The basic principles of my method are in fact quite simple:
Firstly, except in exceptional cases I only buy the stock of companies in new or developing industries, i.e., companies whose growth and earnings prospects look highly promising. I never buy stocks in established industries, in companies with huge capitalizations, or in companies which are already so big that the prospect of substantial growth is highly unlikely.
Secondly, having found such lively stocks, I certainly do not buy them straightaway. I first check the overall market trend to ascertain whether stocks in general are in an uptrend. I then check whether the stock belongs to a strong industry group, i.e., a group that is performing well in the market relative to other groups. Only when I have satisfied myself on these two points do I look in more detail at the stock that interests me.
Why all these precautions? Because I like to be sure that the odds are in my favor. If the market is in a downtrend, and the industry group is performing weakly I know that the cards are stacked against me and that my chances of making big profits are poorer than if the market and the industry are strong. You cannot be too careful in the stock market.
What a devastating week for the bulls. The market internals continue to weaken, with only 24% of stocks in my universe of 4,000 in a short term up-trend. The GMI remains at +1, with only the Weekly QQQQ Index still barely positive. There were only 28 new highs on Friday and three times as many new lows. On Friday, only 55% of the Nasdaq 100 stocks, 66% of the S&P 500 and 50% of the Dow 30 stocks advanced, an insignificant bounce up from the week long decline. Friday was the third day in the QQQQ down-trend (D-3). Since its peak on August 2, the QQQQ (Nasdaq 100 ETF) has declined 4.3% and only 34% of its component stocks have advanced, with only 18 stocks (18%) advancing 5% or more. Why fight these odds?
The WPM shows the extraordinary weakness in the short and long term trend measures of five market indexes. All five indexes are below their 30 day averages and only 20-34% of their component stocks are above their 30 day averages. The Dow 30 stocks continue to show the greatest weakness, short and long term. The big industrial companies are clearly weak. The DIA and SPY ETF’s are both below their 30 week averages, an indication of longer term weakness in trend. Only 30-50% of the component stocks in all five indexes closed above their 30 week averages, suggesting that all of these indexes may find themselves below this key average soon……….
It has taken me 40+ years of trading to understand the folly of fighting the overall market trend. Whether I look at Livermore’s “line of least resistance,” or O’Neil’s “M” in CANSLIM, or Nicolas Darvas’ writings (See Boik’s books at right) I find these gurus all saying that there is a time to be out of the market when it is declining, or to be short. This is a very difficult rule to follow because even in weak markets, I am tempted to go long when I find the “perfect” text book price pattern that brought huge profits in a prior rising market. The critical point to remember is that the same price pattern that works so well in a rising market, is likely to fail in a declining market. Half of the battle for conserving capital is to resist the temptation to buy that unusually strong stock in a bad market. The odds of success are against me. And yet, being in the market is so seductive. (One way I handle such a temptation is to use a very small portion of my portfolio to buy that irresistible stock–just in case I am right.) This topic is so important, I will prepare another post this weekend that will delve into the writings of my favorite guru, Nicolas Darvas, as they apply to the importance of following the market trend.
The GMI is still +1 and the market internals deteriorated Thursday. (I erred yesterday in saying that the QQQQ Weekly Index was negative, so yesterday’s GMI was actually +1.) There were only 22 successful 10 day new highs, the least since I started counting this statistic in May. There were 107 successful 10 day new lows, the most I ever counted. Clearly, buying new highs 10 days ago in the hope of making a profit has been unlikely to work out, and was far less successful than shorting new lows. Only 26% f the 4,000 stocks in my universe are in a short term up-trend, and only 30% are above their 10 week averages. There were 28 new highs and 152 new lows on Thursday. Only 23% of the Nasdaq 100 stocks rose, along with 30-31% of the S&P 500 and Dow 30 stocks. More stocks are now within 5% of hitting a new low (13%) than of hitting a new high (11%). Thursday was the second day (D-2) in the QQQQ down-trend……………
I am therefore mainly in cash. I will use any bounce to unload my few holdings if they start to weaken again. The trading gurus I admire all said to get out of the market when the trend is down–except to take the short side. With more daily lows than highs and with more stocks near new lows, taking the long side is clearly going against the trend………..