Tharp's Thoughts Weekly Newsletter (View On-Line)

  • Article August 2011 Market Condition: Bear Volatile by Van K. Tharp, Ph.D.
  • Trading Education 2011 Fall Workshop Schedule
  • Trading Tip August 2011 SQN® Report by Van K. Tharp, Ph.D.
  • Mailbag Following the Rules of Your Trading System

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Market Update for the Period Ending August 31st, 2011
Market Condition: Bear Volatile

I always say that people do not trade the markets; they trade their beliefs about the markets. In that same way, I'd like to point out that these updates reflect my beliefs. If my beliefs and your beliefs are not the same, you may not find them useful. I find the market update information useful for my trading, so I do the work each month and am happy to share that information with my readers.

If your beliefs are not similar to mine, then this information may not be useful to you. Thus, if you are inclined to perform some sort of intellectual exercise to prove one of my beliefs wrong, simply remember that everyone can usually find lots of evidence to support their beliefs and refute others. Know that I acknowledge that these are my beliefs and that your beliefs may be different.

These monthly updates are in the first issue of Tharp's Thoughts each month. This allows us to get the closing month's data. These updates cover 1) the market type (first mentioned in the April 30, 2008 edition of Tharp's Thoughts), 2) the five week status on each of the major US stock market indices, 3) our four star inflation-deflation model plus John Williams' statistics, and 4) tracking the dollar. I also report on the strongest and weakest areas of the overall market as a separate SQN® Report.

Part I: Commentary—The Big Picture

Last month I sent out an emergency alert when the stock market became Strong Bear Volatile and long-term US debt was downgraded from AAA to AA+ for the first time in history. When we get into a Bear Volatile market type, you want to be out of the market completely unless you are an expert trader. Towards the end of August we actually moved into Bear Strong Volatile territory for a while. However, this is still a long way from the peak volatility in 2008-2009 bear market. When the VXX ETF was formed, it sold at around $400. It recently bottomed at $20, and it’s currently at about $40.

Part II: The Current Stock Market Type Is Bear Volatile

Each month I look at the market SQN score for the daily percent changes over 200, 100, 50 and 25 days. For our purposes, the market is defined as the S&P 500 Index. The 25-day through the 100-day signals are all in bear mode. The 200-day signal has moved from bullish to neutral since last month. Below is the graph of the 100-day market SQN score for the last year that shows us in bear territory now. And the trend is pretty obvious—down, with a base now oscillating between Bear and Strong Bear. Yes, we have had a number of up days in the market and moved back to bear territory, but the volatility says that this might not be that significant.

chart 1

 

Last month we were still in the normal volatility range. But look what happened since then. We’ve gone all the way through volatile, entered into very volatile and just returned to the top of the volatile band. These are not the sort of conditions in which I would expect a bear market to end.

chart 2

Here are the performance figures for the three major US indices over the last month. The indices were up heavily the first week in July and have been in a downturn since that time. The acceleration down was quite strong for the week ending July 29th.

Although the Federal Reserve hinted last week at more stimulus which seemed to quiet the market for a bit, the early part of this week proved the bear is not ready to hibernate just yet.

Weekly Changes for the Three Major Stock Indices
  Dow 30   S&P 500   NASDAQ 100  
Date Close % Change Close %Change Close % Change
Close 04 10,783.01   1,211.12   1,621.12  
Close 05 10,717.50 -0.60% 1,248.29 3.07% 1,645.20 1.50%
Close 06 12,463.15 16.29% 1,418.30 13.62% 1,756.90 6.79%
Close 07 13,264.82 6.43% 1,468.36 3.53% 2,084.93 18.67%
Close 08 8,776.39 -33.84% 903.25 -38.49% 1,211.65 -41.89%
Close 09 10,428.05 18.82% 1,115.1 23.45% 1,860.31 53.54%
Close 10 11,577.51 11.02% 1,257.64 12.78% 2,217.86 19.22%
29-Jul-11 12,143.24 4.89% 1,292.28 2.75% 2,362.81 6.54%
5-Aug-11 11,444.61 -5.75% 1,199.38 -7.19% 2,194.38 -7.13%
12-Aug-11 11,269.02 -1.53% 1,178.81 -1.72% 2,182.05 -0.56%
19-Aug-11 10,817.65 -4.01% 1,123.53 -4.69% 2,038.22 -6.59%
26-Aug-11 11,284.54 4.32% 1,176.80 4.74% 2,161.97 6.07%
Year to Date 11,284.54 -2.53% 1,176.80 -6.43% 2,161.97 -2.52%

Part III: Our Four Star Inflation-Deflation Model

Here is the data from our four star inflation-deflation model.

