The Deipnosophist

Where the science of investing becomes an art of living

My Photo
Location: Summerlin, Nevada, United States

A private investor for 20+ years, I manage private portfolios and write about investing. You can read my market musings on three different sites: 1) The Deipnosophist, dedicated to teaching the market's processes and mechanics; 2) Investment Poetry, a subscription site dedicated to real time investment recommendations; and 3) Seeking Alpha, a combination of the other two sites with a mix of reprints from this site and all-original content. See you here, there, or the other site!

10 November 2008


Deipnosophist reader, Ray Seakan, notes, "I noticed there hasn't been any recent posts regarding specific investment recommendations. Is this a change in the direction of the blog?"

No. Please do not interpret a lack of investment recommendation posts as a change in this blog's direction or purpose. I attempt to accomplish two core items as an investor:

1) Investigate further my favored investment opportunities, old and new
2) Discern how each opportunity trades in relation to the market's direction, its relative strength (more below).

And please recall my preferred investment opportunities tend not to change from one season to the next. Price action does not determine my decisions and actions, only changes the reward:risk ratio. In light of these comments, what more could I add to what I have already said re Apple/AAPL, Google/GOOG, and Johnson & Johnson/JNJ, et al? I admit, though, that my 9 Core Opportunities have changed quite a bit; when the time is right, I will reveal those changes. For now, though, please see #s 1 and 2 above.

Matthew writes...
"You make posts about issues that play key roles in determining the financial zeitgeist. My difficulty is that while now I have a better understanding and more knowledge, when I log into my trading account I still don't know what to do. There is a distance between understanding the financial situation and where to actually invest. Sometimes the gap is alienating and shows little clear relationship -- and other times the relationship is painfully obvious. How to bridge that gap?" ... "You're helping me to better understand the context in which I am trading. These "background" variables obviously play a huge role in individual stock prices. And of course the background/foreground distinction is not ultimate since they both participate in each other. More and more I am seeing how understanding the system and the environment is crucial to success on an in individual level. I always knew that background variables played a huge role but I was at a loss to understand the whole environment. I don't have capital to utilize at the moment so I haven't been actively trading these last few months. But in the end, is not all this background info useful in as far as it informs our direct actions (i.e., trading and investing). Unless one is studying these matters like a "pure science" or out of interest we want this information to translate into action. I wonder if this kind of knowledge could even be fit within the confines of an algorithm. A good test of knowledge too of course is its predictive value. I still don't understand the whole environment to have a sense on how deterministic its features are. If the variables are massively complexing and changing (if even only by virtue of the fact "more is different" -- quantitatively larger systems are qualitatively different -- then how to create fixed knowledge structures that remain efficacious? Sometimes we don't even need to understand the underlying mechanisms to exploit the higher level phenomena. I think a chartist might go that direction. Due to my lack of understanding I'm still having difficulties translating background info to a usable form in the foreground."
Whew, excellent questions and comments, Matthew. Thank you. Where to begin?

I once labored for many hours each day, before the markets opened and after they closed, to discern background noise from salient points I could bring foreward into the foreground of that day's decisions and actions. Meanwhile, my colleague and friend, Trader Dan, would stroll into the office, yapping away with friends, grab coffee, and did not sit down at his desk until the markets opened. At which moment, he became a whirlwind of decisions and actions; his trades outnumbered mine (although neither of us are or were day-traders), despite my preparation. How could this be? The markets' ovements should appear random to him, as they lacked any background to foreground context. And then I understood: I could control only this moment -- here, now -- not what occurred in the past or would occur in the future. Investors whose time frame measures in hearbeats especially live in the moment; for example, Mark Haines (of CNBC) typically introduced Jim Cramer as "He, from the Church of What's Working Now." While that quality makes for a good trader, it also hallmarks a terrible investor. (And certainly disqualifies the person from politics. Sorry, Jim; 'tis so.)

The US equity markets, by and large, are open for 360 minutes each weekday; i.e., Monday through Friday. Does your holding period exist within that daily measure of 360 minutes? Then the background information you require is only to know that today, now, is a market day, and you can make money; not dissimilar from heading to the supermarket knowing that you need cereal and eggs and milk, etc, but care not at all for brands, etc. Any stock works for you, so long as it works; just as Special K works equally as well as Rice Krispies, if only one is available that day. But if, like me, only Special K will do, then you wait to purchase when it is next available.

A similar rationale applies to my investment decisions; not every stock passes muster, only the best. (Or what I perceive to be the best.) I seek what I view to be Core Opportunities, and then attempt to find opportune moments to purchase, and sell. Market trends come and go and come again, but my favored investments should stick around for more than a season or two; not one is a flash in the pan.

A wise investor, Ed Hart, who sadly is no longer alive, frequently described a phenomenon he described as tension on the tape. While the markets trend in one direction or another, something other would occur under the surface, less obviously. Ed would create a basket of securities, frequently reconstituted, that would betray a market's subtle clues of directional change, and as those items broke through their surface tension, up or down, the market often would follow. I view Ed's method an excellent perceptual tool for all investors, of all time frames. Professional investors tend to accumulate, and distribute, during periods of sideways-trending prices, always mindful of time frame and periodicity.

