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Lesson 1: The Bull and Bear Lines – for Phil

When I was living on an island in Belize I met a very amiable man who always had a warm smile a deep tan and a positive outlook on life his name was Phil. We were talking about investments one day and Phil had found a very good financial planner who took care of most of his modest investments. Like many other people I meet Phil does not want to learn to be a trader like me, he just wants a simple way to be sure his money is safe. Also like many people I meet, the 2008 financial meltdown really called into question if it is a safe bet to be in equities at this time. I explained to Phil that you can be safe in the markets if you set limits on when you are owning equities. So here we will discuss a very simple system for protecting your wealth from the worst pullbacks. If you follow this simple system anyone can out perform many mutual funds and still sleep well at night.

Yes I use this system myself, in fact the chart I am going to show you is always the first chart I look at when evaluating my portfolio. 

The heart of the system is using a fast and a slow moving average line. Almost any charting software or Internet chart site can draw moving average lines. The longer the moving average the smoother the line is, but the more “lag” there is and the short the time period you use the more “noise” you see but you get your answers quicker.  

For this chart I am going to use a free web site called Stockcharts.com, but as Google will tell you, there are many many other sites that make stock charts.

We will base our finding on the prices of the 500 leading US companies. This is know as the S & P 500. You can find today's value for the S & P 500 on and financial news web site. For our chart we will plot the 50 and 250 day “exponential moving averages” of the equal weight S & P 500 (stock ticker symbol RSP).

Here is the link to the chart:


Go to the chart and bookmark that page.

On the chart you should see that the fast line (50 day exponential average) is in dark green and the slower 250-day version is in red. Now all you do is ask you financial adviser to be in cash or super low risk investments when the red line is over the green. If the pattern last more than a few months, accept no investment but cash, bonds, gold or if your risk tolerance is very high even “short” the market through an “inverse ETF”.

Here is a bull and bear chart for 2006 to 2014 notice how the line would have saved you from the worst of the sell off and kept you in equities for the very profitable ride back up.


With is lesson comes the CME4PIF number one rule:

WHEN THE BULL BEAR LINES ARE GREEN OVER RED BE LONG EQUITIES AND WHEN THE BULL BEAR LINES ARE RED OVER GREEN BE IN CASH, BONDS, GOLD OR SHORT, NEVER BE LONG EQUITIES. IF ON THE EDGE -- CASH IS A POSITION TOO.


You Are Done
If you want to keep things simple, you can stop reading now, but if you want to see some more tricks you can do with this tool read on.


Whipsaw
There will be times when the green line dips just below the red line for a few days only to bounce back. For an example look at what happened on the above chart in October 2011. This is called whipsaw and it will cost you a small amount of money in commission and selling a little low only re-buy a little higher. With this system it will happen about once every four months. However that is the trade off for safety, about once every five years the market will nosedive and you will be safely on the sidelines for the next disaster.

During a whipsaw you many here a few quotes that financial planners often use. “Its not timing the market that makes you rich, it is the time in the market” or “buy and hold always wins in the long run” or “if we sell now we are locking in losses”. Well I will tell that is a load of poop! I watched so many small investors loose it all in 2008 quoting that stuff. Trust me, at the big investment banks they live by the philosophy of “when in doubt get out”. In other words the stock market pros don't follow the buy and hold advice they give out and now you to can avoid the big sell offs.

Use Some Common Sense 
In the pull back in the summer of 2015 I was asked by a reader about buying SPY. I said now was not a good time, but the reader was confused because the Bull Bear lines were Dark Green over Red. The chart in my Market Comment that week looked like this:


Clearly when things are this close to a cross it is not a good time to be in the market. Two Weeks later it looked like this:
and two weeks after that this:

So before putting new money to work, make sure there are no big clouds on the horizon.


Here are the Hard Numbers
In computer simulations trading from January 2008 to September 2018 the RSP ETF using the Bull Bear lines would turn a $100,000 investment into nearly $400,000. A 9.9% return per year trading through the worst market sell off in our life time. Buy and Hold in the same period would turn $100,000 into $271,450.

As the chart below shows the key is avoiding the draw-down so you can buy low.


Using the Bull Bear Lines over longer period, say 25-years you would have had 11 winning trades and one money-losing whipsaw trade. Also, your money would only be at risk 74% of the time. That can make a huge difference to your long term return.

Let me give you a more real world version:
Two investors put $10,000 into the market on the worst possible day, June 4, 2007 the market  top for many months to come. The each buys 225 shares of RSP the equal weight S&P500 at $44.59 each. But lets see what happens;

Investor 1 uses the Bull Bear Lines, they cross on November 23 2007 and sell at $38.69 a share recovering $8,705. The lines cross again on July 27, 2009, and investor 1 returns to the market buying about 300 shares
  • Result: By the end of September 2018 Investor 1's 300 shares are worth $32,427.

Investor 2 calls his broker in late 2007 several times, and is reassured all will be fine. On September 15, 2008 Lehman Brothers files for bankruptcy. His drinking buddies tell him he is a fool to stay invested, the banks all might fail. After a week of hand ringing, Investor 2 gives up -- selling his shares the next week for $29.16 each -- receiving $6,560. After swearing off the market for a while, in early 2012 investor 2 returns to the market using his $6,560 to buy about 140 shares of RSP at $46.62 each.
  • Result: By the end of September 2018 Investor 2's 140 shares are worth $15,133
That is the problem, gut feeling and emotion will cut your net worth in half. 


Symbols
The long term bull and bear lines above are based on the S&P 500. These are the 500 largest companies traded in the USA. I use the ticker symbol RSP but strictly speaking the S&P 500 symbol on stockcharts is $SPX. The way the $SPX index is selected is weighted by size of firm so Exon and Apple are a huge part of the traditional $SPY index. The symbol RSP is the same index but each firm is "re-balanced" to be 1/500 of the index and so the big players do not over effect the results.

As you will note I said Phil has a financial planner buy and sell for him ... but you might not. No worries, simply get a discount brokerage account and buy and sell a broad market ETF like RSP, SPY or IWM based on the bull bear line graph and you will still out perform most hedge funds.

You can use other indexes, IWM is the 2000 smallest stocks a much broader (and more volatile) index. DIA will allow you to just focus on the DOW 30 stock a very narrow focus of the very biggest firms. Here some more things you can track:

GLD, Gold
OHI,  Oil Service Providers
XLY, Cyclicals Sector
XLE, Energy Sector
XLB, Materials Sector
XLI, Industrials Sector
XLF, Financials Sector
XLP, Consumer Staples Sector
XLK, Technology Sector
XLU, Utilities Sector
XLV, Health Care Sector
EEM, Emerging Markets
UUP, US Dollar

You can Track country funds too, for example EPHE is the Philippians EWG is Germany.

For that Matter you can track specific stocks using the same graph. For example F is the ticker symbol that would tell you when to be in the stock of the Ford Motor Company.


Why It Works
Well quite simply if the average price is rising on anything then the short average will rise above the slower average and vice-versa. So if we color our fast line green and our slow line red then all we need to do is be in higher risk assets like equities when green is above red. Also you can see this is not just true of equities (stocks) it can also be used for currency trading, bonds, metals, commodities and even art, stamps and real estate if you look at a long enough time frame.