice the horsepower. IOW's if the S&P goes up 2%, this fund goes up 4%. OTOH, if it declines 2%, you are just as likely to see a 4%-6% decline because of the derivitives they use. It's important that you are not on the wrong side of these funds. When you are on the right side however, the growth can be spectacular. I believe OTC was up about 170% last year.

I'd suggest getting your feet wet with conventional funds and going slow. You are going to be investing for many years so there is no hurry. It's much more important to learn a strategy that will keep you in for the gains yet keep you out for the losses. You will make mistakes, espect that and learn from it. Once you have developed some confidence in avoiding losses, then you can go for the higher flying funds. For now, just play safe and learn the craft. Don't be afraid to ask questions, there is some real talent here and most will be only too happy to offer advice. Just keep in mind that you are the final authority and the captain of your ship. You will receive the gain and suffer the losses so make sure it's what you want to do.

If you stay in house, Fidelity has a number of good funds as does Invesco. Possibly others can offer some additional companies that they have first hand experience wtih.

Hope this helps.

Cheers

Art