1. If you lose one-third, or 33.33%, of your assets, you will have to make 50% on your remaining assets to break even. If you lose 50%, you will need to make 100% to restore your original capital. If you lose 77.9%, you will need to make 352.5% on the assets left to break even. I think you get the idea by now. Capital preservation is, by and large, more important for successful long-term investment than securing an occasional large profit. Keep in mind that even sell out one day after the bad news is not too bad.
2. Mutual funds data from 1983 to 2003:
On a relative basis, more volatile mutual funds involve greater pain to gain, lower profit/loss ratios than less volatile portfolios. The gain/loss ratio of the most volatile portfolio segment is 1.5, while the least volatile group is 2.7.
The greater the volatility, the lesser the gain/loss ratio, the greater the risk.
Maximum drawdown for the most volatile portfolio group is 70% while the least volatile portfolio group is only 16%.
To sum up, for buy-and-hold strategies, higher volatility has historically produced little, if any, improvement in return for investors, despite the greater risks involved.
3. The basic principles of relative strength investing are as follows:
• Identify the leaders.
• Buy the leaders.
• Hold the leaders for as long as they lead.
• When the leaders slow down, sell them and buy new leaders.
The Nasdaq Composite Index tends to rise and fall at rates that are between 1.5 and twice that of the New York Stock Exchange Index. The Standard & Poor’s 500 Index, which includes issues that are listed on Nasdaq as well as the New York Stock Exchange, is more volatile than the New York Stock Exchange Index and less so than the Nasdaq Composite Index.
The links between the direction and levels of interest rates and the performance of the stock market, again, are well known (“Don’t fight the Fed”). Although correlations are, again, not quite perfect, as a general rule, stocks do best when interest rates are stable to declining, and worst when interest rates are unstable and rising
This is not surprising if you consider the positive impacts of relatively low interest rates on the economy and on the stock market. Low interest rates, for example, lead to reduced mortgage payments, which support the pricing of homes and commercial real estate, which leads to increased building, which benefits all those industries connected to home and office building and adds to homeowners’ sense of well-being, which leads them to spend more on goods and services, and so on.
Low interest rates also support business investment, the purchase of inventory, installment sales to the public, and so forth—all of which are favorable for business conditions.
Finally, low interest rates reduce the competitiveness of long-term bonds, shorter term money market funds, and bank certificates of deposit in comparison to the stock market. This encourages the concentration of investments into equities and, thereby, directly and indirectly into new and established companies.
All of this is no secret, of course. Meetings of the Federal Reserve Board are closely monitored in the financial press for indications of policy changes that might affect the levels of interest rates. The Fed has been quite sensitive to the potential effects of monetary policies upon the stock market, in recent decades moving rapidly to lower short-term interest rates (which are under its control) whenever the stock market runs into serious trouble. For example, the Fed lowered rates almost immediately following the market crash of 1987 and during the market correction of 1990, lowered rates a dozen times during the 2000–2002 bear market, and maintained low rates during the market recovery of 2003.
Just two items of data are required to maintain the Monetary Model. These are the yields each week provided by two intermediate U.S. government notes: the three-year Treasury note and the five-year Treasury note.
4. For 10-day (short-term) MA
Let’s consider now the moving average pulses that developed in mid-April, late May, and early July. The April to late May advancing pulse was relatively long in its consistent advance, which developed at a strongly rising angle. The May to June pulse was shorter (signifying lessening upside momentum or strength). The June to July pulse showed further reductions in its length and steepness of thrust, reflecting still diminishing upside momentum.
As a rule, a series of diminishing upside pulses during a market advance suggests that a market correction lies ahead. A series of increasing upside pulses suggests that further advances are likely.
5. For 50-day (Intermediate-term) MA
When intermediate trends are strong, the strategy of choice is usually to buy when prices fall to or below the shorter-term moving averages. Such patterns frequently provide fine entry points within favorable, strongly rising stock market cycles. The rules are reversed during more bearish periods. When intermediate-term market trends are clearly in decline, selling opportunities frequently develop when daily stock prices or market indices approach or penetrate shorter-term moving averages from below.
6. For 200-day (Long-term) MA
Again, accelerating slopes suggest extensions of trends in motion. Decelerating trends imply that current trends might be approaching reversal.
Be sure to check the lengths of pulses and the slope of moving averages that you are tracking. The longer the pulse is, the more vertical the slope is and the greater the odds there are of a continuation in trend. As pulses and slopes moderate, the odds of an imminent market reversal increase.
In both periods, the series of pulses involved were completed in three waves. This three-wave pattern, which occurs frequently, appears to be associated with The Elliott Wave Theory, an approach to studying wave movements and their predictive significance that has a wide following among stock market technicians.
7. For 30-month (Very Long-term) MA
First, consider the significance of the moving average in providing areas of support for the stock market. During positive market periods, price declines frequently come to an end in the area of key intermediate- and major-term moving averages. Second, note that the accelerating rise in the moving average creates a rising parabolic curve. Such formations usually occur only during very speculative periods (for example, consider the price of gold in 1980) and are generally followed by long-lasting and serious market declines.
It is frequently said that the stock market is in a bullish position because prices lie above their 30-week moving averages or that it is bearish because prices lie below their 30-week moving averages. Sometimes 10-week or 20-week moving averages are referenced instead. There are some elements of truth to these generalizations, but strategies of buying and selling stocks based on crossings of moving averages tend to add only moderately, if at all, to buy-and-hold performance.
As you can see, there has been very little benefit or disadvantage to trading the Dow Industrial Average based on penetrations of either the 100-day or the 200-day moving averages. The Dow has not been a particularly volatile or trendy market index. The Nasdaq Composite Index, more volatile and trendy, has generally proven in the past to be somewhat more compatible with this form of timing model, although less so in recent years because this market sector has lost a good deal of its autocorrelation, the tendency of rising market days to be followed by rising market days, and of market-declining days to be followed by market-declining days. Rising and falling days are now more likely to occur in random order than in decades past.
Results of buying on upside penetrations of moving averages and selling on downside penetrations seem to improve if exponential moving averages, which provide more weight to recent than distant past periods, are employed.
8. The Rate of Change Indicator
21-day rate of change.
I have found ten-day rate of change readings to be helpful for shorter-term trading and 21-day to 25-day rate of change readings to be useful for intermediate-term trading. It is helpful to maintain both shorter- and longer-term rate of change measurements. Often changes in direction in the shorter-term readings presage subsequent changes in the direction of longer-term rate of change measurements.
Popular as this generalization is—and it’s usually accurate enough during neutral market periods—it becomes less reliable in its outcomes when the stock market is strongly trended.
