So, first note that the title to this post involves finding stocks that will appreciate $25 in a month, and not a percentage increase.  I have been told by many, and it is mathematically true,  that a rise from $5 to $10 is the same percentage increase as a stock that goes from $50 to $100. But psychologically, I find it easier to trade a stock that is rising $50 on the way to a double, than  a stock that must go up $5 to double.  In other words, it is not the percentage move that I am after, it is the  number of points in the rise.

Let’s assume for this discussion that the typical stock that breaks out of a base goes up 20% before it consolidates or reverses.  A 20% move in a $10 stock is only $2, but it is $20 in a $100 stock.  I have more time (at least psychologically) and courage to add to a position in a stock that is rising for $20 than to one that is only on the way to a $2 rise.

So I want to hop on board a stock that is breaking from a base or support and that is likely to advance $20+ if I am right. How do I find such stocks?  Well, I used TC2000 to look at all stocks that advanced $25 or more in the past 30 days.  I found 21 stocks as of Friday.  The most consistent characteristic of these stocks was that 90% (19/21) were priced at $80 or more 30 days ago;  17 were greater than $100 per share.  I have done this analysis before and it always comes out the same.  Most stocks that  rise $20 or $25 or more in the past 30 days were above $80 at the beginning of the period. During this period, GOOG rose +$101, AAPL +$61 and ISRG +$63.

So, if I want to ride a stock that will advance a lot of points, I should be looking at stocks that are already expensive, more than $80 per share. Other reasons I like expensive stocks is that the in and out high frequency day-traders are less likely to have the money to play with these stocks. And expensive stocks are there for a reason, people, mainly funds, are bidding them up.

So, trading expensive stocks may be a fine strategy, but  many people, you say,  cannot buy many shares of an $80+ stock.  This is true, but the missing ingredient is deep in the money (DITM) call options.  I use DITM call options to buy expensive stocks for 10%-20% of the cost of the stock.  What I do is to find an expensive stock that I think is bouncing off of support or breaking out.  Once I find one, I look for a near month call option that has 3-6 weeks before expiration and which will cost me under 20% of the price of buying the stock.

This example should illustrate the strategy.  If I believe that NFLX, which closed Friday at $276.58,  is in an up-trend and bouncing off of support, I go to yahoo.com and look up the August call options.  I find that the August 230 call can be bought for about $49 per share, or $4900 (each option covers 100 shares).  This option would give me the right, but not the obligation, to purchase 100 shares of NFLX at $230 each through August 19.  Since I am paying $49 per share for the options, if I were to use the option to buy the shares, my cost or break even point is $279 (230+49), just about $2.50 above the current price of NFLX.  (With a DITM option the break even price is close to the current price of the stock.) Once NFLX rises above $279, I make $100 per point, just as if I owned the 100 shares of stock.  If NFLX rises $25 to around $301 per share before the option expires in August, my profit would be about $2200 (301-279 x 100).  And I never have to buy the 100 shares of NFLX because I could now sell the option that I bought for $49 for the price of $71 (301-279).

So what we have manged to to with a DITM call option that cost $4900 is to control 100 shares of NFLX, which would have cost $27,658.  In a sense, we only had to put down and risk  about 18% of the price of the stock.  I say risk, because it is accurate.  If I bought the 100 shares of NFLX and it fell to zero, I could lose the entire cost, $27,658.  But with a call option, the most I could lose is the $4900 that I paid for the option.  If the stock is below the strike price, $230, at expiration, it expires worthless.  But I would never wait for that to occur.  If NFLX declines below support. I would just sell the option at the best price available at the time.  For example, if on August 19, NFLX is trading around $270 per share, my option would trade for about $40 (270-230 strike). In other words, at expiration someone would use the option to buy 100 shares of NFLX at $230 and be able to sell the stock immediately in the market for the current  price of around $270, a $40 per share profit.

So this all comes down to that, all other things being equal,  if one wants to buy a stock with a better chance of appreciating many dollars during the next month, it is preferable  to buy a very expensive stock by using DITM call options. Chapter 7 of Jim Cramer’s latest book, Getting Back to Even,  gives some examples of the uses of DITM call options. I assign Michael Sincere’s book, Understanding Options,  to my students who want an options primer…….

The GMI closed the week at 5 and the GMI2 at 6.  So I am comfortable being long.  It looks like the money is rotating into tech stocks again, so I own QLD as a way of riding this trend.  QLD is a leveraged ETH that aims to rise or fall each day twice as much as the QQQ, or Nasdaq 100 index. Once the short term trend changes, I slowly accumulate QLD (for up-trends) or QID (for down-trends).  On Friday the QQQ completed its 17th day of the short term up-trend. The QQQ and SPY have now closed above their critical 10 week averages for 4 weeks.

