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

• Workshops Don't Wait—Workshop Space Sold Out Last Month
• Article New Ways to Manage Your Portfolio: July Results by Dr. Van K. Tharp, Ph.D.
• Trading Education Announcing Ken Long's New Workshop!
• Trading Tip A Small but Useful Victory for Technical Analysis by D.R. Barton, Jr.
• Mail Bag More Questions and Answers about the Super Trader Program

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Feature Article

New Ways to Manage Your Portfolio: July Results

by Dr. Van K. Tharp, Ph.D.

Since the crash in the fall of 2008 and the bottom in March 2009, I have been fascinated by how the market has been behaving.  First, while the overall market made a record recovery, it was difficult to find any consistent trends.  One area of the market would be the strongest one month, only to be the weakest the next month.  That doesn’t happen in most markets.  Usually, the strongest sectors stay the strongest sectors for some time.

As a result, just for my own interest, I’ve decided to do a monthly study of the strongest and weakest stocks and ETFs.  I look at multiple screens:

(1) an SQN® 1001 screen of the S&P 500,  
(2) an SQN 100 screen of the top ETFs, and
(3) a positive and negative efficiency screen2 of the entire stock market.

In each case, I’ll look at all my screens and subjectively decide the best and worst stocks based on their price.  What’s classified as best or worst depends on my own subjective interpretation of the charts based on what looks efficient to me. For the worst negative candidates, I’m looking for issues with a price above $25 per share.  For the best positive candidates, I’m looking for prices above $10 (unless it’s an ETF).  These candidates, by the way, are not recommendations to buy or sell.  This is purely a personal interest project of mine and I hope it will also be educational for you.

Using these screens I created two conceptual portfolios in which I have 50% of the equity allocated to 5 short stocks and 50% of the equity allocated to 5 long stocks.  In the first “regular” portfolio, I went long on the 5 best positive efficiency candidates and short on the 5 best negative efficiency candidates.  In the second portfolio, which takes a contrary stance, I did the opposite—I shorted the positive efficiency stocks and went long the negative efficiency stocks.

I would expect that positive efficiency stocks go up and negative efficiency stocks go down but these days they might just do the opposite.  Anyway, with an equal number of long and short stocks, both portfolios are neutral.  I’ll continue my research over the next six months unless the market type changes dramatically.  For some more information on the background for this research, please read last month's article.

Market Check

Our initial portfolios began by using the opening prices on June 21st for our positions and ended with the closing price on July 16th.  Before we check how the portfolios did, let’s look at what the market did over that period of time.

The market was clearly down with an average loss on the three indices of 5.67%.

Regular Portfolio Performance

With the market having moved down in the last four weeks, we’d expect that shorting the negative efficiency stocks would have provided us with great candidates to keep going down.  The actual results, however, were exactly the opposite of what we expected. The next table shows the value of our short candidates at the open on June 21 and the close on July 16. 

My negative efficiency screen found the five worst performing stocks in mid-June when we were in a bear market.  I have defined “worst performing” and “bear market” with my subjective criteria.  In the last month, three of those five stocks actually went up more than 10%, one rose 7%, and only one of them continued further down. The short portfolio was down 9.12% (or up that much if you were long all the positions). 

The stock that was in the news negatively for almost the entire month in the US, British Petroleum, was up 21% on the month.

With that in mind, how did our strong efficiency candidates do (our long stocks)?  The results are shown in the next table.

While we might not expect the strongest efficiency stocks to do particularly well in a down market, the average down move in these stocks was 6.01% (all five were down).  This group’s performance was worse than the overall market move of 5.67% down. 

Analysis

Pairing up long and short positions didn’t reduce our risk that much, as eight positions moved in the “wrong” direction—some by a huge amount. That is exactly the opposite of what I expected.

I think the phenomenal performance of the worst efficiency stocks was due to mutual funds (which have to be nearly fully invested) switching to what they decided were “value” plays in the down market.  BP, which was in the news every day, was considered a value play and was up 21% on the month.  And, for some reason, the funds didn’t consider BLK as much of a bargain priced at $160.

