Politicians lie and markets do not so ignore Washington and focus on PRICE and VOLUME action!

So, with that said, what does last week’s action across the US and global market truly mean? The $DJIA was down 5.75% on the largest volume since last summer, the $COMPQ was down 8.13% on the largest volume since May 2010 and the $SPX was down 7.19% on the largest volume since May 2010.

All three major markets confirmed a Dow Theory Reversal, a “Change of Trend”. In addition to the major indexes, the Dow Transports TRAN also confirmed a Dow Theory Reversal by breaking support and making a lower low.

Emotionally, I suspect that the market will bounce and that many stocks and indexes are “oversold” but this will most likely only be short term. Long term, the trend HAS CHANGED according to the charts. And until the charts show a new trend to the upside, all moves up are suspect. No one has to pick the exact bottom or top of a market so be grateful to recognize a trend and grab 60-80% of the move. It’s a lot safer and less risky to jump on board once the trend is confirmed rather than play a guessing game that can get you caught in a 500 point slide, similar to last Thursday. Markets can change on a dime so be prepared at all times but longer term trends stay intact for months, if not years.

I made a mistake in my general market analysis by not paying enough attention to my New High – New Low (NH/NL) Indicator. And it cost me because I put on positions in $RENN and $DANG in recent weeks after warning signals had been given. I did avoid a new position in $LNKD and saved money heading into the earnings announcement. Overall, shame on me but I didn’t lose too much because rules were followed and I am digging deep to listen to my indicators. Regardless of what “ I think may happen”, I am listening to my indicators and charts 100%!

So you ask: What warning signals?
The first signal was given by the Dow Jones NH/NL 10-day average differential (Diff) (chart above). The 10-d Diff started to make lower lows as the Dow was making higher highs, a clear divergence that warns the underlying stocks are weakening while the overall market is making a new high. This one signal alone should have put me on caution while entering new positions. It didn’t because the NH/NL 10-d Diff was still above the critical level of zero. Well, the market took care of that this week by plunging below the zero level, closing at -203 on Friday for the Dow. Consider this, it closed at +15.1 last Thursday ( 7/28) but went red the following day at -2.5 (last Friday, July 29, 2011). The divergence and the reading below zero was now screaming MOVE TO CASH and gave us enough time to do it before the end of the week romp! We all had time to get out without taking a loss. As it stands now, the 30-d Diff is also below zero with a reading of -21.47, the first reading below zero since July of 2010.

It’s interesting that the markets topped in May, just as Osama Bin Laden was killed – I must give a HT to Howard Lindzon for coining the Osama Bin Laden Top (he may have nailed it) and closing his blog post with this statement:

With the mood of financial markets quickly turning negative, the horrific price action of financials, the silliness of IPO valuations and some Bitcoin mishigas, you may not soon forget the ‘Osama’ top.

Now, let’s take a look at a number of charts and see what they “were” saying and what they “are” saying right now, as we head into next week (ahead of the market reaction to the US credit downgrade). NOTE: I personally believe that the downgrade is mostly priced into the market but I am sure we will still see some further selling pressure before a normal bounce.

The first chart that I would like to explore is the percentage of stocks trading above the 50-day moving average on the S&P 500 Index. Oversold conditions typically appear when this indicator drops below 20%. We last saw multiple readings under this level back in May, June and July of 2010, the last time the market traded below the 200-d ma. The reading closed at 3.6% on Friday, the lowest level since the 2008 market correction. This says that the market is oversold and is due for a bounce which may be the case but keep in mind that readings below 20% can exist for months at a time with short term rebounds. So, I see this signal as short term for now, considering the Dow Theory confirmations and the NH/NL readings. We will bounce higher but the other charts are signaling a longer term correction until told otherwise!

This chart shows the NH’s and NL’s added together to give us the daily differential. Friday registered the most new lows since November 21, 2008 when the reading spiked to 1,527 (historically low territory). The NH/NL ratio is best used to tell us when the market is changing trends rather than picking the tops and bottoms of markets. The NH/NL ratio has been mostly positive since March of 2009 so the readings of the past few days are red flags as the strength among the individual market participants is weakening considerably.

The NH/NL 10-d Diff is the average of the daily calculations over the past ten days. This 10-day average allows us to view the market action with less volatility than the daily fluctuations. The chart clearly shows us that the NH’s have weakened considerably since 2010 but did make a new high in February of this year. However, that new high was short lived and never quite made it to the peaks of 2010. The red arrow shows us that the NH’s have been trending downward for the past 18 months but most importantly, the peaks have been coming up short from March, to May to July.

NASDAQ CHARTS:
Similar to the Dow Jones NH/NL chart, this NH/NL chart of the Nasdaq is also racking up new low statistics, the most since March of 2009, the beginning of the bull market. What does this tell me: it tells me that the market may be turning since the readings now mimic the start of the up-trend. Short term, we’ll bounce around but watch the NH/NL 10 & 30-d Diff charts to avoid the daily noise.

The next three charts reinforce the action that we are seeing on the Dow Jones. Trend changes can be taken more seriously when two or more of the major indexes confirm the same action on the charts. We have all major indexes flashing the same signals: NH’s weakening, NL’s increasing, Dow Theory Reversal confirmation and distributions days and weeks on big time volume.

One last signal to watch is the action on the Value Line Index (VLE) which was featured in the post What Should We Do, written on October 27, 2008 when the market was hitting new lows. This indicator was down 9.62% last week, a clear sell signal.

