INVESTMENT STRATEGY HANDBOOK FOR VOLATILE MARKETS
Carl M. Birkelbach
DUE TO THE LIMITATIONS OF THIS DASHBOARD SYSTEM WE ARE NOT ABLE TO SHOW ANY OF THE CHARTS IN THIS BOOK. HOWEVER, PLEASE CONTACT THE AUTHOR AT CARLBIS@AOL.COM FOR AVAILABILITY
ADDITIONAL INFORMATION IS AVAILABLE UPON REQUEST
Mr Birkelbach does not offer investment advice, but merely his own personal opinion. This report has been prepared from original sources and data we believe reliable but make no representations as to the accuracy or completeness. Mr.Birkelbach , his affiliates and subsidiaries and/or their officers and employees may from time to time acquire, hold or sell a position in securities. Past performance is no guarantee of future success. Upon request, we will supply additional information. CarlBis@aol.com
THE TIMES ARE CHANGING The “American Dream” that your children will be better off than you, is quickly fading. Most of us, from the top 20% to the bottom 80% are fearful that their life style is being threatened. This fear is not based on paranoia. Many are now not only facing unemployment uncertainty and reduced equity in their homes, but because of sustained low interest rates and volatile 401Ks, the “ideal retirement” has become virtually unobtainable. How can you cope with the challenges of today’s economic environment? You have the freedom to invest and the markets to invest in. However, volatile stock markets have disappointed many investors and have driven many individual investors away from the markets. I believe that this exodus is because the old traditional methods of “buy and hold” and Modern Portfolio Theory, (which dictates diversification in mutual fund portfolios) are not designed to offer investors an investment strategy that deals with the reality of today’s current volatile investment environment. Don’t be discouraged, this book will equip you with tools needed to make the necessary decision, so that you can use the markets to become financially independent.
YOUR MONEY AND YOUR EGO
I have been giving investment seminars throughout the United States for some 30 years. I always begin by asking the audience a question: How many of you believe the Dow will go up 1,000 points before it goes down 1,000 points?” Then I ask the opposite “How many of you think the stock market will go down 1,000 points before it goes up 1,000 points?” It’s not easy making investment decisions. We involve our money and our ego. Not a good combination. Our ego demands that we be “right”. When my wife and I get into a heated discussion with differing opinions, she says to me “Would you rather be right or would you rather be happy”. When investing, it is not important to be right, it is important to make money and that will make you happy. It is natural to want to be “right”, but we often see things and the markets not as they are, but as who we are. We can accumulate vast amounts of data to rationalize our position. If the price of our investments goes down along with our money, we will likely argue that the market was “wrong” and we are still “right”. However the market is what it is. Just like in the Bible, when Moses asked the Burning Bush who are you? God answered “I am what I am”. The current price is reality staring you in the face. As British Economist John Maynard Keynes said “markets cay stay irrational longer than we can stay solvent”. Sometimes when you buy a security and it immediately goes down or when you sell and it immediately goes up, you think the security is sentient and is punishing you for trying to make money the “easy” way. But you know logically that security doesn’t know of your existence. It is no more than a vehicle that transports your money and has no feelings for you. You don’t have to be loyal to it. No amount of praying or rationalizing is going to move the price. The future is always uncertain and the current price is the “perception” of what investors think the facts will be like in the future. You can be right about the future, but wrong about the markets. It is supply and demand that moves prices. You want to be rational, but the markets are not necessarily rational. As a normal business cycle goes through expansion, peaks and contraction, prices go up too far and go down too far. That’s always been the case and always will be. Now add the computerized trading that generally accounts for some 70% of the volume and you have even more irrational markets. So stop trying to be right and start making money.
You are not a philosopher like Plato and Socrates in search of the “Truth.” You are an investor who is trying to use your access to investment vehicles that will give you financial independence. So take a deep breath! Why not, you are no responsible for the state of the world or the economy. When it comes to investing, you don’t have to make a judgment about the size and the role of government. That’s not your responsibility. You only have to decide how the markets perceive the current political and economic environment, which this book will help you to do. OK. Find that neutral center within yourself where negative and positive forces cancel each other. Be nonjudgmental. Stop trying to tell the markets what to do. Open yourself up to a different approach. Got it! Now take a deep breath – Oh heck, take three deep breaths. You deserve it.
GETTING INTO THE ZONE OF SUCCESS
This book will outline an investment strategy and a methodology that will hopefully make you self-reliant and make your decision making easier. Although this book emphasis is mostly about the stock market, the methods can be used for anything that you can make a price chart for, including bonds, commodities and derivatives as well I believe that while markets are irrational, they can be irrational in a predictable way! Rather than telling the markets what to do, instead this book will teach you how to listen to the markets and let the markets tell you what to do. As Bob Dylan sang “The Times they are a changing- Either learn to swim or sink like a Rock”.
I will refer to music to accompany some of my points. That’s because the state of mind and zone that you need to enter into is an emotional one. Facts alone will not get you there. Remember markets are not necessarily rational. They go too far up and too far down. So the reference to music is my way of saying, let’s go beyond the rational and be able to get in touch with the emotional side of the market. I am not talking about the kind of emotions that has your hands sweating, eyes hurting and head pounding. That definitely means you’re not in touch with the “Zone”. The “Zone” you are looking for is a place where you are able to quietly look at the rational and irrational aspect of the current markets and not be judgmental. Investing successfully will require both right and left side brain process. The left of the brain is analytical, structured, factual and objective. The right side of the brain is subjective, emotional and intuitive.
Hopefully there will be a time when the answers you seek will suddenly click into place for you. It’s like the tumbles of a lock, that one by one fall into place and the lock opens. The methodology I am suggesting is an art, not a science. You will use the right side of the brain to analyze data and input related news, chart patterns, trends and ratios to arrive at your decision. However, only the left side of the human mind can judge the nuances, intricacies and the “feel” that is needed to be “in touch” with the markets. The answer you seek will not necessarily come to you by just listing all the facts or looking at algorithms. You are not a computer or like any machine. You are better. The methodology I am suggesting is a process. You can’t take emotions out of this process. You have to find a place where your emotions are at peace, so that you can get in touch with the emotions of the buyers and sellers in the markets. It has been my experience that the tumbles of the lock that give you the desired perspective can suddenly fall into place when you least expect it to happen. It may happen when you are listening to music or driving your car or digging in the garden. So, therefore be open to finding a place that helps you to be open to revelations. That brings us to another explanation. The other thing I do in this book is to relate investment decisions and successful investing to a Buddhist Zen philosophy. At the end of this chapter you will find the “Four Nobel Truth for Investing” and in the last chapter “The Eight Fold Way to Investment Success.” This metaphysical philosophy has to do with the peaceful state of mind I believe you need to be in, in order to make wise investment decisions and for investment revelations to occur.. It has been my experience that in order to be a successful investor you need to find that quiet place that resides within yourself that can be achieved only when you are at peace within yourself and at peace with others. I believe you need to find this nonjudgmental metaphysical place in order to be in touch with the forces that affect your investment strategy. Look at this force as friendly. In the right state of mind you will join in the flow of “the harmony of the spheres” as Pythagoras called them and they will guide you to success. The laws that govern the markets are the same that flow through the universe. Awaken!
GOOD AND BAD ARE RELATIVE
For those of us who invest (or speculate) in the markets (stocks, bonds, derivatives commodities etc.) it is important to examine the process and the methodology you now use to determine your decisions. It is human nature for most investors to be positive and patriotic and therefore to be Bullish. We want prices to go up because it is in our general “best interests” that the economy prospers, so our careers, economy and families can ptosper. At one time I labeled my charts as GOOD when a security broke out on the upside and BAD when a breakout occurs on the downside. This is a BAD habit that we as investor have to break. The outcome for us is only GOOD if we are “Long” a security when it goes up or “Short” a security when it goes down. There is a misconception among most investor that they can only make money if the market goes up. Investors no longer have to rely on only making money in up markets.
THE FINANCIAL INDUSTRY
A large part of the Investment Industry is built upon you keep repeating this old BAD habit of thinking you can only make money in up markets. In general 401k’s, Banks or Mutual Funds or most Financial Planners do not provide a facility for investor to make money when the market goes down. The Financial Industry is built on a “Buy and Hold” strategy. I believe this “Buy and Hold” strategy has been created by the banking, mutual fund and the financial planning industry to make investors feel artificially “safe.” “They” explain to you that over the last 50 years the stock market has gone up on average over 9% per year. So your Financial Planner suggests that you buy a good allocation of mutual funds and all you have to do is close your eyes and “hang in there” because on the long term you will just be fine. This “safe” feeling perpetuated by the industry is nothing more than an illusion. The May 2011 cover of National Geographic Magazine shows a person standing on a small ledge half way up the side of El Capitan in Yosemite National Park. It’s dangerous up and it’s dangerous down. In investing, if you feel safe, you just don’t understand the situation.
Most MBAs, Chartered Financial Analysts (CFA) and Certified Financial Planner (CFP) have been taught this one “Buy and Hold” methodology. They have been taught that Modern Portfolio Theory (MPT) and the Capital Asset Pricing Model (CAPM). These investment strategies assumes that price changes are always rational and that investors always accurately forecast the future and that the risk reward ratio to owning stocks versus cash, over a long time period, favors being long stocks. Further, the Efficient Market Hypotheses Theory (EMHT) proposes that it is impossible to beat the market by trading in and out and therefore investors should be fully invested in the market in the aggregate by owning an allocation of mutual funds. The dangerous beauty of these theories, models and hypotheses is that accordingly, your goals will always be achieved sometime in the future. Just “hang in there” long enough. This approach gives investors a false sense of contentment. The investment industry would have you believe that any other methodology means that investors are using the “heretical tactic” of trying to beat the market by using individual stock selection and timing as a strategy.
THE GREAT SIDEWAYS
Since 1997 – 2012 UP 50% & DOWN 50%
Let’s look at chart of the S&P500 Index since 1997. This chart clearly shows that since 1997 the market has been up 50% of the time and down 50% of the time. From 1997 to 2000 the market went up from about 800 to 1500 and then after the “high tech” bubble bust in 2000 it went down to about 800 again in 2002. From 2002 to 2007 the market went up from 800 to 1500 again and then as the housing bubble burst, down to the ‘biblical demonic low’ of 666 in 2009. If you invested in the stock market since 1999, you are lucky to be long term even. As pensions are no longer prevalent, employees have been forced into 401ks. The investment industry has emphasized that 401k’s be invested in the stock market with the inferred promise that on the long run, it is the best investment alternative. The chart below shows that in the last 10 years there have been attractive alternatives to stocks AND THE BUY AND HOLD STRATEGY HAS NOT BEEN SUCCESSFUL. The Investment Industry has investors inappropriately looking at the last 30 to 84 years. It is time for an updated strategy!
|ANNUALIZED RETURNS||LAST 3 YEARS||LAST 5 YEARS||LAST 10 YEARS||LAST 20 YEARS||LAST 30 YEARS||JAN 1926* toSEP 2009|
|S&P 500 –StockIndex||(-) 0.4%||(+) 1.0%||(-) 0.2%||(+) 8.0%||(+) 11.0%||(+) 9.8%|
|Long-term GovtBonds||(+) 3%||(+) 6.7%||(+) 8.0%||(+) 8.8%||(+) 9.7%||(+) 5.5%|
|Intermediate-termGovt Bonds||(+) 2%||(+) 5.0%||(+) 6.1%||(+) 6.9%||(+) 8.4%||(+) 5.4%|
|Long-term CorpBonds||(+) 6.0%||(+) 5.6%||(+) 7.8%||(+) 8.3%||(+) 9.4%||(+) 5.9%|
|30 day- Treasurybills||(+) 0.5%||(+) 2.9%||(+) 2.9%||(+) 3.9%||(+) 5.6%||(+) 3.7%|
Now with money market and Treasury bill yields close to zero and bond interest rates so low, investors are being pushed even more towards the volatile stock market. Retirement is becoming more difficult with interest rates below 1/2 % on Two Year Treasury ($1 Million–$5,000 a year) while stock prices are in a volatile sideways trend.