During bullish market periods, rate of change readings rarely reach the negative extremes that can exist for many weeks or even months during bear markets. When they do decline to their lower ranges, the stock market frequently recovers rapidly. During bearish market periods, rate of change readings tend not to track at levels as high as those during better market climates; the stock market more likely declines rapidly when readings reach relatively high levels for bear market periods.
For the most part, significant market advances do not start when rate of change and other momentum oscillators stand at their most negative or oversold readings. They tend to begin after momentum oscillators have already advanced from their most negatively extreme readings. For example, review Chart 3.6 again. The October 2002 advance did not start until the 21-day rate of change oscillator had already established a rising, double-bottom pattern, the second low point of which was considerably higher than the first.
Look for double bottom or double top of Rate of Change for reversal.
More specifically, each day’s new rate of change indicator level actually involves two variables: the current day’s change in price level and direction of movement, and the level and direction of the price movement of the day that is being removed from the calculation being made.
If the day being removed was a day of market decline, rate of change measurements will turn upward even if today shows no gain in price, for as long as it shows lesser loss than the day being removed. Therefore, if weaker market periods are being eliminated from rate of change calculations, rate of change levels tend to rise easily, often before price trends turn upward. If today happens to be a rising day and the day eliminated from the calculation was a falling day, rate of change measurements might rise rapidly.
Conversely, if the days being removed from your calculations were days of market advance, it will be more difficult for your rate of change indicator to gain ground. During strong market periods, rate of change indicators are likely to track sideways, but at relatively high levels. It might appear at such times that negative divergences are taking place, but if you examine the data stream carefully, you might notice that the stock market is not really weakening at all and that, in fact, the ability of its rate of change readings to remain high is a sign of strength.
What made this negative divergence more significant than the flattening of the rate of change indicator during October and November? Well, for one thing, rate of change readings were no longer tracking at high levels, declining to near the zero line. For another, patterns of price movement had changed, with price trends flattening. As a third consideration, there was very little time between the time that the rate of change failed to reach new peaks that would have confirmed new highs in price, and the rapid turndown in price levels from the early January peak.
Again, declines in rate of change readings and the presence of negative divergences are more significant if they are accompanied by some weakening in price trend. Double-top formations in price (two peaks spaced a few days to a few weeks apart) accompanied by declining double top formations in rate of change measurements can be quite bearish.
9. The Triple Momentum Nasdaq Index Trading Model
The Triple Momentum Nasdaq Index Trading Model: You will need to maintain three daily rate of change measurements: a 5-day rate of change of the daily closing prices of the Nasdaq Composite, a 15-day rate of change measurement, and a 25-day rate of change measurement.
At the close of each day, you add the percentage-based levels for the 5-day, 15-day, and 25-day rates of change measurements to get a composite rate of change, the Triple Momentum figure for the day.
There is only one buy rule and only one sell rule: You buy when the Triple Momentum Level, the sum of the 5-, 15-, and 25-day rates of change, crosses from below to above 4%. You sell when the Triple Momentum Level, the sum of the 5-, 15-, and 25-day rates of change, crosses from above to below 4%.
Rate of change patterns can be employed in conjunction with moving averages to define the four stages of the stock market cycle. Rate of change readings usually change direction in advance of moving averages; the momentum of price movement generally reverses in advance of changes of price movement.
In any event, even if a perfect indicator were discovered, sooner or later its components would become known, with its effectiveness dissipating as investors began to follow it en masse. (Where would the sellers come from if every investor became a simultaneous buyer?) The simple fact is that, at best, market forecasting is a matter not of perfection, but of probabilities. A realistic set of goals is to be right more often than wrong, to develop the emotional willingness and technical ability to recognize quickly when we are wrong and to take appropriate action, even if that means accepting a stock market loss. (Generally, the best losses in the stock market are the losses quickly taken.)
10. Angle change.
Sometimes the stock market appears to be rising or falling at a particular angle, and then the angle of movement changes. If you measure the distance encompassed by the first angle segment (A) and then project that distance along the second angle segment (B) in the direction that it is moving, you can frequently secure an accurate projection of the length of the B segment, which frequently is the same length as the first A segment.
11. The Wedge Formation
Wedge formations tend to be very reliable for short-term and day-trading operations. This is one of my favorite personal charting patterns for day-trading purposes.
12. Rising wedge formations
Rising wedge formations are created when the following conditions take place:
• The stock market (or other markets or individual investments) rises in price.
• Trendlines drawn that reflect support lines rise at a constant angle.
• Trendlines that reflect resistance, where prices turn down, can be drawn at a constant angle as well, but the angle of rise is less than the angle of the support trendline. The result is a converging channel.
• Trading volume decreases as the formation develops. This is an important condition because declining volume during uptrends suggests a reduction in buying pressures.
Wedge could fail, especially when wedges develop in an area of heavy resistance/support,a zone in which there has been heavy trading in the past.
If you detect the development of a rising wedge, especially if the wedge is being confirmed by other indicators, you might take these actions:
• Sell at the upper boundaries of the wedge.
• Sell on a violation of the lower boundary of the wedge.
• Draw the trendlines forward to see the point at which the upper and lower boundaries would meet. If you are selling short because of a rising wedge formation, you might want to use that point as a stop. Cover if the market rises above the level of that point, which usually takes place with an upside run around and above the point of upper and lower trendline convergence.
13. Declining wedge formations
Declining wedge formations have the following characteristics:
• The stock market is falling in price.
• Trendlines drawn across price highs decline at a constant angle, reflecting uniform selling.
• Support trendlines, drawn at price lows, also decline, but a lesser angle than selling trendlines, indicating increasing eagerness on the part of buyers, who are hoping to accumulate stock. Therefore, rising and declining trendlines converge.
• Trading volume decreases during the formation, indicating diminishing sellingpressure. This is an important condition.
If you detect the development of a declining wedge, especially if the formation is being confirmed by other indicators, you might take these actions:
• Buy at the lower boundaries of the wedge.
• Buy when the wedge’s upper trendline is penetrated.
• Place protective stops at the convergence of the upper and lower trendlines.
14. Head and Shoulder Formations
1. The stock market rises to a high following a market advance. It then dips to an interim low before advancing to a new high. The original high point is referred to as the “left shoulder.” The low of the subsequent dip ultimately develops in what will become the first point of the “neckline.” The secondary new high that next develops will be the “head” when the formation is complete.
2. Following the advance to the secondary high, which is higher than the left shoulder, prices dip again. This dip might be to the level of the first dip to the neckline (flat head and shoulder formation), above the first dip to the neckline (rising head and shoulder formation), or below that of a dip that followed upon the rise to the first shoulder (declining head and shoulder formation). The first two formations in Chart 4.3 are formations with rising necklines. The final formation on the right shows a flat neckline.
3. Following this dip, prices rise again, to a level that is not as high as the peak level of the head of the formation. This level is referred to as the “right shoulder.”