The Four Percent Model Indicator uses the Value Line Composite Index (I use the Value Line Arithmetic Index (EOD) or symbol $VLE on StockCharts.com), which can be found on the web or in financial pages of newspapers. The model makes use of the weekly close of the Value Line Index. A buy signal is generated when the index rises four percent or more from the previous week. Similarly, a sell signal is indicated when the index falls four percent or more from the previous week.

I leave you with this: If the trend (this article and analysis applies to the longer term trend, not for day and swing traders) has truly changed for good and does not have the stamina to reverse back to the upside, be careful but understand that this is only the beginning. You still have time to get out before further damage to your accounts. We will have a bounce or two so use them wisely but don’t stay or go long if the Dow Theory doesn’t reverse the trend back to the upside. You have been warned, not by me but by the price and volume action of the market!

I have been trading my own accounts for a decade now and I continue to learn more with each passing day. However, I never thought that a game, a hobby of mine, would advance my understanding and the importance of expectancy and position sizing as much as playing poker. Trading the markets and playing poker both require strict money management rules, stable emotional balance and a solid game plan. If you don’t consider and employ these tools, you will most likely fail sooner rather than later and lose a lot of money along the way.

So, how could a person learn so much from a game that most people consider luck? And why do some traders continually profit year after year while others lose their shirt while making the same mistakes? I will discus the basics of position sizing and expectancy and show you how both items are extremely important when trading and playing poker for profits. I will also close the gap of how each entity (trading and poker) have helped me become better at both.

Many people consider trading and poker pure luck but this is not an accurate observation. Average traders and average poker players taint the outside world with images of luck, quick riches and pure fantasy of the actual grind that is required to succeed. Many factors run parallel with poker and trading but the average Joe would never understand ‘why’ because he or she just listens to what the “talking heads” of television say. Luck may and will play a small part under certain circumstances but rules, odds, risk and money management are the largest components of the two entities.

It’s a grind; trading for a living and playing poker for a living is a grind – a full time business.

I don’t trade for a living but I do trade/ invest to grow my personal wealth. The savings and income from my main career is put to work through investing.

When investing in the stock market, it is essential to have a sound set of rules or a system that has been tested in real time, (back testing or historical testing is not required but can be used, my opinion of course). Back testing helps but playing sports has taught me that Monday morning quarterbacking is for theorists. Once a system has been tested profitably in real-time, the trader or poker player must follow clearly defined rules in order to preserve capital and cut losses. Both traders and poker players must consider the odds of their stock or hand making a gain or making a loss. Price objectives and targets should be a large part of every investor’s system but it is not the essential ingredient to success. Understanding how much to trade or how much to bet and exactly when to make that bet will be based on the system’s expectancy – and this should be the top priority.

So where does system development start? It starts by properly understanding position sizing techniques and calculated expectancies. Using these tools, the investor will be armed to trade only in situations where the odds are in his/her favor. A system that has been tested will have an approximate expectancy that will tell the trader or poker player how much will be gained or lost during each trade or hand over a period of time. Using this as one part of the equation, the investor or trader will now determine how much risk to undertake by calculating a position sizing algorithm that tells them how much to place on a specific trade or poker hand. The word “algorithm” may scare many people away but I have developed very simple position sizing and expectancy spreadsheets that can be found as a link on my blog. They can be downloaded, studied and tweaked without any advanced mathematical experience. This spreadsheet is strictly for trading, not poker.

Most traders and poker players look for three major factors when developing a system:

• How much to trade or bet
• The right odds or positive expectancy
• Multiple trades or hands to play (opportunity)

How do we Calculate Position Size (stock trading example)?

We can determine how much to place on each trade by assuming a $100,000 account with 1% risk on each trade. Using a basic CANSLIM style trading approach, I will place my stops approximately 7-10% below the ideal entry area or pivot point (8% in this example).

$100,000 Account
1% Risk = $1,000
8% Stop Loss
Position Size will be $12,500

We calculate the position size by dividing the 1% risk by the 8% stop loss or
$1000 / 8% = $12,500.

If the stock we are watching has an ideal entry of $50, we now know that we can buy 250 shares or $12,500 worth of stock. Our stop loss is $46 or 8% of $50 and our maximum loss is $1,000 of the original $100,000 portfolio. We can now start to develop system expectancy if we use this basic position sizing algorithm with every trade.

What exactly is expectancy?

Expectancy tells you what you can expect to make (win or lose) for every dollar risked. Casinos make money because the expectancy of their games is in their favor. Play long enough and you are expected to lose and they are expected to win because the “odds” are in their favor. Most games at a casino are completed in a short period of time so they can increase their odds of winning. The only game that does not benefit the casino is poker because the game is played between individuals, not against the house. They do take a rake or a percentage of each pot so we will consider this commission fees. The same holds true for investing. If your expectancy is positive; you can make more money with multiple trades in shorter periods of time. Make sure this style suits your personality before trading or playing poker for a living.

Expectancy is your profit percentage per win multiplied by your win rate minus your loss percentage per loss multiplied by your loss rate. I will use an example of Expectancy from Dr. Van K. Tharp’s Book: Trade your way to Financial Freedom:

Expectancy = (Probability of Win * Average Win) – (Probability of Loss * Average Loss)

Expectancy = (PW*AW) less (PL*AL)
PW is the probability of winning and PL is the probability of losing.
AW is the average gain (win) and AL is the average loss

So let’s do an example using a basic CANSLIM style approach (assume $12,500 per position, a $100,000 portfolio using 1% equity risk):
If my trades are successful 40% of the time and I realize an average profit of 20% but I lose an average of 5%, my expectancy is $625 per trade.

