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Tharp's Thoughts Weekly Newsletter

November 07, 2007 — Issue #346
  
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Article

Market Update for November 2007 by Van K. Tharp Ph.D.

Workshops E-mini Workshop This Weekend
Trading Tip

When to Get Out BEFORE Your Stop Is Hit by D.R. Barton, Jr. 

Melita's Corner

The Fine Factor by Melita Hunt

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Feature

Tharp’s Thoughts

Market Update for November 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’s 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 four star inflation-deflation model, and we’ll be 4) tracking the dollar. 

Starting with this issue I’m also going to show you the five strongest and weakest areas of the overall market.

Part I:  Market Commentary

So far we have gone through October, the normal time for crashes, without even a correction.  Volatility has gone up, but we haven’t seen much of a reaction from the market for the continuing subprime crisis (Citibank, Merrill, Bear Stearns, etc, have all been affected in a major way), the plunge in the dollar (more on that later), or the fact that we actually could be in a recession now.  The market continues its slight upward bias, but with high volatility and large down days. 

Last week the market produced new 52 week lows in all of these banks (just a small example):  Citigroup (C), Wachovia (WB), SunTrust (STI), Wells Fargo (WFC), Merrill Lynch (MER), JP Morgan Chase (JPM), Bank of America (BAC),and Washington Mutual (WM).

Other lows came in newspapers, Sun Times Media (SVN) and Journal Communications (JRN), high end restaurants, Morton's (MRT), and Ruth's Chris, (RUTH), and in real estate and homebuilding, Centex, (CTX), D.R. Horton (DHI), CB Richard Ellis, (CBG), These areas might be bargains at some time in the future, but not yet.  Don’t touch these until they show a CLEAR UPTREND of at least two months. 

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

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 again acting well, 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. 

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 this table.

Notice that the NASDAQ 100 is up over 20% on the year, while both the DOW 30 and the S&P 500 show nominal gains.  The major averages are starting to move down as evidenced by the S&P 500 and the DOW 30.

I want to start a new feature here, listing the five strongest and the five weakest components in the market at the time of this update.  These can change daily, but the information will be accurate as of the publication of this update.  The relative strength of each component is given in parenthesis. 

Five strongest components, in order:

1)      Oil (95)

2)      Indian Stock Market (73)

3)      Commodities (66)

4)      Brazilian Stock Market (66)

5)      Gold (65)

Five weakest components:

1)      Real estate (7)

2)      U.S. Small cap value (12)

3)      Mexico (15)

4)      U.S. Small cap blend (16)

5)      Sweden (16)

The Chinese stock market was very strong, but moved to neutral status because of a huge drop on Friday, November 2, 2007.

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 and a strong dollar devaluation over the pain of the subprime crisis.

Date  CRB  XLB  Gold  XLF 
Dec-05 347.89 30.28 513 31.67
Dec-06 394.89 34.84 635.5 36.74
Jan-07 393.89 36.25 650.5 37.08
Feb-07 410.64 37.45 664.2 35.95
Mar-07 407.45 37.95 661.75 37.57
Apr-07 403.54 38.62 677 37.01
May-07 407.58 40.72 659.1 37.69
Jun-07 410.36 40.5 650.5 36.18
Jul-07 424.52 39.42 665.5 32.9
Aug-07 413.49 39.15 672 33.75
Sep-07 447.57 42.11 743 34.32
Oct-07 453.26 43.86 789.5 33.73

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

Lower

Lower

 

 

+1

 

+1

 

+1

 

+1

+4

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.

As of this writing, Gold is now over $840 per ounce and is not far from its all time high.  However, we’re only in the Gold bull market infancy or everyone would be buying Gold.  I’ve seen predictions of a gold high between $3000 to one which eventually has it exceeding the price of the DOW 30 (i.e., $14,000 per ounce). 

And look at what happened to the CRB now.  It’s really starting to shoot up, which signals inflation.  This is a time to be in commodities, and real assets such as precious metals, and top quality collectables such as rare stamps which we’ve talked about previously in this newsletter.

One of my clients pointed out an interesting web site: www.shadowstats.com.  In it John Williams looks at the real statistics the government doesn’t want you to know about.  For example, the CPI (if calculated the way it was in 1990) currently suggests that inflation is running over 10% per year.  And M3 (which the government stop publishing because they said no one looks at the data) suggests that inflation might be as high as 14%.  Look at the graphs on the web site.  They are quite shocking, but not surprising.  However the data clearly suggest that we’re in an inflationary bear market in which the stock market is not even keeping up with real inflation (much less the decline in the dollar as discussed below).

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 

Jan 05 

81.06 

Jan 06 

84.29 

Feb 06 

85.05 

Mar 06 

85.01 

Apr 06 

83.88 

May 06 

80.63 

June 06 

81.51 

July 06 

81.94 

Aug 06 

81.18 

Sep 06 

81.59 

Oct 06 

82.36 

Nov 06 

81.49 

Dec 06 

80.89 

Jan 07 

82.37 

 Feb 07 

82.07 

Mar 07 

81.23 

Apr 07

79.87

May 07

79.20

Jun 07

78.93

July 07

77.51

Aug 07

77.51

Sep 07

75.91

Oct 07

73.93

Nov 07

72.94

I mentioned earlier that there was historic support at the 80 level and that a drop below the 80 level could signal a plunge.  We’ll that’s clearly happening.  I’ve included data for the first few days of November so that you can see even more of the decline.  This tells me that the dollar’s status as the world’s reserve currency will be very much in doubt in the near future.  And that’s one reason we have oil above $90 per barrel.