4. The formation is considered to be complete when prices then turn down and decline to below the neckline, which is created by drawing a line across the two low points in the formation.
5. Very important: For the formation to have validity, trading volume must decline across the entire formation. Volume should be highest at the left shoulder, should diminish during the advance to the head, and should diminish still further on the advance to the right shoulder.
15. Volume Spikes Are Very Bullish If the Stock Market Has Been in Decline
Long-term and serious intermediate declines that take place on low volume tend to continue for some time. Low volume during market decline signifies two things. First, there is probably little panic on the part of investors; instead, there’s complacency. Prices are likely to be declining not so much because of active selling, but because buying demand is drying up. When buying demand slows, prices frequently fall under their own weight. Second, prices have not yet fallen to levels that will attract aggressive buyers. Buyers are remaining on the sidelines while the typical, still complacent investor retains positions even through periods of slowly falling prices.
16. The Selling Climax
Sooner or later, even the most complacent holder becomes disturbed by the downward drift in prices. Selling pressures increase and become more widespread. Volume increases as shares of stock (or futures contracts, or option contracts, and so forth) pass from weaker, now nervous hands into the hands of aggressive buyers who are stepping in to take advantage of the developing selling panic.
This transition from slow, steady, complacent decline to aggressive, nervous selling and finally to nascent aggressive buying is referred to as a selling climax. It is largely driven by aggressive and fearful selling—the urge to sell at any price. Buying climaxes following extensive market advances sometimes take place as well. The demands of aggressive buyers are met by savvy traders who are perfectly willing to part with the stock that is being demanded. Buying climaxes are less usual than selling climaxes, but one did take develop in certain areas of the Nasdaq Composite Index in March 2000.
Again, market declines of any magnitude, even during intraday price swings (day traders, take note) frequently do not come to an end until trading volume increases, often dramatically.
To sum up once more, although market declines sometimes end with a long, quiet, base-building process, low trading volume during market decline is, at best, a neutral indication. The most bullish development that can take place during a major or serious intermediate market decline is a dramatic build-up of stock market volume following a period of falling prices. This build-up often develops during the sort of terminal downside spikes that characterize stock market selling climaxes.
17. Support Zones
Support levels, again, are zones in which investors show willingness to step in to purchase stocks (or other investment vehicles) that have backed off in price. There may be broad, long-term areas of support (zones from which market recoveries have taken place over considerable periods of time) or shorter-term areas of support (zones in which trading has taken place for only limited periods of time). The broader the support zone is, the more significant it is likely to be.
• Market uptrends are characterized by patterns of rising support levels and rising peaks achieved in rallies from those support levels.
• When a new peak is achieved, the area between that peak and a previous consolidation becomes a support level.
• Uptrends are considered intact for as long as support levels take place at progressively higher zones.
• During market uptrends, resistance zones tend to develop not at or below previous market peaks, but a bit above previous market peaks.
• The test of a bull market is the capability of the market to produce progressively higher support and resistance zones.
18. Resistance Zones
Well, suppose that a market advance has just come to an end, taking a particular issue down from a new high in price of $50 to a price of $44. There are likely to be many investors who regret not selling in the $49 to $50 zone, waiting and hoping for a second opportunity. If the issue recovers back to the $49 to $50 area, many of these investors, recalling that $50 was the last high, will offer shares for sale, perhaps driving the issue back down in price.
In this sequence, a “trading range” might develop between $44 (the most recent low for the stock, perhaps perceived as a buy zone) and $50 (the most recent high), perhaps perceived as an expensive area for that issue. The price of $44 to $45 will represent a support zone. The $49 to $50 area will represent a resistance zone.
When a support area is violated to the downside, the former area of support frequently becomes an area of resistance. When a resistance area is penetrated to the upside, this former area of resistance is likely to become an area of support.
19. Market downtrends
Market downtrends, which characterize major bear markets, represent periods of high risk for investors who are generally well advised to avoid assuming new positions and/or to reduce currently invested stock positions for as long as such downtrends are in effect. Just to review the tell-tale signs and patterns of behavior associated with bearish market climates….
• Market downtrends are characterized by a series of lower peaks (resistance zones) and lower areas (support zones) from which rallies emanate.
• For as long as a pattern of lower lows and lower highs remains in effect, a bear market is in effect.
• Resistance zones during bear markets generally develop at or slightly below peaks of previous market recoveries. Previous areas of support often become areas of current resistance.
• The capability of the stock market to penetrate a previous resistance zone could be an early indication of a significant trend reversal.
The trendline is a useful technical tool, but it should probably not be employed as a standalone indicator because of false trendline penetrations that occur and because trendlines tend to appear more accurate when they are drawn in after the fact than an actual real time. In any event, because definitions of trendline slopes are often somewhat subjective, it is advisable to employ trendlines in conjunction with confirming indicators.
20. Early Warnings Provided by Channel Patterns
The capability of stock prices to rise rapidly to and to even overshoot the upper boundary of a trading channel suggests a favorable market climate and higher prices to come. Diminished slopes of advance and failure to reach the upper boundary suggest incipient market weakness.
The penetration of the supporting lower boundary of a trading channel carries an implication of further market decline. A likely objective for such a decline can be established by drawing a line parallel to the support trendline as far a distance below that trendline as the upper boundary of the channel is above that line. Simply double the width of the channel, placing the support trendline in the middle. That extended channel support line becomes the next support zone. The supporting trendline, which has acted as support, is likely to become a resistance area.
To sum up, support and resistance zones are created and heavily influenced by areas in which previous trading has taken place. Resistance zones, once penetrated, transform into support zones. Support zones, once violated, tend to transform into resistance areas.
Support and resistance zones are also heavily influenced by current trends of investment markets, apart from influences created by previous trading activity. Look for rising areas of resistance and support during bull markets, and for declining areas of resistance and support during bear markets.
21. A Significant Sell Signal
The most significant sell signals often take place following market advances that appear significant and favorable at first, but that rapidly fail. In this regard, you may want to recall that every major market decline originates from a market peak and that every bull market originates from a significant market low point. Here is a sequence of events that frequently takes place as the stock market reverses from a bullish to a bearish trend:
1. The stock market enters into a trading range.
2. A breakout takes place from within the boundaries of the trading range to a level above the trading range. It appears that a market advance is getting underway.
3. The advance ends almost immediately, indicating that the upside breakout was falsely deceptive. Prices fall to back within and then to below the lower boundary of the trading range in question.
4. The penetration of the lower boundary of the trading range when such a sequence takes place is generally followed by a sharp and extended market decline.
22. A Significant Buy Signal
A reverse sequence produces very significant buy signals:
1. The stock market enters into a trading range.
2. A breakdown takes place through the lower boundary of the trading range. This, perhaps, trips a few stop-loss orders in the process, extending the decline a touch, but there is basically little in the way of follow-through to the decline.
