The Gong has Rung!

At "A Dash" we are writing a blog about a book.  Our principal mission is to highlight investment concepts that will help intelligent individual investors who decide to take control of their own portfolios.  We try to show the challenges and possible pitfalls of this decision.

A major theme is that a little knowledge can be dangerous.  In particular, individual investors are inclined to bail out at market bottoms, thinking that what they read in newspapers, magazines, and popular blogs shows them the way to riches.

Sometimes the investor needs some help, and a disciplined system can show how it is done.  This does not mean that one can do it at home, in spite of the many television ads suggesting the opposite.

To this end we have for the last few months provided our own TCA-ETF sector rating with a one-day delay.  We have also commented on Vince Castelli's "Gong Model" which gives a bottom-calling signal on only rare occasions.  It is not intended as a trading signal, but rather an "all clear" call that uses important technical indicators to highlight prospects for the next few months.

The Gong has Rung!

Two weeks ago we cited a number of approaches to identifying a market bottom.  Vince's approach was a bit more cautious than many others, and we avoided some of the recent declines.  We indicated that the hammer was pulled back, and that the Gong would soon ring.  On the basis of Friday's closing data, despite the market decline, the Gong gave a "buy" signal which we shared with our investors.  The signal came despite the decline in the market averages because it keys not on the averages, but on a universe of individual  stocks.  The signal was even stronger after today.

Investors who are interested in this model should not feel like they have missed out because of a one-day move in today's trading.  The signal is good for several months.  Interested readers who send an email request  can get a free report on past signals and the results.

The Gong Approach

For obvious reasons, we cannot discus the exact methodology used.  Here is the description of the Gong Model from our prospectus:

 

“They don’t ring a bell at the bottom,” goes the old market expression. Sharp sell offs are the most difficult times, not just for the average investor, but also for professional managers and traders. Anyone can look at a chart and observe that a sharp “V” bottom proved to be a great buying opportunity. The problem is recognizing this opportunity in an environment of fear and even panic. For every “brilliant” buyer of a V bottom, there is a matching seller who is blowing out of his position. If the seller proves to be right, he saves a lot of money. If he was wrong, then he panicked.

Even though these situations occur infrequently, the impact on overall trading profits is significant. It works both ways. Some traders try to use “oversold” indicators to signal when to buy. The problem with this approach is that oversold markets can get more oversold --- a lot more! An oversold indicator would have had you buying on October 16, 1987, the day before the crash.

The flip side of this is the cost of delay. The aftermath of market crashes or mini-crashes is an extremely volatile time, featuring whipsaw moves and no real trends. If you wait for a clear-cut trend to emerge, you may miss an important tradeable rally.

The Gong model does not attempt to call exact bottoms. One might think of it as an all-clear signal after a hurricane. The worst is over. There might still be some choppy weather ahead, but the risk is now limited and the potential profit is great.

The Gong model is very good at identifying downward spikes.  It is not perfect, failing when the downward move is choppy and persistent.  That includes trading in recent months, where we had a false signal in December.  We are suspicious of perfect models. This usually means that the developer has not done honest development and testing.  It is easy to come up with a model that perfectly fits past data.  This is not what we have done.

Conclusion

Regular readers of "A Dash" know that we have been bullish on market fundamentals.  We are not perma-bulls, since we avoided the declines of the bubble era.  We are more confident than most market participants on several fronts, including the following:

• General economic strength, including recession odds;
• The extend of market pricing for a perceived recession, which we think has been overdone; and
• The expectation for future earnings.

While our trading positions have reflected current conditions, we are always delighted when the systems we employ achieve convergence with our analysis of the fundamentals.