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Tharp's Thoughts Weekly Newsletter

October 03, 2007 — Issue #341
  
New Addition Emini Workshop added to the November Line-up
Article

Market Update for October 2007; 1-2-3 Model in Yellow Light Mode , by Van K. Tharp Ph.D.

Trading Tip

Systematic Trading II – What Style Is Right for You? by D.R. Barton, Jr.

Next week ETF, Excel and Blueprint Workshops
Melita's Corner

A Shift in Priorities by Melita Hunt

New Addition

E-mini Workshop Added to the November 2007 Line- up!


How to Develop a Winning Trading System That Fits You

with D.R. Barton and Chuck LeBeau
Nov 3-4-5

Peak Performance 101

with Van Tharp
Nov 7-8-9

Professional E-Mini Futures Trading Tactics

with D.R. Barton and Christopher Castroviejo
Nov 10-11-12

 

Feature

Market Update for October 2007

1-2-3 Model in Yellow Light Mode

by Van K. Tharp Ph.D.

Look for these monthly updates in the first issue of each month. This allows us to get the closing month data.  In these updates, we’ll be covering each of the major models mentioned in the Safe Strategies book:  1) the 1-2-3 stock market model; 2) the five week status on each of the major stock U.S. stock market indices; 3) our new four star inflation-deflation model; and we’ll be 4) tracking the dollar.

Part I:  Market Commentary

So far, the July-August correction has been a minor correction.  The Federal Reserve has stepped in and lowered interest rates and thus far, Mr. Market has seemed quite happy with that.  The market has resumed its uptrend.  Perhaps the graph of EWZ, the Brazilian ETF, best illustrates what happened (shown below).  The market corrected and then resumed its uptrend.

The subprime crisis, however, is far from over.  Furthermore, autumn tends to be a time for price shocks.  If the Federal Reserve keeps lowering interest rates, then what is going to happen to the dollar, which is already at the brink of a cliff (i.e., all time lows) when people start going elsewhere for better interest rates?  It’s a very interesting situation. 

So let’s look at what the market did in September.

Part II: The 1-2-3 Stock Market Model Is In YELLOW LIGHT MODE and that’s good for stocks

The 1-2-3 Model is borderline yellow light.  The Fed is not in the way and has actually started to lower interest rates.  That’s positive.  The market is  acting well again, and that’s also positive.  However, the PE ratio of the S&P 500 is above 17, which is not positive.  Thus, we are in yellow light mode.  I wrote a discussion on the 1-2-3 model in last week’s issue. 

(Editors note: There is a correction in last week's article. The 45 week moving average was inadvertently written as a 17 week moving average. Click here to review the article).

Let’s look at what the market has done over the last five weeks and compare that with where the averages were December 31st last year.  These data are given in Table 1 below.

 

Weekly Changes for the Three Major Stock Indices
  Dow 30 S&P 500 NASDAQ 100
Date Close % Change Close %Change Close % Change
Close 04 10,783.01   1211.12   1621.12  
Close 05 10,717.50 -0.60% 1248.29 -3.10% 1645.2 1.50%
Close 06 12,463.15 16.29% 1,418.30 13.62% 1,756.90 6.79%
31-Aug-07 13,357.74 7.18% 1,473.99 3.93% 1,988.73 13.20%
7-Sep-07 13113.38 -1.83% 1453.55 -1.39% 1958.35 -1.53%
14-Sep-07 13442.52 2.51% 1484.25 2.11% 2000.82 2.17%
21-Sep-07 13820.19 2.81% 1525.75 2.80% 2049.48 2.43%
28-Sep-07 13895.63 0.55% 1526.75 0.07% 2091.11 2.03%
Yr to Date   10.31%   7.10%   15.98%

 

Notice that the market has produced its entire gain for the year in these five weeks, with the S&P 500 being up 10.31% for the year.  It’s also been a return of high volatility in which most weeks have a return of two percent or more. 