(0.4 * $2,500) – (0.6 * $625) =

$1,000-$375 = $625

I lose 60% of the time yet I show a profit of $625 per trade. If I have a system that produces 65 trades per year, I would realize an annual gain of $40,625 (hypothetical scenario). A 40% gain on the original $100,000 (minus all commissions, fees, taxes and compounding).

Let’s look at the calculation one more time using only percentages:
PW: 40%
AW: 20%
PL: 60%
AL: 5%

(40% * 20%) – (60% * 5%) = 5.00%

What this tells me is that I have a positive expectancy of 5% or $625 per trade from the original $12,500. It doesn’t mean that I will make $625 on every single trade but my system will average a profit of $625 per trade over the course of a year with a combination of winners and losers. I can always make more trades or fewer trades in a year so my total profit will be adjusted accordingly.

With the basics of position sizing and expectancy explained, I would like to explain why poker has made me a better trader. I will start by taking you through a game plan that has helped me use expectancies, emotional balance and position sizing to consistently win money at the tables. I admit that I am not a high stakes poker player but I can hold my own when I feel comfortable with a decent amount of money risked in any one hand ($1-$2 or $2-$5 no limit is my preferred choice – cash games only). As with investing, don’t over trade or trade more money than you are comfortable with. Tournament play is similar to options as a premium is paid up front in exchange for chips or the right to exercise those chips during a specific hand.

As I sit and start to play, my first goal is to become familiar with the character traits of the players around me. Typically 9 or 10 players will be at the table so I will have plenty of time to evaluate the people I am playing with, without risking a great deal of money. After several rounds of play, I will be aware of the character traits of the people I am playing with and will understand that some players may be tight and only bet high odd hands. These players may typically be edgy and nervous and fold cards with force as I have observed in the past. Other players may also play hands with high odds but will mix it up and call bets with cards that carry more risk along with lower odds. Every table has the quintessential bluffer that typically talks a big game, smirks a lot and sports a pair of dark sunglasses. You also may meet the hot shot, “TV-type” player that wants to win the World Series of Poker on ESPN. These players are very similar to traders that buy late night trading systems from infomercials and lose most of their money by incorrectly trading the system or making impulse trades. They also remind me of the people that scour internet web forums, blogs and twitter looking for justifications on their trading ideas or they simply pump their own ideas without following basic rules.

When playing poker, you must pay to gather information from certain types of players and this means calling a hand that you know may lose but the risk and money committed is minimal. Essentially, your overall position size relative to the pot odds justifies the call which allows you to make better or more informed decisions later in the game or tournament. The same holds true when trading. You may have a setup flashing on your screen so you take the trade but it quickly reverses so you close out the position. Don’t consider this a loss; consider this valuable information that warns you that the ideal entry is not now. Instead, you cut the loss while it is small and continue to monitor the situation so you can place another position if the ideal opportunity arrives in the future. You must pay for information in the trading and poker worlds; it will only make you understand the games better.

Don’t forget this rule:

“You must pay for information in the trading and poker worlds; it will only make you understand the games better.”

While poker players are their own characters; stocks are made up of human character traits, similar to the type of people that trade them. Some stocks are risky and volatile while other stocks are conservative and predictable. The market repeats cycles and specific chart patterns because humans repeat their actions and character tendencies. By learning how to target character traits at the poker table, I have started to understand that certain stocks act in predictable ways because the people trading them can’t change their emotional make-up. Many poker players will make the same mistakes and place the same erratic bets no matter how much they try to play differently. Most stocks will act according to historical patterns and follow the trend no matter how much you think the chart will do otherwise.

I won’t get into the exact rules of playing poker but I can tell you that only two players are required to bet per round while the other eight can view their first two cards without risking a cent (my game of choice is Texas Hold’em). The two players required to bet represent the big and small blinds. The dealer and all other player at the table can view the first two cards for free without a bet. If the hand is weak, you can fold and keep your gambling stake.

Here is where it gets interesting; if I have a decent hand, I can decide to call the larger blind and see the next three cards on the flop, which is still a low risk investment. If the flop doesn’t provide me with the cards I need, I can immediately cut my losses short by folding and wait for the next game. The same is true in investing; I can cut a loss short and wait for the next opportunity without risking the farm if I realize an immediate loss. If the cards are good and my probabilities of winning the hand are high, I can call or raise the bet. When I place a trade and it shows a profit, my belief was correct and I will consider adding to the position.

A fourth and fifth card (the turn and the river) are placed on the table after the flop and betting continues with each round. Again, I can decide if I would like to call, raise or cut my losses. The connection I am trying to make with investing in the stock market and playing poker relates directly to cutting losses short (capital preservation and money management) and my odds of winning the game (in the stock market this is called expectancy as explained earlier).

All investors and poker players bring emotions to the table, some people control them better while other people employ more efficient systems and understand the odds on a higher level. The bottom line is to understand the situation around you and to use a sound system to raise your odds. Never bet a hand that represents a low chance of winning and never ride a loss that could multiply overnight. Cut losses short and get out of the game and wait for the next opportunity because they are always around the corner.

