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Tharp's Thoughts Weekly Newsletter

May 07, 2008 — Issue #371
  
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Blueprint for Trading Success

Article

Monthly Market Update by Van K. Tharp, PhD

Trading Education

Peak Performance for Traders

Trading Tip

The Nobel Laureate and the Rice Trader – Psychology’s Role in Trading Strategies Part IV by D.R. Barton

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Feature

Tharp’s Thoughts

Market Update for April 2008

Market Condition: Volatile Sideways

by
Van K. Tharp

 

I always say that people do not trade the markets, they trade their beliefs about the markets. In that same way I'd like to just point out that these updates reflect my beliefs. If my beliefs and your beliefs are not the same, then you may not find them useful.  I do find the market update information useful for my trading, so I do the work each month and I'm happy to share that information with my readers

However, if your beliefs are not similar to mine, then the information may not be useful to you. Thus, if you are inclined to do some sort of intellectual exercise to prove one of my beliefs wrong, simply remember that everyone can usually find lots of evidence to support their beliefs and refute others. Just simply know that I admit that these are my beliefs and that your beliefs might be different.

These monthly updates are in the first issue of Tharp’s Thoughts each month. This allows us to get the closing month’s data. These updates cover 1) the market condition (mentioned in the April 30 edition of Tharp’s Thoughts), 2) the five week status on each of the major stock U.S. stock market indices, 3) our four star inflation-deflation model, 4) tracking the dollar, and 5) the five strongest and weakest areas of the overall market.

Part I: Market Commentary

One of the most interesting books I’ve come across lately is called The Web of Debt: The Shocking Truth About Our Money System and How We Can Break Free by Ellen Brown, JD. Here are two quotes from the back cover (notice the dates) to give you a flavor of the book: 

“The sack of the United States by the Fed is the greatest crime in history. Every effort has been made by the Fed to conceal its powers, but the truth is the Fed has usurped the government.” -- Charles McFadden, Chairman, House Banking and Currency Committee, 1932.

“The real truth is ... that a financial element in the large centers has owned the Government ever since the days of Andrew Jackson” -- President Franklin D. Roosevelt, 1932.

The book proposes that big money interests supported the Civil War because it was a chance to drive the United States apart, with both sides in heavy debt. And that was the chance to take control over the country. They considered physical slavery to be obsolete because the slave owners were responsible for the physical care of the slaves. However, debt slavery of a nation is much more efficient because it involves most of the nation and there is no need to care for the slaves. In fact, under ideal conditions the slaves can even prosper. 

In addition, according to Brown, even our political process was created by huge money interests so that people would be distracted over politicians who quarreled over issues that were insignificant to what the “debt slave owners” were doing. I think that’s particularly evident this year; that this country is in severe financial difficulties that are hardly mentioned by those running for president.

I think this book is very important reading for anyone who wants to stay on top of the big picture. In addition, I think there is a chance that the whole system might undo itself in the next few years. Overall, that would be great for the United States, but the short term ramifications would turn everything upside down since we’ve come to depend upon the system put in place. 

Part II: The Current Stock Market Type Is Volatile Sideways

I have now substituted my new market type for the 1-2-3 model, because as soon as the 1-2-3 model goes below a certain PE ratio (which it is poised to do), another component will turn bullish. However, I expect us to be in a secular bear market until the PE ratios of the S&P 500 reach single digits. Thus, the 1-2-3 model doesn’t really fit my current beliefs. 

In last week’s issue of Tharp’s Thoughts, I showed you how I measured the market type on a weekly basis, based upon a rolling 13-week window. The table below shows the market type since the first of the year. The dates given are the Monday after the close of the week as that’s when Yahoo (our data source) gives out weekly changes.

Volatile Sideways 5/5/2008
Volatile Bull 4/28/2008
Volatile Sideways 4/21/2008
Volatile Sideways 4/14/2008
Volatile Sideways 4/7/2008
Volatile Sideways 3/31/2008
Quiet Bear 3/24/2008
Volatile Bear 3/17/2008
Volatile Bear 3/10/2008
Volatile Bear 3/3/2008
Volatile Bear 2/25/2008
Volatile Bear 2/19/2008
Volatile Bear 2/11/2008
Volatile Bear 2/4/2008
Volatile Sideways 1/28/2008
Volatile Bear 1/22/2008
Volatile Bear 1/14/2008
Volatile Bear 1/7/2008
Volatile Bear 12/31/2007

You’ll notice that only one week this year has been classified as quiet, the week ending March 24. Generally 2008 has been a year of extreme movements. It’s also been generally bearish, although the sideways period has had a general up inclination to it.