3. Prices quickly reverse upward back into and then through and above the trading range. The penetration of the upper boundary of the trading range is frequently followed by an extensive and dynamic market advance.
23. The Key
The key in both cases lies with the false signal that is generated before the stock market embarks on a move in its final, significant direction. In both cases, the false moves attract very little in the way of investor follow-through. Breaks upward from trading ranges that represent false breakouts attract little in the way of investor interest, with advances faltering rapidly. The failure of subsequent trading range
boundaries to hold as support confirms the bearish action reflected in the false move to the upside.
False breakdowns carry similar implications, in reverse. Violations of the lower boundary of the trading range draw very little in the way of further downside activity. Savvy investors realize that the breakdown is false, and large buying enters into the market as soon as the trading range is repenetrated, this time to the upside.
These are very powerful reversal patterns and, again, are among my personal favorites.
One last word on the subject of stock market reversals: Every stock market decline begins after the stock market has just reached a new high in price. New highs are not, in and of themselves, reason to remain bullish.
Every stock market advance begins after the stock market has just reached a new low in price. New lows are not, in and of themselves, reason to remain bearish.
Political, Seasonal, and Time Cycles
The stock market has had a definite tendency to achieve its greatest gains during the last and next-to-last trading days of each month and the first two to four trading days of subsequent months (the exact combinations have varied somewhat over the years). In fact, gains in stocks during the favorable four- to five-day turnof-the-month trading period have typically equaled gains in stocks during all the rest of monthly trading days combined.
Stocks have tended to show above-average strength within the days immediately preceding stock holidays and for three days following such holidays. There are definite bullish biases to periods of favorable monthly seasonality, which include the days at the turn of months and pre-holiday trading sessions. Lately, however, upside biases to holidays have generally excluded the days surrounding Good Friday, Independence Day, and President’s Day. Pre- and post-holiday positive influences are most consistent during holidays that fall within the strongest months of the year, November to January.
The three-month period of November through January has definitely been the strongest three-month period of the year for the stock market—not necessarily every year, but certainly overall.
July, September, and October have tended to be the weakest months for stocks. October has had a history of being the month most likely to see market turnarounds, which makes it a good month in which to plan or to execute the accumulation of shares in preparation for the more favorable year-end period that includes the months of November, December, and January.
Virtually all net gains in the stock market that have taken place within the last half century or so have taken place between November 1 and April 30 of each year. May to October periods have essentially broken even, with stocks often returning slightly less to investors than risk-free income producing investments during these months.
Returns during unfavorable six-month periods have averaged just a bit less than 1% per period, with the rate of return while invested approximately 2% per annum, less than risk-free interest rates in most years. As a rule, investors would have been better off in the stock market for just six months each year and out for six months than being fully invested at all times (although this is not true for every year, of course). These “mood indicators” are not precise on their own in terms of market timing, however, so they are probably best employed as an influential backdrop to investment decisions based upon more specific timing tools or as a consideration for decisions regarding the extent to which you want to be invested at any time.
24. The Presidential Stock Market Cycle
This is a well-known, though hardly flawless, stock market political cycle. Basically, the stock market’s best performances take place during the years that immediately precede the years of presidential elections. Its second-best annual gains tend to take place during the years of presidential elections, with the stock market often peaking shortly after the elections held during those years. The worst years for the stock market have been the years following presidential elections.
25. The Nasdaq Composite tends to lead New York Stock Exchange–oriented market indices during the years before presidential elections but is not as consistent a performer during other years. The relative (not absolute) weakness of the Nasdaq Composite during election years, the years in which bull markets tend to peak, suggests that the Nasdaq tends to reach its bull market maximum strength before the primary market areas and falls in advance of stocks associated with primary market indices.
26. 53-Day Cycle of the Standard & Poor’s 500
There seem to be regular and repetitive cyclically determined time periods between low points, which is how cycles are defined. Frequently there are equal lengths of time from highs to highs as well within full market cycles, generally during neutral market periods, but cycle lengths are normally measured from lows to lows of market cycles. The stock market cycle defines when market upturns are likely to take place but does not predict the length and extent of market advance that will follow.
Shorter-term cycles take place within the 53-day period. The full 53-day cycle is more dominant and produces significant market swings of a larger amplitude than market fluctuations based upon its shorter cyclical components. The 53-day time cycle should actually be thought of as the “nominal” or “idealized” 53-day cycle. The actual cyclical low-to-low measurements that developed within this period spanned a range of 48 to 56 days.
Shorter time cycles—for example, the four- to five-day market cycle—are not likely to miss their projection by more than a day or so. The longer the time cycle is, the larger the potential error. Interestingly, cyclical errors tend to be self-correcting. So, if one cyclical swing tends to be longer than its nominal length, the subsequent cyclical swing will tend to be shorter than its nominal length, and vice versa.
The areas in which a number of shorter- and longer-term market cycles come together at a market low is called the nesting of cycles. The stock market is most likely to show serious cyclical weakness as larger numbers of cycles simultaneously move down into these nests. Upward turns from these nests as multiple cycles simultaneously reverse back to the upside provide very bullish cyclical influences on the stock market.
Often, there is a fine confluence of angle change measurement and cyclical time projection.
The major concept to be recalled is that cyclical influences on the stock market are greatest when a number of significant cycles coalesce in their direction, nesting, falling, or rising together. Cyclical influences are likely to be weakest when a number of significant cycles lie in opposition or are in neutral territory.
27. Some significant cycles:
• The four-year market cycle
• The one-year market cycle
• The 22- to 24-week market cycle
• The 11- to 12-week market cycle
• The five- to six-week market cycle
• The 15- to 17-day market cycle
• The 7- to 10-day market cycle
• The four- to five-day market cycle
• The 17- to 20-hour market cycle
28. The downturn in 2000 was the first market downturn in 30 years marked by a downturn in the major four-year cycle before its midpoint. Downturns in market action early in market cycles imply more than average weakness to come.
29. For still another, as the bottoming process moved along, the RSI traced out a rising double-bottom pattern, a type of pattern that tends to be quite significant when it develops within areas that mark oversold levels during bullish market periods.
30. Cycles that end as strongly as the cycle from November to early January are usually followed by very strong market action at the start of the following cycle, which is what took place in this instance.
31. Longer-term market cycles often break up into 18-month cycles. Also apply the patterns of a
50-day rate of change indicator.
A pattern in which a rising wave starts upward and then turns down to below its starting point is referred to as a cyclical failure, particularly if the turndown carries to below a previous support level. This sort of pattern is usually quite bearish, reflecting a change in basic market trend.
32. As a general rule, rate of change indicators peak approximately 50-65% into a market upswing. The area at which these indicators turn down is an area in which it is probably too late for buying, possibly a touch early for selling; this is an area during which it might be appropriate to prepare for the next downside move.