While watching a re-run of the 2005 US Poker Championships, a statistic caught my attention so I paused the show, wrote it down and thought to myself that it would serve as an excellent example on expectancy.

Poker expectancy example (this relates directly to trading):
Nine players at the table
34 total hands were played in this round

Player A saw the flop 28 of 34 hands or 82% of the time
Player A won hands 16 out of 28 tries for a 57% winning percentage

Player B saw the flop 11 of 34 hands or 32% of the time
Player B won hands 4 out of 11 tries for a 36% winning percentage

Looking at these numbers and assuming that both players had equal chips (they were close), who do you think made more money during the round?

Most people would guess Player A due to the 57% winning percentage on 16 hands. Player B fails in comparison with only 4 wins, a quarter of the wins of Player A.

Well, Player A actually had a net loss of 5,500 chips while Player B actually had a net gain of 10,000 chips.

So what is my point?

The point is that being active is not a way to guarantee success unless you are following a system with a profitable expectancy. You must formulate a positive expectancy system that balances the opportunities with minimal risk and maximum gain. Player B took on less opportunity but made the most of it when the opportunity arrived.

Player A was erratic and played several hands that gave him poor odds and this is what I see so many traders do when the market is weak. They trade for the sake of trading and they lose. Traders must battle their patience and stick to their rules so they don’t trade erratically and play the game for the sake of playing.

By playing poker, I have cemented my understanding of how people act, how to play the right odds, how to develop expectancies based on the cards I am dealt and how to position my trades properly. Watching these techniques and rules in a live situation really drove home the importance of a system that follows the proven rules. Trading can be a long, tedious and impatient road to travel but following the rules and employing proper position sizing and expectancy calculations will almost guarantee success if the rest of you system does it’s job. If your system is broke, find one that works and understand that you won’t go broke by properly placing your trades or bets and understanding how much you can and will win from each trade and/or bet.

Good luck trading and playing poker!!

The chart highlights in red where I was making the sell posts (the articles are listed below):

Anyway, I have been posting twits about the strengthening of the NH-NL ratio which is starting to tell me that the newest trend change is beginning. Yes, this is my first major blog post saying that my screens (market tools) are telling me to wake up because things are starting to change. It’s not time to jump in with both feet and buy every stock that’s up on above average volume but it’s time to sharpen the skills and be ready. We may look back and point to March and April of 2009 as the bottom of the market or at least the start of the changing trend.

We don’t have market leaders yet but when they appear, I will locate them, post up charts and talk about them nightly on twitter (twitter.com/cperruna). Too many stocks still have their 50-d moving averages below their longer term 200-d moving averages and new highs are still limited. However, new lows have dried up considerably and the NH-NL ratio has a moving average that is trending higher for about a month now. That’s the most sustainable trend for this ratio since the big decline started.

Stay tuned to the blog and my twits for follow-ups to my research on individual stocks and the overall trend.

In the meantime, take a look back at the numerous blog articles I posted in 2007and 2008 talking about a market decline, shorting stocks and selling in general. Learn from what the simple tools were telling us. I am far from a market genius and far from rich but I can make a few dollars following the leaders and the NH-NL ratio.

A Review of Articles Pointing to a Stock Market Decline in early 2008:

• May 23, 2008: Smelling Trouble
  

  The bottom line or point of today’s rant is the fact that I still feel that the market is headed for a decline or as I phrased it a couple weeks ago: The Big Decline (long term perspective of course).

• May 8, 2008: Market Distribution
  

  I originally started to point out market troubles back on March 14, 2008 in a post titled Snapshot Friday; I highlighted both the Dow Jones and NASDAQ with clear yellow shaded areas showing the 200-day moving averages pointing down for the first time since 2003 (that’s huge if you ask me).

• May 7, 2008: The Big Decline
  

  I am a positive person by nature and I prefer to buy stocks going up but I am starting to see several leading stocks struggle to hold new highs or fail to challenge recent highs. These patterns are familiar and they are suggesting that the recent bounce is the final stage before a possible market decline.

• January 23, 2008: Setups for Selling Stocks Short
  

  I wrote an article on October 15, 2007 titled How to Make Money Selling Short, precisely when the general market indexes were topping. I am not going to take full credit but subconsciously my charts were giving me signals that the market was showing the major red flags and signals of what we are seeing today.

A Review of Articles Talking about Selling, Profit Taking and Market Distribution in late 2007:

• 10/03/07: Is Shanghai a Nasdaq Déjà vu
  

  Well, the current two year rise of the Shanghai Stock Exchange Composite Index looks remarkably similar to the rise of the NASDAQ of the late 1990’s and the charts below explain better than I can!

• 10/04/07: A Technique for Profit Taking
  

  What do you do in a market like today when you have profits in multiple positions but you don’t want to give it all back? You want to continue to ride the winners but at the same time, you want to maintain the unrealized gains in your account. HOW?

• 10/12/07: Distribution Day
  

  This was the largest showing of volume in two months and is not healthy because it was pure distribution. It was only the second distribution day over the past month so we can’t call this a bear run but please be on the lookout for a possible correction of 5%-10%. Technology stocks led the decline as BIDU gave back 10% of its amazing run.

• 10/15/07: How to Make Money Selling Short
• 10/17/07: Inverse ETFs
  

  Have you ever wanted to short the market because you knew it was going down but your were too overwhelmed, nervous or even scared because you were unsure of how to do it. Well, Inverse ETFs may be your thing.