THE GREAT SIDEWAYS CYCLES OF THE PAST
This isn’t the first time the stock market has gone sideways. A logarithmic chart of the Dow since 1920 finds several other periods that these sideways periods have lasted from 17 to 20 years. During the Depression Era the market went sideways for 20 years. It wasn’t until after 1950 that the Dow was able to break above 200. It took World War II with high Government spending to snap us out of’ the Depression.
SIDEWAYS CHART DOW 1928 to 2009
After 1950 we entered an up market of 18 years of “Happy Days” where Mom and Pop moved to the suburbs, bought new cars every couple of years, had pensions and paid vacations. After 1968, came 17 Years of sideways markets where Vietnam, Watergate and high inflation were problems. This period finally ended in 1981 when the market broke above 1,000 and continued upward to 11,750 in 2000. This growth period was brought on by the computer age and lower tax rates and even saw a surplus federal budget.
THE CURRENT GREAT SIDEWAYS
Our current sideways period has been going on for some 13 years now. This Great Sideways includes two bubbles, the technology bubble of 2000 and the housing bubble that popped in 2008. Why else has the market gone sideways?
1) Globally the piece of the pie the US is getting is a smaller percentage, even though the size of the world pie has grown. Although the US is still a global economic and military power, we have lost ground to places like China, India and Brazil. We took our eye of the ball while fighting two wars during the 2000’s. We are no longer as competitive as we once were. For example 90% of the scientists and engineers live outside the US.
2) The Middle Class in the US is being destroyed. The top 1% of U.S. citizens had 20% of the wealth in 1976 now its 40% (not including houses). The top 20% have 85% of the wealth (91% if housing is not included). Between 1980 and 2003 80% of the total increase in US income went to the top 1%. Between 2000 and 2007 incomes of the top US earners grew 10% per year while the rest lost ground. When we look at the top 1% of the U.S. income earners, their percentage of wealth has grown from 7% of income to 27% of the total U.S. income. Even more startling is that the top one tenth of one percent accounts for some 13,400 families which accounts for some 11% of total income. Whereas, the bottom 11% of income earners represent some 120 million people. How many bars of soap and how many cars can 13,400 people buy as compared to 120 million people? Most of these elite rich are not job creators, but entertainers in the music, movie and sports industry, along with Hedge Fund operators and Wall Street’s top management. In the mid 2000’s Wall Street enhanced their income by creating mortgage backed securities that took the equity out of the homes of the middle class and transferred this equity to themselves in the form of fees. The flow of money is ever increasing larger portions are going to the top ,while the middle class consumers are losing grounds.
3) There has been a redistribution of wealth from shareholders to management as CEOs drain capital from many companies by replacing employees with labor saving technology and then leave with the savings. CEOs earned 24 times the average worker in 1965, now between 275 to 500 times.
4) The budget deficit has swelled to $1.5 Trillion in 2011 or 9% of GDP and Federal Debt of 62% of GDP with forecasts to over 100% of GDP by 2020. Together with state and local governments, budgets are out of control. Most of the recent growth in the economy has been based on debt and stimulus.
5) Unemployment in the US has been a problem as US Corporations are promoting growth outside the US, where the middle class is growing. Corporations use cash for mergers and acquisitions rather than growth in the US. The new high technology industry (Twitter etc.) doesn’t create new jobs in the US as railroads and the auto industry once did. As with Apple, most technology job creation occurs outside the US.
THE NEXT CYCLE?
Buy and Hold worked during the up periods of the 1950’s and again in the 1990’s. However, the current sideways period, based on past cycles, could go on for another four to seven years. Even more to the point, there is no guarantee that this sideways period will end with another large upside move. There is no rule that from sideway the next trend must be up. The jury is still out and the traditional recession/recovery cycle may not happen this time. Most of the market rise since 2008 has been based on increased Government debt and stimulus. American Corporations are doing well in a difficult economy by cutting costs through labor saving innovation and expanding sales in the growing global market where the middle class is growing However, Main Street in the US is facing a “reverse wealth” effect as unemployment increases, credit cards are maxed out, home equity is declining, retirement funds are stumped by low interest rates and volatile stock markets, credit is tight and the cost of living is increasing. Socrates was famous for asking the right question. The BIG current question still to be answered is, “Can American Corporations and stock prices prosper if Main Street is not prospering?” There appears to be tremendous denial among investors that the problems the US faces are over and another upside economic recovery is taken for granted. The next Big move could be down, not up. In addition to Europe faltering, China may be slowing, Japan is stagnant and the Middle East with our oil dependence is always a wild card. At the very least we expect volatile markets to continue for a while.
NEW INVESTMENT STRATEGY
Therefore for investors to not only survive, but thrive in this volatile market environment, they must adapt. I believe a “Buy and Hold” philosophy the purchase of mutual funds can be replaced with either a
1) Bullish Strategy of Buy low and sell high using our methodology and timing techniques which we will outline (Long individual stocks or ETFs) OR a2) Bearish Strategy of sell high and buy low using our methodology and timing techniques which we will outline.(Short individual stocks or ETFs that represent a short position) OR) A Combination Strategy of scenarios 1 and 2 as outlined specifically in Chapter 4
I believe employing the correct investment strategy and market timing techniques are the keys to successful investing. I also believe that mutual funds, for most investors, will become a vehicle of the past. They are not flexible enough for the current environment. They do not allow you to move in and out at will during the day, nor can you go short and make money when the market goes down.
Benefits of using ETFs
Long or Short:
With ETF’s, it is as easy to go long as it is to go short and be able to trade intra-day
Provides broad exposure to asset classes, industry concentration and investment styles
Helps to limit single-stock risk Lower Expenses Management Fees ETF’s as low as 0.07% MF’s avg of 1.4%12-b-1 Fees ETS’s ,ax 0.07% MF’s max 1.0%No teams of analysts to pay Tax Efficiency Passive management Creation/redemption process can help minimize capital gains distributions
LONG OR SHORT—OR LONG AND SHORT- WHY NOT?
Do not be tied to only a Bullish scenario. It is nothing more than a BAD habit that must be broken. Investments are nothing more than a vehicle for your money. If you only follow a Buy & Hold scenario, your vehicle of choice is nothing more than a merry-go- round. A recent Barron’s magazine front page had the cover saying “The Top 100 Investment Advisors”, with the sub title “In choppy seas the best are charting a course away from buy and hold”. Well they got it half right. The other half of this revelation should be that not only is the “buy and hold” strategy not appropriate, but to reveal that since the market has gone up 50% and down 50% during the last 13 years, why not implement an investment strategy for making money when markets goes Up OR
Down. It is not un-American to make money in a down market. Wall Street does it all the time. They can make profits in up or down markets. Why not you? In developing your investment strategy you want to be flexible, not static by investing in mutual funds. Get off the merry go round. You need to be able to drive your own car. You can go forward or turn around and go backward. You want to be in control. Think of the investment strategy methods and methodology in this book as your GPS. Get off the smelly mutual fund bus where you cannot get on or off or reverse whenever you want. One of’ the things I like about my car GPS is when I make a mistake and go the wrong way, the GPS voice (I call her Lola) just nicely tells me “recalculating”. That is the attitude you need to have. (More about taking a loss later)
THE FUNDAMENTAL APPROACH The fundamental approach forecasts price movements by logical cause and effect thinking. Consideration is given to all accounting methods and ratios, future earnings possibilities, current news events and various other pertinent facts about a company and its industry. All this is difficult to interpret and is very subjective. Although this approach may seem quite logical, there are certain disadvantages in thinking only as a fundamentalist. For instance, accounting methods are often misleading. The assets and liabilities of a balance sheet may’ be undervalued or overvalued, depending upon a company’s accounting policy. Future earnings are often difficult to predict because there are many known and unknown facts that must be taken into consideration. It is also difficult to analyze what effect news events will have on prices, for most market information refers to a situation that has happened in the past, which market prices have probably already discounted.
In commodities one has to consider how the carry over compares to previous years,
domestic consumption and exports and how that compares to previous years, the cost of storage weather etc. However, still the question persists of a buying opportunity on the way up or cheaper the way down OR when to sell, on the way up or when to stop a loss on the way down?
In order to become successful in investing, you are going to have to become self-sufficient. Following the Fundamental Approach, interpreting media reports, announcements, business news and S&P ratings could get you into trouble: Research Reports are almost a thing of the past as most brokerage firms have either disappeared or been swallowed up by banks. In the past, even when brokerage reports were available, companies were recommended for investments only because the brokerage company was doing investment banking business with the firm. The best analysts are now working for, where the money is; Hedge Funds. How about S&P ratings? What a joke. The whole time Goldman Sachs was selling worthless mortgage backed securities that were Triple A rated, another division was selling them short. That so far is legal. Maybe not ethical: but legal. The S&P companies are now upgrading the troubled municipalities at the same time they are downgrading US Treasuries.
Company announcements? Enron and Lehman Brothers announcements would have you believed everything was “great” until the very end. The whole time General Motors was going bankrupt, the announcements were all positive. Look at the chart of GM during those good reports. The whole time the company was deteriorating the chart of GM was making lower highs and lower lows. That’s called a down trend and it’s BAD to own the stock that is in a downtrend. . It is GOOD to be short that is going down. Don’t believe the news, believe the trend . The trend is your friend, not the CEO. Depend on yourself and your ability to observe. We will show you how to let the market tell you what to do.
THE FOUR NOBLE TRUTH OF INVESTING
In order to become self-sufficient remember nobody controls the market, we can change our old ways of buy and hold and control own investment strategy selection by going long or short and being flexible with the holding period. It is said a picture is worth a thousand words. But like any picture, the beauty is in the eye of the beholder. Let me help you open your eyes and show you how investors are irrational in a predictable way and to let the market tell you what to do through analysis of pattern, trend and ratio.
So following are The Four Noble Truth of Investing to become financially independent and a successful investor (with the Buddhist corresponding Four Noble Truths in parentheses)
Four Noble Truths of Investing
1) We do not control world events, the economy or the markets
(Life means suffering)
2) We can change our old investment habits and follow a strategy of going long or short and be flexible with our holding period. (The origin of suffering is attachment)
3) Investors are irrational in a predictable way.(The cessation of suffering is attainable)
4) Let the markets tell you what to do through our methodology.(This is the path to cessation of suffering)
A journey of a thousand miles starts with the first step. Now is the time for you to walk the path that ends your suffering and eases financial stress. This journey will teach you a methodology and the metaphysical methods that will let the markets tell you what to do.
 The book “Quants” by Scott Patterson outlines how computer programs generate trades exploiting inefficiency in the markets. It is subtitled “How a New Breed of Math Wizards conquered Wall Street and nearly destroyed it”. See Buy and Hold is Dead by Kenneth R Solow
LET IT BE
During the 1950s when I was in my teens, we moved from our inner city Chicago rented apartment (with one space heater in the kitchen) to a house in a suburbs called Brookfield. (Real estate developers seem to have a habit of naming a community after what they destroy). Anyway, “Happy Days” had arrived for me, as I rode my bike to school with my dog Lucky running along side. My father Max Birkelbach (an immigrant to the US from Germany in 1929) had launched a small entrepreneurial business called Accurate Engineering Company, manufacturing rectifiers and transformers. With his new affluence, he started investing in the stock market. Although he had only tradesman electrician training in Germany he was essentially self taught. When it came to the stock market he attacked this new challenge with the same ferocity that made his business successful. He took courses on the stock market at the local YMCA (not Ivy League) and took me along. They taught us about analyzing company reports, price earning ratios, yields etc. However, what really got our interest were the courses of Technical Analysis (charting). We took these courses and did research together on various technical methods for predicting the direction of the stock market. One such course in 1960, offered by a Detroit firm Swing Measurements Inc., by Ralph Diestant was on the Elliot Wave Theory. Made available at this course was information on the theory and tools for measuring future price movements using the Fibonacci Ratios. In 1962, my father and I visited Charles Collins in Detroit. He was the mathematician, I was told, who over the years vigorously corresponded with Elliott and helped him write his first book.
