Monday, March 15, 2010

Introducing -- The General Liquidity Challenge

In the last blog post I showed how to make a "Super Simple Oscillator" histogram for the General Liquidity Index. (The GLI is an equally weighted basket of 37 ETFs covering stocks, bonds, commodities, preferred stocks, real estate, currencies, and precious metals.)

Since I started tracking the GLI in November of last year there has been four times (the latest being just last Friday) when the histogram has crossed above or below the zero mark. Here is the histogram again, with the price chart of the GLI below so you can compare:

(Click here to view a google docs spreadsheet of all this data. I update the spreadsheet after every trading day, so feel free to bookmark the URL.)

The first cross of the histogram to the plus side occurred on 12/21/09 as the index closed at 1011.26. The histogram then stayed in positive territory until 1/15/10 when the GLI closed at 1035.01. So a hypothetical purchase of the index from the buy signal to the sell signal would have captured 23.75 index points.

From 1/15/10 the histogram stayed negative until 2/9/10. The GLI closed that day at 979.42. A hypothetical short sell of the index at the sell signal would have captured 55.59 index points of downside.

Then, from the buy signal on 1/15/10 to the latest sell signal on 3/12/10 (Friday) the GLI climbed to 1023.88, so a hypothetical purchase of the index would have got you a gain of 44.46 points.

Add up all these hypothetical trades and you have a total of 123.8 points that could have been made buying the index at each buy signal and then reversing the trade and shorting the index at each sell signal. And that's only in 54 trading days. That's a compounded return of over 13% in less than three months, or an annualized compounded return of over 60%. Not too shabby.

But these returns are obviously hypothetical and would be impossible to precisely replicate in the real world. furthermore, they assume no leverage and do not account for transaction costs or dividends paid or received.

But nevertheless, I like what I see with this trade signal so far. We will obviously see a fair number of whipsaws in the future, and three good trades in a row like we have seen the last few months will probably be a rarity. Still, I think the histogram signal will, over time, prove to be a net winner. If you are a fund manager, or an individual investor with sufficient capital, and are looking for a mechanical system to trade a diversified basket of ETFs this might be just the thing for you. I can even help you set it up. Contact me for more information.

But most of you aren't going to buy or sell an equal dollar amount of 37 different ETFs every few weeks, are you? That is why I am introducing a new feature to the blog called The General Liquidity Challenge.

What is The General Liquidity Challenge?

Instead of buying or selling the entire basket of 37 ETFs every time the SSO histogram gives us a signal, I am going to 'recommend' (figuratively speaking -- see disclaimer at bottom of blog) a long or short position in just One (1) of the 37 ETFs that comprise the General Liquidity Index.

So if the histogram gives a buy signal for the entire General Liquidity Index, I will publish a blog post that that gives a buy 'recommendation' on a single component of the GLI that I think is most likely to advance.

Alternatively if the histogram turns negative, thus giving us our short signal, then I will give you my top short pick out of the 37 possible choices.

The pick, whether long or short, will be held in the Challenge's model portfolio until the histogram signals a trend reversal. At that time we will close the model portfolio's last position and pick another ETF (but this time as a short position if the prior position was a long).

The goal of the Challenge is to out-perform the hypothetical returns of buying and selling the GLI as whole using the histogram signal explained above.

Is this making sense to you so far? The concept is pretty simple, I assure you, but I apologize if I have not explained it very well. If anything isn't clear, please let me know and I'll try to explain it better.

Well, since the histogram just went negative, we have to start the Challenge with a short recommendation. As you know, there are 37 ETFs in the GLI (click here for the list). So many markets to choose from. For the first round of the challenge I am going to play it relatively safe and pick DBC, a commodity index ETF. The entry price for the short sell will be recorded at DBC's open price this morning. I'll try to explain why I went with DBC in the next blog post. Stay tuned.