The PENTAD Timing Model Strategy By Nelson Freeburg (Rules, Backtest, Performance)
The PENTAD Timing Model By Nelson Freeburg is an active, complicated strategy that uses four stock indices and one advance/decline line for producing buy/sell signals. This timing model is designed for the US stock market.
Using this timing model, you do not need to be in the market 100% of the time and expose yourself to additional risk, unlike passive/lazy strategies. You enter the market when the PENTAD Timing Model gives an entry signal and exit when the strategy gives an exit signal.
In this article, we will describe in detail the structure of the PENTAD Timing Model and backtest it on historical price data.
Related reading: – We have many more trading timing models, strategies, and systems
Who Is Nelson Freeburg
Nelson Freeburg, the editor of Formula Research, is an experienced futures, fixed-income, cash, stock market trader, and researcher. After leaving the academy to take up trading, Nelson became passionate about finding clear and accurate trading signals by rigorously testing various technical theories.
In 1991, Nelson began publishing his findings in Formula Research, allowing him to share his findings with money managers and traders. Nelson’s research and testing resulted in an impressive array of advanced trading systems.
Instead of relying on subjective chart patterns, Nelson looks for objective signals in an extensive historical database that covers a wide range of traded commodities. He evaluates these signals based on their clarity, reliability, and effectiveness. In addition, he tests the effectiveness of profit targets, stops, and mental stops to strengthen trading systems further.
Nelson’s research has enabled him to provide professional traders with an efficient and reliable tool for trading the financial markets.
Nelson Freeburg was a prominent editor of Formula Research, a stock, bond, and commodities newsletter. As a research consultant, he helped institutional finance managers create custom timing models. Since 1980, Nelson has been an active investor and has given talks worldwide about his research.
What Indexes Does The PENTAD Timing Model Track
The PENTAD timing model is a reasonably complex model that tracks the following indices on a weekly timeframe to generate buy/sell signals:
- S&P 500 Index – is a stock index that includes 505 stocks of 500 selected U.S. listed public companies with the largest capitalization. As an alternative, we will use the SPDR S&P 500 ETF Trust ETF (SPY);
- Dow Jones Transportation Index – is the stock market index from the S&P Dow Jones Transportation Indices, which is the most widely recognized indicator of the US transport sector;
- Dow Jones Utilities Index – is a stock index from S&P Dow Jones Indices that tracks the performance of 15 well-known utility companies whose stocks are traded in the US;
- Dow Jones Corporate Bond Index – The Dow Jones Equal Weight US Corporate Bond Index tracks the total yield of 100 large and liquid investment-grade bonds issued by companies in the US corporate bond market. As an alternative, we will use the iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD);
- NYSE Advance/Decline Line – is a technical indicator that shows the difference between the number of rising and falling stocks. The indicator is cumulative, whereby a positive number is added to the previous number, and if the number is negative, it is subtracted from the previous number. As an alternative, we will use the S&P 500 Advance/Decline Line.
Which Technical Indicators Are Used By PENTAD Timing Model
The PENTAD model uses two types of indicators, which are calculated based on the above indices:
The moving average envelope is a trading range and is built based on a simple (SMA) or linearly weighted moving average (WMA). The upper band of the envelope is a buy zone, and the lower one is a sell zone.
The moving average envelope is similar to Bollinger Bands and has the same trading logic.
The formula of the moving average envelope is as follows:
Middle Line = N-period SMA (or WMA) of the Close prices;
Upper Band = Middle Line * (1 + X%), where X means how much percent the upper band must be above the middle line;
Lower Band = Middle Line * (1 – Y%), where Y means how much percent the lower band must be below the middle line;
Visually, the moving average slope with a 0% upper band (equal to the middle line) and 3% lower band on the weekly SPY price chart looks the following:
The slope of the moving average, which is the difference between the current N-period moving average and the same moving average of N periods ago, is further divided by the number of periods N.
The moving average slope is an oscillator and has the same logic as oscillators like RSI and Stochastic.
The formula of the moving average slope is as follows:
MA Slope = [Current N-period MA – N-period MA N periods ago] / N-periods;
Visually, the 27-week moving average slope on the weekly ^DJU price chart looks as follows:
MA envelopes with different upper and lower band levels are calculated for these indices:
| Market Index | MA Type | MA Period (Weeks) | Upper Band (Buy) | Lower Band (Sell) |
|---|---|---|---|---|
| S&P 500 | WMA | 65 | 0% | -3% |
| DJ Transports | SMA | 25 | 0.5% | -2.5% |
| DJ Corporate Bond | WMA | 38 | 1% | -2% |
| NYSE A/D Line | WMA | 14 | 0.5% | -2% |
MA Slope is calculated for these indices:
| Market Index | MA Type | MA Period (Weeks) | Buy Threshold | Sell Threshold |
|---|---|---|---|---|
| DJ Utilities | SMA | 27 | 0% | -3% |
Trading Rules Of The PENTAD Timing Model
Finally, these are the trading rules:
Trading Rules
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The model works like a voting machine. To enter the market it must be unanimously voted “yes”. If at least two votes are “against” – the model exits the market.
Backtesting Of The PENTAD Timing Model
Let’s backtest The PENTAD Timing Model under the following conditions:
- Only SPY will be used for buys and sells;
- Only Weekly time-frame is used;
- Historical quotes are adjusted for dividends;
- The backtesting interval from 2003 to 2023.