Mr. Collins gave us many insights into the Elliott Wave Theory using ratios in predicting stock prices objectives. In those days one had to do your own charts by hand. I still have most of these hand made charts by my father in an old suitcase and consider them works of art. One day when I was about 16, I came across my father updating his charts when he surprised me by saying “Carl I have a substantial offer to buy my business, but I won’t do it if you eventually want to take over”. It didn’t take me very long to answer, as I really disliked the place. I still remember the address at 2005 Blue Island Avenue (The building is still there). It was three stories high and I had to work there during the HOT summers (vacations), when there was no air-conditioning. I can remember attaching the yellow wire, and then the red wire etc. until the circuit was completed. Once I must have done it wrong, because it started smoking when my Dad tested it. Oh the humiliation. What do you expect from exploited child labor? The thought of “Son, one day this can be yours” did not appeal to me. So I told my Dad “No, I rather earn money the “easy” way in the stock market” His retort was as expected “Ok you think this is so easy, you try it.” I had saved about $400 from birthday presents so I said “sure, let me pick out a stock” So, I sorted through all the charts on Dad’s the kitchen table and picked out the chart of Fairchild Camera and Instrument Co. I liked the charts uptrend, but I especially liked it when I found out what they did. They took pictures of electric circuits and reduced them via photography to smaller entities. That sure seemed better than connecting wires, so I went all in. Lucky for me that was the beginning of the printed circuit industry. To make a long story short, the stock went from the Over-the-Counter market to the American Stock Exchange with the symbol FAV. “Gonna sell now kid” “Not yet Dad”. Then it went to the New York Stock Exchange with the symbol FCI. By the time I did sell my $400 had turned into $10,000. “So what are you going to do now kid?” I kind of like the chart on Royal Crown Cola, They just came out with this one Calorie Cola”. “Nobody’s going to drink that crap kid”. It tastes like…..” After I got out of the RC I had $20,000. Now with car selling at about $2,000 I always had a new car in college. This was easy,. Right? I didn’t want to lose what I “earned” so after College with the book learning of a Major in Finance and a Minor in Economics, I thought I should become more “conservative”. I applied all by knowledge of balance sheets and price earnings ratios etc. and bought good “blue chip” stocks like New York Central Railroad and US Steel. Needless to say I lost a good part of my good start money. However, I was hooked on the stock market and technical analysis. After a couple of years at a Chicago based bank (long gone now), I joined the firm of McCormick and Company as a stock broker. Bert Malmquist, the President of the firm had a lot of faith in the 23 year old me and allowed me to write market letters for the firm and to publish a pamphlet called “Stock Market Profits through Charting” Since then, because of NASD/FINRA rules I couldn’t use the provocative word “PROFITS” and had to change the name of the pamphlet to Stock Market Forecasting Through Charting. Essentially the following is pretty much what was printed in the 1965 pamphlet (except for the sector on Bubbles and Taking Profits or Losses, and a little editing and of course the elimination of the explanation of how to make charts by hand. Just as the Declaration of Independence states “these truths shall remain self evident” so it is with technical analyses, from June 16 1965 when the following was first published, until now and into the future. Like in the Beatles song “you will find the answer. Let it be”. You don’t have to have advanced degree to understand technical analysis. As a matter of fact the brightest among you will have a especially hard time in keeping the following simple. If you over complicate it, you will lose the message. The following is a basic approach to technical analysis. It has been simplified on purpose. I have seen to many people get so lost in the details of wave counts and the input of massive of information, that they cant see the forest for the trees. So, if you’re one of those people, remove all the complications and just “let it be simple. If you are an old hand at technical analysis, read through this anyway, as I haven’t seen anything else on technical analysis presented quite like this. You may learn something new. If you are new to this, these are the basics and all you need to know in order to graduate. This will get you into Grad school (The next chapters).
The Technical Approach
Price change reflects strength in either supply or demand depending on the direction of the price movement. The technician believes that all factors are reflected in that price and each investor’s fundamental knowledge and perceptions and emotions are shown through price movements. Thus the price is the end result of all economic and psychological pressures, including the use of algorithms. By studying price movements, the technician attempts to forecast future price swings by looking at the charts of the price movements and interpreting their formations and trends using historic precedent as a guide.
Let’s start with the BIG picture: Cycles
Cycles are part of our everyday life. Years and days, seasons are cycles. Once you recognize a cycle, predicting what comes next becomes easy. For instance look at a chart of the lowest and highest temperatures in Chicago during a typical year. The chart of this represents a standard Bell Curve. As this cycle approximately repeats itself every year you would have no trouble predicting temperatures weather pattern for the future. If you are in spring next it will get warmer. If you are in summer, next it will get colder. OK good: you’re using a chart to predict the future!
THE DOW THEORY
Charles H. Dow is considered to be one of the first person to recognize that cycles occur in the stock market. Because of this, he is considered the father of technical analysis. Today the theory he developed, and that which was later expanded on by William Hamilton and Robert Rhea, is known as the Dow Theory. Dow recognized that stock prices did not drift aimlessly but seemed to rise and fall in definite patterns. Further he noticed over the years that stock prices moved in trends which had definite characteristics and that these trends repeated themselves. To help prove his theory, he formulated what is known today as the Dow Jones Averages. By careful observation of these average and charting them he concluded that the stock market moved in three simultaneous movements. He compared these movements to the ocean, its major trend being the tide, its secondary movements being waves, and the minor fluctuations being ripples. Dow’s major movement in the stock market is the major primary trend (See Fig. 2). This movement may last for many years and can be best seen in charts going back at least 10to 20 years. It is either a rising ‘Bull Market’ or falling ‘Bear Market’. Within this major trend are secondary movements of the Intermediate Trend which lasts for only months to year which can be seen in 3 to 5 year charts. Dow’s third simultaneous movement is the daily fluctuations of the market which can be best seen in 3 month charts.
Dow also observed that the primary trend went through three phases. In the case of a ‘Bull Market’ these phases would be Phase 1, a rebound from depressed prices bringing them back to their more logical value; Phase II, a further rise in prices due to the recognition of better business; and Phase III, the last rise of prices on the speculation that the future will continue to be prosperous. During this latter period investor’s tend to be overly optimistic about the future.
After a Bull Market there follows a Bear Market Phase I that will show a return of prices to their more logical value. This would be a price, minus the hopes and expectations expressed in Phase III of the Bull Market. Phase II would be the further decline of prices due to a down turn in business. Phase III would be the last decline in prices due to overly pessimistic business prospects. In a typical business cycle investors and markets usually move ahead of the actual business cycle and buy and sell on their perception of what the future will be. That’s why when good news is announced prices sometimes fall, because the good news has already been discounted in current prices. Conversely, market sometimes goes up on bad news. Markets that move the opposite of the news are a strong indicator of the markets eventual direction
The Elliott Wave Theory
Ralph Nelson Elliott wrote two books The Wave Principal in which he introduced the Elliot Wave Theory the book Natures Law. Elliott believed, like Dow, that cycles occurred in the stock market. Elliott further believed that “nature law” directed stock prices and that the stock market cycles moved in certain law-abiding, mathematical relationships that repeated themselves in a rhythmic pattern. In his theory Elliott describes cycles in great detail and how they can be broken down into smaller and smaller cycles; and the use of patterns, time, and ratios in prices forecasting. More in chapter 6.
Elliott saw the same general cycle as Dow but observed that the primary trends for every Bull Market has five impulses (See Fig. 3) with three moves up and two moves down. He also observed that each Bear Market had three impulses with two moves down and one move up. (See Fig. 3). There are rules 1) Wave 3 can never be shorter than #1 or #5, 2) Wave 2 can never go lower than the start of Wave #1 and 3) Wave 4 can never go as low as the top of wave #1.
CHARACTERISTICS OF THE MARKET CYCLE
The following section deals with the characteristics of the market cycle, taking into consideration the Dow and Elliott Theories and some common observations. Although every Bull & Bear market cycle is different, the following characteristics are generally prevalent.
The market cycle can be broken down into four distinct phases. (See Fig. 4). The first phase is Accumulation, which occurs when prices resist going lower or higher after a general decline of prices. This phase is followed by the upward Progression phase, which is characterized by a rise in prices, generally in three phases with two corrections. The Distribution phase, which occurs when prices resist going higher or lower is usually a sideways movement. The last phase is referred to here as Reversion, a decline of prices generally in two phases with one correction.
The general market, individual market groups (technology, airlines, precious metals, commodities etc.), and individual stocks move through these phases. Because of this, it is important before investing to first know in what phase of a cycle the general market is in, second the phase of the group and lastly the phase of the individual entity. All three should sync before investing.
CHARTERISTICS OF MARKET CYCLE PHASES
The economy generally goes through a continuing cycle of prosperity and recessions. Why economic conditions change is not the major concern to the technician. Sometimes markets go through these phases even when the fundamentals stay the same. Market technicians make no judgments about the economy and stay neutral on the fundamental analysis. Instead, market technicians consider the patterns of price movements. What is important to know for a market technician is what phase of the market we are in of this reoccurring continuous cycle.
Markets show a conscious opinion of what people believe the general economy, corporate earnings, etc. will be like in the future. In general market moves ahead of the actual economic cycle by about six months. Since the market is only a prediction of the economy, it is sometimes wrong. Whether the market predicts future economic situation correctly or not, each phase of the general market cycle will usually still occur and has certain characteristics. These characteristics are helpful in recognizing the phase of the general market cycle and, therefore, helpful in forecasting future price movements.
Accumulation: This segment of the general market cycle occurs after the market has come down in panic selling and, after making new lows, the market resists going lower. Price trends tend to move sideways for a period of time lasting anywhere from weeks to years. Neither good nor bad business news affects prices appreciably in this period. Volume tends to be small. During this period people are generally pessimistic about the general economy but there is HOPE that things will get better.
Progression Phase I: Progression begins when prices surprisingly begin to move upward, outside the base of Accumulation. “Large Cap” stocks generally lead the move up, on higher volume. Yields on stocks at this level are at or about the same as bonds. The investing public begins to assume that maybe business or the fundamentals are not as bad as was thought and prices return to more realistic values. OPTOMISM begins
Phase I Correction: The correction of Progression Phase I develops under generally lower volume. This correction is usually caused by profit taking and the uncertainty that business and the fundamentals will get better
Progression Phase II: During this phase prices move above the high of Phase I. This rise in prices is a result of the recognition that the business and the fundamental situation has actually improved. Volume is high and the Large Caps are still leading the upward market trend. Investors are once again becoming EXCITED about the market
Phase II Correction: This phase is primarily profit taking, the same as Phase I Correction.
Progression Phase III: In this phase market prices rise over those of Phase II. Generally investors are optimistic about the market going higher. This rise is based on the hopes and expectations that future earnings will increase. Most bad business news is largely disregarded. Speculative stocks become popular. Large Caps set new highs, subsequently moving back from those highs and small caps take over the attention of investors. EXPECTATONS ARE UNREALISTIC.
Distribution: At this point the market hesitates. Volume is often erratic. Large Caps have moved down from their highs while speculative and small cap stocks make new highs. Fundamental news is good. Average yields are relatively low. At this point the investing public buys stocks in large volume with the theme, “The future couldn’t look brighter!” Investors are in a state of EUOHORIA AND DENIAL of realistic expectations.
