Periodically I write an article that reviews the past few months of articles. Why on Earth would I do this? Primarily for two reasons. One is that many new readers are involved and often they do not go back and look at the past articles. Two is that my articles are rarely tied to anything that is happening in the markets. Generally, they are about experiences I have had as a technical analyst for 45 years; the good, the bad, and the ugly. You can click on the headers for a link to the article.
I witnessed many of these first hand when I was in money management. Here is a synopsis of the article: not beginning the process of preparing soon enough, getting aggressive trying to catch up when you realize you are behind, adjusting spending to align with what you have available for retirement, realizing late that your company offers a 401k plan with matching contributions, and first time some start to think they may not have enough money.
Modern finance is totally wrapped up in believing that risk is volatility. They say that standard deviation is volatility, hence risk is standard deviation. What nonsense! In this piece I show an analysis on how far off standard deviation is based upon the average returns over look-back and look-forward data. I wanted to see how many days had a +3 sigma (standard deviation) and how many had a -3 sigma, hence data outside of a =-3 sigma band. In the first example I did a 5-year analysis where modern finance says you should only have 2 days outside the 3-sigma band. Not so fast! In this example there were 49 days above 3-sigma and 69 days below -3-sigma. A few other time frames were shown with the results being similar. Standard deviation is a poor measure of risk.
This article was done to provide a simple reminder and example that there are and will be bear markets. After over 8 years of a bull, many newcomers to the markets may believe the days of bear markets are over. I show a chart of the Japanese Nikkei Average from 1989 to 2003 where it declined almost 80%. There was an extended period of sideways action, but it was resolved to the downside. Buy and hold seems to work well in bull markets, then a good bear comes along and offers some education.
Here I introduce protective stops; a process that does not use them simply is a bad process. One of the stops I use is a percentage drop from a moving high price. For example, when my model is green and says this is a good bull move, the stop loss is 5% below the highest price reached in the past 21 days. This stop is not available in StockCharts.com, but they do offer a chandelier stop which serves the purpose. Bottom line is this: if you are going to determine what is your best stop loss technique; make sure you follow it when the time comes.
I have often said that modern finance totally abuses the use of average (mean). I show a convincing example of driving a car a fixed distance at one speed, then turning around and driving back the same distance at a different speed. I ask what is the average speed. Most will just add the two speeds and divide by two. That would be wrong, because speed is velocity which is rate times distance (MPH). The example then explains that you cannot average ratios like you can constants.
Just to keep up with the times I thought this would be appropriate if tied to the financial news. News is a total waste of time if you are trying to garner investment information. It misleads, is irrelevant, has not explanatory power, is toxic to your body, increases cognitive errors, inhibits thinking, works like a drug, wastes time, makes us passive, and kills creativity. Here is VanRoy’s 2nd Law: If you can distinguish between good advice and bad advice, they you don’t need advice.
I seem to write about the experts a lot; I think they are frauds in almost all accounts. The book, “The Fortune Seller,” says forecasting is no better than guessing, has no long-term accuracy, cannot predict turning points, there are no leading forecasters, no forecaster was better with specific statistics, no one ideology was better, consensus forecasts do not improve accuracy, increased sophistication does not improve accuracy, and forecasting has not improved over the years. Ignore them!
I think this article helps explain the well is running dry with ideas for future articles. As an aerospace engineer I attempt to tie basic aerodynamics with investing as both use a term called ‘alpha.’ I discuss investment angle of attack, instrument flying 101, and relate it all to a technical model. A technical model is like flying on instruments; it removes emotions, eliminates the current market hype, and it is something you can strongly believe in.
Breadth is an extremely key component to a good trend following model. Breadth offers the following:
It takes advantage of inefficient markets.
Avoids heavy concentration into a few stocks.
Get more exposure to small capitalization stocks.
Breadth analysis is like quantum mechanics, it does not predict a single definite result, instead it predicts a number of different possible outcomes.
I find it amazing that most of the financial media focus on the movements of the Dow Jones Industrial Average. I do agree that long term analysis, it is a decent proxy for the overall market because it contains very large blue-chip stocks. Recently the Dow as reported as make a new high. Remember the following key points about new highs:
New highs are almost always good news; it’s just the last one that is not; in other words, you should worry when something is not reaching new highs.
To say that something is about to make the new 6-year high is essentially the same as saying it has not gone anywhere in 6 years. It took the Dow 16 years to reach a new high between 1966 and 1983.
James Montier is my favorite behavioral investing author. This article relates his thoughts on forecasting, the illusion of knowledge, meeting companies, thinking you can outsmart everyone else, short-time horizon and over trading, believing everything you read, and group decisions. He wrote a terrific book, called, “The Little Book of Behavioral Investing.” I highly recommend it.
It has been a couple of years since I had written about the Zahorchak Measure which was the first rules-based trend following model I had read about. It was a game changer for me. I describe the model again and then remind readers that it and in fact, all of the breadth indicators from my “The Complete Guide to Market Breadth Indicators” are now available in StockCharts.com’s symbol catalog. Have fun!
This is a takeoff of the DALBAR study that shows the average investor does poorly compared to other asset classes and over various time frames. In fact, in the past 20 years the annualized returns of the average investor is only 2.3%, while the S&P 500 was 7.7%. The reasons are many. Chasing performance, no discipline, get rich quick mentality, and most importantly, they do not have or follow a process (model).
Here I go again! The world of finance is fraught with misleading information. They will show you an 85-year chart that clearly shows small cap stocks averaged 12% a year. What they forgot to remind you is that you do not have 85 years to invest. In fact, if you look at the rolling returns and break them down into groups of returns less than 8%, 8%-12&, and greater than 12% annualized, you will see that the middle group is only 22% of the returns.
I’m taking the month of December off to spoil kids and grandkids in Texas. I wish each of you a Merry Christmas and Happy New Year. Stay safe and stay smart!
Dance with the Trend,