EdgeWare FastBreak Standard Version 6.5 - Manual (Page 78)

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Building Market Timing Signals
If you have an overall strategy with an MDD of say, 15%, then don’t make the market
signal too efficient. For example, when building the market timing signal use a goal of
perhaps 20-25% for the signal MDD. Then, when you use the resulting signal to build the
actual trading system, use the 15% MDD goal. The reason for this is that if the signal is
too efficient; no stops will be necessary in the actual trading strategy. It is usually a good
idea to have at least one stop activated because it is unlikely the signal will be perfect in
the future.
We have found it is very difficult to control the MDD of stock trading systems without
market timing signals. Even in a severe bear market there will be individual stocks that
rally strongly and result in whipsaw purchases. This is because a strong rally isn’t sus-
tainable in a bear market. Just as “a strong bull market lifts all boats,” a strong bear mar-
ket drags down good stocks. The market timing signal only needs to keep you out of the
worst markets. The signal may only average one or two switches per year. You can of
course control the switches per year with the optimizer.
We like signals that use a range of indexes in the trading family. In general, most indexes
move together, but there are times when some market segments will diverge. For exam-
ple, small caps may be in an uptrend when the large caps are selling off or are flat. Have
the market timing signal keep you in the market, and let the FastBreak strategy built on
this signal rotate you into the right funds or stocks. We have built successful signals that
combined SP-CP, NDX-X and RUT-I in the signal family.
If you want to trade specific market sectors, such as energy stocks, you should build an
energy sector timing signal. We have built such a signal using Fidelity Select Energy Ser-
vices fund (FSESX) alone in a family to build a signal. We also experimented with Fi-
delity Select Energy (FSENX) alone and combined with FSESX for the signal. We used
these different signals with a batch of energy and energy service stocks with very good
results.
The choice of a money market doesn’t need to actually be a money market fund. Any
fund, stock or FNU file can be used. Just remember that when the signal strategy switches
to the “money market” fund this generates a sell signal in the signal file. This opens up a
whole word of possibilities on building negative correlation timing signals.