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

• Workshops Early Enrollment Discount Expires Today! Register Now!
• Article July 2010 Market Update: Volatile Neutral by Dr. Van K. Tharp, Ph.D.
• Trading Education Announcing Ken Long's New Workshop!
• Trading Tip The US National Debt and a Little Perspective by D.R. Barton, Jr.
• Mail Bag Trailing Stops for High-Leveraged ETFs

Workshop

Upcoming Workshops

$700 Early Enrollment Discount Expires Today!

Van Tharp's Blueprint for Trading Success Workshop can help you transform your trading dreams, goals, and ideas into an organized, sequential, and actionable plan for trading success. 

Overcome your self-sabotage and understand how to develop rock-solid discipline to improve your trading performance in Peak Performance 101.

Feature Article

July 2010 Market Update: Volatile Neutral

by Van K. Tharp, Ph.D.

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. Note, the methods I now use for the market update replace methods I used in the past such as the 1-2-3 model from my book Safe Strategies.

Part I: Van's Commentary—The Big Picture

I read Richard Russell’s comments on the market with some regularity, simply because he’s been in the business longer than anyone else.  He’s been writing a market commentary for 56 years.  This is what he had to say recently:

“My opinion is that the Bernanke Fed is becoming progressively more uncomfortable with the way the economy is going, and they are getting ready to pull out their "big anti-deflationary guns" in another attempt to pre-empt deflation. The anti-deflation "guns" that the Fed manages are zero short rates, buying longer-term bonds and speeding up the money "printing presses." I believe the stock and bond markets already sense all of the above. Thus the stock market is dancing to the money printing tunes, and the Treasury bonds are backing off. The dollar has been weak as it senses the coming avalanche of new dollars. Gold is still reacting to the late deflationary forces.”

As long as new money is being printed for the banks, and banks refuse to lend (see M1 multiplier below), then some of the money is going to flow into the stock market and we probably won’t see big declines.  The 2008-09 big declines occurred as derivatives became worthless and everyone had to sell anything liquid to get cash.  That could still happen, but not right now.

Part II: The Current Stock Market Type Is Volatile Neutral

Each month I apply my SQN® to the market by looking at the daily percent changes over 200, 100, and 50 days.  I thought July would be a nasty month, but it simply continued the disruption of the down market (my opinion). Market conditions continue to be volatile, which is typical of bear markets. 

All three time periods are neutral on market direction.  I’m traveling this week and my 1 year market type charts have some sort of bug, so I can’t show them to you this month.

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.  The Dow 30 and NASDAQ 100 are both up slightly over the first half of the year while the S&P 500 is slightly down.  My data on the S&P 500 showed only 149 stocks with positive efficiencies over the last 60 days; the other 351 have negative efficiencies.  This means they are moving without a lot of directional smoothness either up or down.

Part III: The Strongest and Weakest Market Components

I’ve now decided to use the SQN measurement in my world model in addition to my market type model.  While I liked Ken Long’s world model ranking methodology, I never developed a good feel for the algorithm, especially because ETFs were switching from very weak to very strong (and vice versa) on a month-by-month basis.  I talk a lot about needing trading systems that fit you—this is an example of a big picture system fitting well.  Ken’s world market works incredibly well for him, but it didn’t fit me. 

For the new world model market component measurement, we’ll use the SQN 100, which calculates the SQN over the daily percent change over the last 100 days, for the various ETFs we follow.  A score over +1.45 is very strongly bullish; a score below -1.0 is very weak.  I will continue to use the same color scheme where the strongest areas are green (those areas are more than one standard deviation above the mean); yellow are the next strongest (above the mean up to one standard deviation). Those below the mean and within one standard deviation are brown, and those more than one standard deviation below the mean are red. I've removed 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.

Only two countries are green: Thailand and Chile.  None of the market sectors are green.  There are lots of brown areas, indicating weakness, and two red areas: health care in the U.S. and in Europe. 

