The Van Tharp Institute

April 6, 2005 — Issue #214

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In this Issue:

Feature Article

Van Tharp's New Market Update

April  Workshops

Peak Performance Workshops

Trading Tip

Too Much or Too Little – How Do You Manage Your Trades? by D.R. Barton, Jr.

Real Estate

Becoming A Battle Hardened Real Estate Veteran Without All The Scars by Chris Anderson

Recommended Reading Trade Your Way to Financial Fre-edom
Listening In...

Patience and Trading 

View this newsletter on-line, or read back issues

 

Feature Article

Market Update for March 31, 2005

1-2-3 Model Still in Red Light Mode

By
Van K. Tharp

Part I:  Market Commentary.

Last month I was talking about how some of the market sectors were on fire – Oil, Homebuilding, and Steel, in particular.  But shortly after I said that the market promptly turned around.  And all of those sectors topped out.  Overall the market closed down three or four of the last five weeks, depending upon which index you measure.  And all three major indexes fell during the first quarter.  The Dow and S&P500 were down 2.6% for the quarter, while the NASDAQ finished down 8.9%.  However, during the entire quarter the DOW and S&P 500 only had one week in which the change was more than 2%.  Remember that the average change used to be 2.5% per week.  The NASDAQ only had two weeks in which it changed by more than 3% — and that used to be a weekly occurrence.

The 1-2-3 Stock Market Model IS IN RED LIGHT MODE.  BE CAREFUL.

But before you make specific decisions on where to put your money, let’s take a look at what the market is doing.  Right now it is definitely going down.

Currently, all three major averages are 1) down for the year and 2) down for the last five weeks.  However, two of the three averages were up for the week ending April 1st and all of them only made minor changes, so we don’t get a bear market trading signal.  However, I don’t like this market at all.  It’s just being a very subtle bear, making it hard for anyone to take much money out of the market.  It’s probably nibbling most of you to financial ruin – but just a few percent each month.  However, we could expect some real fireworks once the pension fund money stops moving into the market.

The table below shows the five week status of each of the major markets.

Date

DJIA

% Change

S&P500

% Change

Nasdaq 100 (QQQ)

% Change

3/4/05

10,940.55

+0.9%

1222.12

+0.9%

1520.58

-0.4%

3/11/05

10,774.36

-1.5%

1200.08

-1.8%

1505.64

-0.9%

3/18/05

10,629.67

-1.3%

1189.65

-0.9%

1484.40

-1.4%

3/24/05

10,442.87

-1.8%

1171.42

-1.5%

1469.94

-1.0%

4/1/05

10,404.30

-0.3%

1176.12

+0.4%

1476.72

+0.5%

Incidentally, this data is calculated by hand, based upon last Friday’s close (i.e., April 1st).  There is always a possibility of human error in our numbers.

What’s a good strategy for the month?  For many of you, it might be best to stay on the sideline until this market tips its hand a little more.  There are very few strategies that are working well right now in the sort of market – a low-volatility, down to sideways market.

Part III: Our Four Star Inflation-Deflation Model.

As mentioned in Safe Strategies for Fin-ancial Fre-edom, we are due (in terms of cycles) for a deflationary bear market.  And, indeed, there are major deflationary forces at work in the world today.  And these were listed in the book. 

Let’s take a look at what the model is showing us right now.   Remember, the model says that the more stars, the more likely we are to have inflation.  Let’s look at those four factors.

Commodities Prices are definitely going up.  Commodity prices, as measured by the CRB, have been going up slowly since June of last year.  March was no exception, but the rate did slow down a little.  The CRB futures index remained in the lofty area above 300, with the index closing out March at 311.02.  Commodities are on fire.  And that’s certainly a sign of inflation.  Some of this seems to be pausing, but we certainly have our first star for inflation.

Consumer Price Index – Consumer prices, as measured by the government adjusted consumer price index are starting to heat up – much faster than most analysts have expected.  The governments figure for February was again up – giving up another star for inflation. 

