The core function and raw power of Ark’s trading system comes from its ability to accurately identify newly forming market trends so we can Buy Low and Sell High, regardless of the direction of the market.

In addition, Ark’s recently optimized trading system has also been designed to achieve the following important goals:

1.    Outperform the Overall Market in Both Upturns and Downturns

2.    Safer and Still Profitable in a Volatile Trendless Market

3.    Reduced Risk Through Diversification

4.    Full Protection When the Bubble Pops (without knowing when it will pop)

Let’s dig a bit deeper into how we achieve each of these goals.

1)   Outperform the Market

With a trading system that can correctly identify newly forming up and down market trends, we are able to buy long positions near the start of a new uptrend (buy low) and later sell those long positions near the start of the next downtrend (sell high). 

Because we do not buy-and-hold, we don’t lose money when the market is falling.  This one difference alone means we can outperform the overall market simply by taking advantage of uptrends and avoiding significant downtrends.

But it gets even better than that.  To further increase our opportunities for gains, we can also hold short positions during market downtrends.  This has the potential to significantly increase gains, further outperforming the market.

The goal is to take advantage of trends in either direction and make money in both up and down markets. But what if there is no clear market trend?  In that case, we are…

2)  Safer and Still Profitable in a Volatile Trendless Market

While it doesn’t happen too often or last too long, sometimes there is no larger trend and the market stays relatively flat.  And sometimes there is no larger trend and the market is wildly volatile yet getting nowhere.

Both conditions pose real challenges for active investors.  No larger trend generally means no significant gains.  And wild volatility means it is easy to get faked out and think a new trend may be starting when it is not.  If the volatility continues in a wide range, one could easily repeatedly buy high and sell low, instead of the other way around.  That’s dangerous.

To deal with this, Ark’s trading system requires a waiting period before executing a trade.  That helps limit the risks of trading too often in what we call a Volatile Flat. In addition, the trading system can be used to generate Buy and Sell signals in response to smaller or shorter-term trends that often can be found during flat periods.  In fact, correctly buying and sell in a volatile flat market period can be very profitable if there are big swings up and down within a wide range (see chart below).

Even in a Volatile Flat, Shorter-term Trends Can Create Gains

3)  Reduced Risk Through Diversification and More

We avoid the risks of actively trading individual stocks and instead focus our buying and selling on ETFs (exchange-traded funds) that track the major stock market indexes, including the S&P 500, the Russell 2000, the Dow Jones Industrial Average, and the Nasdaq 100.

By nature, Index ETFs are inherently highly diverse.  The S&P 500, NASDAQ 100, and Russell 2000, for example, are composed of hundreds (or more) of stocks in many industries.   

However, the obvious downside to using ETFs of stock indices is that, by definition, they do not outperform the stock market – they are the stock market.  Here is how we offset ETFs general lack of ability to outperform the market, while also reducing risk:

• We can increase returns while remaining diverse by picking industry sector ETFs that generally outperform the stock market, such as gold, gold mining, semiconductors, emerging markets, and biotechnology. 

• We can outperform the market by trading double or triple levered ETFs that track these stock indices, just at double or triple their rate of growth.  For each index, we choose leveraged ETF pairs that come in both long and short versions so we can easily move from long to short positions.  Choosing leveraged ETFs means whenever the market does well, we do better.  And whenever the market does poorly, we can also do better by going short.  Much better.  (Please note:  Leveraged ETFs are only traded in our separate hedge fund, not for our clients’ individually managed accounts at Schwab.)

• We also limit risk by avoiding direct margin, opting instead for leveraged stock indices ETFs.  This is less risky than using margin because we can never get a margin call on these assets.  More importantly, because we are using a reliable trading system, we quickly exit positions when the trend moves against us.  That makes leveraged ETFs quite profitable and quite safe.  Leverage only hurts when the trend is ignored.  Thankfully, our trading system is there to prevent that.

• We further reduce risk by avoiding direct shorts.  Instead, we rely on inverse ETFs that short the underlying stock index.  While inverse ETFs can be somewhat expensive to hold long term, we generally hold inverse ETFs for far less time than non-inverse ETFs, as the opportunities for shorting the markets are usually much shorter than opportunities to go long on the market.

All of the above provide great risk protection, but nothing reduces risk better than having a trading system that can correctly identify and take advantage of newly forming trends.  When markets change and others hold their positions “into the wind” on the basis of market conviction or hope that the winds will soon change, we simply replace our positions with assets that benefit from the new trend.  

Remember, no amount of diversification or other risk reduction techniques can protect you better than correctly exiting before a steep downturn.

4)  Full Protection When the Bubble Pops

While we know where this market is going in the longer term, we do not try to guess where stocks will go in the shorter term.  By actively moving from the long side to the short side of an investment position when the investment position’s trend changes, we minimize losses and increase gains.  Making good gains in the significant up and downtrends more than offsets smaller losses during less clear trends.

Getting out of positions when the trend changes is absolutely key, not only to reduce risk in any market, but especially when the stock market bubble finally pops.

No one can say WHEN this bubble will blow.  For all we know, the next big drop could just be another good buying opportunity.  And that is everyone’s problem:  even if you see the macro problems, you have no idea if the next big drop will be the pop.  As we say in our books, many market drops (and rebounds) may come before the Big One.

The advantage of Ark’s trading system is you don’t have to know which drop will turn out to be The Big One.  Without knowing the future, the trading system will get you out of market longs and into shorts whether the bubble is popping or not.  When “The Big One” does hit, the system will just see it as another downtrend and be out of the market and shorting it before any of us know we are about to go over the Market Cliff.