- Annualized Return
- Beta
- Dominant Market Theory (DMT)
- The RUTTR Signal (RUT)
- Exponential Moving Average (EMA)
- Maximum Draw-Down (Mdd)
- NC Alpha
- Relative Strength Index (RSI)
- Rate of Change (ROC)
- Sharpe Ratio (SR)
- Standard Deviation (SD)
- Ulcer Index (UI)
- Ulcer Performance Index (UPI)
- NYSE Advance/Decline Line (AD)
- McClellan Summation Index (MSI)
- Volatility Index (VIX)
- Barron's Confidence Index (BCI)
- Treasury/Eurodollar (TED) Spread (TED)

Some term definitions from www.FastTrack.net.

The total, all-in return on a fund or portfolio inclusive of and adjusted for all distributions. It is calculated as:

((TotalReturn + 1 ) ^ (252 / (MarketDays)) - 1

Beta is a classical measurement of the volatility of a fund or portfolio with respect to an underlying index such as the S&P 500. It does not measure return or alpha. A Beta of 1.0 indicates that the fund or portfolio is roughly as volatile as the underlying index. A Beta of 2.0 indicates the fund or portfolio is roughly twice as volatile as the underlying index. Betas are notoriously volatile themselves changing frequently with time.

The Dominant Market Theory (DMT) is an extension of the work presented by Don Beasley in 1997. The theory supports two basic conclusions about dominant market environments based on the relative strength of the OTC Composite Index to the NYSE Composite Index:

- Most severe declines take place while the NYSE is the higher relative strength i.e. dominant, market
- Both OTC and NYSE markets are strong when the OTC is the dominant market

The second conclusion indicates that most diversified funds will do well in a market environment in which the small caps are dominant. Under this theory the bellwether Russell 2000 Index (RUT-I) needs to be in an uptrend for the general investment environment to be considered favorable. The DMT conclusion is that there are identifiable market environments that are highly productive and relatively low in volatility and other environments that are much lower in productivity and much more volatile. The DMT supports the notion that there are identifiable market environments exhibiting the desirable mutual fund investment characteristics of high productivity and low volatility and often lasting for months at a time.

It can be shown that in a market in which the Russell 2000 is dominant most funds and portfolios will chalk up almost all of their gains for the year. Even the S&P500 is 3 times more productive during such strong small cap markets. Clearly, tracking the trend of the small cap indices has value even if you invest primarily in large cap mutual funds since on average large cap funds are 5 times more productive and less than half as volatile during strong small cap (RUT-I) markets. Nearly all stock funds and sectors are capturing their entire net annual returns or more during the 60% of the time that the small cap markets are in an uptrend.

During the remaining 40% of the time those funds and portfolios will go nowhere or even suffer losses. Since the Russell 2000 is only dominant some 60% of the year, the theory indicates that bond fund positions are often the best choices for the remaining 40% of the time. Since the market cycles in which the Russell 2000 is dominant are interspersed irregularly throughout the year, a number of RUT-I based indicators are often used to make such determinations.

It is through the use of those and similar DMT indicators that TSP Pilot makes its TSP Plan fund allocation decisions. Since the DMT allows portfolios to remain invested in the safer, less volatile bond portfolios, such as the G and F Funds, the total risk exposure of the TSP Pilot Portfolios is reduced substantially while still providing for above market returns. Since the intent of the TSP Pilot Portfolio is to be invested only during those productive market environments under the DMT, using the Sharpe ratio, NCAlpha, RSI and other risk-adjusted metrics to find the best choices among the Thrift Savings Plan equity funds (C, S, I Funds) will help to ensure that the plan participant remains 100% invested in the strongest funds through the entire market cycle.

The basic RUTTR intermediate term market timing signal, developed by Werner Ganz in 1998, served as the original "heart" of the Dominant Market Theory for a number of years. While there have been many refinements, it still serves as the backbone for the DMT for many purists.

The original RUTTR signal quite accurately called the 2000-2003 tech market bust back in March of 2000 reinforcing its credibility. In more recent market cycles the classic RUTTR signal has been somewhat late in calling market turns, but it remains the classic trend definition under the DMT.

RUTTR is the progenitor of the many more sophisticated timing signals that followed after 2000 including those that added market volume as an additional parameter. Technically RUTTR combines the MACD and Stochastic of the Russell 2000 index both of which need to be positive for RUTTR to go on a buy.