Reversion Phase I: In this phase market prices falls on larger volume, returning to more realistic values. Large Caps generally hold up better than the rest of the market. The market reacts downward on bad news while largely disregarding good news. Denial is replaced with FEAR.
Correction Phase I: This correction phase results when many people who believe that the Bull Market has not ended and continue to buy considering lower prices a buying opportunity. This buying creates a temporary return to prices. Those who sold short may be covering. To do this, they must buy the shares they were short, creating an artificial rise in prices. These moves are under generally lower volume.
Reversion Phase II: During this phase market prices break down completely in panic selling. At this point prices decline more than might be logically expected. Selling hysteria drives stock prices to new lows. The general opinion is that a recession in the economy and fundamentals will get worse. Most good news is overlooked. Few people think the market will go up. After Phase II investors reach CAPTITULATION and prices are depressed enough for Accumulation and the cycle to start again.
INDUSTRY GROUP CYCLE PHASES
The general market may be divided into industry groups such as automobiles, steels, energy, defence, technology, airlines, drugs, paper, health-care, financials, retail stores, transportation, utilities, etc. Precious metals, grains, meats, building materials, interest bearing commodities groups generally move together in cycles. They go through the phases of Accumulation, Progression, Distribution, and Reversion, which may or may not coincide with the same phases of the general market. Groups alternate and rotate favorites. Airlines may go down while Technology goes up or visa versa
Generally there is a leader (Apple, Gold) within the group that signals the beginning of Progression by breaking out of the base of Accumulation, accompanied by higher volume. The rest of the groups ordinarily follow this leader, in order of quality. During the Distribution phase of the group cycle, the higher quality stocks back away from their highs while the speculative stocks (remember the dot com top) of the group make new highs. The first sign of Reversion occurs when these speculative issues break downward. The downturn is usually fast. Therefore it is better to get out early than too late. That’s not easy. Odyssey found the lure of the cyrons difficult to resist.
Groups tend to become popular and unpopular. One year a group may act better than the general market and the next year worse. Sometimes this action is logical, sometimes not.
When picking an investment, it is as important to not only know in what phase of cycle the general market is in but also what part of the cycle the group is in. As a general rule, if a group is not popular and not acting well when compared to the general market, it is quite probable that the individual investment will act no better than the general market.
INDIVIDUAL SECURITY CYCLE PHASES
The prices of individual stocks and commodities go through the phases of cycle in much the same way as the general market and industry groups. Accumulation occurs after investors who have lost faith in the future sell, and other investors, perhaps better informed about the fundamental prospects, buy.
When investors’ interest increases, prices move up in Phase I of Progression. Some investors who had bought at lower prices sell, taking profits, resulting in the first Correction of Phase I. Progression Phase II may be attributed to improved prospects. Some investors who bought during Phase I now sell, taking profits, resulting in the Correction of Phase II. The rise of prices of Phase III may be attributed to an over estimation of earnings in the future.
During the Distribution Phase the price sells at relatively unrealistic levels. It does so and will continue to do so as long as it is supported from buying by perhaps less sophisticated investors who are attracted to the investment by the preceding rise in price.
Reversion starts when interest and consequently support for this investment wanes and prices begin to drop back to more realistic levels. At a point during the Reversion Phase, the decline in prices appears to offer a good buying opportunity resulting in a temporary flurry of buying activity and consequently resulting in an increase in the stock’s price. Having tested recovery prospects and finding support only temporary, this ultimately leads to a further deterioration in the price, even to the point of “panic selling.” When the price falls below realistic levels, the cycle is ready to begin again.
Alan Greenspan was quoted in the December 03, 2010 Barrons Magazine from an essay he wrote for Brooklyn’s Institute. He said “I fear that preventing Bubbles will in the end turn out to be unpredictable”. Sobering words of caution. So what are these things called Bubbles?
Cycles have been called “bubbles” by the investment community because of the tendency to expand like a growing ever weaker bubble until it “pops” and prices crash. The most famous historic old bubble was the Dutch Tulip mania of 1637. Prices of bulbs skyrocketed for no fundamental reason at all except, no one wanted to be left behind. Higher prices attracted more buyers until the bubble popped and citizens begged the government (sounds familiar) to prop up the market. In the retail trade discount prices and sales usually attract buyers. Not so with emotional investors. Price moving down
in the stock market repulse investors. It is just the opposite with upward prices. Nothing attracts buyers more than prices moving upward. There was a stock price railroad bubble in the 1840s, when railroads got overbuilt. In the 1920s radio was the hot item. We all know about the crash in 1929. RCA (Radio Corporation of America) never reached its high again. In the early 1980s it was Milken Junk bond bubble, in 2000 the dot com bubble and of course the 2008 real estate bubble. If we ever want to solve our addiction for oil we will probably see an alternative energy bubble for that too. From perfect hind sight bubbles are easy to see. However our recent experience with real estate infected many and is typical of the euphoria that’s easy to fall for. One thing for sure, cycles and bubbles will repeat themselves. After all we are only human.
Summary of Cycles
In studying the cycles of the general market, groups, and individual investments, it can be seen that all cycles have many things in common. Investors first underestimate fundamentals and the future, depressing prices to unrealistic levels, and then overestimate the future, boosting prices beyond their values. In Progression, there are corrections against the main trend caused by people who sell, taking profits. In Downward Reversion there are always corrections caused by people who do not believe the bull market is not over. It is interesting to note that even when the fundamentals remain fairly constant, prices may still go through a cycle. Many investors do not economically survive these cycles, so they are not able to apply what they learned for the next cycle. However, there is always a new group ready to again go through the whole gamete of hope, optimism, unrealistic expectations, euphoric, denial, fear, panic and capitulation and finally depression! Knowing about these phases in advance can not only help you to survive but to thrive.
Now that you have been introduced to cycles, it’s time to take a look at trends and trend lines. Trend lines will help you determine what is the Major, Intermediate and Minor trend of the market and will assist you in determining what phase of a cycle you are in. There is an old market adage “The trend is your friend” So, its time to make a new friend. Prices tend to move in a particular direction over a period of time. This direction is called the trend. When prices are generally rising, the trend is said to be up and conversely when prices are generally dropping, the trend is said to be down. If neither is the case, the trend is said to be sideways.
Once a trend is established it will tend to continue to move in that way, resisting change. Prices act in this way because during an uptrend, people will be attracted to buying because it is going up, causing it to go up further and attracting more buying interest, etc. During a downtrend, the decrease of prices will tend to keep possible purchasers away from buying, causing the price to go down further which causes the price to go down further still. When prices move sideways, it attracts neither the buyer nor the seller and continues to perpetuate a continuation of the sideways movement. Trends willcontinue until they are broken. For that we use trend lines that track the bottom or top (or both) of price movements.
Long Intermediate and Short Term Trendlines
The hard part of drawing lines is determining if the trend is the Major Trend, the Intermediate Trend or the Short Term trend. Most investors are primarily concerned with the Major Trend line. However, as mentioned earlier: since 1997 the Major Trend of the stock market has been in a “Great Sideways “movement. In volatile markets or in Sideways markets, or in commodities futures, or in options, investors may have to “trade” the market and use the Intermediate and Short term trends. The trend line that is important is determined by each investors risk reward tolerance and trading frequency.
To confirm that a trend line has been broken, a general rule is that the trend line must be broken for at least a day and on high volume and more than 2% ( as a guideline), Some use Bollinger Bands which show statistical standard deviation above and below the moving averages. We will get into additional indicators later, but for now keep it simple, a breakout above or below a support or resistance area for more than a day by 2% is a ssignal of change (1 day +2% Rule)
The major trend line may be difficult to identify and may be confused by intermediate trends until the trend is fairly well established. (See Fig. 9) Some experience is necessary before one is able to distinguish between major, intermediate and short term trends. Once mastered, the trend line can be a useful and faithful tool. As mentioned earlier it is suggested to use a 10 year chart or longer to get the best view of the Major Trend, a three year to five year chart to get the best view of the Intermediate trend and a three month chart for the Minor Trend. I look at all three of these charts before investing. I even look at a longer term (20 -75 yr) charts when they are available. Think about the hierarchy of trends the way you would in determining a location (Galaxy? Milky Way), (Solar System? Sun), (Planet? Earth), (Country? USA), (State? of confusion. Just kidding) (State?:Illinois); (City? Chicago) (Street? LaSalle). Look at trends in this same way of narrowing down process from big to smaller trends. Each domain has its own characteristics. You want to match your risk//reward tolerance and flexibility with the proper trend. .
CHANGE OF INTENSITY OF TREND
Trend lines can also be drawn joining the tops of the waves of an uptrend or joining the bottoms of the waves of a downtrend. Breaking of this trend line shows a change in the intensity of the trend. Prices will usually move up in the case of an uptrend and go down in the case of a downtrend at a faster rate than previously experienced. A breakout of this kind will allow you to move your trend line thereby creating a new steeper line.
Channels are formed when a trend line connecting the highs of a wave runs parallel to the trend line connecting the lows of a wave.
This formation does not occur often, but when it does, the trend lines of the channel are often quite a significant factor in the price movement. Breakout rules apply as previously described.
Sometimes trends move along curved lines. This is most significant on the bottom or top of a cycle. These formations are called saucers.
Saucers reflect a gradual change in opinion regarding the future outlook of the company. Volume on saucers should decrease on the old trend and pick up upon starting the new trend. Gold had this bottoming formation in the late 1990s
The V Formation, as the name implies, look much like a “V”.
A V formation shows that there has been a sudden change in opinion about the future. This sudden change in trend is usually caused by an unexpected news event, accompanied by high volume at the climax. Sometimes accumulation doesn’t happen and there is a sudden reversal. However, more than likely there is some testing of the previous high or low before the reversal has any follow through.
HEAD AND SHOULDER FORMATION
The oldest, best known, and possibly most reliable formation that signals a change of trend is the Head & Shoulder formation. This is a very powerful formation.
A sell signal is given when a head and shoulder top is formed and prices break the neckline; conversely a buy signal is given when head and shoulder bottom is formed and prices break the neckline. After prices break the neckline there is usually a quick retracement back toward the neckline, followed by another reversal and continuation of the basic trend. Upward and Downward future price measurements can be used using Head and Shoulder (H&S) formation. The future up price move follows a H&S top is the points from the heel to the shoulder times 2. The same is the case of the H&S bottom. The down move will equal the points from the Head and Shoulder times 2. It’s like the release of a coiled spring. We will show you in later chapter how I used a Head & Shoulders Bottoming Formation to project in my Investment Strategy Letter in March 2005, the predicted exact tops of the market in 2008 (Dow 14,309, S&P 500 1,572, NASDAQ 2,892) and in a August 2011 market letter, to forecast a future top of 12,850, a year in advance.(This stuff really works!)
DOUBLE TOP AND DOUBLE BOTTOM FORMATION
Double tops and bottoms are signals of a trend reversal.
A double top indicates that the stock is in a technically weak position because investors are unwilling to purchase a stock that hesitates to go up and make new highs. The double bottom shows strength because people tend to shy away from a stock that is falling in price. Once it shows resistance to further decline, investors begin purchasing again.
These formations can be dangerous if the investors tend to predict that a double top or bottom will be formed before the formation is completed. One can be fooled if prices slowly back away from the “C” bottom and then quickly break on past that point. To protect oneself, the chart history of the company, the price action of other stocks in its group, and the trend of the general market should be checked first. One of the most dynamic formations is when a double top or a double bottom is broken at C, but there is no follow through. This is called an unorthodox Top (1929) or an Unorthodox bottom. This failure of a breakout, signals the possibility of a massive correction in the opposite direction.