Is the pattern having to do with years ending in 7 to continue?  If it is, then we probably can expect a major decline beginning this month.  But presently, the market shows no tendency to do this at all.  We could easily have an up market that occurs in the presence of a declining dollar and strong inflation. 

Part III: Our Four Star Inflation-Deflation Model

As I’ve stated many times in these monthly updates, we are in an inflationary bear market.  The bear market is not necessarily reflected in prices but in PE ratios.  PE ratios will continue in a downtrend even though the Dow is making new highs.  And the inflation is obvious, but simply masked by government statistics.  Okay, so now let’s look at the results for the last six months.  And remember that the Fed has now chosen to produce inflation over the pain of the subprime crisis.

Date  CRB  XLB  Gold  XLF 
December-05 347.89 30.28 513 31.67
December-06 394.89 34.84 635.5 36.74
January-07 393.89 36.25 650.5 37.08
February-07 410.64 37.45 664.2 35.95
March-07 407.45 37.95 661.75 37.57
April-07 403.54 38.62 677 37.01
May-07 407.58 40.72 659.1 37.69
June-07 410.36 40.5 650.5 36.18
July-07 424.52 39.42 665.5 32.9
August-07 413.49 39.15 672 33.75
September-07 447.57 42.11 743 34.32

 

We’ll now look at the two-month and six-month changes during the last six months to see what our readings have been.

Date CRB2 CRB6 XLB2 XLB6 Gold2 Gold6 XLF2 XLF6 Total Score
October Higher Higher Higher Higher Higher Higher Higher Lower  
    1   1   1   0.5 3.5

The results of this model are much more sensitive (I believe) than the model I presented in Safe Strategies for Financial Freedom.  The model once again shows that inflation is winning slightly.  Click here for more information on the model.

Look at what happened to the CRB, Gold and XLB during the month of August.  Those are huge jumps and to me they signal a very strong inflation just ahead of us.  This is a time to be in commodities, and real assets such as precious metals and top quality collectibles.

Part IV: Tracking the Dollar

With the Federal Reserve lowering interest rates, I would now expect currency traders to start selling the dollar and moving to currencies that pay a better interest rate.  Look at the data in the chart because it really says it all.

Month 

Dollar Index 

5-Jan 81.06
6-Jan 84.29
6-Feb 85.05
6-Mar 85.01
6-Apr 83.88
6-May 80.63
6-Jun 81.51
6-Jul 81.94
6-Aug 81.18
6-Sep 81.59
6-Oct 82.36
6-Nov 81.49
6-Dec 80.89
7-Jan 82.37
 Feb 07  82.07
7-Mar 81.23
7-Apr 79.87
7-May 79.2
7-Jun 78.93
7-Jul 77.51
7-Aug 77.51
7-Sep 75.91

The dollar has broken its important support levels and is starting to plunge.  I’ve been warning about this for some time.  The dollar has now fallen every month since the January close, although it didn’t go any lower last month with the subprime crisis.  Since January 2007, the dollar has fallen 7.8%, that's nearly as much as the S&P 500 rose last month.  If your wealth is in the dollar, then you’ve lost real value during 2007.  Think the stock market is up on the year?  No, with respect to the fall in the dollar, you are not even covering inflation if you are matching what the overall market indices are doing.

Until the November update, this is Van Tharp.

About Van Tharp: Trading coach, and author Dr. Van K. Tharp, is widely recognized for his best-selling book Trade Your Way to Financial Fre-edom and his outstanding Peak Performance Home Study program - a highly regarded classic that is suitable for all levels of traders and investors. You can learn more about Van Tharp at www.iitm.com.

 

Coming Next Week...


Exchange Traded Funds (ETF)

Three Day Workshop

October 8-10 Raleigh, NC


NEW One-Day Excel XLQ System Programming Class

Free for ETF Attendees

October 11 Raleigh, NC


Blueprint for Trading Success

Three Day Workshop

October 12-14 Raleigh, NC

Trading Tip

Systematic Trading – Part II
What Style Is Right for You?

by D.R. Barton, Jr.