33. T-formation
The T-formation is applicable to both long- and short-term trading operations. The viability of the formation is based upon the concept that time cycles often are relatively neutral, in the sense that wave lengths or segments are likely to be quite equal in time. Given this assumption of relative neutrality and time constancy between cyclical waves, it becomes logical to assume that if you know the time that the stock market has spent in a cycle or segment of a cycle, and recognize when a new cycle or cycle segment has gotten underway, you should be able to project when the new cycle or segment cycle is likely to come to an end.
The basic T-formation construction is really quite straightforward. The first concept to keep in mind is that, in a double-top formation, you draw the line X from the center of the M formation rather than from one of the two peaks in the double-top formation. The second concept is that the distance A – X is equal to the distance X – B. The third concept is that the T-formation indicates when B waves are likely to come to an end. These formations do not project the price level at the conclusion of the cycle; they project just the time duration of the cycle. Actually, your projections often will include accurate price as well as time projections. Price projections can often be estimated from the slopes of price movement.
From time to time (actually, for short-term swings, more often than that), the stock market traces out advancing and declining waves of rise and fall, with one side almost exactly mirroring the other. The development of such patterns is not all that surprising. For one thing, support and resistance levels that develop on the initial side of the mirror are likely to become reflected as pauses in price movement on the other side in a neutral cycle, as support and resistance levels created on the one side affect price movement on the other. For another, time cycles in neutral market climates, when mirroring most frequently takes place, naturally lead to market reversals that will occur following neutral cyclical patterns.
34. cyclical inversion
For a day or two, the turn downward appeared to be taking place, but it was immediately reversed and prices soared once it became apparent that there would be no follow-through to the cyclically projected market decline. This reversal of cyclical direction is referred to as a cyclical inversion and is generally followed by a strong move in the direction of the inversion. In this case, instead of following through with a cyclically indicated reversal to the downside, the market moved upward—and did so very strongly. Inversions can be troublesome, but if you recognize them and respond quickly, they often provide special opportunities for rapid trading profit.
35. Seasonal and Calendar Influences on the Stock Market
The best days to purchase stocks have generally been the first two to three days and the last one or two days of each month. Stocks also have tended to perform well on the days before most holidays.
The period of November to April has been the best period in which to own stocks. The period of May to October has historically produced stock market returns that have been below rates of return of short-term income investments.
The best years to own stocks have been the years before and the years of presidential elections. The two years following presidential elections have shown lesser rates of return.
36. Time Cycles
Most market cycles can be subdivided into two segments, A and B. A market cycle itself is either an A or a B segment of a longer market cycle. It is a sign of market strength if the B segments take place at higher levels than the Asegments, and it is a sign of market weakness if the reverse is the case.
Cyclical influences are most significant when high percentages of cycles of various lengths are pointing in the same direction, or when a number of significant cycles are reaching bottoms (“nesting”) simultaneously.
The four-year market cycle has been a very dominant cycle for decades.
Time cycles can provide fine indications of the likely periods in which significant stock market buy and sell junctures are likely to take place. However, time cycles and T-formations should be employed in conjunction with other stock market indicators and not employed as standalone buy or sell signals.
Popular market indices represent the “external stock market,” a view of the market most frequently observed. Indicators that measure the numbers or proportions of issues that actually participate in market advances and declines are measures of the internal strength or breadth of the stock market, a generally truer reflection of the strength of the typical stock and mutual fund.
As a general rule, the stock market is on firmer ground when market advances are broad and include large percentages of listed issues than when they are selective, with advances in market indices created by strength in a relatively narrow group of highly capitalized issues.
37. Measures of Market Breadth
1. The advance-decline line, a cumulative total of advancing minus declining issues on each of the various exchanges.
2. The new high/new low indicator
• Market advances accompanied by increases in the number of issues reaching new highs in price are advances that are well confirmed by market breadth. Such advances are likely to continue.
• Market advances that are not accompanied by increases in the number of issues reaching new highs in price are not as well grounded in internal strength as fully breadth-confirmed market advances. There are no precise and regular intervals in time between peaks in the number of new highs and ultimate peaks in the stock market averages.
• Market declines accompanied by increasing numbers of issues falling to new lows are likely to continue. If new lows reach bear market peaks during a downside selling climax, with prices spiking down at the time, there are likely to be further tests of those price and breadth lows before final bear market bottoms are achieved.
• Failures of new lows to expand with price declines represent positive breadth divergences and tend to be forerunners of stock market reversals to the upside.
Again, breadth divergences, positive and negative, do not signal immediate market reversals. This family of indicators usually requires time for its effects to be felt. However, triple-bottom formations, representing declining numbers of new lows during bottoming formations, often resolve in market advances fairly rapidly after the third spike reversal has taken place. The market bottom that developed during 2002 is an excellent example.
38. The NH/(NH + NL) ratio indicator.
The stock market is likely to be on firmer footing when strength in the daily- and weekly-based advance-decline lines confirms strength in the various indices that reflect different sectors of the stock market. In other words, new highs in indices such as the Standard & Poor’s 500 Index should be confirmed by new highs in the weekly- and daily-based advance-decline lines, and vice versa.
The stock market prefers strength in all of its areas. Although it is probably better if measures of breadth lead market indices than vice versa, universal strength is the best. It is more bullish for stocks when peaks in major market indices are confirmed by new peaks in the advance-decline lines, or when new lows in market indices are unconfirmed by new lows in the advance-decline lines.
39. The 21-Day Rate of Change of the Advance-Decline Line
In recent years, intermediate swings have tended to range from high levels of about +9,000 to +10,000 and –9000 to –10,000, which are highly overbought and oversold levels, respectively.
Highly overbought readings generally take place only during fairly strong periods within bull markets. They rarely first occur right at the peaks of market advances; they usually develop when intermediate market advances are roughly 50–65% complete.
The stock market tends to behave differently at market low points than at market tops, particularly during bull markets. Market bottoms tend to be sharper and more climactic than market peak areas, during which prices tend to more slowly roll over. Therefore, whereas overbought readings in timing oscillators such as the 21-day rate of change of the advance-decline line usually provide advance notice of at least a few weeks before market reversals to the downside, upside reversals in such indicators from deeply oversold levels, particularly during bull markets, often suggest immediate bullish action.
The weakening of market breadth that we see in Chart 6.5 suggests that, for most stocks, the bear market did not begin in 2000. It probably began for most issues as early as 1998, and certainly during 1999.
40. The Ten-Day Rate of Change Indicator
Divergences between the direction of the ten-day rate of change indicator and the direction of the advance-decline line itself frequently indicate imminent changes in shorter- to intermediate-term trends in market breadth.