Call it the week from hell, or even a bear market, but the week from Friday, 3 October through Friday, 10 October 2008 will live long in our collective memory. Funny ironic, not ha-ha, how that week seemed to linger on, uninvited, and cause investors everywhere to shun the markets, like avoiding your eyes anytime a character walked through Linda Blair's bedroom door in the movie, THE EXORCIST. "Don't look; fearsome things reside there!" Don Coxe (BMO Capital Markets) tells an interesting tale of how the FRB, in the person of Ben Bernanke, and the US Treasury, in the person of Henry Paulson, in a clever attempt to leverage the markets pushed downhill the first pebble; from Don's essay, I infer the Law of Unintended Consequences assumed control and the pebble quickly became the avalance we suffered in September and October. But is the market decline over, or merely resting before resuming its plummet? Contact me, if you would like a copy of the germane section from Don Coxe's research commentary. (UPDATE: Offer rescinded on 11.17, due to a lack of interest.)

Ugly as the markets' recent trend has been, its woes are nothing when measured against the possible and probable difficulties that lie in wait for the economy, for us all. Our portfolio losses can decline only to $0 before the pain ends, but lose a job, and struggle to pay bills (Which bill first?), and the concerns mount. Consider the ripple effect from the layoffs just now beginning in New York City; not solely Wall Street, but real estate, restaurants, retail, consumer anything. In turn, layoffs will occur in those areas, which will create their own ripple effect, and cause other derivative ripples from there. One of the reasons we, and other nations everywhere, did so well during the 1950s and 1960s was the sudden burst through the surface tension of forced deprivation engendered by the Depression (1930s) and World War 2 (1940s); the 1980s, 1990s, and the the early years of this decade had the digital revolution. I am not a seer, but I see no similar engine of massive, overarching growth that could pull us back from our collective Wile E Coyote moment. (Run off the cliff edge, with the only terra firm beneath us way down there.) We all can hope I am wrong again.

In such an environment, the markets recent ugly action is understandable. Negative chart patterns and setups predominate; an overwhelming 90% of NYSE stocks remain in a negative price trend. But this all, and more, is obvious; too, this bear market has endured for 1 full year, and then some. The markets' recent plummet could be the fireworks that signal a change of direction that endures for more than 3 days or even 3 weeks. Although such a price move, should it occur, would be sideways to slightly up at best, it is necessary to help build a more enduring base and to restore investors' confidence. New trends start somewhere, though; every journey begins with a single step. This reality makes it imperative to note those stocks that build internal bases and improve on a technical basis within the confines of their overall negative trend. For example, after ~10 years of wandering in the desert, I note several key large cap companies, but especially the pharmaceuticals, have produced important long-term relative strength changes in recent weeks. For example, Johnson & Johnson/JNJ produced a relative strength buy signal versus the market this month (upside breakouts above at ~$62 and ~$66), as did Bristol-Myers/BMY. Other stocks in other groups and sectors of the market behave even better.

Subsequent to the low trade, comes the bottom, which self-defines as a lot of give and take, price movement up and down but confined to a range, an area pattern. Time heals all wounds. Whether a bottom builds from recent lows, or later from even lower lows, certain items must transpire before a more bullish price environment (read, continually rising prices) were to appear. Viewed on a chart, these certain items include (but are not limited to):
a) A diminution in the total number of stocks that trade at new lows (recent numbers have been astronomically high);
b) The decline's trajectory loses its nose-dive formation in favor a flattish shape;
c) Hold repeatedly at support;
d) An upside reversal off said support;
e) A subsequent test of the upside reversal;
f) A breakout above initial resistance;
g) A breakout above its 50 day sma;
h) A price rise toward its 200 day sma;
i) A retracement back down toward its 50 day sma;
j) Back and forth price action circumscribed by the two moving averages;
k) A breakout above its 200 day sma;
l) A new right side to the chart builds.

Among the many price tests and re-tests comes the crucial news response syndrome. Stocks fail to make lower lows, even as the economic and financial news worsens, which will happen. Markets, though, rarely are monolithic, and upside opportunities crop up even during the most ferocious declines, and vice-versa of course.

Due to the ferocity and rapacity of the recent portion of the decline, a lot of time must lapse before even the possibility of new all time highs. (In which "lot of time" equals months, if not years. Obvious, then, the lack of need for excitability to hurry and buy now. The confidence of all investors of all time frames must itself rebuild; without systemic faith, which has been shaken to its foundation, most investors will simply stay away.

Items to keep in mind:
• Let not temptation get the better of you. Have available the cash to buy -- but only when the moment is ripe with opportunity.
• Know in advance the investments you will want to own for when that better moment comes to be, if it has not already arrived.
• Keep your head in the game by maintaining the flow of ideas. Leave your heart and stomach out of it.
• Consider that the first group of stocks to emerge could be those traditionally favored by institutional investors; specifically, large cap. Retail investors, mostly, will remain in their trenches, heads down while maintaining a low profile while they attempt to time the market. Whereas the job of institutional investor is to invest, and when the itch hits, they will scratch. Thus, I would seek initial potential winners from large cap stocks, and sort through the groups and sectors whose strength is both absolute and relative to the market in general. I see many examples of that type of cropping up in increasing numbers.
• Remember that the sun does rise every day, no matter how dark the night becomes.

So, yes, Matthew, there is some aspect of "prediction" to chart reading, but in the end, it is just one more methodology, and thus more deterministic than predictive; deterministic of your decisions and actions, and other like-minded investors. But that is fodder for another post.

My titles frequently offer a deeper meaning to the post itself; such is especially true with this post's title. Learn more re

Trade well. Be well.
-- David M Gordon / The Deipnosophist

Labels: , ,

who's online