The chart below shows a clear fall in the dollar.  I went to Europe in 2001 at which time the Euro was worth about 85 cents.  Today the dollar is worth about 0.69 Euros.  In addition, the US dollar is worth 94 cents in Canadian Dollars and about $1.09 Aussie dollars.  All and all, we’ve seen a huge plunge in the dollar and it is definitely NOT over with yet.

And, by the way, if your wealth is in dollar, you’ve undergone a global plunge in your net worth.  But the average American knows nothing about it.

Until the December 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 Freedom 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.

Workshops

 


Professional E-Mini Futures Trading Tactics

This weekend with D.R. Barton and Christopher Castroviejo

Nov 10-11-12

Cary, NC

 

Trading Tip

When to Get Out BEFORE Your Stop Is Hit

by D.R. Barton, Jr.

This weekend at our How to Develop a Winning System workshop, we covered sections on stops (of course).  But there was a discussion on the difference between purely mechanical exiting vs. including some other inputs as part of your trading plan for stops.

Both techniques are valid and both are is used by accomplished traders.  But you have to figure out what is best for you, your psychology and your belief systems.  Here are some thoughts that may help in your development of a plan to manage your stops.

Okay, you just bought the calls (or the stock, or the futures contracts or… whatever).  And, according to your plan, you place your stop, with tender loving care, exactly where it should be.  It’s far enough away to avoid the normal fluctuations of the market.  And close enough to give you a good reward-to-risk ratio if things move in your direction.

And then it happens – a big move against your position.  Within hours (or minutes) you’re already 75% of the way to your stop level.  Ouch.

I’m sure you’ve been there before.  I know that I have.

So what do you do now?  Bail out?  Stay the course? Kick the dog, yell at the cat and blame those stinkin’ floor traders?

Many people have been trained to stick it out and wait for the stop to be hit.  And that is often the best option for many styles of trading such as purely technical styles and value investing.

But there are times that prudent traders and investors will get out of a position before their stops are hit.  Let’s take a look at some reasons why you might want to consider adding an “early exit” contingency to your trading or investing plan.

When to Head for an Early Exit

When you place a stop loss according to your trading plan, we’ll assume that it’s put in the right place.  And in the majority of cases you should stay in the trade until you hit your stop loss, or your trading plan tells you to get out for some other reason.  Getting out on a whim or at the first little move against you can be frustrating – and ultimately expensive.

Your stops were put in for a reason – to protect your capital while giving your trade sufficient room to work.  But there are instances when you may need to build a “contingency” exit into your plan.

Our guiding principle for early exits is this:  When the reason you got into your trade changes significantly – prepare to get out.

Here are three situations that you may want to add to your trading plan:

Technical Change:  Traders may enter a trade because of a technical signal that told them to enter.  After some period of time, while the stop loss has not been hit, that technical signal goes neutral or even reverses, pointing in the other direction.  Many systems do not take this into account and wait for the stop to be hit.  If the reason you got in no longer exists, it’s probably time to get out.

Let's say you are trading a simple long term trend following system.  When the fast moving average crosses above the slow one, you get an entry signal.  A week passes, and the fast moving average dives below the slow one and is heading down.  If your system is not geared to view this as an exit (or even a reversal), you could still be in the trade waiting for your stop to get hit even though your entry indictor is now clearly pointing the other direction. 

Geopolitical or other outside events:  Often, major upsets strike markets because of outside influences like weather, armed conflicts, or governmental actions.  Such activities can signal significant changes that will have wide reaching effects on markets.  The reason you got into the position (perhaps a technical or fundamental indication) is now overshadowed by a bigger move.  It’s like building sandcastles in front of a storm surge – no matter how good your design, your castle is going to get wiped out.

Time – too long to stick around:  Most successful short-term traders include a time component in their trading plan – especially when it comes to waiting for a position to move in their favor.  If a short- term trader puts on a position expecting a move and it doesn’t materialize in a set amount of time, then a time stop can be used and the position is exited.  The reasoning is this: all of the factors were lined up strongly in our favor to get us into a trade, and nothing happened.  Either we have lost the advantage and are starring at a 50/50 proposition, or the opportunity wasn’t as strong as we had expected.  Either way, it’s best to get out and re-evaluate the situation without the influences and biases that an active position impose on us.

This same reasoning is useful for longer- term traders and investors, as well.  If you purchase a stock because the new management team is supposed to turn things around or because of the benefits of a new product line and the stock price goes nowhere after months (or years), then maybe it’s time to reassess the investment.

Stops are part of every well-designed trading and investing plan.  But be aware that there may be situations that arise when an early exit is best.  Do some preplanning for contingencies that might arise and build appropriate responses into your trading and investing plans.

