Corrections are a good time to review whether you're actually on the right track with your strategies. In addition to tweaking my watchlist creation to catch stocks as they become superstocks, I also wanted to review my ETF strategy that I use for my more conservative portions of my portfolio. 

 

This ETF strategy has been described in my previous blogs, and uses a combination of IBD and Morales/Kacher market timing concepts. I'm pretty confident that the timing model I'm using produces real results by making sure I'm recreating my actual live trading conditions. To make this easier, I perform all my buys and sells at the open. I do not consider commissions as this is really dependent on the stake you plan to trade and your broker. Note though, that their effect is far from non-negligible!

 

What I wanted to do here, besides small tweaks and improvements to better simulate real, was try to play different NASDAQ-related ETFs. Not only that, I wanted to see what would happen if I used the ETF itself to generate the buy/sell signal. My premise is that I don't trust ETF volume to give good accumulation/distribution signals. All data comes from yahoo,  where the NASDAQ Composite index ticker is ^IXIC. I also use the index as a reference point to compare strategy results.

 

I decided to use the following bull ETFs:

ONEK: 1x NASDAQ Composite

QQQ: 1x NASDAQ 100

QLD: 2x NASDAQ 100

TQQQ: 3x NASDAQ 100

 

Since the TQQQ is the youngest with data available beginning Feb 11, 2010, I compared them from this data in the following table. Each uses ^IXIC as the signal for buying and selling, and then uses itself as the signal. The first row is as if I'm trading the ^IXIC itself.

 

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From the table above it's obvious that using the ETF itself as a signal is terrible, but using the ^IXIC as the signal and the ETF to buy and sell works out much, much better. Now since 2010 isn't far enough back to backtest over all possible market conditions, I ran the simulations again, this time using only the ^IXIC as the signal, but this time testing each ETF as far back as possible. This gives you larger time frames for each (except TQQQ) and thus a better idea of the long term success of the strategy:

 

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As you can see, the more long term the strategy is tested, the more likely the compounded return will outperform the reference buy and hold return. As I've stated before, commission costs can hurt (1% already is a big effect, but that's another blog...) so outperformance is far from guaranteed. Then you have to consider slip, spread, and all sorts of goblins that can eat up profits.

 

The downside with an ETF strategy like this is that you can only trade one position at a time. Although this makes it easy to analyze, any reduction in risk such as cutting losses, will more directly affect your gains as the risk reduction will also directly interrupt gains. This isn't a CAN SLIM portfolio of stocks where a combo of leading growth stocks, cutting losses and riding gains will lead to index outperformance, as your return is dependent on a low multiple of the index. As well, the gains will never be as big as your best winners on the stock market. The combination of all this plus the cost of trading will definitely lead to underperformance compared to the buy and hold.

 

I hope this sheds some light on index ETF investing. I took a hard hit due to the fake rally that just occurred, and as you can see with the TQQQ, the 11% loss incurred is almost the max single trade loss in the tables above. Not fun, but part of the game.