Saturday, June 29, 2013

06/29/2013 When everyone agrees, they are usually wrong


Sector Model
XLU & XLB
-1.74%
Large Portfolio
Date
Return
Days
CAJ
9/25/2012
-4.45%
277
BOKF
2/4/2013
14.93%
145
ABX
4/11/2013
-34.96%
79
TPX
4/22/2013
-4.59%
68
TTM
5/6/2013
-11.98%
54
DLB
5/13/2013
-2.51%
47
GMCR
5/24/2013
3.14%
36
MATW
6/6/2013
0.32%
23
OKE
6/17/2013
-6.83%
12
TSCO
6/24/2013
6.66%
5
S&P
Annualized
8.90%
Sector Model
Annualized
22.72%
Large Portfolio
Annualized
28.41%

 

Rotation: selling GMCR; buying BTI (in the tobacco industry).

Hmm… selling coffee and buying cigarettes.  Not much guidance there for the total market.  Maybe the recent volatility has pulled us all awake and now we need a cigarette to calm down…

The sector model has XLU in first place and XLB in second place.  I’m tracking the returns of both sectors together (typical for a margin account that can trade all whipsaws).  A cash account would instead avoid the whipsaws by buying in the first position, holding through the second, and selling in the third.  XLU and XLB are both sensitive to the threat of rising interest rates.  Since most threats are overblown, the model is looking for them to recover faster than the other sectors.

In any case, last week I talked about how to do a simplified approximation of logistic curves by simply plotting long term and short term linear regression lines to see where they cross.  The point where they cross is where the market THINKS it is going.

This week I’ll introduce a second idea to simplify log-periodic behavior.

If you want to dig into the math, these two places are a good start:



Long time stock chartists will yawn and recognize this by its more mundane name: a wedge pattern.



Basically what happens is that the high points are where we run out of buyers and the low points are where we run out of sellers.  After a while people on both ends of the fear and greed game notice a pattern and everyone starts to trade the pattern instead of the underlying fundamentals.

This is just two sides of a trend.  But what happens is that folks start buying and selling closer and closer together in both price and time, until the lines reach a point of perfect logical and rational order (yes, that was sarcasm).

Those two lines cross in May 2014 just above 1900 on the S&P.  Right now the buyers and sellers are acting as if the market is worth at least 1518, but no more than 1694.  As long as “at least” is less than “no more” it kind of makes sense.  It may not be RIGHT, but at least it MAKES SENSE.

But what happens on the other side after those lines cross?  Well, in July 2014 one could say “no more than 1956 but at least 2007 on the S&P.”

Right, such a statement makes no sense at all.  It’s like Noam Chomsky’s quip “colorless green ideas sleep furiously.”  You can’t be “at least 2007” but “no more than 1956” at the same time.

And that’s why “rising wedges” normally break down with a sharp rise in volatility.  Everyone’s been lulled to sleep until someone tries to wake them up with smelling salts that have been laced with LSD.

Now, physicists are congratulating themselves by having discovered log periodic power laws.  But most of us will do well enough to realize that once the buyers have a higher price in mind than the sellers, it’s time to step aside long enough for them to make up their freaking minds.

All that said, I don’t want to dismiss the introduction of mathematicians and physicists in the marketplace.  Some of them are quite successful, and all of them are a threat both to traders and to the market itself.  A good little introduction to what they are up to is “The Physics of Wall Street” by James Owen Weatherall:


The most salient ideas for us are:

1) Market returns are randomly random, and

2) When they stop being randomly random, watch out!

That second part has to do with the log periodic behavior (a.k.a. rising wedge pattern) that normally precedes a crash.

You don’t HAVE to have such a pattern for a crash, and you don’t HAVE to have a crash when you see that pattern.  But they do often go together for the simple reason that the market stops making sense and people don’t know what to do when “at least” gets ahead of “no more than.”

Truth is, the market COULD go to 1000 or 2000 before the end of next week.  That’s the “randomly random” part of the first premise.

I try not to worry about it.  I’d rather try to go up a little more and down a little less than the market and sleep at night.

But if you ARE a market timer, this is definitely something to pay attention to.  There is money to be made there – and lost.

Tim

 

 

 

Sunday, June 23, 2013

06/23/2013 You are NOT a mutant!


Sector Model
XLU & XLV
1.14%
Large Portfolio
Date
Return
Days
CAJ
9/25/2012
-2.65%
270
BOKF
2/4/2013
12.99%
138
SWM
2/12/2013
39.21%
130
ABX
4/11/2013
-30.21%
72
TPX
4/22/2013
-10.28%
61
TTM
5/6/2013
-10.89%
47
DLB
5/13/2013
-2.97%
40
GMCR
5/24/2013
2.04%
29
MATW
6/6/2013
-0.51%
16
OKE
6/17/2013
-6.47%
5
S&P
Annualized
8.53%
Sector Model
Annualized
22.80%
Large Portfolio
Annualized
28.17%

 

Rotation: selling SWM; buying TSCO.