The next table shows commodities, real estate, interest rate instruments, and the strongest and weakest areas in the entire market.  Here, we can see that the top ETFs are all bonds or other interest rate ETFs.  Health care sectors are among the weakest, including ETFs like Biotech and Pharmaceuticals.  Does anyone know what’s happening in those areas that has investors so spooked?  Gold, you’ll notice, is no longer green.

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.

Part IV: Our Four Star Inflation-Deflation Model

Our inflation signs started to pick up again in July, with our score moving to +2.  Bernanke, as mentioned previously, fears deflation and has announced again that he’ll do everything he can to prevent it, so perhaps that’s the reason for the pickup in that direction. 

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

There’s a strong monetary force at work opposing inflation right now: the weak M1 money multiplier. 

When the Federal Reserve wants to stimulate the economy, it pumps money into the banking system and then banks typically lend out more than they receive.  Today, however, many banks are in danger of failing so the government has required them to increase their reserves.  Additionally, many banks view loaning money to businesses and consumers as a very risky activity right now.  As a result, banks have not lent out all the new money they have been getting from the Fed. 

When banks lend less money, the M-1 money multiplier drops below 1 and there’s no expansionary effect on the economy.  For a number of decades, the ratio has been far above 1. Right now the ratio is 0.846, which is about the same as the last the last few months.  Banks still are not lending. 

Part V: Tracking the Dollar

I typically visit this site (click to see) to get information on the dollar.  I’ll use the Fed numbers here this time because they all stayed the same over the last four months, which is an unusual occurrence lately as the Fed seems to be changing the numbers. The full link to this site is below.
www.federalreserve.gov/releases/h10/Summary/indexn_m.txt

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 below of the Us Dollar Index (daily prices, February-July 2010) shows the huge increase in the relative value of the dollar that is not showing up in the Fed statistics.  Notice the huge difference between the government data and the futures charts.  The futures chart shows a higher price because it is a futures contract and it shows the July data, which the Fed has not yet posted.  It also shows that the dollar is again in a clear decline since its high in early June.

I’m taking a little vacation right now so, of course, the dollar is on the decline. That seems to happen every time I travel internationally and on this trip, I have gone to Canada.  The US dollar is almost at parity with the Canadian dollar.

General Comments

Let me repeat some general principles so you can understand how market types affect your trading.  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 well in all market types.  The market has volatile conditions right now so you need systems that work in volatility.  The markets are also relatively flat with both long and short term conditions being neutral.  Translate neutral direction to mean it has been moving sideways.  Do you have one or more trading system that work in volatile sideways markets?

If you have a good system for volatile sideways markets, it's probably a short term day or swing trading system. I watched one of my Super Traders take three trades in the first hour of trading last Friday.  All three trades were winners totaling 5.2R.  Day trading and swing trading are the place to be right now if your trading costs are low enough. 

Your trading system(s) should tell you how to make buy and sell decisions.  That’s what the system is for.  But let me ask you a question: do you understand your own decision criteria for when you should start trading a particular system and criteria for when you should stop trading that system?  This is an entirely different form of decision making that I will cover thoroughly in our upcoming Blueprint for Trading Success Workshop this month. 

I’ll follow up the Blueprint workshop with Peak Performance 101. If you are trying to trade these markets right now, the lessons from the Peak workshop are invaluable.  To trade short term systems profitably, you have to be able to trade at a higher frequency and at a higher efficiency—without a lot of mistakes.  Attendance at Peak Performance is also mandatory for anyone interested in the Super Trader Program.

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.

Correction Notice: Last month’s Market Update headline read “June 2010 Market Update: Volatile Bear.”  It should have read “June 2010 Market Update: Volatile Neutral.”  Many thanks to an attentive reader who notified us of the mistake. 

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.  

Trading Education

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

Including Something New!

Trading Tip

by D.R. Barton, Jr.

“Some debts are fun when you are acquiring them, but none are fun when you set about retiring them.”
— Ogden Nash

The long suffering readers of these articles (that means everyone out there who has read more than one…) know that I love a good graphic.

