This simple indicator, which has better than doubled the buy-and-hold performance of SPY with 1/3rd of the drawdown, is near to issuing a short signal.
I developed an indicator some time ago that I use to gauge the long-term health of the market. The indicator has been catching my attention lately because it is near flipping to a short signal. Before I get into the specifics of the indicator, let’s first look at its performance vs. buying and holding SPY.
Using all SPY history, buying the ETF on 1.23.93 and holding it until 8.26.11 (no commissions or slippage included) yields the following results:
- Compound Annual Growth Rate of 5.47%
- Maximum Drawdown of -56.45%.
- Total Profit of 169.11%
This simple indicator (to be revealed below) yields the following results over the same time period:
- Compound Annual Growth Rate of 11.78%
- Maximum Drawdown of -20.27%
- Total Profit of 692.27%
While the performance is impressive for the buy and hold investor, what is more important to me right now is that the indicator is near to issuing a short signal. How has it performed, on the short side?
Remember that a negative %chg means a profit for a short sell.
On the short side, this indicator has a win/loss percentage of 66.67%. If we are entering another extended bear market, there is a substantial likelihood that a short trade will result in double-digit gains. In the past, when the indicator has gone short and the market does not enter into a sustained bear market, it has closed the trade for a small loss.
What Is The Indicator?
It is very simple. Calculate the 5 day rate of change (ROC5) and the 252 day rate of change (ROC252).
- Buy (or cover short) at the close if yesterday the ROC252 crossed above the ROC5 and today the ROC252 is still above the ROC5.
- Sell (or open short) at the close if yesterday the ROC5 crossed above the ROC252 and today the ROC5 is still above the ROC252.
How Close Are We to a Short Signal?
The blue line needs to cross beneath the red line.
As I’ve said many times before, simple is often better than complex. With that in mind, I’ll finish this post by showing the equity curve generated from the long and short signals.