Fear Day Supplemental Q&A

1 www.indexstrategyadvisors.com

Fear Day Supplemental Q&A Q: Just to clarify your point about the trading data you have since 1972, is this for all markets: general session, futures, and options? And, do you have

intraday data, like every hour? (Or, is it possible to have a record of the actual tape, that is of every trade?) A: We have all daily trading data for stocks and indices dating back to 1972 and for futures dating back to 1963. We have intraday data (including every

minute) dating back to 1993 for stocks and indices, and for futures dating back to 1984. We have 6 months of tick-by-tick (per trade) data. Q: How did you determine that 3% is a good cutoff to define a "fear" day? A: Mostly trial and error of data mining. We have model trades and algorithms for trend reversals of far less magnitude, however in general the bigger the

reversal, the easier it is to trade and the more worthwhile it is. Q: Are there also “mild fear” days (like a 2% drop in the market?) A: Absolutely, our first algo written and one of the most profitable was a -1% S&P 500 system. Q: Is the Floor trader pivot point the opening price or the moment after the opening when the market ticks back up? A: Neither. Floor trader pivots are pre-calculated support/resistance levels that do not change throughout the day. I have provided further explanation on

how these pivots relate to the AM reversal trade I referenced previously. We can use either the cash market prices of the Indices or the near contract month futures price to calculate pivot points. I use both depending on which model trade I am executing.

Q: Have you observed other securities with this (what I consider) very high Fear Day correlation? A: Absolutely, what we are calling “Fear days” are trend reversals. The foundation of our trading and investment philosophy is 100% focused on executing

profitable trades based on index trend reversals. It boils down to tax-treatment of gains, risk tolerance and complementing the balance of your portfolio as to what securities from our existing pre-researched list of vehicles I would recommend. I listed a few in this supplement to give you an idea. It would be very neat to seek and discover which indexes and sectors were most politically sensitive then load those securities and cross/compare our base algos for the broader market. Based on my observations, and trading experiences, financials have been the most volatile and easiest to exploit for quite some time now. When trading in anticipation of dislocation in the financial sector FAZ and TZA are the best ETFs and Russell Index options are the best derivatives.

Q: It seems that for JNK and TLT, the trade one does on "fear" day is over by the end of day 3. How would you suggest one best execute to take advantage of

these trades? A: It depends on a few important factors regarding your situation that I am unaware of. Are you wanting a hedged position? How do these proposed

symbols compliment your other holdings on fear days? Secondarily, we should take a closer look at how consistent JNK, and TLT trade in all market cycles, not just fear days. We have several algos we can plug the signals /symbols into and stress test them against various scenarios. These 15 examples were algo outputs not inputs. To test these symbols we’d load hundreds of market scenarios then see what the outputs told us. We also would look at days the market rises significantly which is central to understand in your risk management plan. It wont be complicated or overly time consuming to do so, but we must look at the whole picture to ensure the vehicles will do what we expect them to do when the markets align with our theses.

Q: Wouldn't the column totals (of the 15 “fear” incidents) allow us to judge which symbol was the better one to utilize? A: I wasn’t 100% clear on this but I gave it a shot. Hopefully it is what you were expecting. If not I’ll be happy to get it right on second attempt.

http://www.indexstrategyadvisors.com/


Supplement Contents:

3 Historical market data

11 Rationale for 3% cutoff on Index trend reversals:

16 Pivot points

19 AM reversal

23 Securities with high market correlation

Homepage: http://www.indexstrategyadvisors.com

Address: Index Strategy Advisors, Inc. 2001 Holcombe Blvd. 25th Floor - Suite 2502 Houston, TX 77030

Telephones: 1-800-984-0268 1-832-586-8329 (fax)




Historical Market Data Availability

Futures Data

• 6 months of tick-by-tick data • 27 years of intraday (one minute and above) data • 48 Years of daily (Open, High, Low, Close, Volume) data