  These inverse ETF’s closed Wednesday with gains of 13.42%, 15.43%, 22.31% and 18.76% since I wrote about them.

• 10/18/07:The Real PTR Climax Run?
  

  I was early in September by trying to locate a climax run in PTR in this post:
  Petrochina (PTR) Climax Top? However, the HUGE volume on the latest push to new highs clearly indicates something is going on.

• 10/20/07: Second Major Distribution Day
  

  Technically speaking, we now have 4 distribution days for the NASDAQ and 3 for the DOW over the past month. It’s now time to start focusing big-time on the market leaders to see where they are going to take this market. If they start to roll over, you better be quick to take profits and even quicker to take losses.

• 11/01/07: CROX getting Swallowed
  

  I wrote a post titled Will CROX get Eaten? on September 20, 2007 and strongly noted the declining institutional support (see numbers below). Someone was jumping out of the stock and we now know why!

• 11/08/07: Market Corrections, Bears and the Big Picture
  

  Keep in mind that nearly 75% of all stocks follow the general market trend. Your cash doesn’t need to be committed to the market at all times. This philosophy is suited to making the most money in bull markets or markets trending higher.

• 12/11/07: When to Sell
  

  Why do so few books exist on the subject of “How to Sell”? Selling techniques are far more complicated than buying techniques and subject to considerably more emotional pressure, than those of buying.

I’d love to find someone that can venture through a single day without reading, hearing or talking about the current state of the economy, the stimulus plan, the bailouts or ponzi schemes. It’s sickening but what’s worse is the fact how NO ONE talks about fixing the problem correctly. Does anyone learn from the past?

I didn’t read the stimulus package in its entirety (it appears that our representatives didn’t either) so take what I say with a grain of salt.

We can blame Bush, blame Clinton, blame Obama, blame Regan, blame Nixon, etc. – it’s all the same; they work for the same crooks, I mean corporation, the US Government!

Time magazine recently published a list of the top 25 people most responsible for this crisis but I would argue that their thinking is flawed and dated by at least 100 years. As Victor Sperandeo noted in his book, Trader Vic – Methods of a Wall Street Master, Thomas Jefferson understood better than any political leader in world history that government “profusion” can only be paid by the “labors of the people.” He knew that a growing government budget and an extension of the services government offers “under the pretense of caring for [the people]” can only come at the expense of private property and individual liberty.

“I place economy among the first and most important virtues, and public debt as the greatest of dangers … We must make our choice between economy and liberty, or profusion and servitude. If we can prevent the government from wasting the labors of the people under the pretense of caring for them, they will be happy.” – Thomas Jefferson

“The issue is always the same: the government or the market. There is no third solution.” – Ludwig von Mises

This blog entry is not about playing the blame game, pointing fingers or determining who is responsible but rather a move towards first discussing and then implementing responsibility and accountability based on how economics 101 truly works (without government interference). I am certainly not ruling out oversight and regulation but I am asking the government to just butt out of the free-market system we call capitalism. They will not make things better. For example, Ludwig von Mises once said:

“Government spending cannot create additional jobs. If the government provides the funds required by taxing the citizens or by borrowing from the public, it abolishes on the one hand as many jobs as it creates on the other.”

He made this statement more than half a century ago but the current administration is doing exactly that, spending an unprecedented amount of money (trillions when they look in the mirror and state the truth) on a stimulus plan that will most likely fail to achieve what its authors claim. I am not arguing that is won’t create jobs but how many jobs will be lost due to the new package. What will the net gain or loss total be once we look back in five or ten years?

The talking heads of the media offer no help as they skew the unemployment numbers every chance they get so they can “GET” their headlines. Even the president is talking about the economy and unemployment numbers reaching levels not seen since the Great Depression. Really? What stats are they looking at? This is a sensitive topic as several of my family’s closest friends have lost jobs in recent months but the truth is the truth.

Business Week noted:

In the last year, the U.S. economy shed 3.4 million jobs. That’s a grim statistic for sure, but represents just 2.2% of the labor force. From November 1981 to October 1982, 2.4 million jobs were lost — fewer in number than today, but the labor force was smaller. So 1981-82 job losses totaled 2.2% of the labor force, the same as now.

Job losses in the Great Depression were of an entirely different magnitude. In 1930, the economy shed 4.8% of the labor force. In 1931, 6.5%. And then in 1932, another 7.1%. Jobs were being lost at double or triple the rate of 2008-09 or 1981-82. This was reflected in unemployment rates.

The latest survey pegs U.S. unemployment at 7.6%. That’s more than three percentage points below the 1982 peak (10.8%) and not even a third of the peak in 1932 (25.2%). You simply can’t equate 7.6% unemployment with the Great Depression.

Come on, 7.6% is not 25.2%. Gross numbers of jobs lost today may be larger than a specific time in the 1930’s but an apples-to-apples comparison using percentage ratios shows us that the comparison is stupid. Times are tough and many people have lost their jobs and many small businesses are shutting their doors but let’s not spew inaccurate data to rush a stimulus plan through congress.

“The wavelike movement effecting the economic system, the recurrence of periods of boom which are followed by periods of depression is the unavoidable outcome of the attempts, repeated again and again, to lower the gross market rate of interest by means of credit expansion. There is no means of avoiding the final collapse of a boom expansion brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.” – Ludwig von Mises

As the quote says above, economic cycles of booms and busts are inevitable so let them run their course rather than have these non qualified elected politicians (with lobbyists in their pockets) making the decisions. How many current and past administration members actually started and owned a business or were active investors? So why are they the ones trying to pull us out of this mess? It’s a joke!