In the group of short stocks, the lower-priced stocks did very well in terms of moving up, while the higher-priced stocks either fell or didn’t move that much.  Furthermore, since it was a down month, people were getting out of the best performing stocks so those stocks tended to perform worse.  However, I wouldn’t read too much into the results—except perhaps that bear markets tend to do whatever they can to rid you of your money.

Contrary Portfolio Performance

Obviously, the contrary portfolio did very well because it went long the worst stocks and shorted the best stocks.  The contrary portfolio was up $7,821.07 or 7.8% for the month.

New Portfolios for July/August

So let’s set up another pair of portfolios for mid-July to mid-August and see what happens.  They will start using the opening prices on Monday, July 19th and will end using the closing prices on Friday, August 20th. 

So what are the five most positive efficiency stocks this month?3  I could only find one right now, AZO.  Interestingly enough, AZO was one of the last positive efficiency stocks to hold up when I was tracking positive efficiency stocks in the 2001-2 bear market.  The other was DLX, although it has not done well at all recently.

To remain neutral, I would have to put 50% of the portfolio into the one position—AZO.  While I considered that, I found a better solution, which I’ll get to in a minute. 

My screen for negative efficiency stocks this month found five strong candidates—GILD, NVDA, LLL, CFN, and HD.  I elected not to include any ETFs this month because none of them looked as negatively efficient as the stocks I selected.  Furthermore, while FXE and IIH performed in the same manner as their group in the June portfolio, they were both weak performers compared with the stocks.

In my screen for negative efficiency stocks, I also found four that are in a slight uptrend.  These could be good long performers in the next few weeks: SWY, SHLD, APOL, and DV.

Because of the screen results this month, I’m going to structure our portfolios slightly differently.  Instead of just having positive efficiency and negative efficiency stocks like we did in June, this month I added in a third group: the four negative efficiency stocks that have had slight uptrends recently. 

In the regular portfolio we will short the negative efficiency group and go long on the single positive efficiency stock and the four negative efficiency stocks that have the slight uptrend.  The contrary portfolio will take positions reverse of the regular.  Again this month, both portfolios are built to be neutral.   

July’s regular portfolio positions are in the following table.

I am interested to see if the market remains in bear territory into mid-August and if all the negative efficiency stocks go up again.  I would suspect the least likely up candidate would be LLL at its high price and the most likely would be something like Home Depot.

Questions and Answers

Remember this is just a research project that I’m sharing with you.

After the first article in this series last month, I only received a few questions.   I hope that I have been clear enough on why I am doing this and that a lot of my subjectivity is involved in the process.  While I don’t intend to answer a lot individual questions about this project, there were a few that came in last month that I wanted to address. 

Why are you not determining R ahead of time?  I have some suggestions if you’d like.

This is a research portfolio and my only question of interest is "What happens to the various groups over a month’s time?"  If I were looking for stops, I could always look at a history of maximum adverse excursion as a percentage of the ATR and use that to determine R.

Does your efficiency system allow you to categorize your positions from first choice to last choice?  If so, it would be interesting to see how each holds up over the month.

My efficiency criteria are subjective.  A straight line of price movement with no variability is best, but I have no idea how to rate the slope and that’s really a function of the price scale.  Interestingly enough, all of the worst stocks, except BP, were showing slight trend reversals last month.  Additionally, I don’t expect many positive efficiency candidates in a bear market (e.g., this month I considered AZO to be the only viable candidate). I could subjectively rate the candidates, however, that’s not part of this project. 

Why do you need a normal and contrarian portfolio?  Just change the sign from positive to negative.

That’s exactly what I did, but I am actually looking at all the different aspects of this approach.  How did the best stocks do long?  How did they do if shorted? How did the worst stocks do long? And short?  So that’s four questions.  Last month the best choice would have been to just go long the worst stocks. In fact, to just go long BP, which was the only one of the five worst stocks not starting to move up and thus the worst, would have been the best choice.

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.  

Trading Education

Coming in September...the Next Round of Ken Long's Workshops

Including Something New!

Trading Tip

by D.R. Barton, Jr.

The overall concept of support and resistance levels applies universally in the technical analysis world. 

