2006 Year in Review

FastBreak trading strategies we trade or monitor had returns ranging from a 54% gain to a 32% loss for all of 2006.  This commentary will review several different types of trading systems.

The first version of FastBreak was released in early 1996. Potential users of any investment software product should always ask the question "What is actual performance?" Soon after the initial release we developed trading systems that could be monitored for "real time" performance. We don't modify trading system parameters during the performance reporting period and report on the systems on a yearly basis.  The 2004 and 2005 reviews are available in FastTrack Commentary 8164 and 8165 respectively. If you would like to review all reports since 1997 visit our web site www.edge-ware.com and go to the Strategies page.

With the release of Standard FastBreak and FastBreak Pro version 4.0 in late 2001, we have the ability to run the same strategies in the Standard and Pro versions. All of the systems we report on here were developed with the Pro version but can be run in the Standard version.

We place example FastBreak Pro developed trading systems on the Strategy page of our web site. These systems provide users and potential users a starting point on the many different types of trading systems that can be built with FastBreak. It also allows us to provide an honest benchmark for real time performance. Users of both Standard and Pro versions can download these systems. The Standard FastBreak 30 day demo that can be downloaded from the web site can also run these strategies but will not display the last 60 market days of trades.  Many of these systems are several years old.  We can now build better trading systems, but we keep these systems on our web site to show that many trading systems are effective for long periods of time.

We don’t often post or change the strategies on our web site because we believe investors’ needs are very unique and users of our software should feel confident developing their own trading systems. 

The strategies we report on are "out-of-sample/real time” for the entire year and in some cases the strategies have been unchanged for several years.

The 2006 US stock market followed what is often a standard pattern, i.e., strong start, weak middle and strong finish.  The US markets continued to have a very low volatility and narrow range. A number of market monitors have pointed out that market, as measured by the most common indexes, are approaching record duration without a significant market decline.  For example, the Stock Trader’s Almanac Investor reported that 2006 was the first 4-year Presidential Election Cycle in 108 years where the DJ Industrials did not suffer a bear market or even a 10% correction.  However, there were sectors that did have significant declines, mostly commodity related and especially energy related issues.  The rapid decline in energy stocks had a big impact on some of our trading systems that invest in that sector.  More on that later.  Many international markets had a very good year.

The bond market as measured by Treasuries (STBI-) and Commercial bonds (DJ-2B) had a poor year as the Fed continued to raise short term rates.  FastBreak bond systems did a very good job of weathering this bad market.  As rising rates stabilized later in the year the US dollar (DXY-Z) became weak. 

FastBreak trading systems had generally good results.  All systems with the exception of the energy stock system, preserved capital and several had exceptional results. 

We need a yardstick with which to compare our performance. Here is how common benchmarks performed in 2006:

Rapid reversals in many markets during the year made it difficult for many professional money managers. We include two measures of investment returns for professional managers:

The above values are approximate because of the difficulty obtaining reliable information on these programs.  Hedge funds have had considerable investor interest during the past few years as an alternative investment, and there has been a tremendous flow of money into these funds. Managed futures and hedge funds typically charge 20-25% of gains for their investment services. These funds are usually only open to qualified investors (those with a net worth of $1M or more) and minimum investments of $500,000 or more is not uncommon.

How did the FastBreak strategies posted on our web site perform? Note: the date in the table below indicates when the system was posted on our web site.  In many cases the system was trading real time well before posting. 

Bond systems were generally good and the system that trades more conservative zero coupon bond funds gave an excellent performance.  MDD was excellent for all systems. The weak bond market was a continuation of 2005 as the FED continued to raise rates early in the year and that took the wind out of the bond market sails.  The original bond system posted back in 2002 continues to perform well.  This system has returned 53% in real time compared to 36% for the Shearson Treasury Bond Index (STBI-) The most aggressive bond system that trades long maturity zero coupon bond funds had modest performance, but easily outperformed the Shearson Treasury Bond Index - its benchmark.  This aggressive system is built to take maximum advantage of a strong Treasury bond market. 