Date CRB/CCI XLB Gold XLF
Dec 05 347.89 30.28 513.00 31.67
Dec 06 394.89 34.84 635.50 36.74
Dec 07 476.08 41.70 833.30 28.90
Dec 08 352.06 22.74 865.00 12.52
Dec 09 484.42 32.99 1,104.00 14.10
Dec 10 629.53 38.47 1,410.25 16.00
Jan 11 650.80 39.47 1,327.00 16.74
Feb 11 676.96 39.46 1,411.00 16.85
Mar 11 672.81 40.02 1,439.00 16.52
Apr 11 687.66 40.87 1,535.50 16.38
May 11 656.42 39.75 1,536.50 15.84
Jun 11 632.23 39.37 1,500.30 15.35
Jul 11 645.77 38.01 1,628.50 14.80
Aug 11 661.93 35.34 1,813.50 13.38

We'll now look at the two-month and six-month changes during the last six months to see what our readings have been.

Date CRB2 CRB6 XLB2 XLB6 Gold2 Gold6 XLF2 XLF6 Total Score
   Higher Lower Lower Lower Higher  Higher Lower Lower  
Aug    -0.5    -1    +1    +1 +0.5

We are still in an inflationary environment—and gold recently set new highs, which basically shows that we are in crisis mode. Inflation will probably remain tame, however, unless or until the banks start lending again.

Speaking of bank lending, the money multiplier situation is still terrible but maybe the trend has finally reversed. The ratio moved up from a low of around 0.72 to about 0.78. While that’s not a lot, it is a small movement in the right direction. Still, anything under 1.0 is terrible for the economy. Right now, this means that banks are lending about $78 for every $100 they have. Since the historical norm is about $300 per $100, you can see that this lending situation remains a serious hindrance on growth.

chart 3

The longer the money multiplier stays below zero, the greater the compounded effect on the economy will be as the restricted access to capital continues to limit business growth.

Part IV: Tracking the Dollar

The Federal Reserve still needs to update their figures so let’s look at the US Dollar Index futures price chart to see what really is going on.

chart 4

So far, the dollar has had higher highs off of its May 4 low, but it’s not that far off right now at 74.135. With all of the crises going on in the European Union, I’m amazed that the Euro continues to remain at about $1.43US. However, remember our long-term debt was just downgraded for the first time in US history.

General Comments

The Federal Reserve is talking about additional stimulation and US debt is asymptotic. Shadowstats.com (with accurate statistics) only shows one quarter since 2000 (4th quarter of 2003) in which the US hasn’t been in a recession. People tend to blame the current president for what is going on, but the situation has been getting worse for some time. And someone will be unlucky enough to be president when it all blows up. Will that be Obama?

Our statistics now show that we are in Bear Volatile territory during a secular bear market. I personally believe that this secular bear market has at least 5-10 more years to go.

Warren Buffet, who said he’d never invest in a business he didn’t understand, just put $5 billion into Bank of America (and I can guarantee you he doesn’t understand Bank of America). However, didn’t he also put money into Goldman Sachs? If Oneness becomes global, though, the big money game as it has been practiced for many years has to end. Most would consider this a disaster; however, it is essential for Oneness.

These monthly updates provide valuable information so you can determine which trading systems will work best rather than try to forecast the market Which of your trading systems fit the current market type? The question implies that you have multiple trading systems and that you know how they perform under various market conditions. If you haven't heard this before or the other ideas mentioned above, read my book Super Trader, which covers these areas and more so you can make money in any kind of market conditions.

Crisis always implies opportunity. Those with good trading skills can make money in this market—a lot of money. There have been lots of good opportunities in 2011. Have you made money? If not, do you understand why not? The refinement of good trading skills doesn't just happen by opening an account and adding money. You probably spent years learning how to perform your current job at a high skill level. Do you expect to perform at the same high level in your trading without similar preparation? Financial market trading is an arena filled with world class competition. Additionally and most importantly, trading requires massive self-work to produce consistent, large profits under multiple market conditions. Prepare yourself to succeed with a deep desire, strong commitment, and the right training. Until the September update, this is Van Tharp.

About the Author: Trading coach, and author, Dr. Van K. Tharp is widely recognized for his best-selling books and his outstanding Peak Performance Home Study program—a highly regarded classic that is suitable for all levels of traders and investors. You can learn more about Van Tharp at www.vantharp.com.  


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Trading Tip

August 2011 SQN® Report

I use the System Quality Number® (SQN ®) score to measure the market performance of countries, currencies, commodities, and various equity sectors in this world model. The specific calculation I use is the SQN 100, which calculates the SQN score of the daily percent change for a 100-day period of the various ETFs we follow. Typically, a score over +1.45 is strongly bullish; a score below -0.7 is very weak. We use the following color codes to help communicate the strength or weakness of the ETFs:

  • Green (strongest): Those ETFs with scores that are more than one standard deviation above the mean (about 1/6 of the ETFs scanned).
  • Yellow (the next strongest): Those ETFs with scores above the mean up to one standard deviation (about 1/3 of the ETFs scanned).
  • Brown (weak): Those ETFs with scores within one standard deviation below the mean (about 1/3 of ETFs scanned).
  • Red (very weak): Those ETFs with scores more than one standard deviation below the mean (about 1/6 of the ETFs scanned).

