The Art of the Switch

 
Look before you leap. While the Moose may sound simple and automatic, there is an art to maximizing your performance.

 
There are two types of signal at the Moose: HOLD and SWITCH. They mean what they sound like they mean. Holding for more than a week or two after a "switch" signal is not recommended. Similarly, switching into a position in the middle of its 'hold" signal is not recommended-- particularly if there has been an appreciable price increase in the designated asset since the signal was first given. (See FAQs for more.) Switching out of an old position late, however, and going to cash between signals, may stem further losses.

THEORY vs. REALITY

Although the Moose is nominally invested in a particular asset ALL week, anybody who knows the way this site works (having read the FAQs), and who has followed it with real money, realizes that's never exactly what happens during a SWITCH week.

A weekly theoretical model, the Moose works exclusively off Friday COB ("close of business") data. The site is usually updated by Sunday evening. In switch weeks, it "pretends" to have made the switch on the preceding Friday, when in fact the first opportunity to switch will be Monday. Now sometimes you can get Friday's price (or better) the following week, and sometimes you can't.

As mentioned in the FAQs, the Moose is not a short-term construct. It may spoon-feed you a great intermediate term switch signal, but you do have to do a little of your own chewing before you swallow it. You have to apply your own short-term methods, timing each switch week as best you can. A switch is never automatic. It doesn't have to be at the Monday open (in fact, I generally advise against that), or even by the Monday close. (I've waited up to nine trading days to complete a switch.)

The switch decision is, in reality, an open-ended one. Which is why we use Friday COB data. If not that number, which one? Why collect, store, and tabulate a second, third, or fourth time series, that is no more valid a benchmark than Friday COB? Keep it simple, stupid.

THE PERFECT SWITCH

On the surface, the perfect switch would seem to entail selling an undesirable holding on Monday (or after) at a higher price than the previous Friday's. After that, you have to buy something new and theoretically better on Monday (or later) at a lower price than last Friday's. Sounds tough. But does "perfect" mean that? Actually, no, it's far less rigorous.

Sure, you'd like the asset you're selling to go up next week, right as the new asset you intend to buy dips for a moment. However, if you sell higher than last Friday's price, you can now afford to buy in (the same percentage) higher, and still break even. The same holds true if both assets head lower next week. If the asset you're buying falls in price, you can afford to sell at a lower price too.

The only problem occurs when the old asset tanks, as the new one spikes higher, which isn't often. That's because the top two assets in the model at any given moment are usually (more or less) positively correlated. In other words, their prices are generally headed in the same, not an opposite, direction-- albeit with different momentum and different degrees of volatility.

Although I've never done a data analysis, personal experience suggests that my chance of getting a better aggregate price the following week, combining both the sell and the buy, is about 50-50. It really depends on how well I handle it, but also on conditions at the time of the switch.

MARKET CONDITIONS CAN HELP YOUR SWITCH-- OR NOT

Sometimes, life is wonderful, complacency is nigh, everything is bullish, and one asset simply overtakes another in the model. That is the toughest switch to time, believe it or not, because you're simultaneously trying to sell on a bounce, something that's supposedly losing steam, and after that, buy the purported the new barn-burner on a dip. Although your probability of pulling off that ideal two-fer seems low, ironically, you end up not caring that much-- unless you're really anal. (Once you realize both assets are going up, you know you're getting richer no matter how stupid you were about the switch.)

The November 2006 switch from Europe to Latin America exemplified this. I failed to pull off the perfect short-term switch, but I did have the opportunity. Europe, my sell, did open higher the following Monday, and Latin America, my buy, was lower intraday. Had I put in stops and limits right around the Friday close, I would have been even or in the black. As I recall, I danced around for a few days, sold IEV high, but bought ILF a little higher percentage-wise. (Hey-- sometimes you get the bear, and sometimes the bear gets you.)

So much for hunky dory. Occasionally, the Moose signal hits when life sux, volatility is through the roof, everything is in the tank, and YOUR portfolio is LEADING the herd down into the Fourth Circle of Hell.

(If that situation sounds vaguely familiar to Moose veterans, congratulations! You do NOT suffer from short-term memory loss.) On February 27, 2007, it seemed "Lasciate ogne speranza, voi ch'intrate" was running across my CNBC ticker instead of "ILF". (For the classically curious, that's Dante's account of the inscription above the Gates of Hell- "Abandon all hope, you who enter here.")

Black humor aside, such extremes do lend themselves to an easier short-term switch. When a weekly close in virtually every asset class is really oversold, as we knew and reported that week to be, a one-day bounce the following week is all but assured. And the longer it's delayed, the bigger it gets!

Hence, we enjoyed the spectacle of a bunch of Greedo's bouncing around the next week with their shorts on fire. What is never certain is whether a one-day short-covering rally will carry through to a positive week, although the odds seem to be better than 50-50 when invested in a top-tier asset.

If you followed my switch advice in that week's commentary-- didn't panic on a very scary Monday, and waited for the predicted bounce to sell mid-week, you made out as handily as I did on the week’s pop in ILF. (As that signal ended in cash, the second task of the ideal switch- to buy a stronger asset at a lower price- was moot.)

Again there was irony. This was a near perfect switch that yielded an additional 1-5% over the model. But how to break out the champagne, when I still have the tread marks on my forehead from being run over the week before?

HOW AM I DOIN'?

There will almost always be a difference between the theoretical performance calculated herein using Friday COB data and the actual performance you achieve during a switch. Whether that difference is positive or negative (and whether it's significant or minor) will depend on your short-term trading skills, on the volatility of the assets involved, and on market conditions at the time of each switch.

So don't try to judge your success by looking at one switch. Consider each in the context of the entire program. If you miss on a switch this time, you may make it up next time, especially if you've gotten better at switching, or if conditions are more favorable.

Remember, it's a percentage game. It's not about being right every time. If you hit big on a switch and make, say, 2-5% over benchmark, it can erase (in one swell foop) four or five previous small misses you may have had.

DAY TO DAY, WE'RE ALL ON OUR OWN-- SOUNDS LIKE A PLAN

The Moose gives no short-term switch guidance. I may write something in Moosecalls about my intended approach to an upcoming switch, if I do indeed have a clue-- or I may not, particularly if I intend to wing it.

My switch strategy will depend on whether I'm trading a taxable account or an IRA. Taxable accounts usually allow borrowing on the margin to buy, while tax-deferred accounts do not. Margin allows me flexibility to buy the new asset before I sell the old one. Without margin, in tax-deferred accounts, I must sell first (or simultaneously) to buy. My strategy will also depend on whether the switch involves cash at one end, or is a switch between two non-cash assets.

Either way, I try to get the lay of the land the following Monday before acting. I monitor short-term technical indicators, but usually fall back on common sense.

The decision is much easier when the switch is either to or from cash. Since cash is a constant, only the price of the non-cash asset is important. The following table outlines my basic strategy for completing a switch to or from cash. I put it right up there with the best laid plans of men and mice. Market conditions and the target non-cash asset always play a major role. A fast market and a volatile target can throw the entire strategy to the wind. Nevertheless, it's good to have a plan.