Equities Data

• 6 months of tick-by-tick data • 18 years of domestic intraday (one minute and above) data • 39 years of daily (Open, High, Low, Close, Volume) data • 87 years of daily (Open, High, Low, Close, Volume) data of the Dow Jones Industrial Average

Options Data

• 6 months of tick-by-tick data • All intraday (one minute and above) data since each currently traded option contract's inception • 39 years of daily (Open, High, Low, Close, Volume) data

Forex Data

• 6 years of intraday (one minute and above) data • 38 Years of daily data

International Data

• 6 months of tick-by-tick data • 27 years of intraday (one minute and above) data on most major exchanges



Historical Minute Bar Database

U.S. Stock Database Description Start Date NYSE Stocks 01/01/1991 NASDAQ Stocks 01/01/1991 AMEX Stocks 07/01/1998 INDEX Data Symbol Description Start Date

$INDU, $DJI Dow Jones Industrial(1)

01/02/1985

$NDX.X Nasdaq 100 Index(1) 01/02/1985 $YXY0 NYSE Index 01/02/1987 $RUT.X; $IUX Russell 2000 Index(1) 01/02/1985 $OEX; $OEX.X S&P 100 Index 01/02/1987

$MID.X S&P 400 MidCap Index

01/02/1998

$SPX.X, $INX S&P 500 Index(1) 02/01/1983

Symbol Description Start Date AD.P Australian Dollar 01/13/1987 BP.P British Pound 01/01/1980 CD.P Canadian Dollar 01/01/1980 DM Deutsche Mark 01/01/1980 EC.P Euro FX 01/04/1999 JY.P Japanese Yen 01/01/1980 MP1.P Mexican Peso 01/02/1996 SF.P Swiss Franc 01/01/1980

Equities Symbol Description Start Date NQ E-mini Nasdaq 100 07/01/1999 ES E-mini S&P 500 09/11/1997 ER2 E-mini Russell 2000 10/25/2001 ND.P Nasdaq 100 04/10/1996 NK.P Nikkei 225 09/25/1990 RL.P Russell 2000 02/04/1993 MD.P S&P 400 MidCap 01/04/1993 SP.P S&P 500 Index 04/21/1982

Interest Rate Symbol Description Start Date ED.P Eurodollar 12/09/1981 EM.P Libor 09/25/1990 TB.P T-Bills 01/04/1982

Fiber Symbol Description Start Date LB.P Lumber 01/01/1980

Chicago Board of Trade Equities Symbol Description Start Date DJ.P Dow Jones Industrial 10/06/1997

Grains Symbol Description Start Date C.P Corn 04/02/1982 O.P Oats 04/02/1982 SM.P Soybean Meal 04/02/1982 BO.P Soybean Oil 04/02/1982 S.P Soybeans 04/02/1982 W.P Wheat 04/02/1982

Interest Rate Symbol Description Start Date

MB.P 10 Year Municipal Bond/Note

06/11/1985

TY.P 10 Year U.S. Treasury Note 01/03/1983 TU.P 2 Year U.S. Treasury Note 01/02/1991 US.P 30 Year U.S. Treasury Bond 04/02/1982 FV.P 5 Year U.S. Treasury Note 07/01/1988

One Chicago Single Stock Futures Symbol Description Start Date

Over 500 Symbols Single Stock Futures/ Index Symbols

02/12/2003

New York Mercantile Exchange Energy (NYMEX) Symbol Description Start Date CL.P Crude Oil 01/02/1987 HO.P Heating Oil 01/03/1984 NG.P Natural Gas 01/04/1993 HU.P Unleaded Gasoline 09/01/1987

Metals (COMEX) Symbol Description Start Date HG.P Copper 12/01/1989 GC.P Gold 01/03/1984 PA.P Palladium 01/02/1987 SI.P Silver 12/01/1983

New York Board of Trade Food/Fiber Symbol Description Start Date CC.P Cocoa 07/01/1986 KC.P Coffee 01/05/1987 CT.P Cotton 01/05/1987 OJ.P Orange Juice 07/06/1987 SB.P Sugar 07/01/1986

Index Symbol Description Start Date YX.P NYSE Index 11/01/1983 DX.P U.S. Dollar Index 07/01/1989

(1) The ITRS research methodology employed by Index Strategy Advisors, has been collecting real-time market data for 37 technical studies performed against the DOW, the S&P 500, and the Russell 2000 since June 2002.

