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Tharp's Thoughts Weekly Newsletter

October 29, 2008 — Issue #396  
  
Workshops

Blueprint Workshop Added (for those who need it now!)

Article

What If – What If? by Chuck LeBeau

Trading Education

New Workshop Locations

Trading Tip

What’s Next with the Markets? Volatility Will Show the Way by D.R. Barton, Jr.

 

Workshops

Blueprint for Trading Success Workshop Added to Schedule

December 3-5, 2008
Wednesday-Friday

Regular readers will recall that in the context of the article "The Fate of the Average Investor", Dr. Tharp suggested that the material in the Blueprint Workshop was so necessary to traders in these turbulent markets that he would add a workshop in December if there was enough interest. We've added one! December 3-5, 2008.

Learn More

Register Now

 

Feature

What If – What If?

By 

Chuck LeBeau

As the Director of Quantitative Analysis for SmartStops.net, I spend a great deal of time browsing the web and other sources looking for hard to find information about exit strategies.  On more than one occasion I have stumbled upon articles that oppose any effort at market timing; to further their argument they cite various studies that show how much long term performance might suffer if market timers somehow missed “X” number of the biggest up days in the market. 

These highly biased studies are assuming that any attempts at market timing will be totally futile and ineffective.  These studies assume that market timers somehow missed all the biggest up moves and yet suffered through all the biggest declines.  With that assumption, it’s not surprising to see these studies conclude that with bad timing the performance would have suffered a great deal.  I believe these studies are totally one-sided and extremely unfair to market timers.  To set the record straight I’m going to take one of the most credible and complete studies and present the results in a manner that is fairer to market timers.

The data I will be referring to is from a study encompassing more than 100 years of daily data on the Dow Jones Industrial Average.  (Black Swans and Market Timing: How Not To Generate Alpha, by Javier Estrada, International Graduate School of Management, Barcelona, Spain).  The data presented in this study begins on December 31, 1899 and ends on December 31, 2006.  In total, the study encompasses 29,190 trading days.

1)     1. A $100 investment at the beginning of 1900 turned into $25,746 by the end 2006, and delivered a mean annual compound return of 5.3%.

2)     2. Missing the best 10 days reduced the terminal wealth by 65% to $9,008, and the mean annual compound return one percentage point to 4.3%.  But avoiding the worst 10 days increased the terminal wealth by 206% to $78,781, and the mean annual compound return by more than one percentage point to 6.4%.

3)     3. Missing the best 20 days reduced the terminal wealth by 83.2% to $4,313, and the mean annual compound return to 3.6%.  But avoiding the worst 20 days increased the terminal wealth by 531.5% to $162,588, and the mean annual compound return to 7.2%.

4)     4. Missing the best 100 days reduced the terminal wealth by 99.7% to just $83 ($17 less than the initial capital invested), and reduced the mean annual compound return to—0.2%.  But avoiding the worst 100 days increased the terminal wealth by a staggering 43,396.8% to $11,198,734, and more than doubled the mean annual compound return to 11.5%.

This data clearly shows that successful attempts to skip the worst down days would not only reduce risk but gain much more than might be lost by missing some or even all of the biggest up days.  But perhaps more importantly, there is no evidence in this or any other study that shows that trying to avoid the biggest down moves will result in missing the biggest up moves.  Why do the people who write these one-sided articles assume that the market timers will be wrong all the time?

Most of the big days up or down occur in the midst of major trends that can easily be identified with simple timing tools that do not need to be particularly precise to be effective.  Market timers do not have to exit exactly the day before the major decline day or enter the market exactly the day before a major advance.  A precautionary exit in a downtrend identified weeks before the major decline day will suffice and perhaps produce even better results as some of the less spectacular decline days might also be avoided in the process.  The same is true of entries.  Market timers need only identify that an uptrend is underway, and in most cases the major up day will follow sooner or later.