Portfolio equity curve:
Portfolio underwater curve (drawdowns, i.e., decline in value from a relative peak value to a relative trough):
Portfolio monthly and annual returns:
| Year | Jan | Feb | Mar | Apr | May | Jun | Jul | Aug | Sep | Oct | Nov | Dec | Yr% |
| 2003 | 0.0% | 0.0% | 0.0% | 0.0% | 0.0% | 0.0% | 2.6% | -1.7% | -3.6% | 5.4% | 1.1% | 3.5% | 7.2% |
| 2004 | 3.4% | 1.4% | -2.1% | -0.7% | 0.0% | 0.0% | 0.0% | 0.9% | 0.4% | 1.6% | 4.9% | 2.6% | 12.8% |
| 2005 | -2.8% | 3.4% | -0.9% | 0.0% | 0.0% | 0.0% | 0.0% | -0.5% | -0.5% | 0.0% | 0.0% | 0.0% | -1.3% |
| 2006 | 0.0% | 0.0% | 0.0% | 0.0% | 0.0% | 0.0% | 0.0% | 0.0% | 0.0% | 0.9% | 1.8% | 0.8% | 3.6% |
| 2007 | 0.4% | 2.2% | -1.9% | 5.3% | 1.4% | -0.3% | 0.0% | 0.0% | 0.0% | 0.0% | 0.0% | 0.0% | 7.2% |
| 2008 | 0.0% | 0.0% | 0.0% | 0.0% | -5.3% | 0.0% | 0.0% | 0.0% | 0.0% | 0.0% | 0.0% | 0.0% | -5.3% |
| 2009 | 0.0% | 0.0% | 0.0% | 0.0% | 0.0% | 0.0% | 0.0% | 0.0% | 0.0% | -3.4% | 5.8% | 2.3% | 4.5% |
| 2010 | -3.6% | 0.0% | 5.7% | 1.9% | -8.2% | 0.0% | 0.0% | 0.0% | 0.0% | 3.4% | 0.3% | 6.4% | 5.2% |
| 2011 | 1.6% | 3.6% | -0.3% | 3.9% | -2.1% | -2.3% | -3.4% | 0.0% | 0.0% | 0.0% | -5.1% | -0.7% | -5.3% |
| 2012 | 5.0% | 3.9% | 3.3% | -0.3% | -3.4% | 0.0% | 0.0% | -0.5% | -1.7% | 0.0% | 0.0% | -0.8% | 5.3% |
| 2013 | 7.3% | 1.0% | 0.0% | 0.0% | 3.3% | -0.2% | 0.0% | 0.0% | 0.0% | 0.0% | 2.9% | -0.4% | 14.6% |
| 2014 | -2.7% | 0.0% | -0.4% | 0.4% | 3.4% | 2.1% | 1.0% | 1.5% | -0.9% | 2.7% | 2.7% | 1.2% | 11.4% |
| 2015 | -4.3% | 2.5% | -3.7% | 0.0% | 0.0% | 0.0% | 0.0% | 0.0% | 0.0% | 0.0% | 0.0% | 0.0% | -5.5% |
| 2016 | 0.0% | 0.0% | 0.7% | 1.6% | 1.9% | -2.8% | 6.8% | 0.1% | -1.7% | -1.5% | 0.0% | 0.0% | 4.9% |
| 2017 | 0.0% | 0.0% | 0.0% | 0.0% | 0.0% | -0.5% | 2.1% | -1.1% | 1.9% | 2.6% | 0.1% | 3.0% | 8.3% |
| 2018 | 7.4% | -8.8% | 0.0% | 0.0% | 0.0% | 0.0% | 0.0% | 0.0% | 0.0% | 0.0% | 0.0% | 0.0% | -2.0% |
| 2019 | 0.0% | 0.6% | 1.6% | 3.9% | -3.6% | 0.0% | 3.1% | -3.1% | -1.4% | 2.1% | 4.2% | 3.2% | 10.7% |
| 2020 | -0.3% | 0.0% | 0.0% | 0.0% | 0.0% | 0.0% | 0.0% | 0.0% | 0.0% | 0.0% | 0.0% | 0.0% | -0.3% |
| 2021 | 0.0% | 0.0% | 0.0% | 0.0% | 0.0% | 0.0% | 0.0% | 0.0% | 0.0% | 0.0% | 0.0% | 0.0% | 0.0% |
| 2022 | 0.0% | 0.0% | 0.0% | 0.0% | 0.0% | 0.0% | 0.0% | 0.0% | 0.0% | 0.0% | 0.0% | 0.0% | 0.0% |
| 2023 | 0.0% | 0.0% | 0.0% | 0.0% | 0.0% | 0.0% | N/A | N/A | N/A | N/A | N/A | N/A | 0.0% |
Portfolio performance statistics compared to benchmark S&P 500 Total Return index:
| Statistical Metric | Portfolio | S&P 500 TR |
| Annual Return % | 3.54% | 8.95% |
| Exposure % | 34.36% | 100.00% |
| Risk Adjusted Return % | 10.30% | 8.95% |
| Max. drawdown | -13.05% | -55.19% |
| CAR/MaxDD | 0.27 | 0.16 |
| Standard Deviation | 6.81% | 22.64% |
| Sharpe Ratio (3% risk-free) | 0.08 | 0.26 |
Conclusion On PENTAD Timing Model
- This model is quite complex to implement because it tracks five intermarket indices;
- Since the exposure is low, you should use this model along with others;
- The maximum drawdown is low, lower than -15%; this is a strong argument for many investors.