We experienced a modest sell off in Treasuries early in 2006 which allowed the system that shorts bonds (trades Rydex Juno fund) to make a nice trade.  This system only trades between a money market fund and the Rydex Juno fund.  The following graph shows how this system (Juno) was nearly perfect in capturing the gains during the decline in Treasuries (STBI-).  Though the sell off in Treasuries was rather modest, the system had excellent returns.  If bonds have a sell off even remotely similar to what was experienced in the early 1980’s this system should perform very well.  This system could have been combined with one of the other bond systems.  For example, an investor could have been trading the Conservative zero coupon bond system, but any time the Juno system went out of money market and into Juno the investor would take the Juno trade.  The results of this strategy are shown in the chart below and summarized in the table above.  The equity curve for the combined strategy is shown as the red/green line in the Adjusted Return chart in the bottom half of the chart.  The return would have been over 15% for the year with a 4% MDD.  This is outstanding performance for a bond strategy.  You may ask, “Rather than trading a separate system, why not just include Juno into the bond trading family?”  The answer is that we have found with experience that it is better to trade inverse systems as separate systems rather than trying to build a single system that trades both on the long and short side.  This is true of both the bond systems as well as stock fund systems.  

The International system continued to have stellar performance. This same system was up 21% in 2005, 29% in 2004, 63% in 2003 and 30% in 2002. This has been a fantastic system returning in excess of 200% since 2002 (compared to less than 50% for the S&P); however, since the strategy was built in 2002 many of the funds have closed or incorporated short term redemption fees. The results do not reflect those fees. We have maintained reporting on this strategy to demonstrate long term strategy performance. We have developed two international strategies that use closed-end country funds, and we will cover them later in this report.

The Arktos and Ursa systems short the market (OTC 100 and S&P 500). Without significant market sell offs both systems stayed in money market for the vast majority of the year. The systems went short during the midyear weakness, but quickly went back to money market when the market recovered. Having a flat return may not look like good performance, but several investors who tried to short in 2006 had very significant losses.  Many investors were expecting a major market correction in 2006 and were short the market because: it was the second year of a presidential cycle (historically a very week year), $70 oil, slowing of the housing market, rising interest rates etc.   We keep these systems in reserve when we have another 2001-2002 bear market, or the systems could have been used in combination with a stock trading system similar to how the Juno bond system was combined with a long bond system.   These two bear market trading systems are somewhat dated.  We built newer, more robust bear systems with FastBreak Pro Version 5 and they had gains of 4 to 5% in 2006.

The three growth systems that use the RUTTR and RUTVOL market timing signals did well. Both of these two market timing signals had excellent signals in 2006.  These market timing signals have been very popular with the FastTrack investor community. We admire the excellent work that went into building these signals, and we built the trading systems to take advantage of signals.

The Income strategy had another excellent year.  What is surprising is that this performance was made in a year when interest rates were generally rising and bonds falling.   This strategy trades a variety of Fidelity bond and real estate funds with few trades per year.  Note: When we built this system in 2003 we built a similar program that used a different momentum ranking method.  We initially posted what we thought was the slightly better system on the website, but after the posted system continued to underperform we replaced the posted system.  This was fully disclosed in the 2005 commentary.  This system has returned 60% (compared to 19% for the S&P) in real time since 2005.  This has been an excellent trading system. 

The Weak Dollar trading system had a reasonable year.  This system was built to take advantage of a falling US Dollar.  We posted the system in 2005 just in time for the US Dollar to go on a major upswing.  This year the Dollar was under modest pressure late in the year and this system came to life.  If the US Dollar begins to have serious problems we would expect this system to take advantage of the Dollar’s decline.

Other Mutual Fund Systems of Interest

Potential FastBreak users often ask about other systems such as Rydex and Fidelity Sectors. Here are some other systems we traded or monitored during the full year to provide additional information. The trading files for these systems are not posted on our web site.

The annuity system holds four positions in a trading family of 45 funds. The trading family includes a very diverse group of funds including international and bond funds. This is the same system that returned 5% in 2005, 17% in 2004, 60% in 2003 and has easily outperformed the market index benchmarks.  Several users contacted us about this program and we supplied them this trading system.  The annuity company slightly modified the available funds in 2006.  The reoptomized strategy will be reported on in 2007.

Rydex and Fidelity sector system performance was mixed.  The story this year was the exact opposite of last year.  Last year the systems not using general market timing signals did much better because they went into energy funds during a general market sell off and the energy funds had excellent returns.  This year the story was different.  All the sector systems were holding energy funds when the energy sector had a rapid sell off in May. The systems that didn’t use a timing signal were slow getting out of these funds and took a hit.  The systems were rapidly recovering later in the year but just couldn’t get out of the hole from mid year.  We haven’t been trading the Select funds and the Select systems are very out of date. We report them here to show that even old systems don’t “blow up” like many trading systems. The last two years have shown the benefit of trading more than one sector rotation strategy.  Combining the signal and non signal systems the past two years would result in very respectable performance.

