The Van Tharp Institute

June 1, 2005 — Issue #222

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In this Issue:

Feature Article

Van Tharp's Most Recent Market Update-Understand the Big Picture

Recommended

Psychology of Trading CD Program 

Trading Tip

Leverage: Households Try It On for Size by  D. R. Barton

Coming Workshops Learn Swing Trading from Two Pro's, Chicago, August 26-28, 2005 Chicago IL
Listening In...

What's the Next Step....

View this newsletter on-line, or read back issues

 

We're Moving....

The Van Tharp Institute Will be Moving to a New Building Next Week
(Wednesday, June 8 & Thursday, June 9)

Our new address is 102-A Commonwealth Drive, Cary, NC 27511

Although we are planning a smooth transition, there may be slight delays with emails, phones, orders and shipping during this time. 

THANKS in advance for your patience - from all of the team !

Feature

 Market Update for May 2005

1-2-3 Model Still in Red Light Mode

By
Van K. Tharp

Part I:  Market Commentary.

On April 15th I issued a special bulletin because 1) all three major averages were down over 3% on the week.  In fact, it was  only the second or third weekly change over 2% for 2005.  In addition, 2) all three market averages were below their price five weeks ago.  As a result, it was the first clear signal for our bear market mutual fund strategy since Safe Strategies for Financial Fre-edom was published.  By the time our May 1st update came out, the market had resumed its do-nothing state and by week of May 20th we had been stopped out because the S&P 500 was above its price five weeks ago.  In fact, all three averages were above their price five weeks ago.

So what does the market seem to be doing now?  It’s clearly in an uptrend – despite being in both a Red-Light mode and being in the season when the stock market tends to go down.  Furthermore, we’re clearly in an uptrend despite another (i.e., the 9th) interest rate hike by the Federal Reserve.  So what’s going on?  I suspect it has to do with the strength in the dollar.  See my comments below.

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

What the market is doing?  Currently, all three major averages are still 1) down for the year but they are 2) all up over the last five weeks.  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. 

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

Date

DJIA

% Change

S&P500

% Change

Nasdaq 100 (QQQ)

% Change

4/29/05

10.191.51

+0.4%

1156.85

+0.4%

1420.79

-0.0%

5/6/05

10,345.40

+1.5%

1171.35

+1.3%

1456.00

+2.4%

5/13/05

10,140.12

-2.0%

1154.05

-1.5%

1470.63

+1.0%

5/20/05

10,471.91

+3.3%

1189.28%

+3.1%

1538.06

+3.9%

5/27/05

10,542.56

+0.7%

1198.78

+0.8%

1549.80

+1.4%

Incidentally, this data is calculated by hand based upon last Friday’s close (i.e., May 27th).  There is always a possibility of human error in our numbers.

What’s a good strategy for the month?  Homebuilding stocks seem to have resumed their trends, lead by Toll Brothers which declared record earnings last week.  One reason is that long term interest rates are coming down (a deflationary sign?) despite the Federal Reserve raising short-term rates.  Energy stocks also seem to have resumed their uptrends. 

Part III: Our Four Star Inflation-Deflation Model.

So what’s our new indicator telling us about inflation?

1)      The CRB index

2)      The price of Gold

3)      The CPI and

4)      The trend in interest rates.

I’ll leave our description of the model in Tharp’s Thoughts for one more month.

1)  The CRB Index.  I already said that I believe that the CRB index is the one we have currently that is the least manipulated by the government.  But what’s the best way to measure it?  For consistency, I plan to give two measurements. 

·        Is the CRB index higher than it was six months ago.  If it is, we are on track for inflation.

·        Is the CRB index higher than it was two months ago.

Now there are several ways to monitor these two indices.

·        If both differences are higher, we’ll count one star for inflation. 

·        If the six-month change is higher, but the two-month change is not, then will only count ½ star for inflation. 

·        And if both the two and six month changes are lower, then we’ll be minus one for inflation.

·        However, if the six-month change is lower, while the two-month change is higher, then we’ll be minus ½ star for inflation.  Obviously, the two minus scores will point to deflation.

