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Tutorial

Self-Directed Approach

General Rules and Procedures

The general procedures. Trading indexes (TIs) are updated and displayed on our web site sometime after the close of the markets each Friday. The user examines them each weekend. Decisions are made to buy, sell, trade, or hold following the general rules and procedures discussed below, and any changes to an account are made before the market closes on the following Monday.

If Friday is a market holiday, the TIs are provided sometime after the close of the market on Thursday. If Monday is a holiday, any changes to accounts would be effective on Tuesday.

The first step. Using a 1-fund approach (the simplest), a person starts using the FTI System by buying the available fund having the highest current TI, provided one has a positive TI. If the funds you currently own have TIs lower than that of the one having the highest current TI, they should be sold and that top fund purchased with the money. If your funds do not appear on our current list, they probably either have TIs lower than those on the list or they are not considered in our system. We screen funds and include only those meeting certain criteria (see Funds.) If no available fund meeting our criteria has a positive TI, including the funds you currently hold, the money goes into (or stays in) money market.

If you are uncomfortable making sudden moves, they can be made over a period of time, but there is no long-term advantage of doing so. Many users of the FTI System may prefer to hold more than one fund at a time, which is a less aggressive approach. The system researched and described in Using Mutual Fund Trading Indexes keeps the investor in only one fund, for reasons explained in the book. There is nothing particularly wrong with holding more funds, but it can become more complicated as it can increase the number of trades and the total time in managing accounts. There may also be slightly lower profits by doing so, depending on how much the best fund outperforms the close contenders. These points are more thoroughly discussed in the book.  We do not recommend holding more than four funds in an account at a time. The procedures for using two funds are detailed at the end of the tutorial. This tutorial is based on the one-fund approach.

Example -- Second half of 1998

Table 1 gives data for five funds. Four of these were good performers for most of the period. They are somewhat diverse in their investment styles, there being two funds heavily weighted in technology (one mid cap, one large cap), a growth & income fund, a pure value fund and a value/growth hybrid fund. The Value fund is included for the purpose of illustrating how a poorly performing fund is not considered as a "buy" or "hold" because its TIs are consistently lower than the other choices. During the research and testing of the FTI System, all of Fidelity's non-select funds were considered, approximately 75 or 80 total. TIs were calculated each week for a much larger group of high performing funds than are shown. Only the five are shown, in the interest of saving space and making the example easy to follow.

This period of time was chosen because it illustrates all of the decisions, namely buy, sell, trade, or hold, it demonstrates the application of the general rules and specifications on TI differences, and it illustrates the advantage of being safely in money market during an overall bear market of even a couple of months. The TIs are shown in Table 1 for each Friday. Other than the starting date at the end of June, the decision dates for changes were August 7 (sell), October 16 (buy), November 27 (trade), and December 11 (trade). In reality, decisions were made on all other weeks as well. Those decisions were to hold.  The one-fund approach is used for simplicity.

View Table 1

June 26 – Decision to HOLD the Fidelity Fund

If you had been using the FTI System prior to this date, this fund would have been the fund held at the end of June based on the fact that its TI is the highest of those being compared and it is positive. If your money was in money market (cash) or some other fund at that time, you would buy Fidelity Fund from the cash account or trade the fund you were holding for this fund sometime after June 26. We will assume the investor was already holding Fidelity Fund, and that 3,000 shares were owned. The June 30 price is used for computing the value of the account at the beginning of the second half of the year. This is shown in Table 2.

August 7 -- Decision to SELL Fidelity Fund (move to Cash)

From June 26 through July 31, the TI of Fidelity Fund remained above those of the other funds and remained positive. However, on August 7, it dropped to -0.10. This matched our specification of -0.10, the SELL signal. Had there been another fund with a TI at least 0.20 greater than this, we would have traded to that fund. Even though the TI of OTC is positive, it is only 0.01 and thus not high enough to meet this specification. It would have needed to be at least 0.10 to make the required difference. Since there are no other funds with positive TIs, the only option using the FTI System is to move the money to a money market fund. Fidelity's Cash Reserves is the fund used here. The sale is made on Monday, August 10. The computations for the transaction are shown in Table 2.

Note that a $1.46 dividend/capital gain was distributed to the Fidelity Fund on August 7. This increased the number of shares from 3,000 to 3,132.768 before the fund was sold on August 10. The drop in TI was caused by market factors, not the drop in the share price due to distributions of dividends and capital gains. TIs are unaffected by such distributions.

October 16 -- Decision to BUY Dividend Growth

For the nine weeks from August 7 through October 9, the TIs of all funds remained negative. Therefore, the money remained in Cash Reserves. But, then, on October 16, after ten weeks in Cash Reserves, some TIs became positive, the highest being that of Dividend Growth at 0.23. So, the decision was made to buy the fund using the money in Cash Reserves. This transaction was made on Monday, October 19. During the ten weeks hold of Cash Reserves, the money was earning about 5.3% (annual rate), and hence the gain of over $1,000 during that time. See Table 2 for the calculations to this point.

November 27 -- Decision to TRADE Div. Gr. for New Millen.

Toward the end of the five week period from October 16 through November 20, the TI of a couple of the funds exceeded that of Dividend Growth, but not by the required 0.20, so Dividend Growth was held during the period. Then the TI of New Millennium surpassed that of Dividend Growth by 0.22 (being 0.98 minus 0.76) on November 27, and so the decision was made to trade Dividend Growth for New Millennium. This trade was made on Monday, November 30. The account is updated in Table 2. For the purposes of this example, we will assume New Millennium was not closed to new investors.

