As our mid-term model is currently going through a period of drawdown, it is a good time to look at how our model was designed and what makes a successful stock market model in the long-term. Our mid-term model was based on the concept that we could accurately detect extreme overbought and oversold conditions on a mid-term level often enough to make a large amount of money in the long-term. Our system was designed with statistics in mind and therefore will perform in correlation with how well the days and weeks ahead in the stock market act like they have in years prior. If statistically speaking, there is a 75% chance we are still in a bull market, the long trade will hold up three out of four times. How should we react the 25% of the time when the model doesn’t hold up? This is where the difficulty in designing a model lies.

 

One of the reasons we have been long since January is that our systems are telling us that we are still in a bull market. If our systems were telling us we were in a bear market, we would most likely have a sell signal right now. As our systems are designed with a concept in mind, in this case one of the concepts is that we are still in a bull market; they will not be proven incorrect (most likely) until the NASDAQ Composite falls further than it has. Therefore, our buy signal is theoretically still correct.

 

Many systems are not designed with theory, but with more simple ideas, such as moving average crossovers, the current price compared to the price of a certain moving average, and/or the relative value of one index compared to other indices in the stock market. Many of these systems have experienced several whipsaws recently. While some subscribers may be frustrated with our long signal, I doubt any would have preferred seven to ten signals the last few months that ended up with an even higher negative result. This is what has happened to several of our competitors. Some of our competitors are altering their systems due to their recent frustrating, are taking out stop-losses that were originally apart of the design of their system, ignoring signals (yes, this is true), and even taking subscriber recommendations for improving their system (yes, this is also true). It is amazing what people will resort to when they have unrealistic expectations for their system or have realized that they did not spend enough time backtesting their system. The recent activity by so many of these market timers is equivalent to a poker player going on tilt. Systems work because they are mechanical and remove human emotion, when human emotions get involved (desperation or frustration) in designing or altering a system, the results are often horrific.

 

In closing, we knew our systems would have drawdowns and we knew that our system could not be perfect. As poker has become so popular recently and as most of our subscribers have probably seen in on television, we will use a Texas hold ‘em analogy. If you are holding two aces and your opponent is holding two kings and you go all-in, you have an 81-82% chance of winning the hand. If a king comes on the river, did you make a bad play? Of course not, the odds were in your favor. Stock market systems do not work differently. Our systems will never be perfect (an 81-82% chance of something working out in the market is fantastic), but our systems were designed well, and historically (based on the concepts used in our system) the best move was a buy signal in January and a hold on that buy signal today.

 

Commentary 

The stock market continues to frustrate. The S&P 500 moved slightly above the 1290 area last week (the area we have continuously mentioned that the S&P 500 needs to break for confirmation before we know for certain that a test of the 2006 highs is ahead at a minimum) and quickly reversed.  The Dow broke above the level it needed last week as well (11300 area) and quickly reversed. The Russell 2000 is at the bottom of its trend channel, but SMH and QQQQ look a little healthier. This is intriguing, as these two ETFs have been underperforming and have looked the least healthy in recent months. It is hard to know what to make of all of this and we will not know until the market makes its move to the upside or breaks its recent lows. Historically, our mid-term system is telling us that a buy signal is correct here and we will stick to that buy signal until our system “tells” us that a buy signal is no longer correct.