Meat Symbol Description Start Date FC.P Feeder Cattle 01/01/1980 LH.P Lean Hogs 04/01/1981 LC.P Live Cattle 01/01/1980 PB.P Pork Bellies 01/01/1980



5-minute Data Example (E-mini Crude) IEA Oil Release 6.23.11

Announcement

“Full day window ”


http://www.cmegroup.com/trading/energy/crude-oil/emini-crude-oil_contract_specifications.html





Announcement

“3 hour window”




“30 minute window“

Announcement



Tick Data Example (E-mini Crude) IEA Oil Release 6.23.11

“1 minute window“

Announcement



Multi Asset Example (E-mini Crude vs. JNK, GLD, TLT) IEA Oil Release 6.23.11

Announcement

“Full day window ”



Tick Data Summary (%) Example (E-mini Crude @8:14 A.M EST)

IEA Oil Release 6.23.11

Date Time Open High Low Close

6/23/2011 8:14 -1.59 -1.59 -1.59 -1.59

6/23/2011 8:14 -1.59 -1.59 -1.59 -1.59

6/23/2011 8:14 -1.59 -1.59 -1.59 -1.59

6/23/2011 8:14 -1.617 -1.617 -1.617 -1.617

6/23/2011 8:14 -1.617 -1.617 -1.617 -1.617

6/23/2011 8:14 -1.617 -1.617 -1.617 -1.617

6/23/2011 8:14 -1.59 -1.59 -1.59 -1.59



Rationale for 3% cutoff on Index Trend Reversals: Bigger Moves are Less Frequent…

19%

53% 51%

2%

29% 27%

1%

17%

12%

0%

10%

20%

30%

40%

50%

60%

Historical Average* 2008 2009

S&P 500 Index Daily Price Fluctuations (1948-2009)

Days of 1% Moves or More

Days of 2% Moves

Days of 3% Moves

Daily price movements measured using closing prices. * Historical average between 1948-2009



Rationale for 3% cutoff on Index Trend Reversals: …so when they do occur volatility is maximized making monetization is easier.

9%

4%

11% 53%

40% 79%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Support Resistance

Avg. Delta Gain within 2 std dev. from Reversal Pivot (1985-2009)

Days of 1% Moves or More Days of 2% Moves Days of 3% Moves

Increase in delta when compared to pre-reversal ratio. * Historical average between 1948-2009



60%

40%

20%

0%

1965 1970 1975 1980 1985 1990 1995 2000 2005 2010

Rationale for 3% cutoff on Index Trend Reversals: A two decade pattern of low volatility has been broken…

Through December 31, 2010 MSCI World returns are hedged into US dollars; trailing tree-month data. Source: MSCI

Global Equities Realized Volatility 1965-2010



90%

80%

70%

60%

50%

1971 1975 1980 1985 1990 1995 2000 2005 2010

Rationale for 3% cutoff on Index Trend Reversals: … combined with the growth of ETFs this should exacerbate correlation making most equities “De facto indexes”

Source: MSCI

Percentage of S&P 500 Stocks Moving in Same Direction



Rationale for 3% cutoff on Index Trend Reversals: … more reasons

• We target larger reversals for both rallies and corrections. In both cases the reversal tends to lead an extended trend making the trade safer and more profitable. • Trade winning percentage (real and simulated) is in the very upper 90% range on 3% days. It drops to 70% for reversals of lesser magnitude.

• The Larger trading range makes execution easier.

• Algorithmic probability distributions for outcomes have narrower medians: It is easier to statistically predict how a majority of market participants will respond because markets (and technical indicators) are highly correlated on these days.