 

Last week we discussed the different types of systematic trading.  My belief is that systematic trading is any trading strategy that follows a defined a set of rules.

This means that one CAN trade systematically, even if the rules are not readily programmed into computer code.

Bu there are also some key advantages to being able to convert trading rules into programmable code.  Since there are pluses and minuses to each style of systematic trading, let’s run through them.  This exercise should help you decide which is right for you.

Purely computerized trading 

By way of definition, this is any strategy that can be programmed and executed via computer.  For some diehard adherents, this is the only “true” systematic approach.  But this is a very constrictive and less useful belief about systematic trading.

Pros:

*If trades are executed by the computer then any psychological or emotional issues are removed from the decision points of entry and exit.

*Can be easily back tested to add to a trader’s confidence.

*Rule set can be applied across a wide variety of instruments to test for robustness.

Cons:

*Automatic systems must be monitored consistently for proper operation of order routing and other interface components.

*Parameters must be monitored and updated as market characteristics change.  Failure to do this inevitably leads to system failure.

*The system’s automatic nature can give the trader a sense of complacency, leading to improper system performance monitoring, which can lead to significant losses if not caught in time.

Mechanical Trading 

In this subset of systematic trading, the rules are completely mechanical (all decisions are either “yes or no”).  But some of the rules may be difficult or impossible to program. In this style one may ask questions like, “Is there news on this stock?” or Has Market Profile shown time/price contraction or a similar rule that is tough to program?  However, those type of questions can have a binary “yes or no” answer, making the system purely mechanical in both design and application.

Pros:

*Binary decisions help reduce psychological or emotional issues at decision points such as entry and exit.

*Some components of the system can be back tested to add to a trader’s confidence.

*Rule set can typically be applied across a wide variety of instruments to test for robustness.

*A broader set of inputs can be used since all parameters don’t need to be reduced to code.

Cons:

*Parameters still must be monitored and updated as market characteristics change.  Failure to do this inevitably leads to system failure.

*It can be difficult to reduce non-mechanical decisions to binary ones without introducing significant subjective input.

Now we need to stop (again!) and add a definition— one that makes mechanical traders wince.  A rule CAN BE a decision that requires trader input (even subjective input).  And to be honest, I know many more traders who have rule-based systems that aren’t purely mechanical than those that are.

For example, traders will look at various market breadth inputs (advancing issues versus declining, new highs versus new lows, up volume versus down, etc.) and make a subjective judgment on which is the most important at the time.  But their rule might be that they will go long (or short) without supporting market breadth.

Hybrid Mechanical / Rule-based Trading

I added this category, which is a combination of mechanical rules and rules that require a trader’s input, because lots of traders use this style of systematic trading – more than any of the others.

Pros:

*Some components of the system can be back tested to add to a trader’s confidence.

*A broader set of inputs can be used since all parameters don’t need to be reduced to code.

*Experienced traders can build in flexibility to take signals that satisfy subjective criteria that aren’t clearly binary (yes / no) answers. This is a key to many good traders' ongoing success.

Cons:

*Parameters still must be monitored and updated as market characteristics change.  Failure to do this inevitably leads to system failure.

*With subjectivity comes added responsibility to manage emotions, psychology, and data overload.

Rule-based, Non-mechanical Trading

Here is the style where a trader follows rules, and follows them every time, but those rules aren’t a mechanical set.  My belief is that the most successful intuitive traders fit into this category as well.  They have rules that they follow, but they just haven’t formalized them in a way that a linear/logical thinker would understand.

Pros:

*A broader set of inputs can be used since all parameters don’t need to be reduced to code.

*Experienced traders can build in flexibility to take signals that satisfy subjective criteria that aren’t clearly binary (yes / no) answers. This is a key to many good trader’s ongoing success.