One person suggested that we could classify markets as being quiet when they are really volatile by not using the average true range of the days of the week as our measure of volatility. For example, it’s quite possible to have a week with the following days: 1) Up 5% on Monday, 2) Down 5% on Tuesday, 3) Up and down 5% on Wednesday with a net close of zero, 4) down 4% on Thursday, and 5) up 4% on Friday. This would result in a zero change for the week and a quiet classification, while the entire week was tremendously volatile. However, that does not seem to occur very often because the entire year of 2008 has been volatile by our measures with the exception of the week of 3/24.  I tend to consider one week changes to be abnormalities. Thus, it looks like we’ve had a volatile bear market from the week ending 12/31 through the week ending 3/24. We have had a volatile sideways market (although with a slight uptrend) since 3/24.

Incidentally, I looked at the week ending 3/24 and there is no way that you could label that week as being volatile. Nevertheless, I will look at how much our classification changes if we were to use the ATR of the daily ranges to measure volatility. 

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   1,211.12   1,621.12  
Close 05 10,717.50 -0.60% 1,248.29 -3.10% 1,645.20 1.50%
Close 06 12,463.15 16.29% 1,418.30 13.62% 1,756.90 6.79%
Close 07 13,264.82 6.43% 1,468.36 3.53% 2,084.93 18.67%
4-Apr-08 12,609.42   1,369.31   1,865.87  
11-Apr-08 12,325.42 -2.25% 1,360.55 -0.64% 1,798.72 -3.60%
18-Apr-08 12,849.36 4.25% 1,365.56 0.37% 1,900.28 5.65%
25-Apr-08 12,891.86 0.33% 1,388.82 1.70% 1,918.58 0.96%
2-May-08 13,058.20 1.29% 1,409.34 1.48% 1,981.87 3.30%
Year to Date 13,058.20 -1.58% 1,409.34 -4.19% 1,981.87 -5.20%

The last three weeks have all been up weeks, but the market is still down on the year.  Last month we were below the 2006 close and we’re now above that in the Dow and NASDAQ.

I’m also listing the strongest and weakest areas of the market in this update. The ratings give the most weight to what has happened recently so they can sometimes change rapidly.  In addition, I have trouble listing an area as being strong when it is actually down in price over the last 40 weeks.  Thus, I plan to only list the strongest areas that are also up over the last 40 weeks.  The relative strength of each component is given in parenthesis.

Part III: The Strongest and Weakest Market Components

Five strongest components, in order:

1)  Brazil (87)  -  This giant from last year has resumed its uptrend, which is interesting because it was very weak last month.

2)  China (72)  -  Another giant is resuming its uptrend.  It’s higher than it was 12 months ago but still a long way from its highs.

3)  India (72) -  Here is another of the big 3 countries from last year that’s starting to look strong.  Again, it's higher than 12 months ago, but a long way from its highs.

4) Oil (65) – Oil has a strong looking chart, but is currently in a minor correction.

Austria is the fifth component, but only because of recent activity.  It’s still weaker than it was 12 months ago.

Five weakest components:

1)     Gold (12)  -- Still in a strong uptrend, but has had a sizable correction.

2)     Mexico (27)

3)     Long Term Treasuries (36) – Interest rates are going down, so this would be expected to be weak.  Plus, the dollar is not that strong.

4)     Switzerland (43)

5)     Commodities (43)  -- Again, in a correction from a strong uptrend.

Part IV: 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 when the Dow makes 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/CCI

XLB

Gold

XLF

Dec-05

347.89

30.28

513

31.67

Dec-06

394.89

34.84

635.5

36.74

Sep-07

447.57

42.11

743

34.32

Oct-07

453.26

43.86

789.5

33.73

Nov-07

451.26

41.65

783.5

31

Dec-07

476.08

41.7

833.3

28.9

Jan-08

503.27

38.62

923.2

29.14

Feb 08

565.65

40.87

971.50

25.83

Mar 08

525.25

40.17

934.25

24.87

Apr 08

524.85

42.31

871.00

26.61

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

CRB 2

CRB 6

XLB2

XLB6

Gold2

Gold6

XLF2

XLF6

Total Score

 

Lower

Higher

Higher

Lower

Lower

Higher

Higher

Lower

 

 

Apr 08 

 

+1/2

 

-1/2

 

+1/2

 

+1/2

+1

 

The results of this model still show inflation, but they are the lowest numbers I’ve seen (at +1) since I’ve been using this model. I suspect they merely represent a correction.  Click here for more information on the model.