One significant disappointment was The ProFunds system which had been trading successfully in real time since June 2004.  The system uses the market timing signal described in FastTrack Commentary 8161.  This signal was built using the signal building option in Version 5 of FastBreak.  The dismal performance in 2006 is due to holding leveraged energy and Japan funds during the market sell off in May.  In retrospect we realized we broke one of our own guidelines for developing systems, don’t depend exclusively on the market timing signal to get out of a trade. We didn’t use a Stop in the trading system and when the general market, and especially energy funds, sold off in May this system was slow to exit.  This system has been rebuilt to include a stop.

Stock Trading Systems

In Commentary 8161 we described stock trading systems built using FastBreak Pro.  Stock systems resulted in both the best trading system and by far our worst failure.  We had one homerun, a triple and a strikeout with these systems.  Please review Commentary 8161 for background.

The absolute star was the closed-end country fund (funds that trade like stocks) trading system that uses a specialized market timing signal.  We described this system in the 2005 Review, and 2006 was the first full year of trading for this system and it returned 53.7% with a 14% MDD. The timing signal did an excellent job of exiting the market in May when most international markets corrected at the same time the US market corrected.

The triple was the original closed-end country fund system that doesn’t use a market timing signal.  This system returned 22.1% with a 9% MDD.  This same system returned 19.7% in 2005. We are pleased that this system has been providing similar returns to the open-end international fund trading system since there are no trading restrictions on closed-end funds.

The strikeout was the Energy stock trading system.  This system lost 33% for the full year.  The problem wasn’t with the stock trading system itself but the specialized energy trading signal built using FastBreak.  This signal was whipsawed twice, i.e., buying near the high, selling near the low.  If the signal had just stayed in the market the full year the energy stock trading system would have actually been up 1%.  This system was built to be very aggressive, i.e., 25% MDD and hold only three energy stocks.  The common practice for a system that exceeds its historical MDD is to stop trading the system.  Sometimes the system is broken or had bad assumptions (See discussion about ProFunds system above) or the market conditions return to historical patterns.   We believe that the energy system is basically sound, but the energy timing signal needs to be reevaluated.   

Last year we reported on a system to trade growth stocks with mixed results in 2005.  We did additional work on stock trading systems this past year.  We have found that trading growth stocks with trend following or momentum trading is hit or miss.  We didn’t find a system that had the kind of steady returns we like.  Yes, there are periods when trading individual growth stocks can produce spectacular gains, but it isn’t the consistent gains we like in a trading system.  Our studies have found that a more profitable way to trade individual stocks may be to trade value stocks rather than growth stocks.  We have built systems with this methodology and will report back later.

Summary

With the exception of the energy stock trading system, it was generally a good year.  The one message that we keep emphasizing is that investors should diversify across multiple trading systems.  

What is FastBreak and Who needs FastBreak

Unlike other trading methods, the FastBreak "mechanical" trading strategies gives specific buy and sell recommendations. Mechanical trading systems leave no room for historic "revision". These types of trading systems may not be for everyone, but we believe they should be considered if you recognize yourself in the following:

• Do you have trouble "pulling the trigger" on trades, e.g., selling your losers, taking profits on your winners, waiting for a bounce to get out of a bad trade ...?
• Do you have a limited amount of time to devote to your investments? If you are a full time investor, or enjoy sitting in front of CNBC and your computer all day, you may be able to do better with other investment methods. However, if you have limited time (or better things to do with your time!) a few minutes an evening is all you need to download your FastTrack data and run your FastBreak strategies.
• We have stopped reporting on some of the older FastBreak systems for a variety of reasons: Many of the mutual funds used in these old trading system families have since been discontinued, the market timing signals (unrelated to FastBreak) used did not stand the test of time, and we can build much more effective strategies with the functionality added to FastBreak in recent years. We felt that those systems don't accurately reflect the performance that FastBreak can produce.

Edge Ware, LLC.

Standard Disclaimer

As the saying goes, "Past performance is not a guarantee of future results."

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