• While 3% days are optimal, we target reversals based on a rolling 7-10 day trend reversal strategy. The stronger the trend (in either direction) the stronger the reversal. 1% reversals are tradable but they monetize to a far lesser extent and involve greater risk.

• Anomaly paradox: People behave more consistently under greater duress whether it be fear or greed based.

o e.g. when there is no smoke and a fire alarm some will head for the exit some wont, but if there is smoke with the fire alarm most will head for the exit; if there is fire, nearly all will head for the exit.

o The same holds true with opportunity. The stronger the opportunity the less unwilling people are to ignore it. And the more popular the opportunity the more people will follow it.

o These anecdotal examples describe the behavior of investors at moments of support and resistance on major indices. Particularly on major reversals.



Pivot Points

• Pivot points are precise daily support or resistance levels that unlike many popular technical indicators (such as moving averages) can be used in very short term scenarios to determine whether a market is overbought or oversold.

• Pivot points are calculated based on the prior trading range of the vehicle.

• For the S&P 500, Russell 2000, and NASDAQ 100 the pivot point ranges when combined with Fibonacci retracement levels are extremely accurate in predicting when a market will reverse course and to what level it will retrace.

• We use pivot points to calculate the price to buy or sell a vehicle based on our profit expectation and maximum acceptable loss.

• We utilize pivot points to execute our trades but not to plan them. We do not place a trade without knowing exactly where the market is in relation to a pivot level. The typical trade is placed based on an alert fired from the pivot macro within the algorithm.

• Pivot points are not perfect. We must use algorithms to calculate the std. deviation of variance in fib levels related to pivot points and several other technical indicators such as stochastic momentum, bid/ask ratio, advance/decline ratio, institutional accumulation / decumulation etc.

• There are several pivot point calculators (Classic, Woodie, Camarilla, Demark) for our system, Classic formulae work the best and are embedded in all of our algorithms.

• The classic formula is: R4 = R3 + RANGE (same as: PP + RANGE * 3)

R3 = R2 + RANGE (same as: PP + RANGE * 2) R2 = PP + RANGE R1 = (2 * PP) - LOW PP = (HIGH + LOW + CLOSE) / 3 S1 = (2 * PP) - HIGH S2 = PP - RANGE S3 = S2 - RANGE (same as: PP - RANGE * 2) S4 = S3 - RANGE (same as: PP - RANGE * 3)



Pivot Points (cont.)

• There are 9 Pivot Point levels calculated each trading day: R 1 through R4, the Pivot point, and S1 through S4. • R = Resistance or the upper range of a trend. 4 is the max upper range, 1 is the min lower range. R levels establish when a

market will stop going up and reverse course (or go sideways). • S = Support or the lower range of a trend. 1 is the max upper range, 4 is the min lower range. S levels establish when a market

will stop going down and reverse course (or go sideways).

• Here is an example of how we use Pivot points based on last Friday’s Russell 2000 Mini futures September 20011 Contract close: Let’s say we are expecting a market pullback sometime this week based on the fact that the market rallied 7.5% in only six sessions, and in six consecutive sessions, is very close to its previous resistance of 850, and that 67% of ISM led rallies retrace within two sessions -- and there are several big employment reports. So we think the market could go higher-- maybe a day or two more, but we are looking for a 50% retracement to occur over two sessions and this 90pt range from the current trend could serve us an immensely lucrative 45pt move to the downside. So we’d first start with “R” because we expect the market to pullback. We’d set alerts at R1 of 842.8 plus the std. deviation the algo says is right for this scenario. That’s it. The algo would also give us a stop level. Say at 843.6-- In this way we would know our max downside was 1pt and our upside was 45pts. Once you program the algos to give you the historical references it is just that simple. We aren't predicting a fear day, but a normal pullback from an overbought market that would be larger than usual.