Gold has now had a 13% correction from its recent highs of over $1,000 and gold stocks have plummeted – some nearly 50%.  In addition even commodities have shown a fall recently.  I would expect this to be a temporary decline in inflation; however, the Fed is still injecting massive amounts of currency into the system.  The Shadowstats statistics show no potential for a decline in inflation whatsoever.

Part V: Tracking the Dollar

With the Federal Reserve lowering interest rates, I expect the dollar to really be weak now.  Who wants to buy treasury bills as the interest rate gets lower and lower?  So expect currency traders to start selling the dollar and moving to currencies that pay a better interest rate.  Look at the data in the table because it really says it all.

Month 

Dollar Index 

Jan 05 

81.06

Jan 06 

84.29

Jan 07 

82.37

Aug 07

77.51

Sep 07

75.91

Oct 07

73.93

Nov 07

72.94

Dec 07

73.69

Jan 08

73.06

Feb 08

72.57

Mar 08

70.32

Apr 08

70.47

May 08

71.31

Notice that the dollar is now showing a slight recovery after a massive decline.  However, I am no longer traveling the world, but I’d expect the dollar to start going down again in July and August once again as I’ll be a world traveler during that time.  Laugh please, because that’s my attempt at humor today.  

Until next month’s 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.

 

Education

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The benefit of taking this course is not dependent on your experience level. It is not system, time-frame or market specific. It is just as helpful to the person who has traded for 10 years managing millions as it is for the new investor with a small personal account, or to the person who wants to trade but has never traded.  This is because the focus of this program is YOU.   

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Trading Tip

The Nobel Laureate and the Rice Trader – 
Psychology’s Role in Trading Strategies Part IV

by
D.R. Barton

Spring has finally sprung here in Delaware.

This morning, I was out for a jog through my favorite haven that is really a little bit a heaven.  There is a little path that runs beside a stream.  And for miles and miles you can run in the middle of suburbia without knowing that there are houses and schools just 100 or 200 yards from the dense undergrowth. I saw baby rabbits, tons of squirrels, and a dozen different types of birds including a pair of mallard ducks hustling to the safety of the water.  I also saw frogs, turtles (including a huge snapping turtle) and even a little water snake sliding effortlessly down the bank into the stream.

It really is amazing how so many animals can thrive in area so close to thousands of people!

When I see such a diverse offering of critters, I have no problem believing that folks can successfully approach the markets in many diverse ways.  As many of you know, this was the central finding of Van’s early work with traders – that all of them traded different instruments, styles and time frames, but they did it with similar underlying processes.

I started off this series of articles because I was struck by how Daniel Kahneman’s studies meshed with the psychology of famous rice trader Munehisa Homma.  

Homma-san delivered one of the best fund performances in history in the 1700s.  He had documented 20% compound growth for 10 years with no fees or leverage in a fund that was fully regulated and open to all investors.  Pretty impressive!

A bunch of articles have been popping up about this great rice trader lately he is notable for more than just his performance.  Consider these items:

·                                He is one of the earliest documented technical analysts (using charts with candlesticks).

·                                He was one of the first documented contrarians (saying that when everyone is buying there is reason to believe prices will go down, and vice versa).

·                                He identified the main driver of financial markets as the psychology of irrational market participants, rather than economic logic.

While Homma-san did sprinkle in fundamental analysis with his trading, it was his use of technical and sentiment analysis that seemed to drive his decision making. He was the pioneer of behavioral finance, much to the chagrin of those modern day thinkers that claim they found something new. What struck me is that this trader from 250 years ago was doing the same things that good traders I know are doing today: using a combination of technical tools and market psychology to drive decision making.  And like Kahneman’s work, he found that markets are not at all rational or random (although the academic community still clings to that notion).

So we come back to everything old is new again!  And fortunately we still have much to delve into from this innovative thinker of centuries past.

I still haven’t found a copy (in English) of Homma-san’s book The Fountain of Gold - The Three Monkey Record of Money, so if anyone has any leads, I’d greatly appreciate an e-mail sent to drbarton “at” iitm.com (replace the “at” with the symbol).

Until next week…

Great Trading!

D. R.

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

 

Melita's Inspirational Corner

Melita is out this week. Check her progress on her blog, listed below.

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 (she is a never-smoker). Please feel free to read her blog at www.myleftlung.com. You can contact Melita at mel@iitm.com

 

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