I try to trade consistent with the market’s direction, and to ignore all other factors, including the news and politics.  The market has a mind of its own and I msut trade in synch with it.

• gmi: 5
• gmi-2: 6
• t2108: 69

So where are we in the current cycle?  It looks like we are in a strong up-trend with no sign of any weakening yet.  In fact, the 30 month average has not yet reversed up, but the 5 month average is moving up nicely above it.  Now I have learned in trading  over the past 40 years that patterns are meant to be broken.  The road is littered with the carcasses of Ph.D.’s who wagered heavily and lost, based upon complicated mathematical relationships that worked in the past.  I can tell you that the simple patterns I have discussed below seem to me to have worked well over the past 95 years.  Major bottoms in the Dow have occurred with this stochastic below 50% and the more severe ones, around 20%.  So, I won’t begin to suspect the end of the current up-trend until I see the stochastic turn down and the 5 month average decline below the 30 month average. I’ll let you  know when that happens…….

Meanwhile, my General Market Indicator (GMI) remains at the maximum reading (6 of 6) and the more sensitive GMI-R is at 10 (of 10). Thus, all of my short term and longer term indicators for the  QQQQ (Nadaq 100 tech stocks), and the SPY (S&P 500 stocks) remain positive. The QQQQ and SPY have closed above their critical 10 week averages for 15 straight weeks. However, Friday was only the 15th day of the QQQQ short term up-trend.  The Worden T2108 Indicator is at 63%, in neutral territory. And 68% of the Nasdaq 100 stocks closed with their MACD above its signal line, a sign of short term strength. The weekly GMMA chart below shows that all of the short term averages (red) are above the rising longer term averages (blue), reflecting an established up-trend. So with my more conservative funds, I am adding to my positions in the major index ETF’s like QLD, SPY and DIA, a comfortable way for me to ride the up-trend.

• gmi: 6
• gmi-r: 10
• t2108: 63

And so the GMI remains at 6 (of 6) and the GMI-R at 10 (of 10).  The SPY and QQQQ have closed above their critical 10 week averages for four weeks.  The QQQQ completed the 14th day of its current short term up-trend on Friday. The Worden T2108 remains over 80%, which is near overbought levels, but it reached 89% in August, 2009. A high reading of the T2108 is not as predictive as an extremely low reading, below 10%.  82% of the Nasdaq 100 stocks had their MACD above its signal line, down from 94% last Friday. This indicator bears watching, because it is very sensitive to the short term trend. Note that buying stocks at new highs has been a promising strategy lately, with 71% of the stocks in my universe that hit a new high 10 days ago, closing higher on Friday than they did 10 days earlier (see the Wishing Wealth  Successful New High Index in this table). Most of the stocks listed on the lower right of my site have been powering ahead to new all-time highs.  I never can understand why most people who want to own a rocket, refuse to buy stocks trading at highs.  A rocket on the way to the moon has to hit many daily new highs along the way……

Speaking of rockets, I have coined the term Red White and Blue as a simple way of characterizing the weekly chart pattern of promising rocket stocks.  I derived this term from one of my students from last year (Marcus) who labeled three moving averages with these colors and wanted the red average to be above the white average, followed by the blue average.  I am applying these colors to  weekly GMMA charts a little differently, where the red lines are the shorter term averages and the blue lines are the longer term averages.  The key to a rocket stock is the presence of a white space between the rising short and long term averages.  It is this white space that shows me that the stock is likely to be a rocket. This pattern is universally applicable to rocket stocks. Below are two examples. (Click on charts to enlarge.)  In the future I will be discussing Red White and Blue (RWB) stocks.  Note that a submarine stock  is the opposite (BWR), with the shorter term averages below the longer term averages. In fact, CMI is a great example of a submarine stock that has transformed itself into a rocket.

Another RWB stock that came up in my Darvas scan is LOGM, which has been on fire since March. While I never know how long a trend will last and must always manage the risk of a change in trend, if I am going to own a stock, I want it to be RWB on a weekly chart.

Finally, IGTE shows that a stock can remain RWB for a long time. The key is to get on board and to sit tight, much as the great Jesse Livermore advised. If one has the patience to  ride a RWB stock for a year, one can calmly let his/her account grow, without excessive day trading and the accompanying stress that frequent trading creates.

I urge my students to paste copies of these stocks to their computer monitors and to compare all potential purchases to them. Accept no less!

• gmi: 6
• gmi-r: 10
• t2108: 82

Dr. Wish’s (Sir Silent Knight’s) Trading Philosophy

Proposition 1. The stock market and stocks are unpredictable

No one can consistently predict changes in the market or stocks. Human behavior is largely unpredictable and no one can predict world and economic events or the reactions to them. Similarly, corporate events and news can be inaccurate or intentionally misleading.

