Gil Morales and Chris Kacher

A new era of extreme market volatility – recently with a fairly bearish overall tone – has left many longer-term investors in a major quandary. By and large, they’ve abandoned the old notion of “buy and hold” as either ineffective or overly nerve wracking (or both) – but they haven’t yet found a suitable replacement methodology.

While there are plenty of trading “systems” being promoted on the Internet and in the mails, most involve the use of high-cost, high-risk trading vehicles and require frequent and precise timing in shifting direction or moving in and out of the markets in order to garner decent returns – assuming they work at all.

Fortunately, we’ve got a better idea, one thoroughly tested and firmly grounded in market history – and one that has become far more powerful thanks to the introduction of new trading tools since 2008.

It’s called the Virtue of Selfish Investing (VOSI) “Market Direction Model” and, as detailed on our website, www.selfishinvesting.com, it has made huge gains over the past three years – and especially since the market’s collapse in early August. But that’s just part of the story.

The Model itself generates trading signals by analyzing the price/volume action of the leading market indices and certain major stocks. That statistical analysis is based on data going back more than 20 full market cycles – nearly 100 years of performance history. Dr. Kacher back-tested the Model using that data over the period from 1974 to 1990, and has personally used it – real-time and under fire – in his investing since 1991, amassing several triple digit percentage (as audited by KPMG LLP, one of the world’s Big Four accounting firms).

More recently, 2009, 2010 and so far in 2011 – the Market Direction Model is up +157.3%, +86.5% and an astounding +342.5%, respectively, depending on the trading vehicles used. And what are those trading vehicles?

They’re the new enhanced-performance exchange-traded funds (ETFs) and notes (ETNs) that employ leverage to produce results two and three times larger than the indexes they track – sort of like funds on steroids! And, because they’re available in both bullish and bearish versions (the latter called “inverse” ETFs), they can produce those outsized results in both up and down markets.

Among the funds we use quite often in executing the trades signaled by the VOSI Market Direction Model are:    

VelocityShares Daily 2x VIX Short-Term ETN (NYSE Arca: TVIX), recent price $98.19, tracks the S&P 500 VIX Short-Term Futures Index, a key volatility measure.

Direxion Daily Small-Cap Bear 3x Shares (NYSE Arca: TZA), recent price $58.23, tracks the Russell 2000 Index on an inverse basis.

Direxion Daily Small-Cap Bull 3x Shares (NYSE Arca: TNA), recent price $29.8, tracks the Russell 2000 Index.

Direxion Daily Technology Bull 3x Shares (NYSE Arca: TYH), recent price $29.41, tracks the Russell 1000 Technology Index.

To give you an idea of the impact using such funds can have, compare the difference in returns they could have provided had they existed during some key market moves over the past 25 years, using the Market Direction Model's buy, sell, and cash signals on unleveraged NASDAQ Composite Index as a benchmark then applying it to 3-times ETFs such as TNA or TYH:

1987 Black Monday crash = +102.5% x 3 (using a 3-times ETF such as TNA or TYH) = +307.5%

1998 rally following “Asian contagion” = +62.6% x 3 (using a 3-times ETF such as TNA or TYH) = +187.8%

2000-2002 collapse on bursting of dot-com bubble = +118.8% x 3 (using a 3-times ETF such as TNA or TYH) = +356.4%

Similarly, but as actually traded based on the Model, when the NASDAQ rebounded by +25.8% following the “flash crash” in May 2010, the bullish 3x TNA gained +86.5% and the bullish 3x technology TYH picked up +83.8% by going long on a buy signal, short on a sell signal, and cash on a neutral signal.

Using signals generated by the Model, the 2x TVIX ETF has also produced a return of +342.5% so far in 2011 – in spite of (or, more likely, because of) the fact that the market has been largely trendless, but with extreme volatility and a big downside break in August.

During the same generally bearish time period, the 3x TNA bullish fund has produced gains of +95.1%. Results are shown here: http://www.virtueofselfishinvesting.com/results along with the documented time-stamped reports shown here: http://www.virtueofselfishinvesting.com/reports.

Unlike many market-timing programs, the Market Direction Model is not a day-trading or ultra-short-term system. Rather, it seeks to capture the intermediate-term trends in the major market indices, averaging only 12 to 20 switches a year – including shifts from a bullish or bearish stance into a neutral, or cash, position.

Signals are based on price/volume action, which is generally considered to reflect the viewpoints and opinions of all market participants – both institutional and retail investors, all of whom cast their votes on market direction with their dollars. As it performs live on our website, the Model senses buying and selling pressure for the major indices and market-leading stocks in real-time throughout the trading day. And, when the pressure increases past a certain threshold, it signals a switch.

The Model has been particularly active since the August market break because, while history may not repeat, it does often rhyme – and history has shown that such a big sudden break is often followed by a period of high volatility lasting several weeks.

That has certainly been the case this time – with the market going through a period we call “the chop zone,” during which investors often lose money quickly if they try to trade each swing. By contrast, the Model ignores such chaos and seeks out predictability, often electing to stay in cash when the volatility becomes truly erratic.

The Model also includes a “safety switch” – one designed to let traders who follow it capitalize fully on true trend-initiating signals, but exit quickly with minimal losses on false signals.

Of course, the leveraged and inverse ETFs are highly volatile trading vehicles so, even with strong fail-safes in place, investors should always size their positions carefully to ensure they stay within personal risk-tolerance levels.

Dr. Chris Kacher and Gil Morales are both Managing Directors of MoKa Investors; LLC, CoFounders of Virtue of Selfishing Investing, LLC (www.selfishinvesting.com) and co-authors of the new book, “Trade Like An O’Neil Disciple: How We Made 18,000% in the Stock Market” (Wiley, 2010).


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Gil Morales and Chris Kacher

Gil Morales and Chris Karcher are co-founders of the Virtue of Selfish Investing.
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