About the Author: Chuck LeBeau is the Director of Quantitative Analytics at www.SmartStops.net and he is also co-author of Computer Analysis of the Futures Market (McGraw-Hill).  

Chuck is a featured speaker at IITM's upcoming How to Develop a Winning Trading System Workshop, January 2009. Chuck has more than forty years experience in the markets and is widely known for his specialized knowledge of technical analysis, system trading and exit strategies. For 60 days of free service (10 stocks) on smartstops.net use the code VANTHARP60FREE.

 IITM Third Party Clause

 

Trading Education

Location, Location Location

In addition to the new December workshop, we're also hosting workshops on the West Coast (USA) and in Sydney, Australia. 

 

New Addition December 3-5

Wednesday-Friday

 

Blueprint for Trading Success

 

Location Announcement:

Phoenix, AZ 

January 30-Feb 1

Friday-Sunday

 

How to Develop a Winning Trading System That Fits You

 

Location Announcement:

Sydney, AU

February 6-8

Friday-Monday

 

Highly Effective ETF and Mutual Fund Techniques 101

 

Location Announcement:

Sydney, AU

February 10-12

Tuesday-Thursday

 

Peak Performance 101

 

Location Announcement:

Sydney, AU

February 15-18

Sunday-Wednesday

 

Advanced Peak Performance 202

 

 

Trading Tip

What’s Next with the Markets?  
Volatility Will Show the Way

by
D. R. Barton, Jr. 

It would be hard to imagine a more interesting and chaotic time in the financial markets.

We’re seeing market characteristics (daily ranges, reversal patterns, etc.) that are literally unprecedented.  The volatility (as measured by Average True Range or ATR) of almost every major trading instrument is at all time highs.  It doesn’t matter if you’re looking at stock indexes, bonds, oil, gold, currencies, etc.  It seems that the only broad groups of instruments not trading at their highest volatilities ever are the smaller commodities that don’t have big hedge fund and institutional interest— things like coffee and orange juice.

This volatility expansion is significant for several reasons:

·        It is broad-reaching.  As mentioned above, it is hitting practically every traded instrument.

·        It is persistent.  The markets are no strangers to volatility spikes.  We see them come and go when particularly juicy reasons for fear or greed enter the markets.  But this volatility explosion has not subsided.  Depending on how you measure “persistence”; the volatility “spike” has lasted four to six weeks, not just for a few days.

·        It is huge.  Back in April of 2000, we made the previous volatility highs when the Internet bubble started to collapse.  Then volatility (as measured by 14 day ATR) was 3.0% of price.  Last Wednesday, this same ratio showed ATR at an astonishing 8.3% of price!!

As if to punctuate the truly wild nature of the recent market volatility—here’s an interesting market tidbit:  today is a “Fed Day” (FOMC meeting announcement) and after dropping both key rates by 50 basis points, it looks like the market will have a day within only 2/3rds of its recent range!

I believe that the market is giving us some really important information through this language of high volatility.  The message is this:  the uncertainty of where the markets are heading next has never been higher.  With the slightest whiff of negative news, the market free falls.  When even a shimmer of hope comes along (like the Fed strongly hinting that the rate cut was real yesterday, sending the markets up 10%), the markets jump through the roof.

It’s like a cat on a hot tin roof... after drinking a can of Red Bull.  Every move is over exaggerated.

One of the questions that I get most often is " when will the market return to some sense of normalcy?"  It’s hard to predict this, of course.  But one key indicator will be when the volatility settles way down from its current unprecedented highs.  It’s okay if the market is directional; I don’t think we’ll see a traditional basing / consolidation period from here.  But what IS needed is a sense that the markets don’t jump every time someone whispers, “Boo”.  And a volatility contraction will be a good (and maybe the best) indication that this is happening.

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”. 

D.R. is presenting the upcoming Professional Day Trading Strategies Workshop and Swing Trading Techniques Workshop.

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