Proposition 2. However, stocks and markets often continue in trends that can last weeks or months or longer.

Trends form identifiable patterns, probably because humans react to trend patterns in repeatable ways. For example, people often trade off of support or resistance levels or at new highs or lows. While trends can be discerned once started, their length and continuation are also unpredictable.

Proposition 3. Given Propositions 1 and 2, one’s success in the market depends on identifying trends once they have begun and staying with them until they end.

But if the length and size of trends are unpredictable, each trade may or may not work out; the likelihood that any given trade will be profitable is unknown. Some successful traders have asserted that only about 50% of their trades are profitable.

Proposition 4. If only 50% of trades will be profitable, then to prosper, the profits from winning trades must be considerably larger than the losses from losing trades.

One can accomplish this goal by limiting the losses on losing trades and by maximizing the profits on winning trades. One can limit losses by setting stop losses and by making small initial trades. One can increase profits by riding the trend as long as possible AND by systematically increasing one’s position as the trend continues.

Proposition 5. Given Propositions 1-4, trading success is mostly determined by one’s strategy for exiting the trade rather than the strategy for entry.

Since one does not know at entry whether a trade will be profitable, one could probably select stocks at random as long as losses are kept at a minimum and profits are maximized. However, systematic entry and exit rules based on technical analysis can improve the likelihood of a profitable trade. For example, most stocks follow the general market’s trend, and trading consistent with that trend can enhance one’s likelihood of success. Nevertheless, given the considerable uncertainty accompanying all trades, the highest priority must be given to the rules for exiting the trade. If one enters each trade assuming that it will fail, one will be better prepared to handle losses.

It is the trader’s job to use technical analysis to develop trading rules that function consistent with these propositions. My blog, wishingwealthblog.com, documents my pursuit of this goal.

Happy Thanksgiving!

The 2X and 3X Ultra ETF’s absolutely outperformed the standard index ETF’s in the period since the March bottom.  For example, while the QQQQ (Nasdax 100) index ETF rose 42.9% in this period, the QLD (2x QQQQ ETF) rose 99.2% and the TYH (technology bull 3X ETF) rose 179.4%.  In comparison, the top five individual stock performers in the Nasdaq 100 stocks rose from 138.8% (JAVA) to 180.57% ( STX).  In fact, only 16 stocks (16%) in the Nasdaq100 (and 23% in the S&P500) rose 80% or more.  So, the choice before us is to  search for the needle in the haystack individual stock that might do really well in a bull rise, or to buy one of these 2X or 3X ultra long ETF’s and ride a basket of stocks with a lot more diversification and probably less risk than owning individual stocks.  The key is to discern the trend accurately and to then ride the ultra ETF with the most potential for following that trend.  Some ultra ETF’s also trade options…..

And the general market trend remains up, as measured by my GMI.  One day last week, we even registered 54 new highs in my universe of 4,000 stocks, the most in a single day since last September.  On Friday, there were 27 new highs and 7 new lows.  And now, 75% of the Nasdaq 100 stocks have their MACD above their signal lines.  With an up-trend like this, I am beginning to reinvest my university pension money in the growth mutual fund.  I am also looking to phase into one of the ultra  ETF’s that I discussed above, in my trading IRA.  If this up-trend has real legs, there is plenty of time for me to wade into the market.  If not, I will get out again. The key is to go in slowly and only add more money if the ETF climbs above my original purchase price.  I never average down.

• gmi: 4
• gmi-r: 8
• t2108: 86

The results, presented in the table below, are quite revealing and unsettling if one is looking for a near term bottom.  I would be interested to learn if you agree with my analysis.

Twenty days after the Dow had peaked, the Dow  was down 7-10% in each of these beginning bear markets. By 40 days post Dow peak, the 1987 decline had already bottomed out (-41% by day 39) and rebounded to -26%.  The ferocity of the 1929 bear was evident early on, showing a 40% decline by day 40.  In comparison, the 1973 and 2007 bears appear puny, registering only 4% to 8% declines by day 40.  The 1973 and 2007 bears tracked each other quite closely until 260 days post the Dow peak.  By day 260, the 2007 bear was actually showing a greater than the decline that started in 1929 (-40% vs. -38%) and was more than twice the decline shown in the 1973 bear market (-17%). Since day 260,  the current bear market has resembled the 1929 bear market closely, with declines being about 14 percentage points smaller.  I would conclude then, that the current bear market is tracking much closer to the one that began in 1929 than to the 1973 and 1987 bears.