Great Trading!

D. R.

About D.R. Barton: D.R. (along with Christopher Castroviejo) will be presenting the upcoming “Professional E-Mini Futures Tactics” workshop, this weekend, 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

The Fine Factor

by Melita Hunt

My cancer treatment began this week at a holistic hospital that incorporates body, mind and spirit therapies. In fact, I am actually on an IV treatment in my hospital room as I type this article one handed (I’m a multi-tasking woman), but I digress…

Upon my arrival I received an activity schedule with quite an array of things to do every day. Nothing is compulsory, but it is all very interesting and in addition to my treatment regimen, the learning has already begun. Today I decided to attend a lecture about the immune system, cellular intelligence and metabolic pathways, which was new information for me. Later in the afternoon I attended a psychology workshop titled “Your Powerful Mind,” which is much more familiar territory.

One of the subjects that we discussed is something that I call the “fine factor.” Everyone was encouraged to introduce themselves and when asked how they were actually feeling, they were NOT allowed to answer with the universally accepted answer of “I’m fine.” We had to pay attention to the actual physical sensations occurring in our body and the emotions that were attached to them. Even with the subject of cancer floating around the room, it still seemed incredibly difficult for some of the people to recognize or verbalize what they were feeling.

Often, people who ask the question “How are you?” are actually just expecting a simple, generic response such as “I’m fine.” And that is okay if it is said in a casual context, however; in this particular case, we were in a safe, therapeutic environment surrounded by other people who are also experiencing an array of emotions under life threatening circumstances. Sharing openly and honestly in this type of environment is useful to both the sharer and the listeners.   

It reminded me so much of the first day of our Peak Performance workshop (which coincidentally started today). Throughout the three days, Van and I are constantly asking people what they are noticing in their bodies, what they are feeling, and encouraging them to pay attention to physical sensations and what they represent. Van throws in a number of “button pressing” exercises, and at times there is still no movement. Many people are far more comfortable being “fine” probably because they are used to maintaining equilibrium of their emotions. It feels much “safer” to control emotions. But which way is the safest way to go? Is it better to shut down and not feel, or is it better to wear your emotions on your sleeve?

It is common knowledge that our emotions play a huge part in the overall quality of our life. And if they are not being recognized consciously then they could be working up quite a storm unconsciously. I have discussed this subject before, and it isn’t about becoming a blubbering, uncontrollable emotional wreck. It is about recognizing and allowing our emotions to flow. It is healthy to feel our feelings.     

But I do think that the environment that we do it in is also important. One of the keys to allowing us to feel our emotions is that we feel safe to express them. I don’t know many people who would want to open up and be vulnerable if they are then ridiculed, mocked or their feelings disregarded. Unfortunately this happens a lot when we are growing up and most of our patterns are set in our formative years and within the family environment. So recognizing this and picking or creating the right environment is crucial.

But here is a question for you: Are you repeating any of the same emotional patterns that you saw in your childhood within your current family environment?

In many family settings, we seem to bow towards the notion of not showing emotions in front of our kids, but I believe that being vulnerable in front of children is a necessity. It has come to the forefront with Mum and I over the last few weeks. There have been many times when Mum has been on the verge of tears and has then run away to shed them alone. She thought that she was protecting me. Not so. To run away and cry, signals to a child that it is not okay to feel your emotions and share them honestly. It was as though it was “wrong” to cry in front of me.

I recognized that this was bothering me and I decide to bring it to Mum’s attention because it wasn’t something new, it was something that I had experienced for a lifetime and, in addition, I cannot remember ever seeing my Dad cry. It was as though I had grown up in a world of unemotional robots, when the truth is that all vulnerability was just hidden from me. I am sure that many families are the same.

Well today in our psychology class, I wouldn’t let Mum run away, when it was her time to share (and she was on the verge of tears because I had just finished) can you guess what her answer was to the facilitator? It was “I’m fine” – “just move on past me or I think I’ll cry.” Well, well!!  Do you think she got away with that? Not a chance. She had to open up and with the tears came the hurt, pain and uncertainty that she was feeling too. It was relief to us all. It was therapeutic for me, for Mum and for others in the room and allowed the space for other people to share as well.

So the crux of this story is, once again, based around allowing yourself to experience your feelings (especially if you are a Mr. or Mrs. Fine). I encourage you to pay attention to the number of times that you act on automatic and use the phrase “I’m fine” even when you are in a safe environment to truly share.  Take a moment to check in with your body and see how you really are feeling. Your body will always give you the signals, whether it is stress, weariness, sadness, anger, anxiety, frustration or even a happy emotion. Recognizing you body’s signals allows you to release, deal with, or support yourself in maintaining a happy and balanced life.  

And here’s some food for thought from my other class:

Did you know that we have over 100 trillion cells working in harmony within our bodies, day in day out?   What type of world would we be in if the mere billions of humans that walk the earth could work with one another in the same way?

Melita Hunt is the CEO of the Van Tharp Institute. If you would like to keep up with Melita’s progress regarding her recently diagnosed lung cancer. Please feel free to read her blog at www.myleftlung.com.

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