Van Tharp's Weekly Newsletter Tharp's Thoughts

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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.

However, if your beliefs are not similar to mine, then this information may not be useful to you. Thus, if you are inclined to do 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. Just simply know that I admit that these are my beliefs and that your beliefs might 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, 4) tracking the dollar, and 5) the strongest and weakest areas of the overall market.

Perhaps I should just consider it a sign of the times. Earlier this week, I had a short position bought out from under me. During the market crisis in 2008, the SEC became very strict about shorting. They went so far as to restrict shorting on some financial stocks for a period of time. Since then, they have remained very strict on shorting rules and now, brokerages will typically only allow shorts when they have another client that is holding more than the number of shares you want to short.

Several years ago if you had a short position, chances were you could short at will and nothing would happen unless you got a margin call or you bought the position back. That’s not the case anymore. When you short a stock today, the brokerage company assigns you specific shares of stock owned by someone else. If that person decides to sell his stock, you are forced to be the buyer for them (or at least they liquidate your short shares before they sell the others shares). So unless you are lucky and get the shares of someone who still has the buy and hold mentality, you might get a nasty surprise. Thus, it may make sense only to sell short if you are a day trader or, at the longest, a swing trader. I currently have some longer term short positions because the market does not look good at all to me. I’ll let you know how many short positions I get to hold all the way through the time I want to cover. So far the involuntary cover has only happened to me once, but RJ just got a notice from his firm that this could happen there as well.

Each month I look at the SQN® of the daily percent changes over 200, 100, and 50 days. The market type is volatile (typical of bear markets). The 200-day SQN is neutral; the 100-day has turned to bear, and the 50-day is now strong bear. The market spent 7 days in neutral territory but now is clearly in bear territory. I suspect that July will be a rather nasty down month.

I now have the ability to show you the 100-day market type (our primary focus) graphically. I believe this presentation of the data is much easier to interpret than the table format that I have been using for the last year or so. Thus, each month I’ll show you a one-year chart of market type and the volatility level.

Let's look at what's happening in the three major US indices. The next table shows the Dow, the S&P 500, and the NASDAQ over the past five weeks and over the last few years. All three indices are down now over the first five months of the year.

For many years the weekly change in the S&P 500 (and the other indices) was a little over 2%. Then we had several years in which we seldom had a week during the entire year in which the weekly change was over 2%. In 2008 volatility returned with a vengeance only to die out with the bull market of 2009. But notice the weekly change last week for all three indices. Returning volatility is another sign of the bear.

I’ve now decided to use the SQN measure in my world model as well my market type model. While I liked Ken Long’s methodology, I never developed a really good feel for the algorithm, especially since ETFs were switching from very weak to very strong (and vice versa) on a month-by-month basis. I talk a lot about needing to have trading systems that fit you and Ken’s world market works incredibly well for him, but it didn’t fit me well.

For the new market component measurement, we’ll use the SQN 100, which calculates the SQN over the daily percent change of the various ETFs we follow over the last 100 days. A score over +1.45 is very strongly bullish; a score below -1.0 is very weak. I’m still keeping the same color scheme where the strongest areas are in green (those areas are more than one standard deviation above the mean); those in yellow are the next strongest (above the mean up to one standard deviation). Those below the mean and within one standard deviation are in brown, and those more than one standard deviation below the mean are in red. I've taken out all the leveraged funds from my database, which means that the top and bottom funds are devoted to the strongest and weakest performers rather than to leveraged instruments.

Right now, Malaysia and Thailand are the strongest countries; however, in this market climate they could be the weakest by next month. The U.S. dollar is the strongest currency and we have two green sectors: REITs, and Food and Beverage. From a country perspective, France, Spain, and Austria are the weakest and the Euro is the weakest currency.

The next table shows commodities, real estate, interest rate instruments, and the strongest and weakest areas of the overall market. Here, we can see that the top ETFs are in bonds, gold, and EEZ, which is an ETF of the top 100 earnings stocks. People are fleeing to income vehicles or gold. Among the weakest sectors, the Euro, the dollar bearish, natural gas, income in Japan, biotech, and wireless are all very weak. It’s pretty straight forward in the chart.

This is a market in which very little can be relied upon to hold its strength. That means the markets can be traded, but long term investors will really suffer.

We are starting to see weakness in our inflation measurements, which signals a movement toward deflation. These are the same signs we were seeing in 2008. Gold and commodities are higher, but commodities are starting to weaken.

We'll now look at the two-month and six-month changes during the last six months to see what our readings have been. The results have shifted to neutral simply because of the drop in XLF.

I also wanted to show you another chart that I think helps explain what is going on in terms of the inflation picture. Typically when the Federal Reserve is stimulating the economy, it pumps money into the banking system and then banks lend out more than they receive; this has a multiplying effect. However, because many banks are in danger of failing, the government is requiring them to increase their reserves, and many banks view the activity of loaning money to businesses and consumers as being too risky now. Thus, they are not lending out the new money they have been getting from the Fed. The graph below, from the St. Louis Federal Reserve shows this happening with the M-1 money multiplier. When banks lend less money, the multiplier goes below 1. Right now it is at 0.838, which is lower than I reported last month.