What can this tell us about the likely duration and depth of the current decline?  First, if the current market decline resembles more the one that began in 1929 than in 1973,  we would suspect that the current decline will last longer than the 1973 decline of  482 days and somewhat nearer the duration of the 1929 bear of  714 days.  We are currently 342 market days post Dow peak, by my count.  This suggests to me that the current decline could last another 370+ market days or about 74 more calendar weeks.  In addition, if the current decline continues to track about  14 percentage points below the 1929 bear, its bottom of -89%, implies that the Dow could ultimately reach a bottom that is down about 75% below the Dow’s peak of 14,198.10 or about  3550.

Finally, it is likely that all market declines are driven by the economic context as well as investor psychology.  So, note that major breaks during the 1973 and 1929 bears occurred around 420-440 days after the Dow’s peak.  This could imply that a major psychological reaction (disgust? fear?) occurs around this stage of a decline and that the current market decline could accelerate at that time, about 4 months from now.

Of course, my interpretations are all based on the idea that the current bear will continue to track the 1929 bear.  One cannot be too sure of how bears will behave though–ask any California state park trooper. Regardless, I think I am now more likely to pull back my horns and stay in cash or in a short position.  It looks to me like this decline will  continue at least as long as the 1973 bear–unless it doesn’t.

The GMI (0 to 6)  and GMI-R (0 to 10) remain at zero. There were 7 new highs and 718 new lows in my universe of 4,000 stocks on Friday.  This was the most new lows since late November 21st (1835) at the bottom of that decline.  The Worden T2108 Indicator is at 13%, in what used to be bottom territory. My General Market Indicators (GMI) have helped me to steer clear of  market declines since 1995.  It is absolutely astonishing to me that the financial establishment continues to urge people to stay invested.  I guess it is because brokers and mutual fund managers make no fees if their customers just sit in cash.

Anyway, as this table  shows my GMI indicators continue to be in a terrible state.  The last time I saw at least 100 daily new highs in my universe of 4,000 stocks was on September 19, and since then the few stocks that hit new highs rarely were trading higher 10 days later.  Thus, buying growth stocks at break-out highs has been a losers game.  This method, made famous by Nicolas Darvas on his way to making 2 million dollars in two years, just does not work when the general market is declining.

Why is it that when most stocks are declining, most people look for stocks to buy?  Falling stocks fall for a reason, and most stocks are falling these days.  It is so easy to make money buying stocks in a rising market when the GMI is greater than 3!   As for now, the best thing for me to do is to be short or in cash.  The way to make big money in investing is to be out of the market during the worst times.

• gmi-r: 0
• gmi: 0
• t2108: 13

Firstly, except in exceptional cases I only buy the stock of companies in new or developing industries, i.e., companies whose growth and earnings prospects look highly promising.  I never buy stocks in established industries, in companies with huge capitalizations, or in companies which are already so big that the prospect of substantial growth is highly unlikely.

Secondly, having found such lively stocks, I certainly do not buy them straightaway.  I first check the overall market trend to ascertain whether stocks in general are in an uptrend.  I then check whether the stock belongs to a strong industry group, i.e., a group that is performing well in the market relative to other groups. Only when I have satisfied myself on these two points do I look in more detail at the stock that interests me.

Why all these precautions?  Because I like to be sure that the odds are in my favor.  If the market is in a downtrend, and the industry group is performing weakly I know that the cards are stacked against me and that my chances of making big profits are poorer than if the market and the industry are strong.  You cannot be too careful in the stock market.

Having decided that the investment climate is right and that the industry is right I am ready to buy the particular stock if it is rising in price on volume.  My basic principle of stock-market investment is that the only valid reason for buying a stock is that it is rising in price.  If the price is rising no other reason is needed, if the price is not rising no other reasons are worth considering.  I am not the slightest bit interested in explanations of why it is not behaving as it was expected to.  I am only concerned with realities, on what is actually happening, not in conjectures, alibis, projections, rationalizations, and excuses.

Nicolas Darvas, “You Can Still Make It In The Market,” 1977, pp. 125-7.

Most of us cannot really explain the reasons for our success or failure when they are occurring,  never mind years later.  In the quote above, 20 years after he made his fortune (in his out of print book that I borrowed  free through inter-library loan) Darvas tries to explain his trading strategy. It is really important for the reader to compare Darvas’ beliefs in the 1970′s about his approach, with the way he actually made money in the 1950′s, as he described it in his first book.   There are important discrepancies.

