04/30/2012 Explanation (and Disclaimer)

Overview:

The Mousetrap is an experimental portfolio attempting to combine technical and fundamental analysis.  The method looks for positive volume divergences in 98 industry groups (as defined by Value Line), and then selects stocks within each industry based on fundamentals.

The expected holding period for each stock is a year, rotating through ten positions.

The model exists in three forms:

1)      Small Portfolio (holding two ETFs)

2)      Mousetrap (holding ten stocks)

3)      Hedged (overlaying a short ETF against the Mousetrap)

The hedged position is not always active, and will sometimes close the short position without replacing it with another.

Market Timing:

Although I do post estimates of what direction I think the market will take, I do not use aggressive timing in my investment models.  These are rotation models designed to be fully invested most of the time.

So far the only type of timing I use is an occasional hedge.

Position Sizes:

The small portfolio is designed to hold a 50% secular position and a 50% sector position.  The secular positions are meant to be held for 5-10 years, and the sector position will rotate a few times a year.  If one position becomes 50-100% larger than the other position, I will rebalance the two positions the next time one of them is rotated.

Secular Rotation:

During secular bull markets the model will hold BND (a generic bonds ETF).

During secular bear markets the model will hold IAU (a generic gold ETF).

I determine if we are in a secular bull or bear market by comparing long term price ratios of $SPX, BND, and $GOLD using 3% point and figure box sizes at www.stockcharts.com.  When gold has the best long term relative strength I will call a secular bear.  When gold has the worst long term relative strength I will call a secular bull.

Using that method we entered a secular bear in 2000.

Sector Rotation:

The nine sectors I rotate are:

XLY	Cyclicals	Bottom
XLK	Technology	Bull 1
XLI	Industrial	Bull 2
XLB	Basic Industry	Bull 3
XLE	Energy	Top
XLP	Staples	Bear 1
XLV	Services	Bear 2
XLU	Utilities	Bear 3
XLF	Finance	Bear 4

When I speak of moneyflow favoring bullish or bearish sectors, I am using an adaptation of Sam Stovall’s work on sector configurations in bull and bear markets, comparing his sector rotation theories with the moneyflow techniques created by Len Mansky – a private investor.

Disclaimer:

Since I am not a professional, the selections of the model are not a recommendation for others to buy or sell a stock or ETF.  I am only sharing my buy and sell parameters for informational purposes.  To be honest, the only person I am trying to convince to follow the methodology is myself, and going public is a way to keep myself on track.  If I can’t explain my reasons to buy a stock on a blog, I have no business investing in it in the first place.

Some sites I've found interesting:

www.stockcharts.com a free charting site

www.validea.com a subscription fundamental analysis site

www.effectivevolume.com a subscription technical analysis site

04/28/2012 Mousetrap

Condition	Bear Market	Rally
S&P Target	1250
Small Portfolio	IAU & XLF	14.64%
Hedge	XLU	-3.68%
Position	Date	Return	Days	Call
GCI	7/14/2011	6.29%	289	Hold
CSGS	10/3/2011	16.14%	208	Hold
NLY	10/25/2011	6.27%	186	Hold
DD	10/27/2011	18.48%	184	Hold
KBR	10/27/2011	18.24%	184	Hold
VG	10/27/2011	-37.99%	184	Buy
TTM	11/30/2011	78.30%	150	Hold
BT	1/4/2012	11.19%	115	Hold
PDLI	3/7/2012	2.30%	52	Hold
CLF	3/19/2012	-12.89%	40	Hold
S&P	Annualized	2.72%
Small Portfolio	Annualized	16.06%
Mousetrap	Annualized	17.97%
Hedged	Annualized	13.93%

I’m moving the Mousetrap to its own blog for a number of reasons:

1)      People should be able to go through older posts to catch up if they want

2)      It will be easier to insert images

3)      I’ll be able to post a detailed introduction to the concept for new readers

The Mousetrap model exists in three versions: small, full Mousetrap, and hedged.  The small version is simply two ETFs, right now gold and financials.  The full Mousetrap is made up of ten stocks.  The hedged position overlays a short position against the Mousetrap.

The concept itself is a hybrid technical / fundamental investment model that selects industries based on breadth and volume, and selects stocks within those industries based on fundamentals.  The ideal holding period has not yet been determined, but we appear to be close. 

The polynomial trend line for the returns on all selected positions has an apex at a holding period of 257 days, which is close enough to a year that we may be able to take advantage of long term capital gains.  Although I’ve rotated earlier positions more aggressively, I plan to hold the current ones until they reach a more mature sell point.

The goal should look something like this:

The sudden jump at 366 days shows the difference in real returns if we can hold each position for as long as a year.  The IRA return rate reflects the fact that no capital gains taxes are paid on an IRA account (at least not until one retires).

A 25% after tax return would be a successful test of the model, and a 30% IRA return would be as well.

I began this live test of the model on 5/31/2011.  At that time I did not know whether to rotate out of an existing stock when a new stock hit a buy point, or whether to hold until a natural sell point for each position.  During this beta test of the model it became very apparent that a stock should be held until it reached a sell point – but that sell point has not yet been determined.

I also included hedges for both the small and full versions of the model: with the small hedge being a position in gold and the full hedge a short position (currently shorting utilities).  At the end of this beta test I may discontinue the use of hedges, but I will not know until the test is complete and the correct sell points for the model are known.

I’ll add more detail in coming days.

Tim

For an overview of the model: http://market-mousetrap.blogspot.com/2012/04/explanation-and-disclaimer.html