When converging trends meet, triangles are formed. (See Fig. 17) Triangles show a struggle between two factions, one tending to push prices up, the other tending to push prices down. When the trend line is broken on the upside, this indicates that the upside faction has won and that prices should continue to go up. Conversely when the trend line is broken on the downside, this indicates that the downside faction has won and prices should continue lower
Generally speaking, ascending triangles and wedges will break out on the upside and descending triangles and wedges will break out on the downside. The symmetrical and expanding head triangles do not tend to break out in any established direction. In general prices tend to break out of a triangle in the direction prices were going before the formation. However, no forecast should be made until the breakout occurs
RESISTANCE AND SUPPORT AREAS
Resistance and Support areas are one of the most important indicators in analyzing charts. Breakouts above or below Resistance areas are BIG, buy and sell signals. Resistance and Support areas can exist at 1) Trend lines, 2) Channels, 3) Tops, 4) Bottoms and 5)Elliot Wave Ratio objectives (Chapter 6). But first below is an explanation why Resistance and Support areas work.
RESISTANCE AREA are formed by human emotion. (See Fig. 17) When a person buys at a certain price (A, B) and that price goes down to (D), chances are that when the price returns to the original purchase price (E), that the person who purchase tis security will be anxious to get their money back and will sell. If a lot of people bought at about the same price (A, B) they will tend to act the same way. The area where people have a tendency to sell is called a Resistance Area. A break out above a RESISTANCE AREA is an UP indicator that a new up move has begun.
SUPPORT AREAS are also formed by human emotion. When a group of people buy at a certain price (A, B) and the price goes up to (D) and the price then returns to the purchase price (E), the stock will usually receive support at that level. This is because the people who purchase at price (A, B) have conditioned themselves to only sell at a profit and now will not sell to just break even on their investment. Also to many people the old price (A, B) appears to be a bargain price at which to buy. A breakout below a SUPPORT AREA indicates that a new Down move has begun.
Each bottom or top area is a potential Resistance or a Support area. When prices return to the top or bottom base area, they will tend to be stopped in this area. If prices break through the top or bottom area, they will tend to stop at the next resistance or support area.
RESISTANCE AND SUPPORT AREAS AT TREND LINES
Now that you know about Resistance and Support areas you can see that Resistance and Support also appear at trend lines. That’s really what they are. An uptrend line that touches tops or a down trend line touching tops offers Resistance. Conversely, an uptrend line touching bottoms or a down trend line touching bottoms offer support.
CONVERTING PAST RESISTANCE AND SUPPORT AREAS
When the price passes through a Resistance point on the way up, that point has the potential for becoming a Support zone on the way back down. Conversely a Support point on the way down can have the potential of becoming a Resistance zone on the way back up.
Our goal is to produce a spread sheet shows the Resistance and Support areas for the Short Term, Intermediate Term and Long Term. Below is example of what I showed the participants of my seminar in Houston, Texas on September 17, 2011. This kind of a spread sheet will be your life line. When emotions occur, this will show you the “truth” of what kind of a market we are in and how to behave. These Resistance and Support points will be the basis for developing our methodology as shown in Chapter 4.
|CURRENT Sept 17 2011||11,485||2,612||1,212|
|Breakout Points||DJIA||NASDAQ||S&P 500|
|Short Term UP (Resistance)||11,715/12,200||2,643||1,230/1,270|
|Short Term Down (Support)||10,604/10,404||2,331/2,298||1,101/1,074|
|Intermediate Term UP (Resistance)||12,200/12,876
|Intermediate Term Down (Support)||9,614||2,077||1,011|
|Long Term UP (Resistance)
17,000 TO 18,000 SEE CHAPTER 7
4,600 TO 5,500 SEE CHAPTER 7
2,000 TO 2,100 SEE CHAPTER 7
|Long Term Down (Support)||9,614/6,470
THE IMPORTANCE OF VOLUME
Volume can be useful. It puts an emphasis on a breakout. Low volume is not as convincing. Look at intraday charts to see if volume is occurring on the upside or on the downside
TAKING A PROFIT OR A LOSS
The biggest mistakes investors make is selling their profits too soon and letting their losses run. We all know we should do the opposite. Charting can help take some of the emotion out of that decision. When an investment breaks below a trend line or below a Support level, as we discussed earlier, apply the 1 day + 2% rule. That is a indication to take a loss if you are long or add to a short. If an investment breaks above a trend line or a Resistance level, that’s a good time to take a loss on short positions or add a long position. An old saying is never try to average down by adding to a losing position, but add to positions that are going up. You can also take profits when your investment reaches an “objective” (a Head & Shoulder objective or an Elliott Wave objective, as we will show you in chapter 6). Like a general in command of an army, have a plan of attack, an objective and a plan of retreat. That way you get to fight another day. Our methodology will help you to:
1) Buy low, Sell high 2) Let profits run, cut losses early
3) Add to a winner not a loser 4) Don’t pick tops or bottoms
5) Wait for the trend to emerge
OTHER VARIOUS INDICATORS
Sure, use whatever works. I have a proprietary overbought oversold indicator that I use called THE STRATEGY INDEX. Buy when the dark black line is above +70 and sell when the line is below -70. There are plenty of other indicators such as moving averages, advance/decline line, put call ratios etc. etc. etc. I believe the methodology I have presented and will present is all you will need. Too much can be too much and can be confusing rather than helpful.
THE SIMPLEST METHOD KISS
However, if you want to use just one method, use the KISS method (Keep It Simple Stupid). Prices that make new highs and higher lows is an uptrend (go long). Prices that make lower highs and lower lows are in a downtrend. (Sell or go short). Keep it simple and remember The Trend Is your Friend!” Don’t tell the market what to do. Just “Let it be”! It is what it is
 See “This Time Its Different” by Ken Rogoff outlining 800 years of bubbles
GOING BACKWARD IN ORDER TO GO FORWARD
“So what” you say. If this guys is so mart, why isn’t he rich?” and secondly how can I apply all this methodology and make some money? Two good questions my skeptical reader. For the long answer to the question, ‘Am I rich?’ (See the chapter 8 “The Eight Fold Way for Successful Investing”). For the short answer, I guess I am rich in more ways than money. Yeah, OK I am certainly in the top 5% somewhere. However, we are all motivated by different things. If money was my only concern, maybe I would be super rich. I guess I feel I have enough stuff! My goals, as our yours, are personal. However, I will share my personal philosophy with you in the last chapter. That philosophy makes me rich and will hopefully help to make you “rich”. Would I like to become a multi billionaire? No! All of the things necessary to be that driven, would I think, actually remove me from my connection with my ‘rich’ life, I’ve chosen. Removal of personal strife, finding peace within yourself and obtaining the “zone” is one of the main ingredients to getting “in touch” with the markets. Go with the FLOW. I must also warn you that this “getting in touch with the markets” can become addictive. World markets are open somewhere all day and all night. The stream of news and prices never stop, even though you must.
For the answer to the second question, how can you make money? It’s not easy. Learning this methodology and process takes your personal involvement. Mutual funds are “easy” but I think wrong. As I say, becoming financially independent using this methodology is not easy and if you cannot make the commitment to these methods, I suggest you either stay out of the markets and just buy a money market or buy short term maturity CDs or Treasuries. In addition to making the time commitment and making the right call, there are all kinds of personal problems one has to overcome in order to make money in the markets. For that, I have a story about gold to tell you. Let’s look at a long term chart of gold below
BEING “RIGHT” WITHOUT MAKING MONEY
On December 03, 1979 with gold at $350 an ounce, I was quoted in Barrons Magazine saying “as for gold, there is, no end in sight of its uptrend, paper currency will be converted into gold at any price” Gold went up to over $800 an ounce before going through a 20 year Accumulation phase. By 1999 I was quoted in Business Week, Reuters and at all my seminars calling for gold to begin a new Bull Market to rise above $1,000 an ounce. Every chance I had, I forecast gold above $1000. So, when gold did break above $1,000 my wife, (who attends most of the seminars with me) asked me “how much gold do we have?” “Two gold coins” I answered. Such is life and somewhat the answer to the earlier question of why I am not super rich. There is always something, (a better house, college for the kids, expanding my business). You can’t do it all. There of course is a good lesson here. It’s like the guy who prayed and prayed to win the lottery. When he died and went to heaven, he asked God “why didn’t I win the lottery?” “I prayed and prayed” God answered “you should have bought a ticket” So after all is said and done you have to put your money where your convictions are. That’s not always so easily done.
Another great foible is selling too early. In the February 23, 2009 issue of Business Week Magazine they printed my quote as “Ford has a fighting chance of getting out of the industry’s deep hole, says Birkelbach, President of Birkelbach Investment Securities, who recently bought the stock, confident it will triple in a year” Ford at the time was $1.79. Gene Marshal of Business Week, wanted a stock pick, so I was bottom picking. There is an old saying “never grab a falling knife”. However, I had other reasons to believe that the general market was ready for a big rise (we will go into Lone Bull III market letter later.) But, I was wrong. The stock didn’t triple. It went up eight times. Did I ride it up the whole way? No! OK so now you know I am not perfect. But you knew that already. Nobody is!
Making mistakes is part of the process. Nobody can consistently pick exact tops or bottoms. It is better to be early, than to be late. It is better to be out too soon, than to be out too late. Try and find the “sacred middle” and be satisfied. Do not be discouraged when you make a mistake. There is no perfect method or methodology. The active methodology I am suggesting is more professional than the traditional buy and hold strategy that says you can’t be wrong if you hold forever. You will make mistakes. Be satisfied with not being perfect.
GOING BACKWARD TO GO FORWARD
I am proud of my Lone Bull and Market Letters and they should help build your confidence in the credibility of the methodology used to make these predictions. I talk a lot about the fundamental story in these market letters. The fundamentals story explains the positive and negative factors of why you develop a particular investment strategy. However, the technical methodology analysis comes first and that will tell you what fundamental stories you should be paying attention to. After the fact, the fundamentals will seem obvious. However, during the development of a strategy both positive and negative factors appear confusing and conflicting. It is the technical methodology that tells you what investors and the market perceives as important.
Since I started in the business in 1964 I have written over a thousand market letters and I have saved most of them. I think taking excerpts from my series of Lone Bull Letters and other Market Letters will be beneficial to you, so you can view the process of developing our methodology for practical use. In addition, in order to forecast where you are going, in my opinion, you have got to know where you have been. So now, let me transport you back to those thrilling days of yesteryear. The entire Lone Bull Letters are printed in full in the supplement of this book and are available on line.
THE FOLLOWING LONE BULL LETTERS and INVEST MENT STRATEGY LETTERS ARE QUOTED
Lone Bull I dated September 1981 forecast Dow from 800 to 2,500
Lone Bull Revisited February 1992 Dow forecast above 8000
Lone Bull II October 2002 forecast Dow from a bottom of 7883 up to above 10,000
Investment Strategy Letter #539 March 2005 forecast Dow a top at 14, 200
Lone Bull III November 2008 forecast Dow to bottom and rise above 11,200
Investment Strategy Letter #567 Sept 2009 and #570 forecast Dow to 11.895 to 13,313
Let’s start with my Lone Bull I dated September 11, 1981 and a chart showing the market as it appeared then, from 1929 to 1981. This puts the 1981 market in perspective, with the Dow at 900 and with the market moving sideways below 1000 for 17 years. The scene is set!
THE LONE BULL LETTER 9/11/1981
(* INDICATES CURRENT COMMENTS)
The Clearance Sale On Discounted Prices
Over the recent years, investors have been stunned by inflation, high interest rates and the volatile bond and stock markets. The United States has entered a period of great uncertainty, which is affecting everyone and from which there appears to be no safe haven. This country was built by men and women who refused to recognize limitations. Through inventiveness and persistence, the United States has succeeded in offering the best standard of living in the world. Now, there are many who are telling us the dream is over. The popularity of the gloom-and-doomers has been exemplified by the success of their books, seminars and market letters. They spin a logical tale. The pyramid of an expanding debt is an ever increasing danger.