In my strategy post on 4/23 I told you how important an influence Nicolas Darvas’ techniques were on my trading.  While I learned a lot from him about buying stocks at all-time highs and ignoring brokers, investment letters and the media pundits, I failed to appreciate the importance of the general market trend to his trading success.  In his first major book, printed in 1960 (see citation to right), Darvas described how he made two million dollars in the stock market in an 18 month period  while he danced around the world.  In this book, Darvas failed to stress the importance of the general market trend, as he did in the quote above.  He used his “box system,” a form of support and resistance, to trade stocks and he emphasized that his method got him out of bear markets in advance, after a succession of failed trades. Outside of reacting to the performance of his trades when he would repeatedly get stopped out, Darvas did not appear to assess the direction of the market in advance, as he claims above.

Darvas also appears to be ambivalent regarding whether to buy stocks in a bear market.  One of his first successful trades occurred when he bought the stock, Lorillard, when it showed strength in a weak market in 1957.  “I felt I had sufficient proof of its strength, and I decided to become a bull in a bear  market” (Darvas, reprinted in 1994, p.87).   Darvas did not state that he checked out the tobacco industry to make sure it was behaving well.  And in the reprinted edition of  his book, in the section where he answers readers’ questions, Darvas says, “I also learned to stay out of bear markets unless my individual stocks remain in their boxes or advance (Darvas, 1994, p. 185). Thus, years later Darvas appeared willing to hold a strong stock in a bear market.

The large quote above was written by Darvas in 1977, after the huge bear market of 1974 and expresses his (revised ?) belief that he should be out of bear markets when the odds are against him.  In his defense, Darvas might say that there is no confusion here.  His method would simply get him out of bad markets when stocks that had broken out of the tops of their boxes, repeatedly fell back into their boxes.  There is a difference, however, between a careful analysis of market trends before trading and determining the trend after trading.  By the way, William O’Neil and David Ryan were fans of Darvas, and it should be no surprise that the CANSLIM approach bears a strong resemblance to the strategy described above by Darvas.

Rather than rely solely on Darvas’ recollections about his success, I thought it would be useful to see what the market was doing during the 18 months that Darvas made his fortune.  Using TC2005, I found that in 1929, the Dow peaked at 386.10 and did not surpass that peak until 25 years later, in November 1954. That rise peaked in April, 1956, at 524.40 and the market entered a slow decline that bottomed in October, 1957, at 416.27.  It was after this bottom that Darvas began nibbling at stocks that would make him a fortune in 18 months.  The subsequent bull market rise lasted through January, 1960 when it peaked at 688.20.  Thus, in the period when Darvas made his fortune, the market was trading at all time highs in a bull market when the Dow increased 65%. This is not meant to belittle Darvas’ accomplishments–his portfolio increased much more than the market indexes.  The critical point is that Darvas’ trading strategy worked in a major bull market with the Dow advancing toward all time highs.  When the market reaches historic peaks, confidence and greed builds and traders can take stocks to extreme levels.  We would not expect to achieve such spectacular gains in flat or slowly rising markets, which are well down from their historic peaks.

So, when did we have similar bull markets after Darvas?  The market continued to a series of all-time peaks until a major top around 1,000 in 1966.  This was a period during which William O’Neil made his money.  The 1966 top was not  decisively broken for  16 years.  And then, from 1982 to 2,000 each new rise took the Dow to an all-time high.  For example, during the extraordinary bull move in the Nasdaq Composite from 1995-2000, that index repeatedly went to historic peaks and yielded a 584% increase. That is when the use of my Darvas and O’Neil inspired trading system helped me to multiply my IRA 14 fold.  However, since their peaks in 2000, the Dow is down 12% and the Nasdaq Composite, 59%. We therefore should not expect to have achieved outstanding trading results using Darvas/O’Neil type techniques, since the top in 2000.  Darvas may have got it right when he said the odds need to be in his favor before taking a position. Perhaps we growth stock traders should stay out of U.S. growth stocks until the market indexes reach historic peaks again–maybe in 2016.    Think about it.

(Copyright ©  2005, by Eric D. Wish.  All rights reserved.)

“There is no magic about buy signals. They are only devices by which we call our attention to stocks that have already begun to attract the attention of others.”

Burton Crane, The Sophisticated Investor, 1964, p. 49

Can you believe this?  The day after I tell you how much I admire Jim Rogers, he goes on television and tells everyone that  he  buys stocks that are near their lows and avoids those hitting new highs.  I guess I better set the record straight by telling you where I stand on this issue.  Assume you are looking over a field of rockets, all on their launching pads.  Your job is to determine which rocket will take you to the moon.   There are a number of ways to approach this problem.  One person might study all they could about the model of the rocket and its history.  They might find what similar rockets have done in the past and that a rocket with a particular size and payload should be able to go quite far.  This strategy is equivalent to the approach taken by the fundamental analyst.  He (or she) knows the company’s prior earnings and projections for the future.  He can tell you all the reasons why a particular company’s stock should do well–earnings, cash flow, sales, industry trends etc.  He can estimate the stocks “true” value.   The problem is that in spite of these great reasons for success, the rocket (or stock) might sit on the launch pad for a long time or may never take off!  An investor cannot wait long periods for a stock to fulfill its promise–lost time is lost money and lost opportunity.