TFU1 30-Jun-

2011 01-Jul-

2011 Change

Change %

Previous Week

Open 819.0 824.5 5.5 0.7% 791.6

High 827.1 839.0 11.9 1.4% 839.0

Low 817.8 822.8 5.0 0.6% 789.2

Close 825.4 836.6 11.2 1.4% 836.6

Range 9.3 16.2 6.9 74.2% 49.8

Volume 126,249 131,863 5,614 4.4% 703,302

Daily Pivots for day following 01-Jul-2011

R4 881.4

R3 865.2

R2 849.0

R1 842.8

PP 832.8

S1 826.6

S2 816.6

S3 800.4

S4 784.2

Source: http://www.mypivots.com/dailynotes/symbol/448/-1/ice-russell-2000-mini-september-2011


http://www.mypivots.com/dailynotes/symbol/448/-1/ice-russell-2000-mini-september-2011














Pivot Points (cont.)

• The key to making Pivot points work in trading is knowing what levels are likely to be taken out and knowing what the std. deviations are. There are thousands of institutional algos currently that push the market to these pivot levels pull their orders to suggest a reversal and then massively reverse the reverse orders. We call these situations a breach of pivot. We have a library of breaches the system cross-checks so that we can anticipate whether or not a given market scenario is prone to one.

• I have not tested the efficacy of Pivot points for stocks or other vehicles because nearly everything worth trading is correlated to one of the three indices we are extremely numerate with. For example, if I want to trade the financial sector I use the Russell 2000 mini futures pivots. If I want to trade tech I use the NASDAQ 100 cash index pivots, If I want to trade the materials sector I use the S&P 500 cash index pivots.

• We use the pre-market session range for the mini futures contracts of the Indices we have talked about to calculate pivot points when trading early intraday models, extended models generally use the cash index prices

• After stop limit orders, pivot points are the best risk management tool in executing trades, because knowing when and at what price the market is likely to turn is the foundation for knowing when to exit a position.



AM Reversal

• The AM reversal is a S&P 500 “Model Trade”, meaning we’ve rigorously tested its efficacy and have exhaustively reviewed thousands of possible ‘rule-exceptions’. All model trades have a 1% stop loss. All model trades have a 70% or better win trade on the simulator. All model trades have a rule set that fires an algo when to execute the trade and at what price (buying and/or selling). Here are some high-level summary points of how the AM Reversal works:

• The trade happens by 10AM EST it is signaled and executed in the first half hour or not at all.

• There are two trades opportunities within the model: 1-the reversal bet (e.g. if the market opens lower you go long at the opening pivot, and vice versa); 2) The counter-reversal bet (if you want to bet with the prevailing trend as well you enter your trend following bet at the 10AM retracement)

• If the market opens at R1 or S1 then >70% of the time a 50% retracement will occur (e.g. if the pre-market high was 10 and S1

is 1 then the market will climb back to 5 before 10AM more than 70% of the time; the opposite is true on rallies).

• The retracement is always priced to the immediate previous trend (including its former self)

• If the reversal retracement is greater than 50% wait until the previous high/low has been hit to enter position.

• If the market opens beyond R1 or S1, the next resistance/support level is R3 or S3 or the 50% fib split of R2/R3, S2/S3. No trade should be placed away from these levels.

• The AM reversal is more accurate with catalysts in the market (good or bad). Examples using Lehman day:



AM Reversal: “Lehman Day” 9.15.08

Chart intentionally left blank.



AM Reversal: “Lehman Day” 9.15.08

Here is an example of an AM Reversal. Note the best long trade is at the capitulation from the open and note the 10AM short entry point is roughly the tradable high for the day. Had we entered at the open our stop los would have liquidated the position as the market gained 1.6% against any ‘opening shorts’ within the first half hour. With the link below you can see that the projected Pivot point of S2/S3 with a 50% fib was 1213.65 within 1.4 of the actual opening sell-off. So the trade would have been to go long at the Pivot/Fib and then go short at the 50% level which would have been 1232.5 right at 10AM. Note the actual 50% level was exceeded. By about 4 pts, but well with the std dev. http://www.mypivots.com/dailynotes/archive/123/20080912/e-mini-sp500-december-2008


http://www.mypivots.com/dailynotes/archive/123/20080912/e-mini-sp500-december-2008










