Riding the Rydex ratio
By David BukeyUnlike most mutual fund companies, Rydex SGI caters to traders, encouraging them to move freely among dozens of their long, short, and leveraged funds. Rydex traders can bet on the market today and against it tomorrow without some of the hassles other fund families impose.
Researchers often track shifts of retail investors between cash and mutual funds to find out if they’re bullish or bearish. Daily changes in mutual fund assets rarely reveal sudden turns in investor sentiment, but when asset levels hit extremes, they can signal market reversals.
This contrarian view is based on supply and demand. Once investors pour all of their money into stocks, few buyers are left to support the market, so the market may eventually pull back. And after investors pile onto the short side, sellers start to disappear, and buyers may return to push stocks higher.
Rydex funds are self-contained, so traders have only three choices: go long, sell short, or hold cash. And if Rydex traders sit on cash, they’re likely undecided about market direction, a conclusion you can’t draw from studying trends in overall assets at other money market funds. Because Rydex positions are easier to interpret, some analysts monitor its funds’ assets, believing shifts precede market tops and bottoms.
For example, Rydex traders on Jan. 12 placed their largest bet on the stock market in nearly eight years. Within seven days, the S&P 500 index (SPX) rolled over and fell 4.1 percent. Was this outsized bullish bet an accurate market-timing signal or just a coincidence?
To find out, this study compared daily assets of bullish and bearish Rydex funds tied to the S&P 500 index, Nasdaq 100 index (NDX), and Dow Jones Industrial Average (DJIA) since May 2001. It then measured how the Vanguard Total Market Index exchange-traded fund (VTI) behaved in the two weeks after Rydex traders piled into either side of the market.
For the complete article, see the April 2010 issue of Active Trader magazine. Click here to subscribe.
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