Tharp's Thoughts Weekly Newsletter (View On-Line)
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Article Market Update. Market Condition: Bull Normal
Trading Tip Chuck LeBeau—The Technical Side by D.R. Barton, Jr.
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Market Update for the Period Ending May 3, 2010
Market Condition: Bull Normal
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 point out that these updates reflect my beliefs. If my beliefs and your beliefs are not the same, you may not find them useful. I find the market update information useful for my trading, so I do the work each month and am happy to share that information with my readers.
However, if your beliefs are not similar to mine, then this 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 type (first mentioned in the April 30, 2008 edition of Tharp's Thoughts), 2) the five week status on each of the major US stock market indices, 3) our four star inflation-deflation model plus John Williams' statistics, 4) tracking the dollar, and 5) the strongest and weakest areas of the overall market.
Part I: Van's Commentary—The Big Picture
Last month I suggested that the Obama health care package was the start of socialized medicine and that every country with socialized medicine has a value added tax (VAT) to pay for it. Furthermore, I wondered when the U.S. would decide to add a national sales tax to the burden now faced by U.S. taxpayers. Some of you thought that I was commenting on the package itself. I was not. I was commenting on my beliefs about the impact of that package (and other things that are happening) on the economy. My company only has seven employees and we still have 100% company paid health care coverage for all of them, even though we are not required to do so—even under the new law. When the President’s “Commission on Fiscal Responsibility and Reform” held its first meeting on April 27th, the possibility of a VAT was raised. However, no specific recommendations will be made until after the next election (i.e., in December). Furthermore, 14 of the 18 members of the committee have to agree to any recommendations and even then it does not have to be put before Congress.
Right now Greece, which has had its debt lowered to junk status, is the scapegoat for the world. What’s happening in Greece is happening all over the world. However, the world is pointing its finger at Greece with the hopes that the rest of the world can borrow/spend its way out of this crisis before it blows up. Meanwhile Obama raised the official debt ceiling in the U.S. to $1.9 trillion with our total official debt at $14.3 trillion.
When the U.S. government decided to let Lehman fail, it led to an almost instant global freeze on global lending and the U.S. government put pledges in to subsidize much of the banking system. It still hasn’t led to that much lending. Small house buyers get government subsidized mortgages for 3.5% down and a tax incentive of up to $8,000 to more than cover that. Most of these people cannot afford to buy a $100,000 declining asset, but the government is buying it for them. Meanwhile, to buy a million dollar house you need perfect credit (i.e., a score of 850, which almost no one has) and you must put down $500,000 in cash. This effectively means that million dollar houses have only sellers, not buyers.
Is it any wonder that there is a major banking crisis going on in the U.S.? There were 3 bank failures in 2007, 25 in 2008, 140 bank failures in the U.S.in 2009, and another 41 in the first quarter of 2010. By my account, more than 70 have failed so far this year. It’s not a pretty picture. Yet the headlines seem to say the economy has recovered.
By the way, Goldman Sachs is considered too big to fail. Don’t be surprised if you see them get a $100 million fine for their “mistakes” and then get billions in return from the government. It’s just a small slap on the wrist.
The U.S. managed to get some concessions out of China, so we did not label them a currency manipulator, but that just goes to show how close we come to more disasters on a monthly basis.
Part II: The Current Stock Market Type Is Now Bull Normal to Strong Bull Normal (which is usually an excellent market for profits)
Each month I look at the SQN™ of the daily percent changes over 200, 100, 50, and 25 days. Volatility is now normal. Both the 200-day and 50-day changes are strong bull and the 100- and 25-day changes are in bull mode. Thus, we clearly have now turned the corner into another down leg of the secular bear market.
However, this bull market is not like any I have ever seen before. There are few strong trends. Money seems to rotate between sectors and, in my opinion, it has mostly been created by the flow of stimulus money to the banks, which they are not lending, but instead channeling into the stock market. In addition, the market seems to go up while the internals of the market are not that strong at all.
Let's look at what's happening in the three major US indices. The next table shows the Dow, the S&P 500, and the NASDAQ over the past five weeks and over the last few years. The market has been just about even over the first four months of the year.