There is a fairly significant six- to seven-week trading cycle in the United States stock market. This cycle can often be tracked with the ten-day advance-decline rate of change indicator, which tends to rise for roughly 15 to 20 trading sessions from cyclical market lows during its six- to seven-week cycle. Caution on at least a shortterm basis is often indicated when the ten-day rate of change of the NYSE advance decline line has risen for three weeks or more.
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41. MACD indicator
The MACD indicator is created by subtracting a longer-term exponential moving average from a shorter-term exponential moving average of prices or other measures of the vehicle that you are tracking. MACD generally rises if shorter-term trends are gaining strength and generally declines if shorter-term trends are losing strength.
• MACD represents the difference of the short-term exponential moving average minus the long-term exponential average.
• When market trends are improving, short-term averages will rise more quickly than long-term averages. MACD lines will turn up.
• When market trends are losing strength, shorter-term averages will tend to flatten, ultimately falling below longer-term averages if declines continue. MACD lines will fall below 0.
• Weakening trends are reflected in changes of direction of MACD readings, but clear trend reversals are not usually considered as confirmed until other indications (discussed shortly) take place.
• During the course of price movements, short-term moving averages will move apart (diverge) and move together (converge) with longer-term moving averages—hence, the indicator name moving average convergence-divergence.
As a general rule, the longer-term moving average will be two to three times the length of the shorter-term average. The shorter the shorter-term average is, the more sensitive the MACD will be to short-term market fluctuations. The 12-26 combination is widely employed but is hardly the only possibility.
MACD signals are more likely to prove reliable if shorter-term MACD signals are confirmed by longer-term trends in the stock market, perhaps reflected by longer term MACD patterns. The maintenance of multiple MACD charts, reflecting varying length of market cycle, is recommended.
The signal line is an exponential average of MACD levels, not of the price of the investment vehicle or index that is being tracked. Signal lines are usually created employing three-day to nine-day exponential averages of MACD lines. The shorter the average is, the more sensitive the signal line will be.
As a general rule, crossings of MACD from below to above its signal line can be taken as confirmations of buy signals originally indicated when changes in direction have taken place in MACD from down to up. As a basic rule, reversals in the direction of MACD carry significance, which is confirmed when MACD crosses its signal lines. Notice that signal line crossings take place after MACD lines change direction but usually before MACD lines have crossed the 0 line.
42. My research over the years has suggested that greater net gains generally occur if reversals in MACD (especially slower-moving combinations) are employed for buying and selling rather than crossings of signal lines. However, using changes in the direction of MACD without signal line confirmation produces larger numbers of trades, with attendant extra expenses.
43. Very Important Supplementary Buy and Sell Rules
• Buy signals are much more reliable when the MACD has crossed from above to below 0 at some time since the most recent sell signal. The MACD does not have to be below 0 at the time of the buy signal, but it should have been below 0 at some time since the start of the recent decline.
• Sell signals are more reliable when the MACD has crossed from below to above 0 at some time since the most recent buy signal. The MACD does not have to be above 0 at the time of the sell signal, but it should have been above 0 at some time since the start of the most recent advance.
• During very strong market periods, usually during the early and best stages of bull markets, the MACD will retreat during market reactions to a level just above 0. In this case, you can shade the previous rules a bit as you might if the MACD tops out just below 0 during a bear market or severe intermediate decline. Most often, however, the 0 crossing condition should be respected.
44. As a general rule, it is best to sell positions following market movements that take prices from oversold to overbought levels, and to buy new positions when the market has become oversold, or at least somewhat extended to the downside. By waiting for the MACD to fall below 0 for buying and to rise above 0 for selling, you are setting up procedures by which you “buy weakness” and “sell strength” rather than buying and selling on very change in minor trend. These supplementary rules are likely to both reduce the frequency of trading (with its attendant transaction costs) as well as reduce the numbers of unproductive whipsaws. These are pre-conditions that are worthy of respect.
45. Using Divergences to Recognize the Most Reliable Signals
The failure of measures of momentum to confirm new highs or new lows in price by failing to concurrently achieve new peaks or new lows, respectively, indicates a diminishing of market thrust in its current direction. Divergences suggest a more or less imminent market reversal ahead, often of at least intermediate significance.
46. Two MACD Combinations Are Often Better Than One
As a general rule, we shall presume that the prevailing market trend is at least neutral and possibly bullish if the 50-day moving average is either rising or essentially flat. If the 50-day average is clearly declining, we will assume that the market trend is down.
• You should maintain at least two MACD combinations: a faster one for buying and a slower one for selling.
• When market trends are very positive, buy very fast and sell very slow. You can employ the 6–19 combination for buying, or you can employ the somewhat more reliable 12–26 combination. The 19- to 39-day combination is used for selling.
• When market trends are neutral to somewhat positive, buy fast and sell slow. Use the 12–26 combination for buying. Use the 19–39 combination for selling.
• When market trends are clearly negative, buy fast and sell fast. You can use the 12–26 MACD combination for both buying and selling, in which case you will sometimes be selling before the slower-moving 19- to 39-day MACD has crossed from below to above 0. However, unless a stop-out takes place, the 12–26 MACD lines should generally rise above 0 as a precondition for a sell.
Remember, during downtrends, it is advisable to use parameters that make it harder to buy and easier to sell! 12-26 MACD is better.
All in all, the MACD indicator neither gains nor loses much, on balance, when you trade against prevailing market trends, but does tend to be quite profitable when you trade in the direction of prevailing trends.
47. The conditions below are required for a delayed sell signal to be placed in effect:
• The stock market must be in an uptrend that can be defined by a rising 50-day moving average. A slow MACD combination is employed for selling.
• At the time that the first crossing of the sell MACD line from above to below its signal line takes place, check whether there have been any negative divergences, either in the MACD that is being used for buying or in the MACD that is being used for selling.
• If there are no divergences—MACD lines and price lines are moving in conjunction—and trends of the market are favorable, with prices above a rising 50-day moving average, you can ignore the first sell signal generated by MACD. You should, however, take a second sell signal.
• As a back-up exit strategy, you can use a crossing of the price of your investment from above to below the 50-day moving average, which would probably take place after the MACD sell signal that you did not follow.
The 19- to 39-day MACD selling combination did not rise above 0, so no sell signal could be generated based upon that MACD line. Therefore, we make use of a secondary sell rule that is triggered when the buying MACD combination declines following a buy signal to a low that is below the low that preceded the buy. The sell-stop is not based upon price falling to below a previous low point. It is based upon momentum readings (MACD) falling to below a previous low point.
As a key point, again, MACD stop-loss signals are created by violations of support areas in the MACD indicator, not by violations of price support. This modification of usual stop-loss strategies often prevents premature selling that frequently takes place when slower basing and bottom formations develop.
