Welcome to the February 2011 issue of The Machine Newsletter!

This past month we’ve added additional strategies to The Machine for you. We recently added quantified Day Trading
strategies for Chairman’s Club Members. We also added a Long Only version of the Day Trading as requested
by a handful of members.

On the equity mean reversion side, we added our highest performing equity strategy yet to The Machine Pro with the launch
of Long Pullbacks V2. Long Pullbacks has long been a favorite strategy and now with the launch of V2 you have additional
ways to apply this strategy to your portfolio.

In the coming months we’ll be adding Automation (more on this from me at our next User’s Group meeting), the new ETF
strategy we discussed last month, along with additional user features to make your experience with The Machine even better.

Thank you again for your suggestions and ideas. As you can see, we take your input very seriously, and its most appreciated
by me.

I’ll see you at the User’s Group meeting next week.

Sincerely,

Larry

Larry Connors is CEO and co-founder of The Connors Group and TradingMarkets.com

This is my second article for The Machine Monthly Newsletter and I would like to focus on the use of trend following
strategies in portfolio building. As many of you know, I use a portfolio in The Machine I call AMP, for “all markets
portfolio,” in my advisory business.

Many investors and traders, for various reasons, don’t especially value trend following strategies. They prefer faster
moving strategies, such as those we call “mean reversion,” as well as other methods that buy and sell over days
instead of months. It’s not hard to understand why: the shorter term strategies seem to make more money overall
and they do well in volatile bear markets. At one time I shared some of these sentiments.

I have since become a strong advocate for using the trend following strategies – both ETF and equity – for
several reasons. Trend following focuses on lower volatility stocks and ETFs whereas mean reversion focuses
on those with higher volatility. Using both reduces strategy overlap in the portfolio and creates smoother
returns.

Secondly, when the markets are experiencing lower volatility as they are now, fewer mean reversion trades are
being filled but the trend following strategies are 100% utilized. This makes more efficient use of money. With trend
following investments lasting for months you do not need to worry about how competitive your fills are.

In terms of client psychology, I believe that trend following strategies are more intuitive. Clients believe that they
should be making money when the markets are trending upward and hope to enjoy some protection during bear
markets. Trend following has done a good job of this in historical testing. So in my opinion the correct approach is to
build trend following as a core of your portfolio and then add mean reversion strategies around that core.

Many Machine users wonder if they should make trend following purchases with new money after the original signal.
For example, if Apple was originally purchased in September 2009, should a new account buy Apple in the summer
of 2010? I say absolutely yes. If you had bought Apple in the fall of 2009, you would not be selling it in the summer
of 2010 without a Machine sell signal. That means you expect further gains.

It is always said in business school that, except for considerations of tax and transaction costs, your portfolio is fresh
money every day. Your portfolio has no memory and you configure it every day, not based on the history of what
prices you paid, but in consideration of how to make money going forward.

Please visit my website at www.kayinvestments.com and contact me to discuss investment ideas.

The investing world is full of that talk about various ways to allocate your portfolio in order to manage risk. The
majority of these articles discuss how to diversify your portfolio through asset class diversification such as stocks,
bonds and cash.

With The Machine, you can diversification to another level. You can achieve diversification and manage your risk by
building a balanced portfolio and selecting your strategies from the six main strategy groups in The Machine.

Including both long and short strategies allows you to profit when the markets move up, as well as when they move
down. The time frame that you trade is another great way to diversify. You can include strategies that trade short
term or mean reversion, as well as the longer term strategies, such as trend following. Last but not least, you can
further diversify by using a blend of stock and ETF strategies.

Designing a balanced portfolio is a simple process once we have some objectives in mind. The objectives for the
Balanced Long/Short Portfolio that we are going to build in this article are as follows:

• Annual Return (CAGR) = >20%
• Sharpe Ratio = >1.5
• Drawdown = <-10%
• Maximum Positions = 50 (2% allocation per trade)
• Balance
  • Long/Short
  • Mean Reversion/Trend Following
  • Stocks/ETFs

By using the Strategy Selector within The Machine, we can build a balanced Long/Short Portfolio within a matter
of minutes.

The Strategy Selector allows us to sort the strategies within The Machine by a variety of metrics so that we can
find exactly what we are looking for when selecting strategies.

The Strategy Selector also allows us the option to sort by maximum positions as well as minimum volume
requirements. This is another important step in order to keep your portfolio diversified and remove any overlap
between the strategies.

The slider filter options in the center of the page are also a great way to eliminate many of the strategies that do not
meet your objectives. Using the sliders makes it easy to only focus on strategies that have a specific CAGR, Drawdown,
Sharpe Ratio or combination of a variety of different metrics.

Choosing the first strategy is most important, since this gives you a base to work off of. Using the Strategy Selector,
we can search for specific strategy groups which make filtering all of the strategies easier. The first strategy was
selected by searching all Equity Long Mean Reversion Strategies that contain a maximum of 10 positions, as well as
having a maximum drawdown of no greater than -25%. The results were then further filtered by CAGR ratio from
highest to lowest and the second variation on the list was selected.

As you sort your strategies you will often find that the first variation on the list isn’t always the best. The second strategy
in this case has roughly the same CAGR, but comes with a slightly lower drawdown.

This process is repeated again for each of the additional strategy groups that we add to our portfolio. All aspects of the
strategy selector were utilized in selecting the remaining strategies.

Some of the more popular metrics for sorting the strategies are CAGR, Sharpe Ratio and Avg. % Profit and Loss per trade.
The additional search fields such as maximum positions, as well as minimum volume were also used to further increase
diversification within the portfolio in order to reduce the amount of overlap amongst the strategies.

Here is an example of a Balanced Long/Short Portfolio that can be built after filtering and sorting the strategies by specific
metrics. Trading capital was then allocated to ensure that the risk per unit is equal to 2%.

Strategy Selector – Click to enlarge

Portfolio Builder – Click to enlarge

Portfolio Results – Click to enlarge



Drawdowns – Click to enlarge

It is safe to say that this portfolio has met the objectives that we outlined above. This is a balanced portfolio comprising of the
strategies from all six of the strategy groups. You can also see that as you achieve balance in your portfolio, your volatility and
often times your drawdown will be lower and your returns will be much smoother and more consistent.

Phil Suarez is Director of Education for The Connors Group

• Two new strategies have been added to The Machine: CRDT Day Trading and Long Pullbacks Version 2.0
• In the next month, we will be adding an additional Short Equity Mean Reversion strategy, as well as the first ever Long ETF Mean Reversion strategy with Limit Prices
• New training and educational videos have been posted to The Machine, including the January 2011 User’s Group Meeting
• To stay updated and learn more about other recent additions and enhancements to The Machine, check out our Twitter feed at twitter.com/themachineus