Part III: The Strongest and Weakest Market Components
By this time, most of you understand how we track the relative strength of the various ETFs representing the economy of the entire world. I publish this model once a month. Ken Long, who developed the algorithm we use, publishes a similar report every weekend at www.TortoiseCapital.com. Ken uses his data as a framework for trading a number of his systems. And Ken will be teaching that material along with his bests systems in our June 2010 workshops.
The areas in green are strongest (those areas are more than one standard deviation above the mean); those in yellow are the next strongest (above the mean up to 1 standard deviation). Those below the mean are in brown, and those more than one standard deviation below the mean are in red. I've taken out all the double leveraged funds from my database, which means that the top and bottom funds are not devoted entirely to those groups.
Right now there are no strong countries—except for the small and microcap sectors of the U.S. stock market. In addition, Home builders, REITs, Consumer Discretionary, and Oil and Gas exploration seem to be strong.
However, there are many weak countries including 1) most European countries with Spain being the worst at 13; 2) Hong Kong; 3) China and 4) Brazil. The Euro, Yen, and Swiss franc are all showing weakness. In addition, health care, metals and mining, and building material in Europe are all weak.
The next section shows the commodities, real estate, interest rates, and the strongest and weakest areas of the overall market.
Generally, home construction in the U.S., Internet Holders, Homebuilders, Microcaps and silver are all strong. Spain, Italy (two of the PIIGS), steel, natural gas, coal, and France are all very weak. Notice that coal and steel were very strong last month, which again shows that trends are not persisting.
Part IV: Our Four Star Inflation-Deflation Model
As you can see from the long term numbers below, gold and the CRB/CCI are both way up from a few years back, but there's no strong multi-year trend visible in the materials ETF (XLB). Conversely, financials (XLF) are half of what they were just four years ago.
We'll now look at the two-month and six-month changes during the last six months to see what our readings have been. The results are still showing inflation.
Part V: Tracking the Dollar
The government is no longer changing the statistics that I look at on the dollar, so I was able to get April’s closing data. The dollar is relatively stable (compared to most currencies), but still has not recovered much of its losses over the years. When I look at the overall figures, which go back to 1973, the dollar high was in May 1985 at 143.91 and it was last over 100 in Dec 2002 after hitting a relative high of 111.99 in February 2002. That’s a drop of 32% in eight years.
Almost 90% of the attendees at our recent Bear Market workshop came from outside of the U.S. We had attendees from as far away as Japan and South Africa. To me that is astounding and it says something about America…but I’m not sure what. I have not seen such extremes since we had 70+ people in a stock market workshop in March of 2000—and that certainly said something (70+ is nearly three times the normal workshop size). The systems workshop is not much different and one American cancelled at the last moment mentioning financial problems.
Our Super Trader program is almost full and more than half of the people in the program are from outside of the U.S. Again, I’m not sure what that means, but I know it says something about the state of the United States. Moreover, 100% of the recent applicants for the Super Trader program come from outside of the United States—75% live more than 10,000 miles away from the United States.
My guess is that Americans are just afraid, but that’s the last thing you need to be. If you have a lot of fear, you tend to get what you fear the most. In other words, what you resist tends to persist.
The key use of this information in my opinion is not to forecast the market but for you to know when to shift systems. You should know how your system will perform under various market conditions. If you haven't heard this before or the other ideas mentioned above, read my book Super Trader, which covers all of this, so you can make money in any kind of market.
We have had some statistical help on our market type from the graduate students at the University of North Carolina. As a result, I’ll be publishing more on our market type over the next few months.
Crisis always implies opportunity. Those with good trading skills can make money in this market—a lot of money. There were lots of good opportunities in 2009. Did you make money? If not, then do you understand why not? The refinement of good trading skills doesn't just happen by opening an account and adding money. You probably spent years learning how to perform your current job at a high skill level. Do you expect to perform at the same high level in your trading without similar preparation? Financial market trading is an arena filled with world class competition. Additionally and most importantly, trading requires massive self-work to produce consistent, large profits under multiple market conditions. Prepare yourself to succeed with a deep desire, strong commitment, and the right training.
Until the May update, this is Van Tharp.
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Chuck LeBeau – The Technical Side
Last week I had a blast writing about some of great times that I’ve had with Chuck LeBeau, who was recently presented with a Lifetime Trading Achievement Award.
Today, I’d like to continue to share some of Chuck’s goodness with you—this time from the technical tools and tricks I’ve learned from him.