I typically go to http://www.federalreserve.gov/releases/h10/Summary/indexn_m.txt to get information on the dollar. But the Fed seems to be changing the numbers. It had been pretty common to see changes for a month or two after a month closed, but lately, the Fed has been very inconsistent with its numbers for a long period of time after the fact. The only other good source of dollar information is the US dollar index, which is a futures contract; I’ll include a price chart of that contract each month going forward. The chart shows the huge increase in the relative value of the dollar that is not showing up in the Fed statistics.

Last month, I showed you the nice uptrend for the USDX. As you can see this month the chart is having at minimum a nice retracement, or perhaps a new change in direction. We should know the answer by next month.

Let me repeat some general principles, so you can understand what’s going on. It’s not that hard to design a system that has “Holy Grail” qualities for any given market type. However, it’s impossible for that system to work in all market types. The market type has changed to volatile bear, so you need systems that work in this type of market. The markets, as shown by the graph are clearly in bear territory. Thus, you probably should be doing the following:

If you are not willing to follow any of these strategy suggestions, then ask yourself what are your beliefs that are causing you to lose money. And also ask yourself whether those beliefs are useful.

To understand your beliefs about the markets and your trading so you can improve your performance, I strongly recommend you enroll in our August workshops: Blueprint for Trading Success and Peak Performance 101. Peak Performance 101 is a required workshop for anyone interested in the Super Trader program—it’s that important.

Once again, it’s my opinion that you should use the information in these monthly updates to discern when to switch trading systems and not to forecast the market. This is why it’s imperative that you know how your system will 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.

Crisis always implies opportunity. Those with good trading skills can make money in this market—a lot of money. There were lots of good opportunities in 2009. Did you make money? If not, then 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 July update, this is Van Tharp.

About Van Tharp: 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.iitm.com.

Your success as a trader depends upon the amount of work you put into applying the principles of this course to your trading. We hear time and time again how the course more than pays for itself ($795) in just a short time due to increased profits and reduced loses. So start now and take charge of your trading success!

When the markets move to extremes, there is a high probability for a snapback in the opposite direction. And we have an extreme occurrence taking place right now.

The end of the trading day on Tuesday (7/6) marked 11 straight days where the NASDAQ 100 Index and the NASDAQ Composite had both closed lower than they opened. For those who prefer candlestick charts, that means 11 red candles in a row. Here’s what that looks like on the chart.

Tuesday’s candle was red (the closing price was lower than the opening price), however, it actually closed higher than the end of the trading day on Friday (7/2). Before that, though, the technology stocks had posted 10 straight down days.

This type of persistent market action is so unusual that I dug back into my historical charts and databases to confirm whether this had ever happened before. Based on the open-high-low-close data for the NASDAQ 100 Index from 1985 to the present, the longest streak of red candles so far had been 9 straight days, back in March of 1994. In this time frame, this type of one-way price action is basically unprecedented.

I then looked at Dow Industrial Index data from 1928 onward. The longest string of consecutive red candles was 12 days. This anomaly occurred twice: first in August of 1941 and again in January of 1968.

So if either of the NASDAQ indices closes below the open Wednesday, we will be looking at the longest streak of intraday losses since the roaring ‘20s. And if the markets can manage to repeat that feat on Thursday, then we will be on truly unprecedented ground.

Strange occurrences seem to be happening more and more in the markets. In the last two years we’ve seen frequent extreme market swings, all-time high volatility and now historic losing streaks.

However, there is still some order underpinning the madness. Like a stretched rubber band, over-extended markets tend to snap back and we certainly are due for a short term recovery from the downward pressure. Those with short positions should tighten stops so they don’t get caught in a snapback rally.

The intermediate time frame is a bit murkier: most fundamental analysts are calling for an upbeat earnings season. This will be balanced by economic data that continues to contain more than its fair share of negatives. I would not be surprised if an intermediate term bottom has been put in place with earnings news coming in to trump any “normal” downbeat news.

But for now, a snapback rally seems to be the highest probability short-term play.

About the Author: A passion for the systematic approach to the markets and lifelong love of teaching and learning have propelled D.R. Barton, Jr. to the top of the investment and trading arena. He is a regularly featured guest on both Report on Business TV, and WTOP News Radio in Washington, D.C., and has been a guest on Bloomberg Radio. His articles have appeared on SmartMoney.com and Financial Advisor magazine. You may contact D.R. at "drbarton" at "iitm.com".

A Note to Fellow Traders: Are you adapting to the changing market condition? Or do you look at the indicators and go do what you always do?

We have had almost two straight weeks of down market here, and all the indicators have been reflecting the worsening conditions. Shorter term traders: examine your trading patterns of the last two weeks and see how many trades were on the short side and how many were on the long side. What are the performance stats for each batch? Are you trading with the market or trying to force it to do what you want it to do?

Everything that we do here at the Van Tharp Institute is focused around helping you improve as a trader and investor. Therefore, we love to get your feedback, both positive and negative!

Feel free to click below to leave us any comments so that we can serve you better. Or, send Van a question that you would like for him to answer.

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