Gold Prices – Gold went down in March and are down on the year.  Gold seems to be tied to the movement of the dollar which is also up for the year.  Thus, as I did last month, I’d call this one neutral.    

Interest Rates – Short-term interest rates are definitely going up, and long-term rates are starting to inch up.  However, a thirty year fixed mortgage is still cheaper than it was six months ago.  The Federal Reserve has now raised short term rates seven times which is certainly a strong reaction to potential inflation, but it’s also a very negative stimulus to the stock market.  Thus, we have another star here.

What’s the net result?  We have 3 stars pointing toward inflation. 

Most of the inflationary figures are manipulated by the government, so the best we can do is estimate the underlying trend.  However, I’ve recently come across some figures that are not manipulated by the government.  As a result, I plan to revise the inflation-deflation model.  Look for a special update on that later this month.

Part IV: Tracking the Dollar.

I just visited Europe and had dollar shock again.  Last time I was there, my $300 got me 200 Euro and $200 got me about 100 pounds.  This time it was more of the same – my $200 in London got me 93 pounds and my $600 got me $385 euro.  Now the exchange rates are a little better than that – but the exchange brokers really take you with their bid-ask spread and their commissions.

The dollar is actually moving up over the year.  In fact, the dollar index has been going up for five straight months.  I really found that interesting, since I got less for my dollar in Europe than I did last November. 

The dollar has probably bottomed out against the Euro.  However, my guess is that it will continue to be weak compared with commodity currencies such as the Canadian Dollar, the New Zealand dollar, or the Australian dollar.  I’d still recommend putting some funds in the Max Yield Strategy for 2005 if you didn’t do so last month.  Be careful here.  Follow the guidelines we set for you in Safe Strategies for Fin-ancial Fre-edom.

Fundamentals (i.e., with the main factor being the US debt) suggest that the dollar has a long ways to go on the downside.  However, we could have made that argument for much of the last ten years.  The dollar is once again looking very shaking and putting 20% of your portfolio in the max yield strategy makes good sense right now.

What this all means.

Our big picture continues to suggest that the stock market is a very weak place to be.  Be very careful.  We still expect a long term, inflationary BEAR market.  However, we might not see big declines until May.  Commodity stocks and very efficient ETFs are probably the place to be if you want a position in the market.  Right now, a flat market looks fairly likely and an inflationary bear market looks like it is ahead of us.  We might not see a major decline until seasonal factors kick in at the end of the tax season.

About Van K. Tharp: 

Dr. Tharp is the author of three acclaimed books published by McGraw Hill; the New York Times Bestseller, Safe Strategies for Fin-ancial Fre-edom, Trade Your Way to Fin-ancial Fre-edom, and Fin-ancial Fre-edom Through Electronic Day Trading. More...

 He is the founder and president of the Van Tharp Institute, dedicated to offering high quality education products and services for traders and investors around the globe.

Editors Note: Throughout the issues you will see certain words with odd spellings, such as Fre-edom and mort-gage. This is because spam filters are likely to block message that contain certain words and this is one solution.

April Workshops:

Peak Performance 101
April 25-26-27, 2005, North Carolina

Learn 15 ways to develop rock-solid discipline in your trading. Discipline really means controlling your mental state. Unfortunately, most people allow their mental state to control them. In contrast, real winners maintain discipline that allows them to charge ahead of others in the field. If you play in a zero-sum trading game, like futures, you need to know every trick. These are the real secrets that separate successful traders and investors from the average person. Enroll Now

Advanced Peak Performance 202 
April 29-30-May 1, 2005, North Carolina

Re-invent yourself as a trader or investor. We identified a minimum of eleven levels at which the trading game is played.  Each level has its own set of rules and tends to superimpose those rules (at least for those who are unaware) on the levels below it.  Most people reading this are probably playing at one of the bottom three levels.  As a result, there are many rules superimposed upon you that you unconsciously obey.  But you don’t have to do that – especially once you are aware of the game and how it is played. Enroll Now

 "My personal performance improved in every area of my life [following the Peak Performance 101 course]. My relationships improved, my organizational skills, my rock climbing improved (dramatically), my golf game... Well...actually my golf game didn't improve but I noticed I am having a lot more fun playing golf than I ever have experienced before. My self-confidence is soaring off the meter! My trading performance has improved. There is a sense of serenity that I learned to create (as a mental state) around my self whether I'm winning or losing. I'm much more calm watching the markets whipsaw. This mental state control has in turn improved my overall technical edge. I can focus better on the programming tasks."— B.C., Salt Lake City, UT, Past Peak Performance 101 Attendee

 

Trading Tip: 

Too Much or Too Little – How Do You Manage Your Trades?