Van did a great job last week outlining several areas of Chuck’s extensive technical repertoire (Read last week's article). Today, I’d like to share my experience and practical application of a few of those many great contributions.
The Trend Is Your Friend but It Doesn’t Always Announce Its Arrival
One of my favorite parts of Chuck’s excellent book Computer Analysis of the Futures Markets was the conclusion drawn after he and David Lucas had tested thousands of pairs of moving averages. Simplifying a bit, they concluded that in a trending market just about any length moving average crossover system worked just fine, but in choppy or sideways markets, those same strategies get chopped up and lose money.
For today’s systems oriented people that’s obvious. However, Chuck and his co-author were among the first to popularize the notion and support it with hard data.
So the question became “If these things are very robust in trending markets and stink pretty broadly in sideways markets, how do we tell one market condition from the other?” Chuck’s research led him to Welles Wilder’s ADX.
Chuck did some pioneering testing on the ADX, and I believe it’s fair to credit him with furthering the use of RATE OF CHANGE in ADX as it’s most important aspect, rather than the absolute value of ADX, which was (and still is) broadly used.
From a practical application standpoint, I have tested and traded systems that use the ADX indicator as an absolute value style on/off switch. In other words, if ADX is above thirty, enable the trade, if it’s below 30, disable.
Almost always, the use of an ADX in a rate-of-change mode improved the performance characteristic of the strategy. Your mileage may vary, but this is still a very powerful tool that I use in several swing trading strategies.
Exits, Exits and More Exits
Chuck was the first person who gave me permission to use multiple exits for a single entry. For those of you not familiar with this concept, after entering a trade, you can have many different ways to exit:
- a trailing stop.
- a multiple ATR profit target exit (this exit allows you to take advantage of an unexpected extreme move in your favor).
- a parabolic exit (this exit will be much further away than your trailing stop at the beginning of the trade, and then moves closer to protect profits as the trade matures).
In short, when it comes to exits, one size does not fit all. And for many systems, a multiple exit strategy will help optimize performance.
I think one of the most important lessons that I learned from Chuck is the evaluation of exit efficiency. When we’re trying to establish the efficacy of a trading system, it’s important to understand the individual contributions made by the component parts of the system; a good exit strategy can be obscured by a weak set-up and vice versa.
Chuck introduced me to the idea of measuring exits efficiency. To do that, he suggested that one should look at each trade and compare the profit/loss for the trade with the maximum profit that could be made if you held the trade twice as long. If your exit strategy is averaging less than 50% of the maximum potential profit, then the exit plan needs some work. Anything over 50% is a useful and efficient exit strategy. With that knowledge in hand it becomes much easier to know which parts of your system need work, and which don’t.
Chuck—congratulations again on your well-deserved lifetime achievement award. The accolade could not have gone to a nicer guy. Thanks for all you’ve done to further my knowledge and experience in the game of the financial markets that you love so much! It’s so clear that your legacy will be that of a man who gave much more than he received.
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Help Pulling the Trigger
Q: I am considering the How to Develop a Winning Trading System Workshop. My issue is not being able to 'pull the trigger'. I am a value investor and find only 10 ideas a year. I have had a lot of success over 20 years and can cut losses. But I can never take full positions. Is this course for me?
A: The primary objective of the systems development course is to help traders understand the process of system development so they can create systems on their own or modify other’s systems to fit themselves. It sounds like you have a positive expectancy system already so your issue is not related as much to your system’s performance as to your execution of it as a trader. Fear of pulling the trigger is a psychological issue.
If you are interested in a course to address that issue, the Peak Performance Home Study course can help you understand why you might be sabotaging yourself that way and some possible resolutions. As far as our workshops, nearly the entire Peak Performance 101 workshop helps people address a host of issues that hold back their trading.
Here are some questions to consider regarding the less than full position size issue: Do you know how much this is costing you on an annual basis? Have you tried to resolve the issue already? If so, how? Has it helped at all? How does it affect your feelings about your trading?
Depending on your answers, it may be a huge problem or a very minor one. In either case, let us know how we can help you trade better.
Everything that we do here at the Van Tharp Institute is focused around helping you improve as a trader and investor. Therefore, we love to get your feedback, both positive and negative!
Feel free to click below to leave us any comments so that we can serve you better. Or, send Van a question that you would like for him to answer.
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