FSO Editorials: Simple & Effective Bear Market Trading by Robert B. Gordon 12/28/2002

Simple & Effective Bear Market Trading
by Robert B. Gordon, Sc. D.
December 28, 2002

This essay will explain and illustrate how to create and manage a series of bear market portfolios that can provide a broad range of growth vs. safety potential. As has been our custom in previous essays, we will discuss our favorite bear market asset classes and let you select your own stocks and mutual funds.

In our recent essays we have been concentrating on building and holding conservative portfolios for the bear market period, counting on periodic rebalancing to correct for price swings up and down in any one asset class. In contrast, we will present here some exciting two-component portfolios, which are designed for automatic relative strength trading using our AccuTrack software.

Three years into a vicious bear market, our view is that the only major asset classes worth owning are these four:

U.S. Treasury Money Market Funds or CDs at an ultra safe bank
Short to Medium-Term U.S. Treasury and Foreign Government Bond Funds
Precious Metal Bullion, Stocks and Mutual Funds
Fully Managed and Reverse Index Short Mutual Funds

The first two asset categories provide only limited opportunities for diversification into sub classes, but the last two have several major sub asset classes. Using our large daily price database provided by FastTrack.net (www.fasttrack.net), we will provide performance data on a number of securities to which we have assigned short names as follows:

MMXX - U. S. Treasury MM fund
USBD - short to intermediate Treasury Bond Fund
GVBD - short to intermediate Foreign Bond Fund

GSBU - closed end mutual fund owning gold and silver bullion
GSMF - closed end mutual fund owning mostly large gold stocks
GSTK - a medium size unhedged gold mining stock

MSHT - a fully managed short mutual fund
RS&P - a reverse S&P short mutual fund
RNDQ - a reverse Nasdaq short mutual fund

In bull markets one chooses two growth funds in different categories that are expected to display individual performance - to march to different drummers. This scheme fails in bear markets with most equity securities going down. In the current bear market, we have chosen to trade pairs of securities against others in the same asset class. In both bull and bear markets it is possible, using the appropriate software, to achieve (1) returns from the pair that are greater than that of either component or (2) that are more predictable or (3) safer.

We have been using FastTrack's AccuTrack relative strength trading program for about ten years and have found it to be quite useful in both bull and bear markets. It provides a beautiful graphic display of relative strength on a daily basis that enables the user to anticipate when a new trade will be generated.

For the results given below, we have used a constant set of trading parameters rather than an optimized set for each pair of securities. So these results are in most cases well below the best that could be achieved over the same time period. We will present the past bear market performance from trading the sub-asset classes versus each other. These trades do not protect against loss if both securities are falling in price, but will produce the lowest possible loss. Of course with the benefit of hindsight, we chose only asset classes with gains.

In the second chart of trading performance, we give the results of trading each asset class against a Treasury MM fund. In all these cases, there is a reasonable protection against loss unless the growth vehicle has an "Enron" type loss.

Trading Results from 3/20/2000 Through 12/20/2002
Security	Total Gain %
MMXX	11.4
USBD	36.3
GVBD	19.2
GSBU	34.0
GSMF	139.2
GSTK	445.0
MSHT	122.1
RS&P	62.1
RNDQ	123.8

Note the extreme range in performance from the 11 percent of the MM fund to the 445% of the gold stock. There is an interesting comparison of the two bond funds in this table and the one that follows. Please note above the large difference in their total return over the bear market period. The trading results below show (1) that they made equal contributions to the total gain and (2) that the total gain was greater than the average of the two funds. This is what relative strength trading can do when the two funds have their major gains at different times.

Here are the results of trading the same asset class securities against each other:

Trading Results from 3/20/2000 Through 12/20/2002
Security Pair		Total Gain			% Time In		No. Sw.
#1	#2	#1	#2	#1 + #2	#1	#2	Per Year
USBD	GVBD	14.9	14.9	32.0	69	31	1.4

GBUL	GSMF	24.6	60.2	99.6	37	63	1.8
GSTK	SSMF	214.6	59.5	403.6	75	25	1.4
GBUL	GSTK	-8.5	392.6	341.3	20	80	1.1

MSHT	RS&P	44.3	26.2	82.1	64	36	1.8
MSHT	RNDQ	33.7	53.2	104.8	40	60	2.2
RNDQ	RS&P	61.9	12.6	82.4	68	32	1.4

When trading similar funds against each other, one cannot expect greater final gains as in the two quite dissimilar bond funds. The big advantage to the investor is the automatic taking of profits from a volatile fund promptly after a major down turn and reinvesting the gains in the less volatile partner. The investor gains stability and consistency while sacrificing the chance for maximum gains. This is a huge advantage in the case of both precious metals and short funds, both of which can be very volatile.

Note, in the case of the volatile gold stock, the table shows that 20 to 25% of the time was spent in the less volatile fund. With the smoothing constants used for this example.

Trading Results from 3/20/2000 Through 12/20/2002
Security Pair		Total Gain			% Time In		No. Sw.
#1	#2	#1	#2	#1 + #2	#1	#2	Per Year
GBUL	MMXX	8.1	1.4	9.6	48	52	2.5
GSMF	MMXX	70.6	5.4	79.8	62	38	1.8
GSTK	MMXX	327.5	3.9	344.3	76	24	1.1

MSHT	MMXX	67.1	4.1	73.9	67	33	1.4
RS&P	MMXX	37.5	4.2	43.3	63	37	1.8
RNDQ	RS&P	69.8	3.7	76.2	69	31	1.4

As would be expected, the results of trading the precious metals and short funds against the MM fund are lower due to the very small contribution from the much lower returns from the MM fund. Surprisingly, the GSTK vs. MM combination did slightly better than the GSTK vs. GBUL which had three times the growth of the MM fund. Presumably, other such cases might be found if the results had been optimized by making a serious of software runs. Believe it or not, optimizing the values of total growth vs. the number of switches is very easy and pleasant - almost like a game.

The great advantage of trading vs. a MM fund in a bear market is that it can give an iron-clad assurance of maximum gains and minimum losses. This would certainly be a wise choice under very uncertain market conditions or with a new stock or fund with unknown price action.

With a 3 year old bear market well established, I would personally choose not to trade against a MM fund at this time. However, the AccuTrack software is so easy to use, it would be quite reasonable to do both, trade a volatile fund against another volatile fund AND against a MM fund.

For this essay, I chose not to trade the precious metals funds against the short funds. In this case, the dissimilar price vs. time actions of the two asset classes would make it more likely to achieve a trading gain greater than either of the individual funds.

I suggest that experienced investors obtain full information on this great software product by going to the web page of the FastTrack.net. In addition to AccuTrack, there are many other software capabilities. And, best of all, this fine company offers unlimited 800 phone service that is really available. I receive no favors for this recommendation and pay my bills like all customers.

I regret to inform all readers, and especially my long-time readers and supporters around the English speaking world, that my first 57 essays can no longer be found at the original gold-eagle.com web site. They were abruptly erased by the angry web editor when he discovered I was publishing on other sites - a cruel blow to intellectual freedom.

All of my past and current essays are now archived at www.freebuck.com and can be accessed by selecting their Commentary link. Many of my recent and future essays may also be found on another great web site, Financial Sense Online at www.financialsense.com FSO has kindly given me a web page, which contains my photo for those who might wish to view an 87-year-old investor.

At these new sites. I will enjoy greater freedom to express my thoughts and will eventually reach an even large audience. I request the assistance of all my old and new readers in publicizing my great new web sites.