AM Reversal: “Day after Lehman Day” 9.16.08

Here is another example of an AM Reversal. Note the 10AM entry point is roughly the tradable high for the day (like the previous trading day). Also note that the 50% retracement was crossed by a meaningful amount and a short at any point before a) 10AM and b) the previous high would have resulted in a loss. Note the 10 point breach of pivot violently pushing the market higher right at 10AM. Several big banks have massive algo programs that try to counter this AM reversal that many traders exploit. Very few disciplined traders would hold a ten point gap against their position. 10pts is nearly the average daily range for this vehicle. Following the dark pool assault at 10AM the market did what it usually does at that threshold. Our algos calculate the difference between the fib/pivot combo and the actual price level historically. There will always be institutions with capital to push beyond the exact projected levels so this calculation is a must. It is also different for different environments and our best indicator of its efficacy (besides hindsight) is the advance/decline line. If the breadth is decidedly negative/positive against the trend reversal we know there are competing algos and can wait beyond the time frame. You can probably guess what we call the late afternoon model trade. You can see a similar (double 50% retracement/reversal) move. http://www.mypivots.com/dailynotes/archive/123/20080915/e-mini-sp500














Securities with high market correlation

• Based on my research and experience, the most consistently profitable way to trade any market, is with directly correlated securities that are index linked.

• Stocks move faster and farther than indices but they lack a pre-known consensus in their pricing behavior, thus they are largely unpredictable. When

the S&P 500 is rising or falling and pauses, we can look at the advancers/decliners within it and surmise based on historical data of the underlying forces (e.g. sectors and stocks) and patterns how long and how far that trend may continue. If the a/d line is split 50/50 we can simply not trade it. We can wait until there is conviction on either side. There are many other technical indicators we can use to see leading indicators regarding an index price momentum. Whereas when stocks pause there is no way to know why or what’s next-- there is only one indicator and it is lagging: price. We have to get in and hope for the best or sit out and possibly miss out. Stocks definitely follow patterns and devoted followers can learn them. But these patterns inevitably change with the companies fortunes, life-cycle, industry trends, institutional participation and many other factors that are highly labile. There is a constancy of reshuffling impactful factors and no one yet has figured out how to corral these factors. Ironically this may change as correlation and volatility continue to rise, but that is another discussion.

• I have listed several ETF securities that have outstanding (e.g. consistent) behaviors in relation to broad market pullbacks and rallies. With nearly a thousand ETFs created since we built these algos there are no doubt many others too; I am falling in love with EDC as a international market vehicle but it is too early to endorse yet, however the algos we are testing it with are showing unmatched reliability, profitability, and accuracy. For right now, and the up until the election, the ETFs listed below will get the job done: adequate liquidity, minimal spread, consistent correlation ratios, and very predictable price behaviors in relation to market movements. Most importantly the only variable you need to care about when in the position is the price of the index behind it. For the options market the Index options are fantastic. I have trained around 30 professional traders based on the index options and we have 11 models for the NASDAQ 100, Russell 2000, and S&P 500. If you want to trade options you will experience greater liquidity and save anywhere from 200-400% on the cost of the spread by trading index options vs. options on any ETF. For your political theses, I would strongly recommend we discuss the Russell 2000 Index options for you. Both as a vehicle to exploit your market expectations surrounding political events as well as a vehicle to exploit our existing trend reversal expertise. On the following page I have a concern about the inconsistency of JNK as it correlates to the S&P 500. We can discuss during our call.

Thesis ETF Vehicle Option Vehicle

Market rout led by financials FAZ, TZA Russell 2000 Index Options

Market rally led by financials FAS, TNA Russell 2000 Index Options

S&P rally UPRO S&P 500 Index Options

S&P rout SPXU S&P 500 Index Options

Tech rally TYH NASDAQ 100 Index Options

Tech rout TYP NASDAQ 100 Index Options



End of supplement


Business

Fear Day Supplemental Q&A