I don’t have all of the answers and I am not the smartest or most qualified guy in the room; however, Washington doesn’t have the most qualified guys in the room either (the most qualified guys/gals were not even on the ballots prior to the election)! With all of the bailouts running though Washington, what’s the incentive to do the “right thing” when Uncle Sam will come to your rescue and in some cases reward you for fucking up! Sorry but this pisses me off.

Many of the quotes throughout are from Ludwig von Mises (1881 – 1973), who was an Austrian Economist, philosopher, and a major influence on the modern libertarian movement. Although I don’t agree with everything Ludwig wrote, I can say that the vast majority of his writings are singing the tune: “I told you so”.

One last thing – I HATE THE PHASE: “Distribution of Wealth”

• “The masses, in their capacity as consumers, ultimately determine everybody’s revenues and wealth.” – Ludwig von Mises
• “Taxing profits is tantamount to taxing success.” – Ludwig von Mises
• “It is untrue that some are poor because others are rich. If an order of society in which incomes were equal replaced the capitalist order, everyone would become poorer.” – Ludwig von Mises
• “The riches of successful entrepreneurs is not the cause of anybody’s poverty; it is the consequence of the fact that the consumers are better supplied than they would have been in the absence of the entrepreneurs effort.” – Ludwig von Mises

Finally, I sure as hell hope we are not walking down the path of Socialism (and I am not targeting Obama and his administration; this journey started decades ago).

“A society that chooses between capitalism and socialism does not choose between two social systems; it chooses between social cooperation and the disintegration of society. Socialism: is not an alternative to capitalism; it is an alternative to any system under which men can live as human beings.”

Tell me what you think, let’s start a discussion! I prefer to hear from you as the media and these so-called experts are pure garbage.

• Listen to My Audio Interview
• My Interview at StockTickr
• Position Sizing and Expectancy
• The Holy Grail of Trading: It’s not your System
• How to Create a Successful Stock Watch List
• My CANSLIM Screening and Buying Strategy
• Fundamental Screens and Scans
• CAN SLIM Breakdown
• Understand the ‘M’ in CANSLIM
• Paper Trading: Nothing to Lose, Nothing to Learn
• Focus on You
• Could you Trade Full Time?
• Position Size to Determine How Many Shares to Buy
• Trading Mistakes: Avoid at all Costs
• How to Calculate a Stock’s Pivot Point
• Do Not use Fundamental Analysis Alone!
• How to Short a Stock
• Learn to Focus when Investing
• Markets are not Efficient
• Point and Figure Charts

I will refer to a couple of quotes I have posted numerous times on this blog:

“All through time, people have basically acted and re-acted the same way in the market as a result of: greed, fear, ignorance, and hope – that is why the numerical formations and patterns recur on a constant basis” – Jesse Livermore

“Wall Street never changes, the pockets change, the stocks change, but Wall Street never changes, because human nature never changes” – Jesse Livermore

The books listed below were found through a fabulous list provided by the Hess Collection from An Exhibit at The University of Toledo ‘s William S. Carlson Library. February 22–April 30, 1999

As you can see, things will never change, as much as we wish they would because it’s in our DNA (we’re human).

Don’t these titles sound familiar:
How to Cope with the Developing Financial Crisis
By Ashby Bladen, New York: McGraw-Hill, 1980.

Financial Crises
By Theodore E. Burton, New York: Appleton, 1931.

Our Mysterious Panics 1830-1930
By Charles Albert Collman, New York: Morrow, 1931.

Booms and Depressions: Some First Principles
By Irving Fisher, London: George Allen and Unwin, 1933.

The Stock Market Crash–And After
By Irving Fisher, New York: MacMillan, 1930.

When the Merry-Go-Round Breaks Down
By Wilfred J. Funk, New York: Funk & Wagnalls, 1938.

The Great Crash 1929
By John Kenneth Galbraith, Boston: Houghton Mifflin, 1955.

The Causes of the Panic of 1893.
By W. Jett Lauck, Boston: Houghton Mifflin, 1907.

The 70s Crash and How to Survive It
By John F. Lawrence and Paul E. Steiger, New York: World Publishing, 1970.

Anatomy of a Crash–1929
By, J.R. Levien, New York: Trader’s Press, 1966.

History of Business Depressions
By Otto C. Lightner, New York: Northeastern, 1922.

Wall Street Panics: 1813-1930
By D.W. Perkins, Waterville, NY, 1931.

Deficits and Depressions
By Dan Throop Smith, New York: Wiley & Sons, 1936.

Prelude to Panic: The Story of the Bank Holiday
By Lawrence Sullivan, Washington, D.C.: Statesman Press, 1936.

Trade Depressions and Stock Panics
By Richard Whitney, New York, 1930.

The Work of the New York Stock Exchange in the Panic of 1929
By Richard Whitney, New York, 1930.

Past Blog posts about “Crisis” Authors/ Books:
Make Millions Selling Fear
‘Crisis Authors’ feed on people’s Fears!

So, why are the same goons that created our mess trying to solve it?
The politics in our country is a joke!