Another strategy is to focus on rockets that have already taken off.  A rocket that has begun to climb and is accelerating may have a good chance of continuing to climb.  You might look at the thrust being generated by the rocket.  A huge thrust and increasing speed might signal a good candidate for a high flyer.  You could also look at the angle of ascent.  You may have to know little about the capabilities of this rocket model.  The fact that it has been launched and is climbing nicely may be enough to indicate that it is a good choice to take you on your trip to the moon.

The technical stock analyst follows a similar logic.  He looks for evidence that a stock is moving up.  The reasons why the stock is climbing are less important than the fact that the rocket has been successfully launched.  Increasing volume of trading as the stock advances indicates potential thrust to achieve new highs.  Moreover, you would never seek to find a surging rocket by selecting one that has fallen back towards the earth or is pointed downward.  The way to ride a rocket to the moon is to find one that is continually climbing higher towards the moon. (An exception is a rocket that has reached new heights, fallen back for a while, and then has the power to regain lost ground and burst through to a new high.  I love such stocks.)

There is an analogous pair of approaches to human behavior in psychological theory.  The psychoanalyst spends most of his time trying to understand the unconscious motivation that he believes underlies behavior.  By analyzing ink blots and dreams and client free associations, the psychoanalyst hopes to help the client gain insight into his unconscious motivation in order to produce a change in behavior.  According to the psychoanalyst, pathological behavior is symptomatic of unconscious motivations that must be dealt with to achieve lasting behavior change.  Opposite to the psychoanalytic perspective is that of  the behaviorists, most famous of whom was B.F. Skinner.  The behaviorist is skeptical of even the existence of an unconscious and of cognitions.  One merely needs to focus on changing the behavior without regard to any underlying psychological processes.
I remember reading in graduate school the case study of a female patient who was inseparable from her broom.  The psychoanalyst on the case said that this behavior was indicative of some form of penis envy that needed to be worked out in therapy before the patient would give up the broom.  A behaviorist, on the other hand, broke the patient of the habit quickly, simply by rewarding or punishing (I do not remember which) the carrying of the broom, without any need to address the patient’s unconscious motivation!

I have always been more of a behaviorist in my approach to life.  Focus on the behavior and don’t worry about the hypothetical underlying cognitive processes.  Perhaps that is why I have been partial to the technical approach to stock analysis.  A more mundane reason is that it takes years of training and schooling to become a psychoanalyst–or a fundamental security analyst.

It turns out that both the technical and fundamental approaches to stocks represent extremes and it does not make sense to blindly follow just one of them.  Nicholas Darvas pointed out years ago that a blend of the two approaches is most effective.  One needs to choose a rocket that has been launched already, with extraordinary thrust (volume), and that shows signs of climbing to new heights.  At the same time, I want to know something about the capabilities of the rocket so I can increase the likelihood of selecting the rocket most likely to reach the moon.

Growth stocks really are like rockets.  One cannot predict (except for insiders) when one will be launched nor know how far it will travel once launched.  The key to picking winning stocks, as Crane’s definition of a buy signal quoted above implies, is to find a stock that has already shown strength through the buying of others, and to jump on for the ride.  Darvas used to say he had become a silent partner of the insiders.  By doing so, one increases the chances of success, but this approach in no way guarantees a winner.  A rocket can run out of fuel at anytime and fall to the earth.  However, I have learned that buying fallen or falling stocks, or stocks that have not yet shown strong buying is an ineffective way for me to make money in the market.  To make money as quickly as possible, one needs to buy stocks that have already been launched and are on a steady rising course (trend).
But just as bad weather can delay a launch or throw a rocket off course, so can the overall market environment.  It took me many years to appreciate that the best rules for picking stocks will fail in an adverse market environment.  One needs to determine the likely trend of the overall market as well as of specific stocks to have the best chance of success.

My method of trading stocks is based on minimizing risk, but not eliminating risk.  My technical tools and trading strategy enable me to increase my odds of success, while limiting my risk of loss.  In future posts, I will identify stocks that I think have lifted from the launch pad and may travel to the moon, but only when we are in a healthy market.

Tomorrow, I will return to the state of the market.