Trading Tip

by  D. R. Barton, Jr.

“Enough is too little. More is better.  Too much is just right. ”
                                                --Shade tree mechanic saying

Tuesday’s (4/5/2005) Wall Street Journal had an article about the CEO of GM taking over the day-to-day management of the beleaguered automakers most troubled division.  Perhaps this is a good idea -- perhaps it’s not.  But I have found that in trading, micromanaging a trade in progress is usually a bad idea.

On the flip side of that coin, a “hands off” approach can be even worse.  It’s not uncommon for folks to have a trade or investment go against them and then, instead of taking action, they completely ignore the trade. They end up wishing and hoping that things will get better.  Call it the “ostrich syndrome” (putting one’s head in the proverbial sand).

What is the right frequency with which to monitor your trade?  The answer depends on several factors, but it’s clear that too much and too little – the polar extremes, can both be bad.  Let’s look at a couple of issues we must all deal with when deciding how much time we should spend monitoring trades.

Do you stick your head in the sand?  To be honest, I’ve never once heard  someone say, “My trade is going so well, I’ve quit looking at it all together.”  When a trade is going our way, we tend to check it every day or every hour or every minute.  It’s exciting to have a nice winner.  Contrast this with a trade that’s not working.  Many people just ignore it.  And if you don’t have your stops in place, this can lead to disaster.  I know more than one trader who has had day trades turn into long-term buy and hold positions because they stuck their head in sand when things went bad.

Do you micromanage?  Many folks tend to look at their trades far too often, whether they are going well or going poorly.  If you have a long-term position in your IRA account, and you check it every day, chances are that two things are going to happen.  First, you’ll drive yourself crazy worrying about meaningless daily gyrations, and second you’ll allow those daily gyrations to influence you to take action when you should be letting the trade or investment work.  The same can be said for any time frame; swing traders who hold their trades for several days should not be checking the prices every 15 minutes.  And day traders should not be watching tick-by-tick data unless their strategy requires it.  Set your stops and profit taking exits then let the trade work.

Finding the right balance of when to monitor your trade and when to sit back and let it work is one of the keys to cutting losses short and letting profits run.  Find out what works for you by checking your stress level.  Are you constantly on edge about your trades?  Maybe you’re monitoring too often.  You may even find it useful to add a section on monitoring criteria to your trading plan. 

In the end, here’s an axiom that may prove useful:  don’t do any monitoring unless it’s needed to take action.  That should help to keep your profits running and your stress level low.

D. R. Barton, Jr. will be teaching the upcoming Professional Tactics of Day Trading Course, May 14-16, 2005. 

He is the Chief Operating Officer and Risk Manager for the Directional Research and Trading hedge fund group. D. R. has been actively involved in trading, researching and teaching in the markets since 1986.  D. R. has created extensive and innovative new training products and taught extensively in many investment areas including intra-day trading, swing trading, and cutting edge risk management techniques. 

His writing credits include co-authoring Safe Strategies for Fin-ancial Fre-edom and co-creator and contributing author on Fin-ancial Fre-edom Through  Electronic Day Trading. He also writes a stock screening newsletter called Ten Minute Trader, has feature articles in Market Mastery, writes for Traders-U and is a regular contributor to Tharp's Thoughts.

Real Estate

Becoming A Battle Hardened Real Estate Veteran Without All The Scars:

Seven Steps That  Real Investors Make

by Chris Anderson, Ph.D.