By the way, we are not in a depression (the talking heads just won’t shut up). The restaurants and movie theatres are packed, the malls and box stores are packed, the parking lots are filled with SUV’s, etc…

Recession, yes, but we are NO WHERE NEAR a depression. Just some thoughts as I celebrate my grandmother’s 85th birthday; she lived through a “real” depression.

Yes, my post title is slightly misleading…

Everyone is an expert when it comes to the market, or at least a certified psychic. Everyone seems to think they know what’s supposed to happen, especially if you read the articles around the web and the newspapers on the stand.

You know what I think: Talking heads are useless!

Why don’t we just sit back and allow the market to tell us where it wants to go. I can’t say that expected the market to rally more than 10% or almost 900 points the exact morning I post the parameters to a pivot reversal (the article was written Monday night while watching the Titans smack around the Colts).

In any event, the market clearly marked day one of the attempted rally. No argument here.

Is it too early? Should we wait on the sidelines? Should we wait for the election? Are you scared to trade? Are you scared to lose? Are you embarrassed to be wrong?

Rule #1: Wait for a follow-through on overwhelming volume, 4-10 days from today’s 10% surge. The signal will be “buy” if we get a follow-through, so add a few shares at that time. Maybe it will reverse but we can’t think to hard about rules etched in stone, so we can only act based on the historical odds presented by this scenario. Trade small; enter a position that is 1/3 or 1/2 of your regular position size or trade fewer units but don’t sit on the sideline because you “think” this is a false move.

As I said yesterday, 20% of all moves that provide a pivot and a follow-through will fail so we do have a 1-in-5 chance of witnessing a head-fake. But that also means that we have a 4-in-5 chance that a rally can form if we get a follow-though starting this Friday and lasting until Monday, November 10, 2008 (day 10).

I’ll admit, I have many biased views on this market and it is will take a lot of courage for me to pull the trigger but I must clear my head and follow the tape, follow the price action and most of all, follow the rules.

According to some, today’s 10.88% Dow gain on above average volume was a first or second follow-through from the pivot reversal established on Friday, October 10, 2008. This is true because the Dow has not undercut the previous low during this attempted rally but the follow-through is also coming on the 13th day – outside of the 4-10 day period that we typically assign to the start of a rally. Besides, the NASDAQ did in fact undercut its previous pivot reversal. IBD has been quoted to say: “Follow-throughs that occur after Day 10 yield lower success rates.”

I don’t consider this a follow-through because we have exited the 4-10 day follow-through period and the market has trended lower with distribution days. Today is day 1 in my book, for purposes of analysis on this blog.

When does a rally attempt end? A rally ends when an index such as the Dow or NASDAQ undercuts the rally’s low. The count will restart from 1 when the next pivot reversal appears.

Don’t rush to buy stocks after a prolonged down period because stocks with quality bases will be difficult to find and they will lack ideal accumulation or entry points. Build a watch list instead. My watch list is slim because it’s very difficult to find quality candidates at this time. The best method in my mind is to look for stocks with strong relative strength ratings that are trading above their 200-day moving average.

So, let’s sit and wait to see if we get a follow-through four to ten days from Tuesday.

“Whenever I have had the patience to wait for the market to arrive at what I call a “Pivotal Point” before I started to trade; I have always made money in my operations” – Jesse Livermore, 1940

Market direction or the ‘M’ in CANSLIM as I have highlighted it in the past is the most critical characteristic to consider when investing. Seventy five percent of all stocks follow the general market averages with these numbers becoming more skewed in times of extreme pessimism (like now – 90% of all stocks are following the carnage).

Bear markets are necessary to help deflate the overvalued price/ earnings ratios and overpriced shares in times of extreme exuberance. Bear markets create widespread negativity, overwhelming pessimism, fear, uncertainty and a total lack of confidence among investors. Cash exits the stock market as people panic like sheep and prices start to adjust back to reasonable levels, paving the way to new opportunities around the corner.

We are clearly looking for a new uptrend that sustains some life with a rally on above average volume. Bear markets will provide several head fakes as they typically fall in multiple waves of lower highs and lower lows. It usually takes the majority of stocks listed on the exchanges to sell off enough that a true base can form that will propel the next up-trend or bull market.

Study the charts below for the down-waves prior to the 1982 and 2002 bull markets. I selected these two years because they represent the strongest up-trends (bull markets) following a bear market over the past 30 years.

The first rally will feature one or more of the major market indices gaining at least 3% or more on higher volume than the previous day. It is then critical for at least one of these indices to follow-through with similar action four to ten days later (preferably four to seven days later – rules from original O’Neil books).

We won’t be able to tell if the market is building a rally after the first 3% up-swing so give it time and look for at least one, if not multiple follow-throughs from the four day on. The more, the better. Markets will give head-fakes about 1/5th of the time after a true follow-through so we will pay careful attention to the number of waves down during the current bear market. We have had three waves down but only one major wave down on the DOW (it could go lower – easily, before moving higher).

See charts below for the pivot point reversals and follow-throughs for the 1982 and 2002 bull markets.

We must understand that head-fakes and multiple pullbacks are clearly in the historical descriptions of former bear markets. I don’t quite know if the current markets have had sufficient pullbacks before launching a new up-trend (see the charts of the DOW and NASDAQ from yesterday’s post).

What I can tell you is that bear markets typically end while the business cycle is still suffering. With our media, this sucker will last forever – a bunch of useless talking-heads. Why does this happen? Because the stock market is discounting events three to six months in advance (long time readers of the blog know I believe this more than most theories of the market – I consider it fact).