Aren’t you tired of fighting this market?  I think it is time for us to work on a general market index that summarizes the indicators I use to monitor the general market trend.  Keep in mind that I am a chicken and have successfully dodged the 98 bear, the 2000-2002 bear and most of the present decline.  I put together the Wishing Wealth General Market Index above (click on it to enlarge).  It counts the following elements:

1.  Wishing Wealth 10 Day Successful New High Index Greater than 100.  I follow a “universe” of almost 4,000 actively  traded stocks that were $5 or over several months ago.  I use TC2005 to count the number of these 4000 stocks that hit a new 52 week high 10 days ago and closed today higher than they closed 10 days ago when they made their highs.  In a rising market, traders have the confidence to let strong stocks climb, so they have a successive number of new highs.  In a bad market, anxious traders take profits quickly and stocks tend to gyrate.  I have only been computing this index since last March, when I had a count of 106.  I am suggesting that any number above 100 will be a bullish sign.  However, I reserve the right to change this threshold as I gain more experience with it.

2.  At least 100 new highs in a day in my 4,000 stock universe.  In a good market we should at least have 100 stocks hitting new highs.  Furthermore, when a market has more daily new lows than new highs (as the current market does), we really should not be buying growth stocks with the expectation of making a profit.  The odds are simply against us.

3.  Wishing Wealth Daily QQQQ Index Positive.  The QQQQ tracks the 100 largest non-financial stocks in the NASDAQ. I watch the QQQQ to track the tech stocks, and often trade it or its options.  This index is positive when my technical indicators suggest that it is in a rising trend.  (You don’t really expect me to disclose how I do that, do you?  You would never visit me again.)

4. This index is similar to #3 above, but is a daily measure of the SPY, an index that tracks the S&P 500 index.  The SPY is another useful way to buy or sell the market and is an excellent indicator of the general market trend.

5.  The weekly QQQQ index is the same as #3 above but is based on the weekly trend.  A change in trend will occur in the daily indicator before the weekly indicator.  In a strong market both the daily and weekly trends will be positive.

6. The IBD Mutual Fund Index comes from the Investor’s Business Daily (IBD) newspaper.  A chart of this index appears in the mutual fund section.  To be positive, this index must be above its 50 day moving average, shown daily.  Update: IBD no longer publishes the 50 day average in the graph in the paper or online edition.  IBD subscribers can get the full chart by typing in 0muti in the charting function on the IBD home page. I have found that when these growth mutual funds are rising, then I can expect to successfully buy growth stocks.  (Don’t take my word for it.  Go back and see how this index relates to your trading success.)

The Wishing Wealth General Market Index just counts the number of these conditions that are positive.  The index is 0 today.  I will continue to track these indicators daily and publish them on the blog. I hope that they will be as useful to you as they have been to me.  With a zero reading, I will not waste our time talking about stocks to buy.  A better use of our time would be to discuss stocks to short.

“it is utterly useless for us on the outside, who buy and sell comparatively small blocks of stock, to conjecture about what “they” are doing.  We cannot know what the insiders intend to do, but we can see their orders on the tape when they execute them.  That is why my plea is for everyone of us to have no mere opinions of his own, but to allow the actions of the market to tell him what is passing.”
(Humphrey B. Neill, Tape Reading & Market Tactics, 1931, New York: B.C. Forbes Publishing Company; 14th printing, 2003, Vermont: Fraser Publishing Company)

When Nicolas Darvas was interviewed by Time Magazine in the early 60′s and it came out that he made almost 2 million dollars in the market in 18 months (while he was dancing around the world!), he noted that he read and reread Neill’s book (along with Gerald Loeb’s).  Neill’s book has been reprinted many times and I happened to find it on the shelf of my local Barnes and Noble store.  Neill dedicates his book, “to my losses, with a deep appreciation for the experience and knowledge which each loss has brought me.”

If anyone tells you that the market is different today, refer them to the successful traders from the 1929 post-crash era–Livermore, Baruch, Loeb.  Darvas, who made his fortune in the 60′s, clearly learned something from Neil’s original writings–and so have I.  Livermore used to say that when you lose you were paying the tuition required by the market. As a college professor, I see some students who pay tuition (more accurately, their parents pay) but are not focused on learning.  Losses can provide knowledge–but you have to look for it.

Perhaps the most important thing I did a few years ago was, after a series of losses, to print out their charts and note down my precise buy and sell points.  It looked like I had followed exceptionally accurate rules that flawlessly led me to buy at the top and sell at the bottom of moves!  So what did I do?  I reversed what I was doing and began to trade profitably.  Every great trader (including IBD publisher William O’Neil) urges us to study our losses.  However, most of us rarely do this important exercise in the market, or in the rest of our lives.

I have received many emails asking for details about my trading strategies.  So, I will begin today by reprinting some of the comments originally published in The Worden Report on November 7, 2003 under the pseudonym of The Silent Knight.  The Worden Report is published daily along with the data downloads for TC2005 (www.worden.com), the charting and analysis program that I use and find to be an invaluable tool.