The World Market Model spreadsheet below includes most currently available ETFs—including inverse funds—although there are no leveraged ETFs.

World Market Summary

The predominant colors in August for the US market segments (top center) are 60% brown and 40% red. This is weaker than last month and last month was weaker than the prior month. Brown is a negative sign according to the model and red is the weakest possible condition.

As we compare the US Market segments to the rest of the world, we don’t see much strength in the other regions either. Europe is now more red than brown. Other countries in the Americas are brown. Asia is brown and red. And even most of the sectors are now brown, with a few turning red.

Last month, there were three individual countries that were green but this month, there are no green countries in the model. So in the last 100 days, the markets around the globe have shown a broad weakening. Now is the time to get very defensive with your portfolios. Last month I said the only encouraging sign was that volatility was neutral. But that’s no longer the case—volatility (VXX) is now light green.

sqn 1


The Japanese Yen is now the strongest currency, with the Swiss Franc second and the Yuan third. Everything else is neutral or worse. Remember last month I said avoid anything dollar based.

As a group, the industrial sectors’ strength is waning compared to last month. This month there are no green sectors. Consumer staples are yellow and utilities (in the US) are yellow. Everything else is either red or brown.

The next table shows the relative performance of commodities, real estate, and interest rates, plus the strongest and weakest areas of the all of the ETFs.

sqn 2

Gold is the strongest area of the commodities as it just hit another new high. Bonds are also strong across the board (except for Junk Bonds) as people flee to safety. However, this could be a sad place to be if the US debt gets downgraded further. Either way, it certainly is not a wise place to be.

Big money has become less and less smart these days. But they have to be fully invested and even cash means that they are exposed to the US dollar. It’s a sad economic world right now. Silver and agriculture are both neutral and everything else shows weakness.

All the real estate sectors are yellow and generally very weak.

The top ETFs tend are in long-term bonds. The weakest ETFs tend to be global clean energy, US brokers, home construction, and banking.

What’s Going On?

People used to ask me in 1999 “Where is the market going?” To answer them, I would throw something in the air and then let it fall meaning, it’s going up, but it will eventually fall to the ground. Now the question is, “Where is debt going?" and I can answer in the same way – only it might take debt a little longer to fall to the ground (that is to default and disappear). It is the same old story of unsound governments overspending and being in serious jeopardy of default. The US is definitely in this position, although our default may take some time.

Here are the other key factors driving the markets right now:

  • We’re in a secular bear market that will probably run another 4-9 years. And we may be due for another serious down move.
  • • The St. Louis Federal Reserve has had a paper posted on its website for several years stating that the US is bankrupt. Compared to when that piece was published, conditions have become much worse.
  • According to www.shadowstats.com, the US economy has been in a recession since 2000 (except for one quarter) when measured by the original definitions for GDP growth. 
  • QE2 is complete, and we simply have a bandage on the US debt. The Fed seems to be suggesting that more stimulation is on the way; however, Fed stimulation will not work if the banks lend at less than 1:1 and that has been the case for about four years now.

Things are serious.

The markets are in crisis mode and if you want to be in them, you should be a trader, not a long term investor. Crisis always offer opportunities but to capture them as a trader, you MUST know what you are doing. We’d like to help you with that, if you’ll let us educate you. Trying to navigate these markets without such an education is hazardous to your wealth.

Until next month, this is Van Tharp.

About the Author: Trading coach, and author, Dr. Van K. Tharp is widely recognized for his best-selling books and his outstanding Peak Performance Home Study program—a highly regarded classic that is suitable for all levels of traders and investors. You can learn more about Van Tharp at www.vantharp.com.  


Mailbag

Following the Rules of Your Trading System

Q: Each system or market filter gives a number of signals at a time. Which ones should I take and which ones should I ignore? Above that, to find the effectiveness of the system, you should take 100% of the trade. This is still not possible with limited capital that you have. What are your thoughts?

How do you achieve all this with less than 25% drawdown? Do you trade only options? Do you trade only futures?

A: Your trading system rules define how you find setups for good trading opportunities and your entry rules define which setup signals to take and which to ignore. In his newsletter interview in July, Thomas Krawinkel talked about the performance effects of not taking all of the entry signals from a trading system.

In order for you to take all of your entry signals, you could do a number of things: increase your capital, increase the use of leverage, decrease the number of units traded, or adjust the system rules so that you have fewer setups and entries. You might revisit your objectives for your trading system—is it accomplishing what you want it to?

Realizing a drawdown of less than 25% is a trading objective, meeting that objective is a function of your position sizing™ strategy that you have employed with a trading system. There are innumerable position sizing strategies to keep your drawdown within an acceptable range and the proper use of leveraged instruments could be one of them. For more help in this area see Van's Definitive Guide to Position Sizing.


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September 7, 2011 - Issue 542

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