Past economic history has shown that there have been similar cycles, all of which have ended with a depression and bankruptcies. But timing is everything. Financial independence can be obtained through the proper timing of your investments. There is a time to buy and a time to sell. The recent changes investors are facing means an opportunity is being created. If it were easy to make money in the markets, everybody would be rich. The obvious is most likely obviously wrong. Today, where do you think the average investor believes the best return on his or her money can be achieved? The most likely answer is obviously against the bond and stock markets. Investors often base their decisions on past criteria. After all, why would anyone invest in the stock or bond market during these uncertain times when a good safe record high yield can be achieved in money market funds? I think this obvious answer is wrong. I believe the bond and stock markets to be a clearance sale on already discounted prices. Don’t expect to see a headline in the paper saying: “The Stock and Bond Market Is Ready To Bottom”, with a sub headline stating: “Buy Now And Sell At A Much Higher Price Later”.
The markets don’t operate that way. By the nature of markets, the majority can never be right. A market bottom is formed when all the negative news is fully discounted. That is, when everyone that could be frightened into selling, has already done so. Discouragement, disappointment, apathy, fear, frustration, and the most important ingredient, panic, are all part of a typical market bottoming scenario.
I believe the persecuted bond and stock market to be one of the best investment alternatives available for today’s investor. In the next several years, I foresee a rise in the Dow Industrials to record levels and a large rise in the bond market. What makes me so bullish? First, a little background is needed to more clearly understand my conclusions.
Gaining an historical perspective of the past is important in obtaining an ability to forecast the future. Many investors and most money managers were not investing during the last series of bull markets. What was it like? Well, bull markets double, remember? The Dow Industrials doubled from 160 in 1949 to 300 in 1952 and doubled again from 250 in 1953 to 524 in 1956 and doubled again from 400 in 1957 to 750 in 1961. (Stocks then sold at a record high of 22 times earnings.) It then doubled again from 524 in 1962 to 1000 in 1966. Can this kind of performance repeat itself? Yes.
Psychological patterns tend to repeat themselves in cycles. Whereas the news in every cycle is different, the way investors react emotionally appears to follow a pattern. The Dow Theory and the Elliott Wave Theory is based on the premise that price is the end result of all economic and psychological pressure and those future price movements rise and fall in recognizable patterns. Based on these theories and my own observations, Figure 1 (see page 2) denotes a typical cycle. A new series of bull markets begin after negative news and a large drop in the market has panicked investors into selling.
At the bottom of a Bear Market, the future can look so bleak that the future of the country is in question. Bull Market I occurs in anticipation that things will get better. Although the news during Bull Market I continues to be negative, the market usually doubles in value. (Figure 1 #1)
A correction then follows which is approximately 50% to 62% of the Bull Market I upmove. (Figure 1 #2) Nature and the market show some consistencies over time. One such consistency is the tendency to regroup and pause after a movement or a series of movements. Corrections can be associated with the pressing down of a spring. A spring must be pushed down if it is to spring upward. So it ‘is” with the market. The correction after Bull Market I occurs because there is doubt if news items and the economy will in reality get better.
Bull Market II actually reflects the improvement of events. This phase of the market can be elongated by the positive outcome of events. (#3) After Bull Market II, there is usually only a 38% to 50% correction of the Bull Market 11 up move (Figure 1 #4) The Correction occurs because investors doubt if the good news can continue.
Bull Market III can be attributed to the over exhilaration of investors. Prices obtain unrealistic levels as investors are attracted to the market only because it has risen in the past.
After all the possible money that can be attracted into the market is invested, the Bull Market is over (Figure 1 #5) and a Bear Market begins. “Sell, to whom?” becomes a problem, as prices drop to more realistic levels (Figure 1, A). After a big drop, there is usually an upward replacement in what appears to be a good buying opportunity. (Figure 1, B) This up move can sometimes go higher than the top created by Bull Market III. After testing recovery prospects and finding support only temporary, the final phase of the Bear Market begins. This phase is usually accompanied by negative news and usually leads to panic selling from 50% to 62% of where Bull Market I started (Figure 1, C).
During the 1932 depression, prices almost fell to nothing. This usually happens every other cycle. Individual issues also follow this same pattern, which may or may not coincide with the general market cycle. Although the above explanation is rather simplistic, I believe it to be basically a realistic explanation of how markets move.
For the following, use Figure 2 as a guide.
DOW-JONES INDUSTRIAL AVERAGE (Figure #2)
Let’s relate the above to what happened in the past to see if we can identify what phases have transpired, and what phase the market is now in. Then, we will tackle the future. The Dow in 1932 was 41 and was the beginning of a series of Bull Markets that finally ended in 1966 at 1000. After 1966 the small investor began to step away from the market because pension funds, mutual funds and professionals managed their money.
Also at that time, discounted commissions were only available to the large investor. The professional money manager’s philosophy was such that they would only invest in issues having a large equity and a good record of increased earnings. However, there were only some 50 issues that qualified. Money poured into these stocks and they rose, while everything else fell. Since the large institutions were making large paper profits, they attracted more money. So the favorite 50 issues rose to 20, 50 and over 100 times earnings, while the rest of the market fell.
Officially, the Dow Industrials made its high at 1067 in 1973. However, that was just an artificial high for a few Dow types and the 50 institutional favorites. Between 1966 and 1973, most stocks topped out. For instance, General Motors hit its top at 110 in 1966 and a low of 30 in 1974. Whereas IBM (one of the institutional favorites) made its high of 91 in 1973 and its low of 38 in 1974. Somewhere in between 1966-1973 (depending on the individual issue) the old Bull Market died and a Bear Market began. The old joke of sell to who (or whom) became a reality for the large institutional investor.
When stocks began to fall, they dropped very quickly. During the drop, the “professional” money managers decided to diversify and index. Indexing is where the money manager tries to match his portfolio to the general market. To me, indexing was an excuse for mediocrity. With the help of the oil embargo in 1973 and a series of negative-news items, the Dow averages fell from the 1973 high of 1067 to the 570 low in 1.974. This was about a 50% drop of the gain since 1932. Some stocks like MGIC fell from 100 to 8, Polaroid from 140 to 18, Control Data from 160 to 10 and so on. The favorite 50 joined the other issues, which had already fallen. More than 90% of the issues traded formed a bottom in 1974. Such was the devastation of a major Bear Market bottom. The 1974 bottom was not as bad as had happened during the 1932 depression, but never the less, a significant low. Catastrophes do not end every cycle. There are some advisors who believe that the stock market is still in a Bear Market. I believe the Bear Market ended in 1974. No one wanted to own stocks. The Vietnam War and Watergate were tearing the country apart. Major brokerage firms were going out of business. Inflation and interest rates were accelerating at record rates. New York City was going bankrupt. The country could not adjust to skyrocketing oil prices. The dollar was selling at a record low. The U.S. had lost its prestige throughout the world.
The New Bull Markets
Through seminars and the Five Point Investment Strategy Letter, I have forecasted the beginning of a new series of Bull Markets, such as outlined earlier under my cycle explanation. Bull Market I did a typical job of doubling as the Dow Industrials went from 570 in 1974 to 1026 in September, 1976. The market also typically rose on expectation, because negative news continued throughout most of the upward cycle. The biggest and fastest rise occurred during the first quarter of 1975. In that first quarter, the Dow Industrials rose 300 points, even though the Gross National Product declined 11%, (the largest single quarterly decline since the depression) and interest rates and the inflation rate hit record levels. Such things are Bull Market’s made of. The correction, when it came, was also typical. The Dow corrected 62% of the 570-1026 up move to bottom at 740 in February, 1973. However, untypical, the market double bottomed at 740 in April 1980. These corrections occurred under quite a few fears. Investors were faced with a record inflation and high interest rate, a sagging economy, energy extortion, Soviet aggressiveness, low confidence in leadership and a loss of national prestige.
The double bottom at 740 in 1978 and 1980 reflects a problem solving period. It is similar to the problem solving periods after the Depression and after World War II. Between 1936-1942 and 1945-1950, solutions to major problems were being formed. During those periods, the market moved sideways. Since 1978, solutions are being formed for this country’s major problems of energy, productivity, inflation and military weakness. After the 1936-1942 and 1945-1950 problem solving periods, the stock market exploded on the upside. I expect Bull Market II to reflect the solution of this country’s major problems.
I believe Bull Market II began in April 1980 with the Dow Industrials at 730. At that time once again, almost everybody was bearish. I was quoted in Barron’s as being one of the few bulls and predicted a run up from 730 to 980. The first phase saw the market rise from 730 to 1030 (April 1980 to April 1981). The stock market has since fallen to 850. I believe the stage is now set for a big stock market rise.
Before I explain, let’s take a look at the negative side. If there is a large profit potential, there must also be risks. The enemy must be known if it is to be conquered. The market’s enemy is fear. Shall we proceed?
First let me remind you that market bottoms are not formed under periods of good news. Market bottoms are formed during periods when the news is so negative and the market is dropping so fast, that positive factors seem to be ignored and are considered almost pointless. Price drops scare investors into selling. Price rises intrigue investors into buying. That’s why most investors sell close to bottoms and buy close to tops. Obviously, the process should be reversed, but it is difficult to hear logic when prices are tumbling. Investors presently fear an economic crisis. Tight monetary policies could have a devastating effect on the weak areas of the economy. Investors doubt the outcome of the Reagan plan and fear that the medicine may kill the patient. Confucius was known to have said: “Good government results when the near approves the distant approach.” However, investors are not patient when it comes to the distant approach.
The Reagan administration has initiated plans to cut government spending, reduce taxes, reduce government interference, encourage capital goods investments and to make the U.S. militarily secure. The problem is that government cost cutting will not immediately offset increased military spending and reduced federal income because of tax cuts. Large government borrowing and deficits are bound to result. Without a tight fiscal policy, an ever tighter monetary policy must be maintained. The administration hopes that tax cuts will inspire more revenue. (Previous tax cuts have resulted in higher incomes.) Until more difficult cost cutting can be accomplished, or increased revenues are achieved, huge government borrowing will be needed. The Treasury expects to borrow some $40 billion in the fourth quarter of 1981. The uncertainties outlined above have caused a crash in the bond market. I use the word crash, because the decline of bond prices can be compared to the drop of stock prices in 1929. Investor skepticism has turned to panic, so bond market activity has almost come to a standstill. Issues that have come to market have yielded over 17% for corporate bonds and up to 15% for tax free municipal bonds. Because of the inaccessibility to the bond market, corporations and municipalities are being forced into the short term interest rate market. The effect on short term rates is still being felt. Corporations, municipalities and individuals are finding it increasingly difficult, under slowing business conditions, to keep cash flow high enough to meet interest and principal payments. The Savings and Loan Industry (S & L) finds itself in an equally perilous situation. If the S & L’s were to mark their mortgage portfolios to the market, the S & L’s would have a negative net worth. Also, because of the reduced prices of real estate, there may be little equity to back up loans. California is reported to have an 8%, 60-day delinquency rate.
To compound the situation, money has been flowing out of the S & L’s into the more flexible money market funds. Even knowing all these negatives, I still believe that the stock and bond markets have a big upside potential. Markets are like a big offsetting equation. If there is a big profit potential, there has got to be a big risk. There is a very difficult economic period ahead of us. The stock market usually discounts the future by about six months. That’s why markets usually go up during negative news periods. Negatives can be discounted by the market before the event. The first quarter of 1975 was given as an example, when the market skyrocketed, while news continued negative. Another example happened in 1980, when the Dow rose from 730 to 1000 while interest rates rose from 10% to 21%.