December 11 -- Decision to TRADE New Millennium for OTC

The hold of New Millennium was brief, but we abide by the signals and rules and traded it when the TI of OTC exceeded that of New Millennium by more than 0.20. Note that the TI of Over-the-Counter (OTC) was greater than that of New Millennium the week before, but not by 0.20 and so no trade was made then. The trade was made on December 14. The TI of OTC remained above those of the other funds for the rest of the year and so we end the year with all of our money in OTC. This final transaction and the account value at the end of the year are shown in Table 2.

TABLE 2
Fidelity Fund Trades
Second Half of 1998
TUTORIAL EXAMPLE

Dividend distribution on Fidelity Fund on August 7.   See text for explanation.  

6-MONTH EARNINGS

Comments On This Tutorial

It may seem strange to many people that a trade would be made so soon in December, and perhaps even the other trades seem to be a bit frequent, but this is the way the system works. We do not question it. Eight years of superior results in our back-testing is too compelling to do otherwise. Actually the number of trades in this example is a bit higher than usual, but we needed to make a good example as a tutorial and this seemed to work for that purpose. In any case, the application of the FTI System is contrary to many traditional ways of investing and trading. To apply it means that a person must change old habits and ways of thinking.

Note the returns for the 6-month period and comparison with those of the indexes, shown in Table 2. This is not necessarily a typical gain over the indexes and should not be considered as a constant pattern to expect during any similar period. Just as with any system applied to investing in variable markets, nothing is highly predictable. The results in this example did, nonetheless, somewhat mirror the returns over the eight year period used to back-test the FTI System.

Remember, this is merely an illustration here, using a limited number of funds, from only one fund family. The fund listings on the web site will include the funds with the highest TIs, regardless of fund family. 

The two month hold in Cash Reserves was profitable in that fund prices continued to drop during that time and the prices of any of them on October 16, (when signals dictated returning to variable funds) were all lower than when we moved out of the market in August. Had the bear market continued longer, we would have profited even more by being safely in money market. Worthy of note here is that our current brokerage system (much larger universe than Fidelity only) would have put us in a fund such as BEARX on 8/10 instead of cash reserves.   BEARX grew from $5.94 to $7.18 per share from 8/10 to 10/19, an astounding 20.9%! The 6-month return would have been 41.6% instead of 18.3%! Buy-and-hold? No way! You may need to read the book to fully appreciate this exclamation.

Holding More Than One Fund

Introduction.  Holding two or more funds can reduce the fluctuations of your account balance, prevent some trading back and forth between the top funds, reduce the effects of redemption fees, and give many people a better feeling of security. Although trading between the top funds is reduced, total transactions will increase, since more than one fund might sometimes be "transacted". This increases total brokerage trading fees and the time required to analyze TI data and make trades. Research showed that holding three funds at a time instead of one approximately doubled the number of transactions, despite the fact that switching between the top funds is avoided. Holding two funds should increase the transacting, as compared with holding just one fund, but it should not be doubled. Research showed that the returns, over the long run, were not significantly different holding either one or three funds at a time. We can assume the same to be true for holding two funds at a time. We feel that the testing done offers sufficient evidence that holding two funds at a time will achieve gains comparable to using just one fund at a time, with only slightly more transactions. 

The main reason for considering holding two or three funds is the human factor. We have found that many people feel more comfortable having somewhat less volatility in the account balance in the short term, and are reluctant to place everything in one fund (especially when their account balance is high and when redemption fees apply) even though my back-testing showed that the one-fund approach achieves high profits in the long run. The two-fund approach is therefore suggested as an alternative, and as a way to encourage people to use the system.  Be assured I am not advocating asset allocation, but only an FTI System involving holding two funds instead of one.

Holding two funds at a time.  The procedures are essentially the same as used in the book and in the tutorial, with a few modifications. Assuming there is no desire to diversify between fund styles, the following is an explanation of how two funds are held.

1. Start by dividing your money between the two funds having the highest TIs, assuming that two of them have positive TIs of at least 0.10. If only one has a positive TI of 0.10 or more, place or hold half in money market.

2. Trade and sell using the same rules and criteria as used in the book and in the tutorial (as updated with the 0.30 trading specification), except that the fund with the next highest TI is always held, in addition to the one with the highest TI. For example, on any given week:

   1. If another fund's TI exceeds that of one of the two funds, but not the other, by 0.30, hold the top fund and trade the other one for the new fund.

   2. If another fund's TI exceeds those of both funds held, by 0.30, continue to hold the previous top fund and trade the one having the lower TI for the new fund.

   3. If two or more funds exceed the TIs of both of the funds held, by 0.30, sell both funds being held and buy the two having the highest TIs.

3. If money is in a money market fund initially, due to no funds having positive TIs, follow these rules for buying funds:

   1. If a single fund reaches a TI of 0.10, buy that fund using 50% of the assets.

   2. If two or more funds reach TIs of 0.10, place (or hold) half of your account balance in the fund with the top TI, and half in the fund with the next highest TI.

4. For selling funds, use the same procedures as in the tutorial. That is, sell when the TI of either or both funds drop to -0.10 or less.

Note:  The above is modified somewhat using the methods explained elsewhere on the web site, since some diversification among fund styles is suggested using our Moderate Growth and Conservative Growth methods.

Holding more than two funds.  The above can be applied to three or four funds, with slight modifications. We do not recommend holding more than four funds at a time in an account using the FTI System. The more funds held, the more is the possibility that you will be missing the gains offered by the top performing funds, the more complicated the process becomes, and the more you will be paying in transaction fees. Furthermore, we did not research beyond a four-fund holding system, and therefore cannot address the possibilities regarding results. 

If the investor does not experience much anxiety regarding seeing the balance fluctuate and having some perceived feeling of risk, the one-fund approach is still the simplest.

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