Whether you read William O’Neil, Jesse Livermore, Martin Zweig or Gerald Loeb, they have all confirmed over the past 100 years that no bull market has ever started without an explosive price and volume pivot reversal and follow-through.

The charts displayed today show markets with a pivot reversal and a follow-through – the exact scenario that will take place when the next bull begins and this bear comes to an end. As William O’Neil always says: “The big money is made in the first one or two years of a normal bull market cycle”

So, what should we do?

That’s the question everyone seems to be asking.

A number of people have e-mailed me, sent me messages on Facebook or have asked me in person what I am doing or what they should do. It’s not a simple answer because everyone’s goal is different and the road each of us takes will vary. So, the best way for me to answer this question is to tell you what I am doing.

Let’s start at the automatic investments: 401(k) or IRA. Both my wife and I have these accounts and we will continue to fund them, especially with employer matches (why not – it’s free money). For example, my company matches 100% of the first 3% and then 50% of the next two percent. That’s a 5-to-4 ratio for the first 5% of my salary or in other words, I get an 80% return on the first 5% I add to my account without making a move (profit sharing is another perk that gets added to this account as well).

For example, a $100,000 salary would get $4,000 added by the employer for the first 5% or $5,000 invested into that 401(k). I suggest that anyone that doesn’t currently participate in a plan that offers a match is not making a great decision (in my opinion). Enroll and start making “automatic” deposits into the account; every year wasted is a year you lose out on an employer match and more importantly, the power of compounding. I don’t think this is the best option to grow wealth but it’s not bad when you get a match.

What about my individual stock investing account?

First, I always run to my personal library of “yellow highlighted” stock market books in times of extreme pessimism or extreme optimism. Why, because I can pick the brains of men and women who have gone through similar situations and learn from their experiences. In particular, I read Martin Zweig, Jesse Livermore, William O’Neil, Gerald Loeb and Victor Sperandeo (see reading list for details). I’ll also glance at pieces written by Warren Buffett and Peter Lynch for fundamental pointers.

Benjamin Franklin once said: “The things which hurt, instruct” – so pay attention to the indicators mentioned below and be disciplined and flexible, poor market speculators are never flexible and rarely follow the tape. It seems that every indicator is hurting big time so listen to what they are saying.

Let’s get started: I am analyzing my stock screens every week (nightly when possible). I am trying to understand the flow of the market, I’m looking for market leaders and industry groups that may want to take the lead when a bull market does decide to begin. Bull markets (up-trending markets) begin when one or more of the major indices are up at least 3% and then have a follow-through 4-10 days later with similar action. This is the first parameter we must look for.

Next, I will borrow a few techniques from Martin Zweig: I am closely watching the Advance/Decline Indicator, the Up Volume Indicator and his Four Percent Model Indicator. Definitions are below:

Advance/Decline Indicator

Advance/Decline measures the ratio of rising stocks to falling stocks on – in Zweig’s examples – the NYSE. It excludes stocks whose price does not change. If 2000 stocks rise and 500 stocks fall, the A/D ratio would be 4. Zweig uses the example of the rare event of a 10 day A/D ratio of two or more (2-to-1). If you had invested in the market as a whole each time this has happened, in the following 6 months, your investment would have risen by an average of 19 percent.

Up Volume Indicator

Up Volume is the total number of shares whose price rises. On the NYSE, the daily volume runs into billions of shares. Zweig has found that when 90 percent of the volume (excluding volume in shares whose price has not changed) is upward (9-to-1 ratio), significant upward momentum in the market is likely.

Four Percent Model Indicator

The Four Percent Model Indicator uses the Value Line Composite Index (Recently, I use the Value Line Arithmetic Index (EOD) or symbol $VLE on StockCharts.com), which can be found on the web or in financial pages of newspapers. The model makes use of the weekly close of the Value Line Index. A buy signal is generated when the index rises four percent or more from the previous week. Similarly, a sell signal is indicated when the index falls four percent or more from the previous week.

I am paying attention to Zweig’s indications as well as the New High – New Low Ratio (NH-NL), the general action among the major indices (mentioned above) and the market leaders. Other charts of interest that suggest a buying opportunity is now is the percentage of S&P 500 stocks above their 50-ma. and the percentage of Nasdaq stocks above their 200-d m.a. which is at its lowest level since it started to be tracked by my software.

My next blog post will focus on the stocks/ industries that have the strongest relative strength and best values according to my screens.

For a raging bull market (up-trending market), you need falling interest rates, probably an economic recession, lots of cash on the sidelines, good values in the market-namely, low price/earnings ratios, and a great deal of pessimism because it means there’s an abundance of cash. – Martin Zweig – We currently have all of these conditions.

“One of the frustrating things for people who miss the first rally in a bull market is that they wait for the big correction and it never comes. The market just keeps climbing and climbing. It feeds on itself in frenzied fashion and propels prices considerably higher for six months or so, and sometimes longer.” – Martin Zweig

Hang in there, no one truly knows when the carnage will end but historic opportunities are setting up right in front of our very eyes. I may be a little early but I will definitely be prepared.

“Buy when blood is running in the streets” – Baron Rothschild
“I long ago realized that the stock market is never obvious. It is designed to fool most of the people, most of the time” – Jesse Livermore

Let’s nail this sucker together!