2)  The Basic Materials Sector ETF (XLB).  In an inflationary environment, basic materials will definitely go up and this sector, to the best of my knowledge, is not manipulated by the government.  Thus, I will use this sector to monitor inflation and we’ll use the same measurements use for the CRB.  (1) Is the XLB higher than it was six months ago; and (2) Is the XLB higher than it was two months ago.  These two measurements give us four possible results.

·        If both differences are higher, we’ll count one star for inflation. 

·        If the six-month change is higher, but the two-month change is not, then will only count ½ star for inflation. 

·        And if both the two and six month changes are lower, then we’ll be minus one for inflation.

·        However, if the six-month change is lower, while the two-month change is higher, then we’ll be minus ½ star for inflation.  Obviously, the two minus scores will point to deflation.

3) The London PM Gold price at the end of each month.   Although Gold can be manipulated by the government, I still like to look at monthly gold prices.  However, to be consistent, we’ll use the same two measurements that we’ve used for the other indices that we are monitoring.  1) Is the price higher than it was six months ago and 2) is the price higher than it was two months ago.  Again, these two measurements give us four possible results.

·        If both differences are higher, we’ll count one star for inflation. 

·        If the six-month change is higher, but the two-month change is not, then we'll only count ½ star for inflation. 

·        And if both the two and six-month changes are lower, then we’ll be minus one for inflation.

·        However, if the six-month change is lower, while the two-month change is higher, then we’ll be minus ½ star for inflation.  Obviously, the two minus scores will point to deflation.

4) The Fourth Measurement we’ll use is related to the Financial Sector of the S&P 500.

The financial sector (XLF) tends to do well when we have deflation and poorly when we have inflation.   Martin Pring, in fact, has used an index in which he divides the XLB by the XLF.  Since we already use the XLB, we’ll use the XLF by itself as well.  Again, we’ll use the change over six months and over two months.  However, the four possible outcomes will give us a different interpretation.

·        If both differences are higher, we’ll count one star for deflation. 

·        If the six-month change is higher, but the two-month change is not, then we'll  only count ½ star for deflation. 

·        And if both the two and six month changes are lower, then we’ll be plus one for inflation.

·        However, if the six-month change is lower, while the two-month change is higher, then we’ll be plus ½ star for inflation.  Obviously, the two minus scores will point to strong inflation.

Okay, so now let’s look at the results for the year.  We’ll pretend that April 15th is the end of the month so that we have a current reading.

Date

CRB

XLB

Gold

XLF

September 30

285.1

27.30

415.65

28.13

October 31st

283.70

27.04

425.55

28.38

November 30th

291.10

29.24

453.40

29.16

December 31st

283.90

29.63

435.60

30.37

January 31st

284.75

28.72

422.15

29.71

February 28th

305.00

30.98

435.45

29.51

March 31st

311.02

30.16

427.15

28.39

April 30th

303.75

28.01

435.70

28.44

May 27th

300.09 (26th)

28.03

418.25

29.33

We’ll now look at the two-month and six-month changes over during 2005, to see what our readings have been.

Date

CRB2

CRB6

XLB2

XLB6

Gold2

Gold6

XLF2

XLF6

Total Score

Jan 05

Lower

Higher

Lower

Higher

Lower

Higher

Higher

Higher

 

 

 

-+/2

 

+1/2

 

+1/2

 

-1

+1/2

Feb 05

Higher

Higher

Higher

Higher

Lower

Higher

Lower

Higher

 

 

 

+1

 

+1

 

+1/2

 

-1/2

+2

Mar 05

Higher

Higher

Higher

Higher

Higher

Higher

Lower

Lower

 

 

 

+1

 

+1

 

+1

 

+1

+4

Apr 05

Lower

Higher

Lower

Higher

Higher

Higher

Lower

Higher

 

 

 

+1/2

 

+1/2

 

+1

 

-1/2

+1.5

May 05

Lower

Higher

Lower

Lower

Lower

Lower

Higher

Higher

 

 

 

+1/2

 

-1

 

-1

 

-1

-2.5

The first four months of the year each showed signs of inflation, with a huge jump (+4) in March.  But look what has happened since March.  We showed a clear decrease in April and in May we showed our first signal for deflation.  And if this becomes a deflationary market, you’ll want to avoid debt (see more about this in D.R.'s article below) and you’ll want lots of cash.  Let’s see if this trend continues next month.  