On a regular basis, folks want to discuss the interesting topic of why support and resistance levels seem to work.  Two philosophical ends of the spectrum support the concept:

1. Underlying pattern or foundation of the markets.  Adherents to this school of thought would describe the market as following a set of rules that are much like “the laws of nature.”  Many students of Elliott Wave theory and Gann theory would fall into camp.  This type of analysis tends to be predictive and very adaptive or fluid.  If the markets don’t fit the current model points, the model has built-in adjustments that allow updates (that wasn’t really wave 3, this is now wave 3).
2. Self-fulfilling prophesy.  From this perspective, those that see support and resistance levels believe in the “many eyeballs” theory—if enough people are watching a level or an indicator (and more importantly take action there), then the market has a good chance of turning or reacting at that point.

Personally, I don’t really care which reason is more “true” as long as using the idea of support/resistance provides an edge.  (I fall more in the self-fulfilling prophesy camp, even while I think some market philosophies have more than a grain of truth to them!)

Why discuss this? Last week, I published an S&P 500 Index chart (created on Monday 7/12) that showed an area with a confluence of support and resistance indicators that had a high probability of containing the up move that was underway.

If we look at that same exact chart, six market days later, we see that the area inside the light blue ellipse actually held the price activity.

The trend line remains intact, the 50-day moving average held, and the index tested but did not breach the 0.382 Fibonacci retracement in a definitive way—more on the concept of precision later.   In addition, the market failed to pierce the psychologically important whole number of 1100.

In the bigger picture, this small victory for the technical analysis (and the bears) has no earth-shattering significance and the bulls will test this area daily.  Regardless, the bears indeed are winning as long as these levels hold and the downtrend that started in late April remains intact with lower highs and lower lows.

Next week we’ll take a look at the concept of price zones for all of my precision-oriented friends out there (who might be stuck thinking about how the market actually did trade 0.85% above the 0.382 retracement line in the chart above).  Until then…

Great Trading,
D. R.

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".

Disclaimer »

Mailbag

More Questions and Answers about the Super Trader Program

Q: What kind of background does a typical Super Trader have?

A: Well, we’ve had large-fund managers, doctors, other professionals of every stripe, and even one full-time homemaker enroll in the Super Trader Program.  Their motivations vary to a degree and they also match in certain ways. 

Q: Why should I sign up for the Super Trader program?

A: The obvious underlying motive for everyone is that they were totally committed to being the best possible trader they could become.  They also knew the quality of our products and believed the program provided a clear path toward their objectives.

Here are a number of additional good reasons:

1. Super Traders pay about $50,000 for about $120,000 worth of products and services.  That's a real bargain—at some point we may actually charge full value.
2. According to all of the Super Traders currently enrolled, the transformational portion of the work is well worth the price alone.  They have become happier, more spiritual (regardless of their particular path), and much more in control of creating the life they want.  And they got that sense well before they completed the psychological portion of the work.
3. The Super Trader Playbook, as it is developed over a few more Summits, probably will be worth the $50,000 by itself. That will be available to eligible Super Traders only, in addition to numerous other Super Trader-only features.
4. We won’t accept anyone into the program if we don’t believe that their trading would improve enough to pay for the program within a few years.  For some, that could occur easily before the program is over.  My very first Super Trader, a floor trader on the former Life Exchange in London, said that that as a result of our first consulting session, he paid for his entire program tuition with the profits he made shortly afterwards. 
5. Each person’s program is completely customized to fit them.   The psychological part of the program will be what you need to gain control of your life.  The business plan you develop will be a working document that fits you.  The systems you’ll trade will be systems that you design to fit your needs and beliefs.  It is totally your program.

The only way that someone cannot benefit tremendously is if they are not committed to doing the work.  We turn down people that we don’t believe are completely committed.  In the unlikely event that someone gets through our application process who is unwilling to do the work, they always have the option of leaving the program at any point.

I’ve designed this program to be win-win-win!  Based on the comments and results of those who have completed it, the design works very well. 

For an extended Question and Answer session with Dr. Tharp regarding the Super Trader program, click here.  

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!

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