At some point the negatives become fully discounted and anyone who was going to sell has already sold. At some point, investors will look across the valley of our present problems and begin to see the next mountain top. Presently, investors fear the light at the end of the tunnel might be an oncoming train. This is a very critical stage for this country. Our survival as a capitalist system may be at stake. There is certainly no profit potential in that outcome. Anyway, I am certainly more optimistic than current stock and bond market evaluations. Here’s why.
A Big Upmove Is Coming
As mentioned earlier, when the stock market starts dropping, investors tend to think of the positive aspects as pointless. In my opinion, the biggest factor that is being ignored is the value of stocks. Major U.S. corporations are selling below 5 times earnings. To more fully understand the significance, please note figure 3, which is a chart of price earnings (P/E) ratios since 1949. Missing in the chart is the previous P/E peak of 20.5 in 1946. The present P/E ratio’ is 6.7. The record low P/E ratio in 1978 and 1979 reflected the problems of energy independence, inadequate defense, low respect for leadership, runaway inflation, record high interest rates, a stagflation economy, growing government interference and lower productivity. Some of these problems are being solved. Inflation is now running below 10%, government spending and government interference is being reduced, productivity should be encouraged by the tax incentives and the U.S. is regaining its leadership role and respect. In my opinion present evaluations on stocks have already discounted every fear except an economic catastrophe. Stocks, based on their P/E ratios, were not overvalued before the correction from 1030 began. That’s why I earlier likened this period to a clearance sale on discounted prices. A recession will probably cause some revision of earnings estimates. However, it appears to me that these earnings revisions have already been discounted by lower prices.
DOW-JONES PRICE-EARNINGS RATIO (Figure #3)
What would happen if the Reagan plan begins to work? The market has discounted fear, but it hasn’t discounted the hope of a positive outcome. Should investors begin to discount the positive outcome of this country’s problems, the stock market could sell at an historically reasonable P/E of 15. Using a 15 P/E ratio at present earnings levels, the Dow Industrials would be above 1700 and the Dow transports above 550. Stock prices are also cheap when compared to book value.
Presently, the price to inflation adjusted book value of the Standard and Poors 400 Index is about 70% of the market price. This compares to about the same evaluation during the devastating 1974 period (look back to page 3 to see how negative the news was then). This 70% of book value valuation is historically low, as since 1959, bear market bottoms have averaged 118% of book value. It can be argued that P/E and asset evaluation is useless because of the inflationary impact, which cannot truly be measured.
But then again, remember, all positive factors appear to be pointless at market bottoms. It is only after the market rises that one can say: “Of course, the market was a bargain then.” Between 1978 and 1980, corporate earnings have increased 13.6% a year and dividends 11.7% a year. Although value is a judgmental factor, the low evaluation of U.S. equities becomes more than elementary when acquisitions are made. During the sale of a company’s division, the parts can suddenly become worth more than the whole. Also, entire companies are being bought out at prices much higher than the market price. Many acquisitions are presently being held off because of high interest rates. When rates do begin to fall, I expect a buy out mania to strike the market.
Technically, I believe the primary trend of the market to be strong up. Since 1974, new all time highs have been made in such places as the Dow Composite Average, the NYSE Composite average and the Standard and Poor’s 500. So far, the correction since 1030 has been nothing more than a standard 62% correction of the Dow 740 to 1030 upmove to 840. Should the market fall further, I still believe the primary trend to be up. The uptrend in the Standard and Poor’s 5OO is shown in Figure 4 as an example of how bullish the primary trend is.
Helping my bullish attitude is the position of the Birkelbach Indexes. *(NOW CALLED THE STRATEGY INDEX) All three of the Dow Industrial Birkelbach Indexes (Short, Intermediate and Long Term) are in oversold territory (below 70). These indexes in the past have been a very accurate indication of a major market bottom. (See figure 5 on page 7). The last time all three indexes were in oversold territory was at the 730 bottom in 1980. The Birkelbach Index is shown weekly in this letter and is updated daily on the telephone update service. Other overbought/oversold indicators are also in oversold territory. In addition, the Dow Industrials are selling at approximately 10% below the 200 day moving average. Support is usually found at that level. A measure of market bearishness can be seen in the Investor Intelligence index of investment advisory sentiment. Presently, the percentage of bearishness has been above 50% for eight weeks. This usually means that the bearishness is fully discounted and a rally is due.
Now, let’s take a look at the upside projections. I calculate my objectives by determining the past down moves and multiplying these amounts by 1.62 and 2 for upside objectives.*(SEE CHAPTER 6). This is my interpretation of the Elliott Wave and the Fibonacci golden ratio of .6182. (For a further explanation, obtain the following books: The Elliott Wave Principal and the Major works of R.N. Elliott by Prechter from New Classics Library, P.O. Box 262, Chappaqua, N.Y. 10514.) The last big downmove was from 918 to 737 in 1980. Using this method to calculate the next minimum and maximum objective is as follows: 1.62 times the 918-737 downmove of 181 points calls for a 293 point minimum upmove to 1030. No further calculations for the maximum objective are needed. This minimum objective calculation predicted the 1030 top made April, 1981. Again, using this method, let’s gauge the upside potential of the downmove from 1026 to 737 in 1976/78. 1.62 times the 1026-737 down move of 289 points calls for a 468 point upmove to 1205 (minimum objective). The maximum objective is 2.0 times the 1026-737 downmove of 289 points, which calls for a 578 point upmove to 1315. The upside potential of the 1067 all time high down move to 570 in 1974, obtains a maximum objective for an upmove to at least double above a Dow of 2000!.
Fig. 4 These objectives may sound high, but a Bull Market II can act that way. There are very few investors that remember how the bull markets of the 50’s behaved. The fault of the new money managers and individuals in the future may be that they sell too soon. The market spent 15 years trying to break above 100 at the beginning of the century. When the market finally did make the break above 100, the Dow rose 400% in five years. The Dow spent 13 years trying to break above 200 between 1937 and 1949. After the market finally broke above the 200 barrier, the Dow rose 500% to 1000 in 17 years. The Dow has been stopped by the 1000 barrier for fifteen years. When the market does finally break above 1060, expect a big rise that will discount hope.
As can be seen, an objective of over 1500 is not an unreasonable expectation. This rise will merely bring prices back to a realistic P/E ratio. Bull Market III has an objective of over a 2000 Dow and, of course, may reflect an overestimation of value. Timing is little more than guess work. However, I expect a Dow 1300-15OO by 1984.
You may wonder where all the money is going to come from to propel any big upmove. The money supply is almost twice the size it was in 1966, when the Dow was at 1000. So, it will take no greater percentage of the money supply to get the Dow to 2000 than it did to get it to 1000. Once the market goes up, the upmove itself will attract investors. Buying is also likely to come from outside the U.S. European institutions own less than half the normal amount of U.S. stock. There are several factors that would lead investment dollars back into the U.S. stock market. The U.S. dollar has strengthened substantially and the U.S. inflation rate continues to fall. The tough stances of Volcker and Reagan have regained worldwide respect for the U.S. Also, oil is paid for in U.S. dollars. As the dollar has risen, oil to other countries has become more expensive and has increased their inflation rate, while slowing down business. All this is happening while the European Monetary System is under pressure because of the above items, the socialist French government and the Polish problem. Even if U.S. interest rates do come down, the dollar should remain strong because of the above stated reasons. U.S. dollar denominated investments should be in demand soon. Pension and profit sharing plans are another possible big buyer. These funds are presently growing at some $40 billion a year. Then how about that $150 billion in money funds? A drop in short-term interest rates could cause a buying panic into stocks and bonds.
I don’t mean to leave the impression that profits will be easy to obtain. Upmoves usually occur very quickly and leave behind most, thinking they will buy the next setback, which never comes. Somehow, interest is aroused and there is plenty of time to get in just before a drop. Then, there is a thing called rotation. That’s where an upmove occurs only in a specific group. About the time you sell your unpopular shares and get the “hot” group, it goes down and your old stocks go up. That’s what makes this business so interesting and so challenging. One must constantly update and adjust.
In the bond market, I prefer long term bonds having a coupon of about 10%, currently priced at about $60 to yield 16%. Should corporate bond yields drop to 10% in the next couple of years, this kind of bond offers a 50% capital gains possibility and a high yield, while you wait. In the stock market. I prefer some of the big name companies. If the country prospers, the earnings and dividends of these companies could rise quickly. These kind of issues presently appear so undervalued (5 times earnings) that their stock performance may even outperform some of the high technology companies. Suggestions of stocks and bonds are given weekly in this letter and updated on the daily telephone update service.*(THIS WAS WAY BEFORE THE INTERNET) I approach investments the way a general approaches a battle. A plan of attack is initiated, with an objective in mind. Once that objective is attained, it must be secured. Many a profit has been lost by forgetting to take it. Should the battle go badly, a plan of retreat should be used, so losses will be at a minimum. If the plan is made before the battle, emotions will play a smaller role in the heat of battle. Market timing and proper selection are important. However, discipline may be the most important factor in investing. Discipline is even more important than luck. Just the same, good luck.
Carl M. Birkelbach 09/11/81
So with the stock market moving sideways for 17 years I became known as “The Lone Bull” (as everyone else was bearish). I took what little money I had to put the beow add in Barron’s Magazine on September 17 1981. I have also thrown in a couple of quotes from 1979 and 1980.
Following is the Lone Bull Revisited Letter with the Dow at 3,000 and issued on February 24 1992 where I predicted the Dow to 8000 and higher
THE LONE BULL REVISITED
A DOW OF 5000 TO 8000
Dow at 3000
Does the title get your attention? Good. No, I didn’t write it just to get your attention. I really do believe it. How can I be so bullish when the economy is so bad? Some people think that we’re in a Depression. Well, if those pessimists are right, it would appear that we’re all going to be miserable. But let me ask you, what if the pessimists are wrong? What if we are in the greatest Bull Market of all time? What if this country were to refocus its energy from fighting the fallen “evil empire” of Communism to focusing on global competition? What if the kind of technology that produced the Patriot anti-missile missile and other highly sophisticated smart weapons were to produce competitive consumer electronic goods? *(MICROSOFT ETC.) What if our smaller innovative companies were to create a need for employment sufficient for bubble-up (opposite of trickle-down) employment for major U.S. companies now in the doldrums? What if the lessons learned by new MBA’s taught in todays universities can actually be applied successfully?
What if the Federal Government were to motivate savings and investment through intelligent fiscal programs? What if the “peace dividend.” proper business incentives and careful spending by our government were to reduce the deficit? What if the laid-off workers from the union-intensive auto and steel industries would be motivated towards productivity in their next jobs? What if the Federal Government were to help finance companies engaged in “joint efforts” to compete in global markets in such areas as electronics (high-definition television, semi -conductors) aircraft and shipbuilding? What if, in light of the events of the past year, the time for pessimism is over? What if this is the greatest opportunity for growth since the beginning of the industrial revolution?
What if this is the greatest country in the world? Got the picture?
Sure, we have our problems, but there are always problems. There are those who believe that a problem is just another name for an opportunity waiting for a solution.
We don’t have a homogeneous society like the Japanese or the Germans, but perhaps that is to our advantage. This could also be a time when everyone can win. New markets are opening for us, as the former Communist countries and third world nations lift their living standards. The “manifest destiny” that our forefathers envisioned for this country might truly bring dignity to mankind and the realization of the potential for freedom expressed in our Declaration of Independence and Bill of Rights. This is more than revolutionary. It is evolutionary.
The Lone Bull Letter of 9/11/1981 Revisited
In September of 1981, with the Dow below 800, I wrote the “Lone Bull Letter”. I was quoted in Barron’s as calling for a “surge in the market to even 2500”. Pretty heady stuff for that time. Now with the Dow above 3000, I foresee even loftier heights. Then, as now, there was a great deal of pessimism. But that’s what Bull Markets are made of. No! I cannot guarantee it, and therefore, there is a risk as always.