Today, we’ll look at a graphic that I consider more insightful than cool or beautiful.  It simply displays who owns our debt. 

Which countries own our bonds, T-Bills, etc?  Often, I’ve heard different numbers kicked around about different countries but I’m not sure I’ve seen the information consolidated like this before. 

I like the graph from Barron’s below mainly for two reasons:

1. It relates which countries holds US debt currently.
2. It shows the progression of ownership over the past five years. 

Based on what the graph shows, Bob Dylan would say, the times, they are a changin’.  Let’s have a look.

This graph struck me in several respects. 

You can clearly see the prevalent trend of growing holdings by the BRIC countries (Brazil, Russia, India and China). The chart does not show India because it holds a paltry $27 billion.  The rest of the BRIC countries, however, expanded their US debt holdings exponentially over the past five years.  China’s holdings are up almost threefold, Brazil by almost a factor of eight, and Russia jumped from a negligible amount to sixth on the list at $127 billion.

China, now our largest debt holder, supplanted long-time US debt champ Japan (who is still a close second).  In fact, only five short years ago, Japan held over 35% of the US’s foreign debt.  Japan’s ownership proportion has fallen now below 20%.

As interesting as these figures are, this chart fails to show the most remarkable number of all—zero (or very near zero for my precision minded friends).  This chart compares current foreign holdings of US debt against those from five years back.  If instead it showed foreign holdings from a bit further back—like 30 years, the base figures for all of these countries would have been about $0 billion.  Now they hold $3.9 trillion—and that figure is likely to keep growing.

So What?

Lest we begin to think that the US economy would collapse if China sold its US Treasury holdings, let’s get some perspective.  According to mint.com, the Federal Reserve (along with other governmental agencies) holds $5.4 trillion in US debt, while domestic investors hold another $3.5 trillion.   Domestic investors still hold 70% of US debt. 

While 70% may not impress you nearly as much as Japan’s 95% domestic holdings, this level should provide us with reason to believe that the US is not at the edge of the debt abyss—yet.

As the Barron’s article states, however, the US certainly continues to depend on the kindness of strangers.  If China, Japan or our other major lenders suddenly lost their appetite for US debt, the cost of borrowing money could rise rapidly for the US.  This would make the servicing costs of our burgeoning debt an even greater strain on national resources.

Next week we’ll take a look at some additional perspectives on this debt issue.  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

Trailing Stops for High-Leveraged ETFs

Q: In your books you recommend the use of a 25% trailing stop. Does it stay the same for high-leveraged ETFs (e.g., 3X)?

A: Van recommends the 25% trailing stop as a sort of "last resort" for investors who may not be familiar with stops.  If people have nothing beter off of which to base an initial stop (like a swing low or volatility multiple) or they have no effective method to move up their stop as the price moves up, then at least they can use a 25% initial and trailing stop.  It keeps these people from losing a great deal of their position and equity. 

Leveraged ETFs were designed for, and are best suited for, short term trading. As they are engineered to multiply their underlying index's daily movements, they will not move in unison with the underlying instrument over weeks or months.  In other words, you can lose money buying and holding a leveraged ETF, even if the underlying index is higher than where you entered the position. The same can be said for leveraged inverse ETFs.

Leveraged ETFs make great short term trading vehicles (perhaps even only intraday trading vehicles) which suggests that some type of exit other than a 25% trailing stop would work more effectively. — R.J. Hixson

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.

Click Here for Feedback Form »

Back to Top

Email Us

Email us [email protected]

The Van Tharp Institute does not support spamming in any way, shape or form. This is a subscription based newsletter.

To change your e-mail Address, click here

Or, paste this address in your browser: http://www.iitm.com/moved_new_info.htm

To end your subscription look at the very bottom, left corner of this email and click on that link. That section will also let you know which email address was used to send the newsletter.

800-385-4486 * 919-466-0043 * Fax 919-466-0408

Back to Top