My trading strategy;  Part 1, of many

I have been trading since my college student days in the mid sixties.  When I began, I used to make money in bull markets only to lose all of my profits and more in the ensuing bear markets.  I began a methodical study of the markets and my trading that continues to this day.  Five books, described below, have had a huge impact on my trading.  I devised a set of rules that have helped me to reduce (not eliminate) risk and to enhance the probability of success. TC2000 (now TC2005) is my invaluable analytic tool.

In my early years I read the accepted stock market books available to the masses.  Buy conservative stocks with low PE’s and stable dividends.  Diversify your portfolio and blah, blah, blah.  I never made money following these commonly disseminated rules.  I did not begin to understand the markets until I read that great classic, How I Made 2 Million Dollars in the Stock Market, by Nicolas Darvas (recently reprinted).  That book and his next little known book, Wall Street the Other Las Vegas, opened my eyes.  I often times reread the books for their insights. From Darvas, I learned such things as to buy stocks at all time highs, with great products and a vision of the future.  I learned about stop loss orders, cutting my losses, and to blot out the opinions of Wall Street and other pundits.

I applied Darvas’ techniques with some early success.  However, while Darvas had written that his techniques worked in bull markets, he never described the market averages or trends during his huge run.  It was only after I used TC2000 to trace the DOW during Darvas’ trading that I realized that he made his fortune from 1957-61 when the DOW moved to new heights, from the low 400’s to the low 700’s.   I discovered that I had often been using his techniques to buy when the market was not experiencing a prolonged bull move.  This experience taught me a most valuable lesson:  the same buying techniques that work in a bull market do not work in a bear market. This theme is also reflected in William O’Neil’s CANSLIM strategy (in his book, How to Make Money in Stocks), where the M stands for the general market trend.  If one is out of step with the market’s general trend, one’s odds of success are greatly reduced.  I can’t tell you how many losses I took because I was buying the right stocks while the market was trending down.

I therefore vowed never to be long when my general market trend indicators suggest a declining trend.  I sell all of my holdings and sometimes buy puts.  Using TC2000 I have been able to go back to prior periods and calculate that more than 70% of all stocks move in the same direction of the trend in the major indexes.  It makes no sense to go long when 70% of the stocks can be expected to decline.  It makes so much more sense (and cents) to place my bets consistent with the market trend, when the odds are in my favor.

The books by Darvas and O’Neil  taught me to cut my losses quickly and ruthlessly.  While O’Neil was a very successful trader early in his career, his book presents a sample of his trades over a winning period.  I was amazed to see so many more losses than gains even though he made a net profit. Most important, his losses were small and his gains were very large. The fact that a successful trader like O’Neil could have so many losses somehow gave me the freedom and confidence to have many small losses.  My motto is that every loss brings me closer to the next gain.  I can turn on a dime and it does not cost dearly because I use a deep discount broker.  And by trading in a tax sheltered IRA, I am not concerned with tax consequences and wash sales rules.  I love to buy back a stock I have sold after a small loss, even the same day, if it resumes its up trend.  Such trades have often been among my most profitable. One has to give oneself permission to admit mistakes and then correct them quickly—there is no place for a big ego in a successful trader.

Lefevre’s classic book about the great trader, Jesse Livermore, (Reminiscences of a Stock Operator) also offers a number of extraordinary trading insights.  One must stay with the major trend and not trade too often—do not lose your position.  Sit tight with a winning trade because you need to make big money those few times when you are right.  And perhaps most important, make a pilot buy and do not buy more until the stock has moved in the predicted direction.  Average up, never average down.  I control my risk by betting the most dollars on the few stocks that have proved me right over time.  I buy more and more shares as the stock moves up.  I never bet all of my money at once.  A winning stock will continue rising for weeks or months and give me plenty of time to get aboard and to take on my full position.  Too much diversification guarantees mediocre results.  Concentrate on your few winners.

Another book that made a real difference to my trading is, Secrets of Profiting in Bull and Bear Markets, by Stan Weinstein.  This book shows a simple way to use charts and moving averages.  Weinstein uses the 30 week moving average to determine trends and describes a successful approach called stage analysis.  I have found his methods to be very useful.  His book provides a nice introduction to technical analysis without getting too complex.  I have found that the simple statistics are most useful to me, in my professional research and in my stock trading.

That’s enough for today.  I hope you find my insights useful. My goal in sharing is to stimulate you to develop your own methods that work for you.  If you just want a recipe for trading, you may be disappointed.  Profitable trading requires a lot of study, experience, self-knowledge, independent thinking and a willingness to learn from your mistakes. In the coming months I will explore with you in more detail the role these attributes have played in my trading.

Will post again on Sunday.