While RUTTR is not used primarily to trade the Russell 2000 directly, it is used to determine whether the market environment favors small cap stocks or large cap stocks. When on a "buy," the RUTTR indicator basically says that small caps will prevail and therefore that the TSP S fund will likely outperform the TSP C fund over the intermediate term future.

By the standards of today's DMT "quants" the RUTTR is a bit "weathered" as a tracking indicator, and there have been many improvements offered over the past year or two. TSP Pilot currently uses some of the newest variations and improvements on the original RUTTR signal in the systems it currently follows to develop recommendations for the Thrift Savings Plan funds.

The EMA was developed to provide a quicker reaction to recent price changes than does a standard moving average. The goal of the EMA is to produce a smoothed line through the price data while improving price sensitivity. The exponential moving average (EMA) is calculated by adding a percentage of yesterday's moving average to a percentage of today's closing value. The EMA increases emphasis for recent price data and de-emphasize the older or more historical price data.

1) Calculate a smoothing factor (SFactor) derived from a parameter value (typically a number of days) . This factor is a constant throughout the averaging process.

SFactor = 2 / (Parameter + 1)

2) Each day's moving average value (MA)

is computed as follows,

MA = ( Price * SFactor ) + ( prior MA * (1 - SFactor) )

On the first day, MA is set to the first day's Price. The MA is carried forward to the next day to be used as the prior MA in the formula.

The Maximum Draw-Down is perhaps the best measure of investment risk as it measures the maximum percentage one could have lost during a certain period while invested in a fund or portfolio by buying at a high price and selling at the subsequent low price. The smaller this number the better. An Mdd of 25% would indicate that an investor would have suffered a loss of 25% in the value of his fund or portfolio, usually within a given year.

Non-Correlated Alpha (NCAlpha) represents the "productivity" of a fund or portfolio-how much "bang for the buck" you get for a given level of risk versus that provided by a benchmark index. The "father" of NCAlpha, Werner Ganz, expresses it as

NCAlpha = Returns of fund - (SD of fund / SD of index)

* Returns of index

If a fund has twice the volatility of an index and has twice the return, its NCAlpha will be zero. NCAlpha is a variant of the alpha term used in Modern Portfolio. Alpha uses "beta" in place of the relative standard deviation term in NCAlpha. Beta merges standard deviation with the investment's correlation to the reference index. It allows for de-correlation of the components of the portfolio to reduce the apparent volatility of the portfolio.

The Relative Strength Index (RSI) is a trading-range momentum indicator developed in the 1970's by J. Wells Wilder. The RSI compares the magnitude of the recent gains of a fund or portfolio to its recent losses and generates a number that ranges from 0 to 100. It takes a single parameter (P), the number of time periods to use in the calculation.

The Rate of Change is the simple percentage change between today's closing price for a security and its closing price "x" days ago. While simple in concept, the success or failure of the ROC will depend on the chosen value of "x", or how many days ago the comparison is made. Too short a time period and the selected security's performance can be quite unreliable. Too long a time period and the securities performance can "run out of steam" leaving you with a sub-par performer.

Popularized by the "father" of Modern Portfolio Theory, Bill Sharpe, the Sharpe Ratio (SR) is another excellent risk-adjusted metric. Whereas NCAlpha represents the "productivity" of a fund or portfolio, the Sharpe Ratio is the best measure for how much "bang for the buck" is provided for given level of risk versus a benchmark index. The Sharpe Ratio is the best risk-adjusted metric when it comes to volatility. It is calculated as:

(Issue's annualized Return - Low Risk Return's annualized Return)

/ (Issue's annualized Standard Deviation ) Where annualized Standard Deviation equals Monthly Standard Deviation

* Sqrt(12)

The Sharpe Ratio demands that market returns come from something other than increasing volatility. Simple arithmetic will show that a 50% increase in returns created by a 50% increase in standard deviation is a loser. This ratio can be used as the basis of a ranking system that measures the fund manager's performance more than it measures the fund's performance.

Standard Deviation (SD) is generally described as the difference between the mean and the square. There are other types of SD calculations which will differ from FastTrack's results. Standard Deviation in this case is calculated on a daily basis and then adjusted to a monthly basis by multiplying by the square root of 21 (the average number of market days in a month.). Since standard deviation does not distinguish between gains and losses, the Ulcer Index (UI) is the better measure of downside market risk.