As I noted on the blog, the sector model has been adjusted to hold two sectors instead of one.  The returns are more consistent, and if one sector is in free fall (such as XLK in the 2000-2001 dot com collapse), the second sector will serve as a control.

Now, there are two ways to do this.  One could hold both sectors and trade all the whipsaws, or buy the first sector, hold when it moves into the second position, and only sell it when it hits the third position.  A small cash account would be best served with this approach – and in fact that is what I’m doing with one account.  This is a bit of a conveyor belt approach, and holds longer while avoiding all whipsaws.

The drawback with that conveyor belt approach is that it is not as stable as holding two sectors.

In any case, the first position is XLU, and the second is XLV.  Both of these are defensive, bearish sectors (utilities and healthcare services).  They fairly reflect the amount of fear in the market right now.

The full model is scrambled.  These are the top industries:

AUTO
FUNL SVC
ENTTECH
GOLDSILV
FURNITUR
UTILWEST
BUILDSUP
ELECFGN
BANKMID
THRIFT

 

Auto, Bankmid, Elecfgn, and Thrift are bullish sectors typical for a market bottom (not a top, but a bottom).

Goldsilv, Furniture, and Building Supply are late bull inflation plays.

Enttech, Funeral Services, and Utilwest are more bearish.

So, two bullish sequences and one bearish one.

In other words, it’s ANYONE’S guess what the market will do.

So I want to talk about something different – namely, the different approaches to investing people have.

The vast majority of folks who actively trade are trying to time the market.  They read the news and look at charts to try to determine where the markets will go next.

There’s a problem with that.  Our brains are cross-wired so badly that we cannot be trusted to make sense of charts.  There’s an entertaining Cracked article that I STRONGLY RECOMMEND:


No, serious – stop reading what I write until you finish that article.  It’s… eye opening.

Don’t cheat.  I mean it.

Read the article yet?

Good.

Now back to me…

1) Don’t trade the news.

2) Don’t trade a price chart.

There, I just eliminated 90% of trading activity online.

That leaves the three profitable types of trading.

Buy and hold: buy a non-leveraged index ETF, and walk away.  Have a life.  Save regularly.  Work hard.  You might be able to even retire if you start early enough.  People who’ve been adding a little each month to SPY have made money this past decade, and will most likely make money in the next, and the next, and the next.

Buy based on fundamentals: think Warren Buffet.  You aren’t buying a stock.  You’re buying stock in a company.  So look at the freakin’ company instead of the stock.  If you buy a company because you like a stock, you’ll lose money.  If you buy a stock because you like a company, you’ll make money.

Be a mutant: think George Soros.  This one takes a bit of explaining.  Remember those first warnings – Don’t trade the news and Don’t trade a price chart?  Those folks lose money to people like Soros.  I don’t know what makes him tick or how he does it, but somehow that man is wired differently than the rest of us.  He’s like a magician on stage pulling sleight of hand tricks and making money off of our confusion.  He’s brilliant, but if you don’t have the gift you’ll lose and lose hard.

Here’s the long and the short of it.  People who buy and hold stop losing money.  People who buy based on fundamentals stop losing money and make money instead.  Both profit off of the economy and earnings.

Soros doesn’t profit off of the economy and earnings.  He profits off of people who trade the news and watch price charts.

Buy and hold folks are long and don’t time.  Fundamental folks are long and don’t time.  Soros is long and short and times – making money off of people who trade the news and trade price charts.

I can’t stress it enough.

The first goal of an investor is to stop losing money.

PERIOD.

Now, there are services out there that can give options.  I’ve even recommended a few.  But you have to STOP losing money first, and that means ignoring the news and price charts.

And don’t think you’re Soros.  You’re not.  If you were, you wouldn’t be looking at my little blog.

In any case, the news is scary right now.  I don’t know if it’s a good time to buy or to sell. 

And that depends on the way you think of time.

Remember when Buffett was screaming “BUY BUY BUY” in October 2008?  Was he right or wrong on the timing?  He was wrong by 5 months and right by 5 years.

The key is to get the years right and you won’t have to worry about the months so much.

Tim

 

 

Friday, June 21, 2013

06/21/2013 (premarket) change to sector model

Quick note on the sector model.

After some back-testing it appears that the sector model is more consistent when holding the top two sectors instead of just one.



I’ll keep the current numbers as reported, but going forward I’ll track the top two positions.

There are two ways to do this.  One way is to hold both at the same time (which the blog will track).  Another way is to buy in the first position (currently XLU), hold in the second position (currently XLV), and sell in the third.

The second method should approximate the performance of holding both positions, while trading less often and eliminating whipsaws.

So then, the model will change from:

XLU

To

XLU & XLV.

Tim