48. Use trendline to confirm buy and sell signals:
The combination of trendline violation and MACD penetration of signal lines is more powerful than either element alone. There are situations in which buy signals took place right in the area at which downward sloping trendlines were penetrated, and situations in which MACD sell signals were confirmed by declines in the MACD down and through rising uptrend lines.
49. Use time cycles to confirm MACD signals:
Market cycles exert their most apparent influence during periods of neutral price movement. If a market cycle takes longer than normal to complete, the next cycle will frequently be shorter, with the average of the two defining the basic cyclical length of the cyclical wave.
50. MACD does have its Achilles’s heel. In this regard, it does encounter occasional difficulty in dealing with steadily trending, narrow-channeled market advances or declines.
Sometimes such patterns take place during market declines. Prices decline steadily, quietly and persistently, even as MACD rises; the stock market is very slow to respond to the favorable implications of diminishing downside momentum. I know of no ready way to deal with such situations, if decisions are based upon MACD patterns alone. However, we have already reviewed a number of tools that might well have identified strength in the stock market and counteracted daily based MACD sell signals at certain times. For example, the 10-day ratio of new highs to the sum of new highs and new lows might be tracking above the 90% level, or weekly ratios of advances in relationship to the number of issues traded on the New York Stock Exchange could be producing their own signals to remain in the stock market.
51. An MACD Configuration That Suggests More Active Selling
One MACD configuration carries clearly bearish implications—not on every signal, but based on extensive research into the history of the stock market, in the aggregate. These are the parameters:
• The 19- to 39-day MACD combination is employed for the signal to stay out.
• The 19- to 39-day MACD combination must be falling. If it turns up, the bearish implications are cancelled.
• The 19- to 39-day MACD combination must also be below 0. Although the most dangerous periods for the stock market develop when the 19- to 39-day MACD combination is still falling and has declined to slightly above 0, for practical purposes, you can view the 0 line as the crucial level that defines the completion of the most reliable MACD sell signals.
To restate, a “full-fledged” MACD sell signal takes place when the 19–39 day MACD line is in decline and has fallen to below 0. It is cancelled when the MACD line turns up, even below 0, although you might await buy signals from more rapid MACD combinations before actually re-entering the market.
• Even given the previous conditions, not every decline will graduate into serious market damage. However, on average, the sell signals described are followed by further market decline and should be respected.
• Total timing results likely will prove slightly more efficient if all MACD sell signals are followed when they occur, rather than waiting for the 19- to 39-unit MACD to decline to below 0. However, this comes at the cost of more frequent trading, with its attendant expenses and greater numbers of whipsaws.
• One recommended money-management strategy involves lightening up more rapidly with some long positions on initial sell signals, but maintaining at least some holdings until full-scale MACD sell signals take place.
52. Monthly-based MACD patterns have had a fine, if imperfect, history of confirming reversals in major market trends, as a general rule generating buy and sell signals approximately three months after actual major term peaks and lows in the stock market. (During some of the period shown, the 12- to 26-month MACD combination would have been more usually employed as the buy trigger than the 6- to 19-month combination illustrated.)
53. The MACD would be worth following even if only one of its capabilities existed: its ability to define market re-entry junctures following serious intermediate- and long term market declines. We have already seen this ability as it relates to longer-term market trends in the ability of monthly-based MACD charts to identify major bear market lows.
54. The 21-day moving average tends to reflect market trends based upon a seven- to eight-week market cycle, roughly twice the length of the moving average employed. The ten-day moving average reflects short-term trends and tends to reflect a three- to four-week market cycle. I have found that moving averages ranging from 21 days to 50 days (or weeks, for longer-term charts) to be generally useful.
55. As a general rule, you should employ offsets to your moving averages so that approximately 85–90% of price movement of the data that you are tracking lies within the boundaries of the trading channel. The exact percentage is not crucial. The bands can generally be set by eye if you have a computer program that allows you to experiment with varying channel widths. Some analysts suggest that bands be set so that 95% of activity takes place within the channel. I find it useful to allow a little more frequency in excursions outside the moving average channel, but this is almost certainly not a crucial differentiation.
The amount of offset from the moving average is influenced by two factors: the volatility of the market index or investment vehicle that you are tracking and the length of the moving average.
56. Remember synergy! Maintain confirming indicators and time cycles to go along with your trading channels. Like MACD, they benefit from outside confirmation when such confirmation is available.
57. Moving Average Trading Channels in Operation
Rule 1: the stock market usually (not always) can be purchased for at least a short-term upswing when prices decline to below the lower boundaries of a significant moving average trading channel. By and large, however, such scalping attempts are best avoided when virtually all trends and measures of price momentum remain in a state of deterioration.
Rule 2: As a general rule, the first rally following a downside penetration of the lower boundary of a moving average trading channel is likely to fail, frequently stalling at the moving average line in the center of the channel, which normally acts as resistance to initial rallies from very oversold positions.
If the penetration through and below the lower boundary of the trading channel has been considerable, perhaps as wide as half of the moving average trading channel itself, the first area of resistance might lie at the lower band of the channel rather than at the center band moving average line.
The general pattern suggests a market recovery to at least the middle band of the trading channel, with at least fair possibilities of an attack on the upper band because this is the second, not the first, attempt at rally from the lower band.
Rule 3: Rallies that originate from the lower band boundary of the moving average trading channel usually meet resistance at the center line, especially if such rallies are the first attempt at rally from the lower band. However, if the center line of the channel is penetrated, the next area of resistance will often be the upper boundary line of the moving average trading channel.
Rule 4: If prices reach the upper boundary of the trading channel, unless technical conditions are unusually weak, the first areas of support during initial downside corrections are likely to develop at the center line of the channel, or at the moving average line.
Rule 5: If a market advance does not carry prices as far above or as close to the upper moving average channel boundary as the previous advance, this is a sign of weakening market momentum and a weakening market.
Rule 6: If a market advance fails to carry to the upper band of a trading channel, the next decline will probably penetrate the moving average or center line support.
With each swing of the stock market (and other markets), compare the power of its impulse with the power of the impulse of the market swing that preceded. If prices are falling, you might want to check out some pertinent issues. Is the MACD losing or gaining downside momentum? Are declines carrying lower in relation to the moving average line and to the bottom boundary of the moving average trading channel? Are slopes to declines increasing or moderating? Is the channel itself declining with greater or lesser momentum? With each swing of the market to the upside, question the reverse. Are upswings gaining or losing momentum? Slopes? MACD patterns? Relationships of price to the upper boundaries of the moving average trading channel? You will often be able to gain insight into future developments by comparing the present to the past.
Rule 7: If a market top or market low indicated by the action of price movement within the moving average trading channel is confirmed by supporting technical indicators, the odds of a trend reversal taking place increase. A synergistic approach to trading bands is definitely useful.