*Experienced traders can use their skills to identify points where other participants are in trouble and capitalize on these moments.

Cons:

*With subjectivity comes added responsibility to manage emotions, psychology, and data overload. 

*This style of trading is difficult to repeat or model.  Some of the core beliefs and intrinsic rules may be buried deep in the other-than-conscious mind of the trader.

*This style takes the longest time to develop.

My firm belief is that all successful traders have a rule set that they follow consistently.  Some traders through experience, natural ability and self-mastery are able to have wider latitude on their rules.  The important element is that you, as a trader, identify your own trading style that fits you best.

Great Trading!

D. R.

About D. R. Barton: D.R. will be presenting his upcoming “Professional E-Mini Futures Tactics” workshop, November 10-12.

A passion for the systematic approach to the markets and lifelong love of teaching and learning have propelled D.R. Barton, Jr. to the top of the investment and trading arena where he is one of the most widely read and followed traders and analysts in the world.

He is a regularly featured guest analyst on both Report on Business TV,  and WTOP News Radio in Washington, D. C., and has been a guest analyst on Bloomberg Radio.  His articles have appeared on SmartMoney.com and Financial Advisor magazine. You may contact D.R. at drbarton@iitm.com.

Melita's Inspirational Corner

A Shift in Priorities

by Melita Hunt

What would happen to you if you suddenly received life changing or life threatening news? How would you handle it?

I guess we can always imagine what the answer would be and how we would respond, yet in the last few weeks I have had the opportunity to live it.  Two weeks ago, in the midst of our Swing and Day Trading Workshops, I was diagnosed with lung cancer.

This will probably come as a shock to many of you who know me personally or read my column regularly, just as it was for me, my family and friends because I am a healthy 39 year old who has never smoked, has a clear medical history and is still suffering no symptoms (I had an initial bloody cough one evening that took me to the doctor a few weeks ago).

No one (other than a select few) at the workshops, knew that I was going for tests, because my priority was ensuring that everyone there had a good experience and there was no reason to create any drama.

Now my priorities have shifted and it is time for me to focus on me. I love to write and will endeavor to continue this column as I investigate my illness and pursue treatment options, but right now, I don’t really know what the next few months will entail.

However, being the Aussie traveler that I am, I decided to jump on a plane the day after my diagnosis (while I still could) and took off traveling with a friend. We had a wonderful time in Colorado (at the Hot Springs). In Arizona we visited the airplane graveyard and then off to Sedona to enjoy the sunset. We ended the trip in Vegas to watch a show and win some money (yes I doubled my money and walked away).

Now I am back in Raleigh (a little bit richer), and have just completed the next round of tests (brain and bones are clear – yippee).

One thing I do know is that my attitude so far is testament to the self work that I have done over the years, and I am really proud of myself. There have been up and down moments, but all in all I am doing great.

I have been told by many people that I should “fight this” and “beat this” – yet that is not my style. I’m not angry, and I sure don’t need to fight anything. That’s just negative energy in my books. For me, this is just another experience to work through and learn from. I plan to do it peacefully, with grace and with dignity.

My good friends at Trading Education.com are currently setting me up a blog so that anyone who wants to track my progress can read along. I will let you know when it is up and running. I am planning on calling it “My Left Lung” because if there is one thing that I truly believe, it is that laughter is the best medicine…

About Melita Hunt: Melita is CEO of the Van Tharp Institute. She has had a diverse career working in the fields of telecommunications, accounting, marketing and sales, real estate investing, and ultimately speaking, coaching and writing; which are her passions. Her energy and enthusiasm is the cornerstone of her writing and speaking success and she has a special interest in inspiring people to be the best they can be. She has an innate ability to simplify complex subjects and enjoys traveling the world and sharing her experiences. She has worked throughout Australia, in London and is currently working in the USA. You can contact Melita at mel@iitm.com.

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