As part of a new web site that we just launched, www.GetPreconstructionDeals.com, I get repeated requests asking if a particular deal is good or not.  While we can’t answer this for individual projects, we can certainly look at what HAS to get done by the investor to dramatically increase the odds of a successful transaction.

Step 1 is always to determine the fair market value (FMV).  As a real estate investor, you can always buy properties at the FMV.  My question is why would anybody want to do that?  Through careful selection, you can always find properties that are priced below FMV, regardless if they are existing or if they are a preconstruction project.  The best way to determine FMV is to work with someone already familiar with the area or determine yourself through local websites showing recent sales histories.

Step 2 is to determine the market trend for the area for which there are two critical pieces: 1) is the average price increasing AND 2) is the volume of sales increasing.  If both are moving in your favor, then you have the comfort of knowing that the right trend is in place to keep prices moving forward.  In stock market investing, there is the saying that the trend is your friend and traders frequently observe price and volume data to confirm the trend.  If a hotly priced real estate market shows signs of dropping in volume, be very careful.

Step 3 is to learn about supply, especially in the preconstruction marketplace.  In some areas, there are very few projects on the books and in others, there are 15,000+ units expected to emerge within one  zipcode, in one year.  Same is true for investing in houses.  In you are competing with a bunch of new houses that are coming on-line, then rapid price escalation may be limited.  For most savvy investors, they like to see lots of demand with very little supply which is nothing more than common sense.

Step 4 is to make your OWN opinions of the macro conditions of the local and regional marketplace.  So, for example, if you are a strong believer that real estate is overvalued in the target area, why would you ever consider investing?  On the other hand, if you believe that market forces will continue to escalate in the market, then why would you not be actively looking?  As an example, some people believe that the graying of America is just now starting to drive people to warm, more attractive climates.  Even though property values are high in these areas right now, are we going to see 20+ years of additional migration to them?  You have to decide for yourself because we won’t know the answer for another 20 years!

Step 5 is one of the most important risk management tools available to the investor in real estate.  Each property has typically an inherent rate at which it can be rented, even if that is not your intent.  By looking at rental rates, relative to the amount of principle, interest, taxes, and insurance (PITI) that you will have to pay, then you can understand the amount of cashflow that may be required to support the property.  If your objective is to produce cashflow, then you need to be cashflow positive very quickly.  If your objective is capital gains and the cashflow is negative, then you now understand what you may have to support on a monthly basis if things don’t work out.

Deferred maintenance then becomes our Step 6.  For an existing property, how much maintenance has the previous owner neglected that you will need to catch up?  Be careful here since this can be one of the major places to get nasty surprises.

And now, I saved the best for last: Step 7 is to determine your own personal risk tolerance.  Some new investors look at a deal and only see the positive.  This is a huge mistake.  EVERY REAL INVESTOR I KNOW HAS LOST MONEY IN A DEAL. But they gladly will do more.  Why?  They understand their risks going in, they understand how to limit their downside, and the gains are much larger than the risks they are taking.  If you were standing beside them and saw what they saw, you would gladly take the risk as well and rapidly ignore any small losses that you experience.

Hopefully this has given you a good start at learning how to analyze a potential opportunity.  Obviously each of these steps requires additional work or training but they are what separate the new investor from the seasoned, battle tested veterans.

Chris Anderson is a leading authority on preconstruction real estate investing.  Get his 4 day e-mail course and a 33 minute video free today!  

Visit www.GetPreconstructionProfit.com & www.GetPreconstructionDeals.com.  In addition, Dr. Anderson is the on-line training coordinator at the Van Tharp Institute, a group dedicated to providing world class training for investors and traders.

Recommended Reading:

Trade Your Way To Financial Fre-edom

by Van K. Tharp

Learn what the best traders in the world do to produce top notch systems. The Holy Grail for you is in knowing yourself and your biases and how to overcome them. In this book, you'll learn specific techniques for overcoming your biases, entry techniques used by the masters, how to develop a high expectancy system through understanding exits, and how to achieve your objectives through proper position sizing.  There are many critical topics that most books ignore such as expectancy, R-multiples, position sizing, the importance of objectives, and many more. 344 pages. $29.95

Order Book

Listening in....