Part IV: Tracking the Dollar.

Look at the next Table, showing the dollar index over the last five months and comparing in with its price at the close of the last three years.

The Dollar Index

Month

Dollar Index

December 02

98.62

December 03

86.27

December 04

80.19

January 05

81.10

February 05

83.50

March 05

84.20

April 05

84.92

May 05

86.42

The dollar is now much higher than it was at the start of the year and its gone up every month of the year.  The dollar has probably bottomed out against the Euro.  In fact, with the European Union constitution now in doubt, with France voting against it and the Netherlands leaning in that direction, the Euro is in trouble.  However, this is still only comparing the dollar against the Euro – which is a major component of the dollar index.

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.  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’s strength against the Euro could explain some of the unexpected strength in the U.S. stock market.  For example, when Europeans invest in the U.S. stock market, they get the advantage of currency appreciation in addition to stock appreciation (i.e., if there is any).

What this all means.

Our big picture still suggests a long-term BEAR market.  That might be turning into a deflationary BEAR or in might suggest that the dollar is simply getting stronger.  Let’s let the market tell us what will happen.  

Until the June update on the market…..this is Van Tharp.

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.

 

Recommended:

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You will learn the tools and techniques that you need to transform your trading and investing results.  Topics covered include: 

  • The Psychology of Discipline
  • Belief Change and Mental State Control
  • How to Fix Mistakes and Two Tasks of Trading--Rehearsal and Daily Debrief
  • Games People Play
  • Self-Sabotage
  • Creating Your Future by Goal Setting and Manifesting
  • Personality Type and Trading

The material in this CD series is one of the best overviews of the psychology of trading that Van Tharp has produced. 

Based on Van Tharp's years of experience working with traders and investors and modeling the best traits and characteristics of high performing investors. 

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Trading Tip: 

Trading Tip

Leverage: Households Try It On for Size

by  D. R. Barton, Jr

"This would be a much better world if more married couples were as deeply in love as they are in debt." -- Earl Wilson

I’ve written about the potential housing bubble before and don’t want to jump back into that area just yet (we’ll do a comprehensive update later this year).  But a back section snippet in the Wall Street Journal certainly caught my eye today (Tuesday).

While traders and investors often use leverage to try to improve their return on equity, it seems that American households are now trying this trick with real estate.  Or more correctly, with their house – their residence – their home.

Here’s the eye-catching statistic:  the debt-to-income ratio for U.S. households reached an all-time high of 1.2-to-1 at the end of the 4th quarter of 2004.  So if a household has an income of $100,000 they are carrying around $120,000 in debt, on average.  This level of debt may not seem overly daunting, but it is the result of two trends that cannot continue indefinitely.

The first trend  is one that we’ve gone over in the past – consumer debt (short term debt not secured by real estate).  American households continue to extend (overextend?) themselves with short-term debt, seeing no plasma TV or new set of wheels that is unobtainable. 

The second debt-growing trend is perhaps more worrisome: residences are being leveraged to the hilt.  The fact that household debt is far north of parity with income for the average household is really remarkable when you consider how many people own their homes outright or at least have a big chunk of equity in the house.  The 1.2-to 1 ratio means that more people than ever are leveraged with loans equal to or greater than the equity in their houses; combined with burgeoning consumer debt this now more than offsets those folks who own homes or large parts of them.  This wasn’t the case ten years ago, when the same debt-to-income ratio was only 0.9-to-1.  The ability to buy a house with a “no-money-down, interest only mortgage” didn’t exist 10 years ago.  But it sounds like a good deal to homebuyers who can only see “up” as the single direction for housing prices.

As with all forms of leverage, the leverage on homes is a double-edged sword.  With little or no money down, the investment seems to have huge cash-on-cash return upside.  But the first hiccup in the housing market that comes along will find large amounts of “home owners” with negative equity.  Such a reality check will have magnified effects on the markets.

