How My Signal System Works

SUMMARY:

In this video, you’ll learn how my signal system works to change the way you see the stock market.

Instead of listening to pundits commit the narrative fallacy of weaving news into a story explaining why the market went where it went or, worse, why they think it will go a certain way in the future, you’ll come to see the market as a meaningless series of changing numbers.

This controls emotion and allows for rational reaction to price changes. You won’t care why the numbers went up or went down, you’ll just react in a predetermined manner to the change by selling fluctuations above a signal line and buying fluctuations below it.

In this manner, you will beat the market with no stress from indecision and no more time wasted listening to pundits make up stories from the news.

TRANSCRIPT:

Hello, I’m Jason Kelly. Thank you for joining me.

In this video, I’ll show you how my Signal system works.

I’ll demonstrate the power of reactive rebalancing to a signal line, the concept behind all three of my market-beating Signal strategies. They are:

3Sig using 3% quarterly growth and no leverage,
6Sig using 6% quarterly growth and 2x leverage, and
9Sig using 9% quarterly growth and 3x leverage.

While each of the three uses slightly different parameters, they all operate within the same Signal framework I’m about to show you.

Stock market moves are unpredictable, as you probably know. Guessing where the market will go next is a fool’s errand, but remains an obsession of the financial media just the same.

The Signal system discards entirely such guessing in favor of reacting to where the stock market already went. It can even work within test beds of randomly changed numbers, not even real stock-market numbers, showing that the method is robust.

The idea is simple. I use just one stock index fund and one bond index fund in each one of the plans. I specify a quarterly growth pace that I want to compare stock-market movement to, and then react to where the market went in relation to that signal line. That’s what I call it: the signal line.

If the stock fund rises to a level above that line, I sell the surplus and put it into the bond fund. If the stock market does not rise above that line, so it’s down here, maybe, I use the money from the bond fund to buy the shortfall distance. This requires no guessing about what’s going to happen, just reaction to what already did happen.

In The 3% Signal, there’s a helpful chart on page 39 showing this process in action. Take a look:

Now, you can see in this chart, we have on the y axis, the vertical axis on the left, the different balances of the fund or levels of the stock market. In the bottom, the x axis, we have the different quarters, so Q1-4 in the first year, Q1-4 in the second year, on this particular chart.

Now, on the left, notice there’s a 10,000-dollar or 10,000 level marked above and below the signal line. That shows you the line has no thickness, it’s just made thick on the chart so you can see clearly where it is, and it’s labeled “The Signal Line.” Can’t go wrong with that.

Notice, we see the movement of the stock market above and below this signal line over these eight quarters, and along the top of the chart, circled in white, we see the signal line balances along the way. This is it just growing at 3% per quarter. So, we have 10,300 then 10,609 then 10,927 and so on.

So, that’s where we want to rebalance our fund back to each quarter along the way. So you can see in the beginning, Q1, Q2, and into Q3, the stock market was doing well. It was rising above the signal line, and we would sell those respective amounts at the end of Q1 and Q2.

Later, let’s look into the second year, you can see the stock market over Q1, Q2, and into Q3, fell down below the signal line. So, you see indicated on the chart, “Buy This Amount,” buy that shortfall below the signal line.

That’s how it works. Very straightforward isn’t it? It takes away all the guessing games.

It helps to stop thinking of the stock market in terms of the stories that pundits tell every day using the news. There’s a term for making up stories to explain stock-price movement: narrative fallacy.

When a pundit says why stocks rose or fell, or worse, why he thinks they’re going to rise or fall, he’s committing the narrative fallacy.

He simply doesn’t know why prices went the way they went, and certainly doesn’t know where they’ll go next, and neither does anybody else — including me.

But the key takeaway is that it doesn’t even matter. Why should you care why stock prices went where they went?

The Signal system helps change your view of the stock market away from prices meaning anything or bearing any relation to the news, and being mere numbers meaning nothing. Sometimes the string of numbers gets bigger, sometimes smaller. That’s all.

If you react appropriately to the number changes, you will profit. How to react? As you saw earlier in the chart: by selling surpluses over the signal line, and buying shortfalls under it.

Let’s see how this works with even random numbers.

To generate the numbers we’ll flip coins to create random increases and decreases of a line, then react appropriately to them.

On page 44, you’ll find this chart:

[Chart shown in the video, at 5:19.]

In this chart, what’s happening is I’m increasing and decreasing this line by flipping coins. In the upper right corner of the chart you can see white is heads, and that increases the line by 5%. Gray is tails, which will decrease the line by 5%.

No, this is not a true indication of how the stock market works. It’s not the greatest randomizer, but it’s simple and you get the idea: random changes. We’re just going to flip these coins.

So, you can see along this line how we did. We had three head flips in the beginning, sending the line higher, then we got a couple tails in there, and we progress through 50 coin tosses and the line moved along this route to end at a balance of $10,382 after it started at $10,000 even.

Alright? That’s how it works.

Now that we have our simplified version of a random price line, let’s add a simplified version of rational reaction to it.

When the line rises, we’ll sell 5% of our stock position. When the market falls, we’ll use our cash balance to buy a 5% increase in our stock position. Let’s see how that went.

On page 48, you’ll find this chart showing the result:

[Chart shown in the video, at 6:32.]

We have here in gray, we see the coin toss balance. It’s the same line you saw in the last chart but with the coins taken away so you can just see the movement there. In black, we see the reactive balance, the result of our taking those rational reactions along the way.

Notice that as time goes on, our black line deviates from that gray line and we end up growing our balance more by just reacting rationally to where the market went along the way. So, the ending balance of the market is $10,382 but our ending balance by reacting rationally is $10,661.

Again, yes, simplified, things work a little bit differently in the real stock market, but it shows that you don’t even need to care about any story behind the numbers. You don’t have to care what news might or might not move the market, you just have to react rationally to the actual numbers the stock market serves up, and discard all the narrative fallacy of the pundits on TV.

Alright, now you know the basics of how the Signal system works. In the next video, you’ll learn how well it works in the real stock market.

Thank you for watching!


To check the performance of my stock/bond signal system, please visit my Strategies page.

Want more videos like this? Subscribe to The Kelly Letter YouTube channel.

Thank you for watching!

This entry was posted in 3Sig, Education, Kelly Letter Show. Bookmark the permalink. Both comments and trackbacks are currently closed.
  • Here are your three options:

    Option 1: Annual Subscription (no refunds)

    For just $200 per year, you’ll receive everything listed above to completely upgrade the way you manage your investments. This is 17% cheaper than the monthly option. This is what I recommend:






    Option 2:Monthly Subscription (no refunds)

    If you'd like to try The Kelly Letter  without paying the full year, you can pay $20 per month.





    Option 3:Free Email List

    If you'd like to hear more from me but aren't ready to part with any money yet, you're welcome to join my free email list:

    Join the free list





    Thank you for the work you do. You're a household name here and my wife and I often discuss your letters on Sundays. My ten- and seven-year-old children recognize your name and will eventually be taught to invest using 3Sig and 6Sig. You've had an enormously positive impact on our investing and inspired me to look at the world in more rational and clear terms than I did years ago. I'm sure that thousands of others would say the same. Kelly Letter subscriber Matt Barnes
    Matt Barnes
    Product Line Director
    OCLC

    Join Matt and thousands of other rational investors to invest without stress.

    Subscribe to The Kelly Letter  now!

Bestselling Financial Author