An Add-On For The ETF Rankings System

Monty Pelerin / Economic Noise

A new tool will be provided with the January momentum-volatility ranking. I am excited about its potential. It is still preliminary in nature, but offers the promise of significant risk reduction without corresponding reductions in return. It may provide the investor the ability to both eat well and sleep well. It should make sleeping easier at least.

This indicator is an important step toward making the ETF rankings system, which is already pretty good, a better and safer approach to markets.

The Pelerin Protection Indicator

All indicators need names and all pseudonymous authors should have at least one indicator named after them. Hence, this indicator shall be known as the Pelerin Protection Indicator or PPI (not to be confused in any way with the purchasing price index). The PPI is a composite index of trend measures and long term oscillators. It performs like an oscillator, ranging in value from 0 to 10. It measures market strength and provides a means for determining how strong a financial commitment should be made.

The motivation behind this effort was to provide a front-end screen for the ETF rankings. Selecting from a large pool of ETFs invariably catches some fish, even when markets are weak. Rarely do no ETFs not pass their individual screens. A front-end screen to modify the overall commitment was needed. It is difficult to make money in weak markets, especially on the long side. If markets appear weak, that information should be reflected in investment decisions.  

To test the efficacy of this indicator, it was applied to the ranking selections of the ETF system. The test was a fairly simple one. What would happen if the PPI was used to alter the weight of money committed?  The ETF ranking system was not changed. Only the amount of funds committed to the selections in a particular month were were changed.

Here are some early testing results of combining the indicator with the ETF selections.

Initial Results

Only the amount of funds to be committed to the ETF selections was affected by the PPI in this test. The results are discussed and shown below.

The monthly returns were used from the ETF backtesting. When the PPI indicated strong markets 100% of the funds were committed to the ETF system. Otherwise, a lesser percentage was committed. Premium members know that ETF selections often include cash. That was not altered; only the funds applied in any particular month changed.

continue article at Economic Noise:

http://www.economicnoise.com/2013/12/18/strength-index/