Our current three positions are TMF, SSO, and IFN. There were no position changes in the country model this week. The stops and targets model is in 2/3rds a position of IFN, full position in SSO, and stopped out of TMF.
This Week’s Strategy Lesson: How to Trade the ETF Models (Part 1)
Overview of the Models
The ETF models are a medium-term trend following system. This means that we define a universe of ETFs and then position trade the leaders in that list. Each model has a different focus. The sector model focuses on the different sectors of the U.S. economy. The country model focuses primarily on county ETFs. The global macro model combines index, regional, commodity, and alternative ETFs. In addition, each of the models has access to some short exposure ETFs that will give us the potential to profit from sinking markets.
The universe of ETFs for each model is between 20 and 25 ETFs. These lists were constructed to meet the primary goals of each model. They provide exposure to ETFs with good volume, trading history, and broad exposure to each models objectives. We have included a few leveraged ETFs in these lists to give us additional profit potential on some of the larger longer-term movers.
Each model holds up to three positions at a time. We say “up to three” because the models have certain rules that can put us into cash. The most common reason we will be partially in cash is if we have reached profit targets or have been stopped out of a position. When this happens, the portfolio slot will be in cash until the model generates a fresh signal.
The second reason we could be in cash is if there aren’t enough ETFs with positive TSI to fill our three slots. One of our rules is that the model will never hold an ETF that has a negative TSI score. This scenario typically might only happen in severe market corrections. In the back-testing of the model, this happened during some periods of the financial crises of 2008.
Trend Strength Indicator
The Trend Strength Indicator is a proprietary indicator we used to measure trend strength. It functions differently than oscillators like relative strength. The calculation looks at a series of different return periods with custom weightings for each. We then rank all of the ETFs based on the relative TSI scores.
The TSI rank is updated every day after the close. Our initial three holdings are the three highest ranked ETFs. However, we have added some features that are designed to reduce position turnover, particularly when several ETFs are clustered around similar TSI scores and rankings.
Similar to how average true range measures the volatility of a stock, we have an internal dynamic calculation that measures the volatility of the TSI score and allows us to remain in holdings even if they temporarily fall out of the top three. It is only when they cross a certain threshold that the model issues a position change. This system actually succeeded in both reducing unnecessary turnover while improving the overall performance of the models.
The TSI ranking is available to view in the “Model Portfolio” section of the website.
Setting up the Initial Portfolio
Each of the component models have up to three holdings at a time (with a total of nine possible holdings in the ETF Complete portfolio). If you are just trading one model, you can take whatever amount you intend to trade the system and divide it into three “buckets.” If you are trading more than one system, you would divide that same amount into six or nine equal-sized buckets.
Since many of our positions are already in various parts of their lifecycle, you have the option of either waiting for fresh trading signals, using the buy zone entries, or starting with potentially smaller position sizing with the existing trades.
There are advantages and disadvantages to each. There are many trades that can last a long time so waiting for fresh signals or even buy zone entries can sometimes take considerable time. However, waiting for these types of entries can help keep your risk/reward in line with the model. If you are going to jump right in, we recommend starting with smaller position sizing until you get used to how the model trades.
Initially, each position will start with about the same size. So a $10,000 account would set aside around $3,333 for each position. We have provided some basic calculators to help with position sizing, though the math for this is not too complicated. You can find these tools in the “Trade Tracking Tool” section of the website.
Next week we will go over some of the mechanics of rotating positions, trading the stops & targets, and how to handle rebalancing.
The Current Condition of the Model
For the country model, we are in TMF, SSO, and IFN. TMF closed the week lower, but showed some resilience on Thursday and Friday. Both India and the SPY put in new 2014 or all-time highs this week.
Stay tuned to daily updates for any position changes.
Here is a summary of the weekly performance of all the ETFs that the strategy monitors:
Best wishes for your trading,
James Kimball
Trader & Analyst
MarketGauge