Excerpts from Dr. Tharp's Mastermind Discussion Forum

Patience and Trading 
Author: PMK


I was thinking how big a part patience plays in the success of a full-time trader and how this was completely at odds with my own personality (lets just say I'm not Mr Patient).

Patience plays a part all the way through the trading system lifecycle:

Patience to wait for a good idea for a system
Patience to properly test it before risking real money
Patience to wait for confirmation of your entry signal before jumping in
Patience to wait to realize an unrealized profit
Patience to wait for your systems to realize their profit during the year
Patience to trade though a drawdown etc. etc.

Now I know I will never be a patient person, so how have I accounted for this in my trading? First I treat trading as a bio-mechanical process and I allocate the right responsibilities to the bio (me) and the mechanical (the computer) parts of the system. Anything to do with setup/entry/position sizing/stops/exits I allocate to the computer - this eliminates all my impatient impulses to 'do something' when there is nothing to be done.

The 'bio' part of the system is all done before a trade takes place - the research, development, testing, tweaking, deciding what markets to trade, what is tradable etc etc. I can do this all as impatiently (but thoroughly) as I like. Lastly, to placate my impatience with those horribly-boring-to-trade- but-essential-for-diversification-medium-to-long-term-trend-following systems I include a good smattering of intra-day and short term system that generate signals on an almost daily frequency. These allow me a diversion while I wait for the profits to come, or the drawdowns to mount.

Anyway, it is interesting how I seem to have overcome a character flaw (as far as trading is concerned anyway, you can ask my wife how well I have 'overcome' this in my personal life) by working with it, rather than trying to eliminate it.

Anyone else have any useful experiences with how they have dealt with (possibly) negative personality traits in their trading?

PMK

Reply To This Message 


Re: Patience and Trading 
Author: Bruce
Date: 03-30-05 17:34

Hello PMK,

When I started trading I had a lot of fear. Fear of failing, fear of losing money. When I look back on those days I realize that the fear was more to do with confidence in the systems I was trading, rather than fear of execution. I have never had a problem with pulling the trigger thank goodness. I thought I had confidence in my systems but I soon lost it when I went through a string of losses. The confidence was skin deep rather than deep down. It finally dawned on me that I was trading systems that didn't suit me, even though the concepts were good. I'm a black/white person who likes certainty, not too much gray please. The systems came from a guy who followed rules but the rules nailed the concepts and no further. In short there was a lot of discretion available to the trader. I had to nail down the detail, all the detail, so that nothing was left to choice. I did this, and this helped my confidence immeasurably because I could also back test the systems much more thoroughly. I also found that I could not completely eliminate discretion, but I got to a point where the mechanical vs discretionary ratio sat comfortably with me. My fear now is that if I don't follow my rules 100%, my performance is likely to be not as good. 'Good' fear one could say. That's not to say I haven't done different things. As I see a better way of doing things I'll test the idea and change the rules if it's good enough.

Following on from your patience stuff, good stuff too, I have a poster on the wall that reads "Patience + Persistence + Performance = Profit." The patience issues I've had to deal with is the need for action. I can follow my rules perfectly, but only because the systems I trade are relatively short term, one day trades stocks, the rest a max of 10 - 12 day holds. They satisfy my action needs.

By the way, thanks for all your other posts too mate. 


Bruce


Read the full, unedited thread on the forum,   link here. (Hint for finding it, look at the heading and the date) Van K. Tharp and traders, investors and wealth builders around the world connect on this site, share ideas and learn from each other. Search specific topics 

 

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Dr. Van Tharp's Trading Discussion Forum
  www.mastermindforum.com

Ask questions, share ideas, information and feedback with Dr. Tharp and other like-minded traders and investors. 

 

 

 

 

 

 

 

Feedback:

 

Dear Authors,

I have recently bought the book [Safe Strategies…] and am reading it thoroughly.

This is a great book where you have talked about all the correlations like inflation, deflation, currency and other strategies.

Much appreciated!

Mr. Praveen Marwah