Rule 8: If a market peak fails to carry as high as a previous market peak, the odds are good that the next decline will carry to a level beneath the level of the low area between the two peaks. If a market low is followed by a lower low, the odds are that a following rally will not rise above the peak level of the rally that took place between the two lows.
58. As patterns of this nature emerge, the strategy is generally to gradually phase out long positions, to place closer stops on remaining positions, and to increase selling activity as early warnings of a weakening market become confirmed. We are looking not so much for a one-day signal to exit all long positions as much as for a general area in which to shift emphasis from buying and then to holding and then to gradually selling positions as Stage 3 (topping) of the stock market moves along to the start of Stage 4
59. Organizing Your Market Strategies
60. The First Step: Define the Major Trend and Major Term Cycles of the Stock Market
• The direction of major term moving averages—the 40-week or approximately 200-day moving average—is very useful for this purpose. Consider not only the direction, but also changes in the slope of the moving average.
• Study the direction of longer-term moving average channels and the patterns of price movement within these channels.
• Maintain monthly and weekly, in addition to daily, MACD charts.
• Employing the previously mentioned tools, try to define and establish the position of the stock market in terms of its four stages. These include Stage 1, basing and accumulation; Stage 2, rising, the most positively dynamic stage; Stage 3, topping and distribution; and Stage 4, dynamic decline, the weakest stage.
• Keep track of longer-term indicators that have had a good record in the past of defining major-term market low areas. Review the Major Term Volatility Model, and new high and new low, and TRIN.
• Do not neglect stock market time and political cycles. The 48-month or approximate four-year stock market cycle has been significant for decades.
61. The Second Step: Check Out Market Mood Indicators and Seasonal Cycles
• Maintain and keep track of the Nasdaq/New York Stock Exchange Relative Strength Indicator.
• Maintain and keep track of the Intermediate Monetary Filter
• Seasonal influences as well as cyclical forces provide their own market mood suggestions. The three-month period between November and January has a strong bias to the upside. October historically has been a month that sees the completion of market declines.
62. The Third Step: Establish the Direction and Strength of the Current Intermediate Trend and Try to Project the Time and Place of the Next Intermediate-Term Reversal Area
• MACD
• Moving average trading channels
• Rate of change indicators, 10-day, 21-day provide perspective on whether trends are gaining or losing momentum.
• Market breadth indicators: Advance-decline lines of major exchanges, as well as the numbers of issues rising to new highs or falling to new lows.
• Intermediate-term time cycles and T-formations
• Chart patterns—Angle changes, reversal formations, wedges, trendline support, and resistance areas
• Seasonal considerations.
• Sentiment indications, such as VIX
• The Triple Momentum Nasdaq Index Trading Model
• The MACD Filtered Breadth Impulse Model
• The 90–80 New High–New Low Indicator and the Weekly Impulse Continuation Signal
63. The Fourth Step: Fine-Tune Your Intermediate-Term Studies with Studies Based on Shorter-Term Daily—or Even Hourly—Market Readings
• Check out daily and/or hourly data for short-term market trends and momentum. MACD, rates of change, chart patterns, and shorter-term hourly and/or daily market cycles might be useful.
• Here’s a special short term buy/sell timing model: The short-term version of the Daily Based Breadth Impulse Signal triggers infrequently but very reliably to indicate shorter-term, high-momentum market advances. This indicator can be employed with MACD as a sell filter, in which case it can graduate into a full scale intermediate-term hold indicator.
The method of selecting mutual funds based on relative strength is among our favorite strategies for selecting and rotating your investments.
64. Lessons I Have Learned During 40 Years as a Trader
• The news media, including the stock market TV channels, tend to be the last to know and almost always tend to follow stock market trends rather than to lead them. As a general rule, a good time to buy stocks is when the popular magazines and front pages of major newspapers are featuring stories dealing with bear markets and investor doom. In a similar vein, stock market newsletters and advisory services have not had the very best of records in terms of market forecasting. The greater “gurus” have often tended not to be more correct than others.
• There might be many benefits in attending lectures, meetings, and technical classes regarding trading tactics and investing, but it is probably best to operate alone in making and implementing actual trading decisions and to assume, within yourself, the responsibilities of poor trades and the credit for good ones.
• Similarly, it is best to keep your results and performance private. The temptation to boast of your successes and fears of reporting failures will almost certainly not help your performance.
• Human nature operates against good trading practices. We enjoy taking profits and hate taking losses. As a result, traders often tend to close out their strongest positions too early (locking up the profit) and maintain their weakest positions for too long (“not a loss until I take it”) instead of letting their strongest positions run and closing out their weakest with small losses. Keep in mind that even the best timing models tend to be profitable only a certain percentage of the time, but their winning trades are much larger, on average, than their losing trades.
• The name of the game is to make a good (but not unreasonably good) return for your time and capital, not to feel “smart.” I know many, many people who overextended their welcome in the stock market as 1999 moved into 2000, not because they failed to recognize the dangers of the stock market, but because they were having such a good time feeling smart during the bull market that they hated to leave the party.
• Don’t confuse rising stock prices with being a financial genius.
• For most people, in-and-out trading will not be as profitable as well-considered intermediate-term trading. It is not easy to overcome the additional costs in transaction expenses and bid-ask spreads involved in day trading and very short-term trading, although there are, no doubt, successful traders in this regard.
• It is better to miss a profit than to take a loss.
• For the most part, it is probably best not to operate at the market opening. There are pauses during the day, usually at around 10:30 a.m. Eastern time and around 1:15 to 1:30 p.m., when the stock market is quieter and when you can act with relative calm.
• Do not enter into an invested position without an exit plan.
• It is much better to trade with no more capital than you can comfortably risk.
• One successful trade makes us feel good. Two successful trades in a row make us feel pretty smart. Three consecutive successful trades makes us feel like a genius. That’s when they get us.... (hnu)
• Make note of your losing transactions. Have you violated some basic rules of trading or investing because of some emotional reason? There will be losses. Not every losing trade is a mistake. The stock market, at best, is a game of probabilities.
• Finally, we have reviewed in this book many techniques and tools that are designed to help you identify market conditions that most favor profitable investing. There is no need to be invested in the stock market at all times. If matters appear unclear or if you are less certain than usual (there’s no such thing as certainty regarding stocks), be free to simply stand aside until matters clarify.
http://www.equis.com
http://www.TradestationWorld.com
Formula Research, by Nelson F. Freeburg, Editor, 4646 Poplar Avenue, Suite 401, Memphis, TN, 38117 (1-800–720–8607).
Technical Analysis of Stocks & Commodities, 4757 California Ave. S.W., Seattle, WA, 98116 (http://www.traders.com).
Bollinger on Bollinger Bands, by John Bollinger (McGraw-Hill, 2002).