Ours is a consumer driven economy.  With high real estate leverage combined with large consumer debt, the first blemishes will be felt on the consumer side much more quickly than in the residential real estate world.  Another way to view this potential tremor is that when we start seeing localized pockets of falling real estate prices, broader drops in consumer spending will follow very quickly.  High levels of leverage tend to correct itself very quickly.

How does this affect your trading today or this week?  It really doesn’t.  But every trader and investor will benefit from keeping an eye on the macroeconomic picture.  Be prepared to act quickly (i.e. reduce your equity exposure) if even the smallest element of the housing market starts to unwind.

D. R. Barton, Jr. will be teaching the upcoming Proven Tactics of Swing Trading Course, August 2005 and is a featured speaker in the Van Tharp Institute Course, Make Money Work for You

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 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.

Coming Workshop...

Proven Tactics for Swing Trading

Profitable Trading that Fits YOUR Schedule

 Chicago, Illinois

August 26-28, 2005

Presented by Brad Martin and D.R. Barton

  • Learn the Pro Traders' Secrets for Capturing Huge Profits in Bear or Bull Markets
  • Become Skilled at Swing Trading - the Trading Style That Fits Into YOUR Schedule
  • Don't Lose a Bundle by Holding Stocks During The Last Market Decline! Find Out the Master Traders' Alternative to "Buy & Hold"
  • Discover the Detailed Trading Strategies that Win in Today's Markets

Learn more...

Register Now

 

Listening in....

Excerpts from Dr. Tharp's Mastermind Discussion Forum

What's the Next Step....
Peak Performance Home Study Course 
Author: ManMohan 

Dear Van,

I started studying your home study Peak Performance course in September 2004. Now I am able to apply quite a bit of what I have learned, ie low stress, though I have a long way to go.

My plan is to continue studying this course again and again. However I am wondering if you would recommend the next step in taking another course, home study or in person.

My score on self assessment test was 11/15.
And score on Developing a winning system was 12.

I live in India and I have been trading in the stock market.

Regards
ManMohan


Reply To This Message 


Re: Peak Performance Home Study Course 
Author: Van

You really haven't given me enough information to tell you what to do next. However, I usually recommend the following steps. 

1) Do the Peak Performance Course until you are certain that you have the psychological issues in hand. If you need more help, I recommend the Peak Performance Workshop (next one in September).

2) Develop a Business Plan for your wealth -- here I recommend the CD series we have on that. Also our new "Money Money Work For You" course is good here.

3) Your business plan should have at least three trading strategies that fit the big picture. I update the big picture (in the US at least) monthly in Tharp's Thoughts. But for the best way to develop strategies that fit you, I recommend the "How to Develop a System that fits Your" home study course or workshop.

Hope that helps.

Van

Click  here to read more   posts on Dr. Tharp's Forum. 

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

 

 

 

 

 

 

 

 

 

 

 

Feedback 
Peak Performance 
Home Study Course

"I just finished Volume 5 of the Peak Performance Home Study Course...

"I can summarize my learning experience in one sentence: "All causation is mental." This isn't my quote but, for me, it exemplifies the power of the mind. Robert Kiyosaki interviewed Dr. Tharp on a tape that was included in the CashFlow 202 game. I was completely absorbed by the approach (so different from most trading commentary), that Dr. Tharp used in his thought processes. What held my attention was the similar 'it's in your mind' component of the BE - DO - HAVE equation that Kiyosaki teaches. I see crystal clear that the seed of the results we get in our lives is germinated first in our minds. The growth or death of that seed also depends on our minds. To me, in hindsight, it's obvious that the most important part of trading is the one doing the trading. The trader is completely controlled by the trader's mind.

"I heard it said once that, in healthy human evolution, we proceed from dependence to independence to interdependence as we grow and mature. This [Peak Performance] course has introduced ways to think dependently, independently, and interdependently; I believe there are useful ways to employ all three modes that will support successful trading.

"The course taught me the basics of fishing instead of depending on someone to give me a fish. The real benefit is the fact that the material can put the power of the material where it should be - between the ears. I anxiously look forward to reviewing the course, using it as a model to build my trading business, and studying further with Dr. Tharp's material.

"Hopefully, you find this useful and an encouragement to keep up the good work!" — Rick Redel