The Ulcer Index (UI) is perhaps the most popular measure of market risk. The smaller the value is the better. The Ulcer Index is a measurement of day- to-day drops in the value of a fund or portfolio. Developed by Peter G. Martin and Byron B. McCann and described in detail in their book, The Investor's Guide To Fidelity Funds in 1989. Peter Martin and Byron McCann, once stated, "the higher an investment's Ulcer Index, the more likely investing in it will cause ulcers or sleepless nights."

Therefore, the smaller the UI number the easier will be the investment to live with. It is considered a better measure of market risk that the standard deviation of returns since it does not penalize for volatility when the market is going up. Unlike standard deviation the UI only considers the volatility of the market when it is declining. Investors generally aren't as concerned about price volatility when the market is climbing. The UI is calculated by taking the square root of the average of the squared retracements. For a more comprehensive technical discussion of the Ulcer Index see http://www.seanet.com/~pgm/ui/ui.htm .

The Ulcer Performance Index (UPI) measures how well a fund or portfolio outperformed a money market index (a risk free investment) over a 12 month period compared with its associated downside risk (as measured by the Ulcer Index). It is calculated by subtracting 5.6% from the Annualized Return to provide a number for the excess return above risk free Treasury Notes. The resultant number is then divided by the Ulcer Index (UI). Essentially, UPI is the measure of the performance of a fund or portfolio per unit of risk taken by that fund or portfolio. The higher the UPI number the better. A high UPI further endorses a stated high investment return. For a more comprehensive technical discussion of the Ulcer Performance Index see the bottom section of http://www.seanet.com/~pgm/ui/ui.htm .

The NYSE Advance/Decline (A/D) Line, also known as the Breadth of the Market, is one of the oldest and most basic of broad market indicators. It is a ratio of the number of advancing NYSE issues divided by the total number of both advancing and declining NYSE issues. The basic premise is that volume precedes price action as volume essentially reflects the money flowing into and out of a stock. The A/D is positive when more issues advance than decline. Such a market is said to demonstrate strong breadth and therefore a bellwether for higher prices.

The VIX is the symbol for the Chicago Board Options Exchange Volatility Index. The VIX is a popular measure of the implied volatility of the S&P 500 index options and an important measure of investor confidence in the general market over the next 30 day period. Thought of as the "Fear Index" the VIX is more specifically a metric for the volatility of the Standard and Poor's 100 Index of puts and calls. Extremes in the VIX often precede important market turning points. Simply put, a low VIX number often indicates trader over-confidence while a higher number implies undue investor pessimism.

The McClellan Summation Index is a broad measure of stock market health. It measures market breadth by netting the number of daily advancing and declining issues in the NYSE index. The McClellan Summation Index is a long term look at market general direction and is a good indicator of current trends in the equities markets. Since it is a broad based measure of market health, it is often referenced by TSP Pilot merely as an indicator of general market condition. It is not sufficiently market specific to be of use in TSP Pilot's market timing signals for individual TSP funds. It does, however, have informative value. The MSI is usually quoted ratio adjusted and oscillates between 0 and 2000. MSI's below -1000 frequently indicate a looming long term market bottom. Conversely, MSI's above 1500 often signal an impending market top. The McClellan Summation Index was developed by Sherman and Marian McClellan and first presented in their book "Patterns for Profit" (available from McClellan Financial Publications). The McClellan Summation Index is computed as:

1000+(10%Trend-5%Trend)-((10 x 10%Trend)+(20 x 5%Trend))

where:

5%Trend = 39-day EMA of (Advancers-Decliners) 10%Trend = 19-day EMA of (Advancers-Decliners)

The Barron's Confidence Index is an indicator reflecting investor confidence and sentiment much like the Dominant Market Theory. It is calculated by dividing the average yield on high-grade bonds by the average yield on intermediate-grade bonds producing a ratio or spread. An increasing spread between the yields indicates investors are demanding a lower premium in yield for increased risk and therefore demonstrating greater confidence in the economy. Optimistic investors are more likely to invest in higher yield, more speculative bonds; the converse is true when investors are pessimistic.

The TED spread is an indicator of perceived credit risk in the general economy. This is because T-bills are considered risk-free while LIBOR reflects the credit risk of lending to commercial banks. When the TED spread increases, that is a sign that lenders believe the risk of default on interbank loans (also known as counterparty risk) is increasing. Interbank lenders therefore demand a higher rate of interest, or accept lower returns on safe investments such as T-bills. When the risk of bank defaults is considered to be decreasing, the TED spread decreases.

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