The fact remains that that old “Lone Bull Letter” looked back in history and saw five bull markets between 1949 and 1966 (the last full Bull-Market series), with the Dow doubling five times in a row. This most recent Bull-Market series has only doubled twice! A Dow of 5000 to 8000 is a possibility for the 1990’s. (maybe higher) Be cautious, but think positive. What if I’m right? (Again).
Carl M. Birkelbach
As can be seen above the Dow went above 8,000 to 11,750 in 2000. Of course markets do go too high and then too lows. As we all know by now, the year 2000 was the top of the technology bubble with a devastating Bear market in 2000 to 2003 as can also be seen above. Making this decline even more difficult for investors to deal with (than 2008-2009 housing bubble Bear Market) was that the only way to participate on the downside then, was by shorting stocks. The process was burdensome. Before shorting, one had to borrow the stock and get brokerage house approval with restraining margin requirements and then one had to deal with the uptick rule (shorting could only occur when the stock traded 1/8 cents higher) (Remember 1/8, ¼,1/2/, 3/8, 3/4 pricing?) However, then as now Put option protection was available. Now in addition to option management alternatives, we have ETFs (Exchange Traded Funds) that have entities that represent short positions (Investors have at last been freed to execute a Bearish Strategy ).
Following are excerpts from Lone Bull II Letter written at the bottom of the Bear Market in October 2002. Note once again, I used fundamental information along with use of technical tools such as Support and Resistance areas.
Lone Bull II – Fall 2002
Dow: 7883, NASDAQ: 1260, S&P 500: 842
Looking For A Bottom
The latest score from the year 2000 high to the new lows established this October is as follows: NASDAQ down 77%, S&P 500 down 50% and the Dow Industrials down 36%. That averages out to be a 55% decline in 34 months. That makes this the worst performing market since the Depression (which lasted 39 months). The previous “worst market” award occurred in 1974 when the market fell 50%. However, that Bear Market lasted only 9 months. So, if you are still reading this “stuff” about the stock market, you are one of the survivors of the worst Bear Market since the Depression. Congratulations! Like the old joke about the optimist: “With all this horse manure, there’s got to be a horse around here somewhere”. So it is with the market: “With all this devastation, there’s got to be a market bottom here somewhere”. Most of the news is still bad, but it always is at a bottom. As the market always moves in advance of anticipated news, the market will probably be up substantially before the news turns positive. Then how can you determine a bottom? How about the market itself.
Here Is What To Look For
The process which is needed to establish a major low is for the markets to first rally from a low (which they are doing), and for that low not be broken for the Dow, NASDAQ and S&P by any setback sell offs. Next, there are a series of former support areas that have now become resistance areas for the market to break above. For the Dow the first major resistance area is 9,010, the NASDAQ 1,426 and the S&P 964. If this can be accomplished the Intermediate Term Breakout points (that in my opinion would end the Bear Market and begin a new Bull Market) are 10,679 for the Dow, 1,759/2,098 for the NASDAQ and 1,174 for the S&P. These breakout points are still a long way off. That is because the Bear Market we are now in has done a lot of damage, which only a major reversal of prices can change. We expect this process to take several years. In the meantime, watch for Short Term Support Levels to hold. They are Dow 7,197, NASDAQ 1,108 and S&P 768. *(THIS WAS THE BOTTOM AS FORCASTED)
Carl M Birkelbach Oct 2002
LONE BULL II REVISITED MARCH 2005
Following is the entire reprint of the Investment Strategy Letter #539 on March 2005 which can be labeled Lone Bull II Revisited with some VERY ACCURATE objectives on the upside
THE INVESTMENT STRATEGY LETTER # 539
LONE BULL II REVISITED
Early March 2005
Dow: 10,940 NASDAQ: 2070 S&P 500: 1222
A Big Buy Signal
We have been alerting our readers for the last several years, to the possibility of the formation of a Giant Head and Shoulders Bottom. We now feel that this formation is complete with an upside potential for the Dow (above its all time high of 11,600) to a new all time high of 14,309, which is 32% above its current levels. The projected upside potential for the NASDAQ is at 2,892, up 45% from its current levels, but almost 50% below its all time high. The projected upside potential for the S&P 500 is close to its all time high at 1,572 up 31%. So, it appears that the danger of a new Bear Market reemerging is quickly becoming a distant horrid memory of the past. A new Bull Market has been silently but steadfastly emerging since forming a bottom in October 2002. (Lone Bull Letter #519)
For those interested in what a Head and Shoulders formation is, see our pamphlet, Stock Market Forecasting Through Charting on page 12 or on our website www.my-broker.com under the pamphlet name. For those interested on how the calculations were made, see the footnote at the end of this written report* and next to the charts on the addendum page.
This Bull Market won’t be easy. It appears that our new Bull Market, which has been in effect since October 2002, is much different than the wild up markets of the 1990’s. The buy and hold (and forget) strategy, where almost any stock bought double-digit returns is over. The current Bull Market requires an Investment Strategy that requires additional scrutiny of selecting individual issues. Not everything will go up. For instance, General Motors is in a continuous downtrend (awaiting a $15,000 Chinese SUV?). There may be rotation of interest. Lately, it’s been the energy stocks leading the pack. That may end abruptly (if oil prices start to sag) and another group may emerge as the favorite. Secondly, implementing a plan for a “buy and sell” strategy could be more productive in an environment in which stocks rise and fall in a cyclical pattern. Become more aware of “support and resistance areas” and our Strategy Index. Stay tuned and stay alert!
Footnote on Calculations
In the accompanying price history chart for the Dow:
- The left shoulder low of 8,300 was formed in response to the 9/11/01 attack and can be looked upon as an aberration. The left shoulder that we believe, should be used, was formed in the year 2000 at 9,500. · The market then advanced to a left shoulder high of 10,793, forming the left point of the neckline (top solid line). · A deep decline then followed, forming the head, at 7,197 in October 2002, the end of the 2000 – 2002 Bear Market. · The high of the subsequent advance in 2003 formed the right point of the neckline at about the same level as the left shoulder high of 10,793. · The right shoulder low was reached in 2004 at 9,600. · The advance in late 2004 to a little above the neckline at 10,753 virtually completed the formation. As is usual at the end of a head and shoulders bottom formation, this advance immediately met resistance after breaking the neckline of 10,753 and declined in January 2005. Late in February and early March 2005, however, there was a quick retracement above the neckline, indicating the completion of a textbook head and shoulder bottom formation and hopefully a big upmove to follow.
- The next step is to calculate how far the market should advance. Technical analysts calculate this projected advance by measuring the distance from the neckline (10,753) to the bottom of the head – 7,197 points on the Dow – and adding this distance 3,556 to the neckline at 10,753. (10,753 – 7,197 = 3556; 10,753 + 3,556 = 14,309). This gives the new projected goal for the next market advance at 14,309. The accompanying charts also show these calculations for the S&P 500 and the NASDAQ Composite Indexes and for the smaller Head and Shoulder Formation of 2002 – 2003.
no chart SORRY
Charts Courtesy of CNBC.COM Carl M. Birkelbach
The trend lines in “red” and “blue” have been added to these charts.
AN EXTRAORDINARY PERDICTION
As can be seen by the above chart, this turned out to be an extraordinary prediction, with my projected market tops falling within 1% of the eventual actual top. I gave seminars throughout the country warning about the eventual 14,309 top and got quoted a lot by the media, but being from a provincial town like Chicago the big recognition for these accurate predictions never happened.
Anyway, what followed was the most devastating Bear Market of my lifetime. I wrote Lone Bull III on November 05, 2008 with the Dow at 8,379. I was too early! The markets went up as I predicted to a Dow of 14,198. However, the drop to 6,470 was unforeseen by me and most everyone else. In perfect hind sight, this drop from 14,200 to 6,470 was about a 62% correction of the entire Bull markets since the 1980s. *(SEE CHAPTER 6 FOR FIBBONCCI PROJECTIONS). This financial collapse almost broke the back of our free enterprise system. Here is Lone Bull III. A little early, but better too early that too late. After the eventual bottom, the market has about doubled.
LONE BULL III
NEW ERA OF OPPORTUNITY
Early November 05, 2008
Dow: 8,379 NASDAQ: 1,493 S&P 500: 850
The Audacity To Hope:
No matter how you voted, all investors now have to deal with the reality that we have a new President. What does this mean for the stock markets? Statistically, on average, in the seven periods when Democrats had complete control of all Houses, the S&P 500 rose 14.7% per year, compared to the eight times the Republicans were in control, the S&P 500 rose 7.4% per year. In these volatile markets, that could happen in one day. Obama is the one who wrote the book “The Audacity of Hope”. Hope sounds good, right now. It has been a scary time, with markets throughout the world experiencing a worldwide credit crisis. Worldwide, markets have fallen some 50% and according to most analysts, the worst for the economy is yet to come in 2009, with corporate earnings faltering and unemployment rising. The correction could continue to a 62% correction. So why a Lone Bull Letter now? Get ready! As I said in Lone Bull I, September 11, 1981 (Dow 800 to 11,200) “Don’t expect to see a headline in the paper ‘Buy now and Sell at much higher prices later,’ the markets don’t operate that way. A market bottom is formed when all the negatives are fully discounted. That is when everyone that could be frightened into selling, has already done so. Discouragement, disappointment, apathy, fear, frustration and the most important ingredient, panic. are all part of a typical bottoming process”. So the stage is set. All we need now to complete the cycle is panic. We even had on October 17, an Asian Black Monday, as Asian markets fell some 14% in one day, while US Markets reaction was “to late to sell”. From Lone Bull II October 2002 (Dow 7,200 to 14,200) “most of the news is still bad, but it always is at bottoms” Consumer confidence is near a record low, the housing markets and banks are in shambles etc. Everyone knows the negatives, as the media has been full of discouraging news. The question is: Has the downside overly discounted the continued negative news that will surely continue? We think so. However, the market always goes up further than it should and down further than it should. We haven’t seen capitulation yet, but it is close. So, wait for a turnaround, somewhere around a Dow of 7,000.
Era of Opportunity
Let’s look at the positive side of an Obama victory and for a change of perception. First keep your eyes open. Stocks like Volkswagen, MGM and Cigna have risen 50% in a day. Opportunity knocks! On the positive side every one cent drop in the price of gasoline, means one billion dollars back into consumers’ pockets. The dollar is rising against the Euro, as a US recovery looks more likely and stronger than Europe’s. A stronger dollar could see foreign capital inflows in US equities and debt securities. In order for the US to avoid a serious recession, Obama is likely to increase spending, whereas McCain said he would put a “freeze” on spending. Government spending on energy alternatives, health care and infrastructure under Obama, will continue to flood the economy with cash. Also money supply is growing at record levels (up 50%). Remember, Nobel Prize winner Milton Friedman indicated that the most important factor in a growing economy and a rising stock market is the growth of money supply. As 50% of the scientists and engineers now live in Asia, an Obama administration will reemphasize the importance of teachers and education. In addition, the Federal Government has shown that it will come to the assistance wherever needed. Of course all this is tempered by run away deficits and by the restructuring of Wall Street and the Banking Industry. Less leverage for debt, will wean a previously over exuberant economy. However we feel, in the long run, these adjustments and good leadership will have a long lasting stabilizing effect on the economy.
Sursum Corda (Lift up your hearts)
There has been a lot of talk and negative connotation about the words “liberal” and “socialism”. So far, what the Treasury and Fed have done will be short lived. They have moved into the credit banking system and will move out when appropriate. This is not a nationalization of our Banking and Financial System. Herbert Hoover in 1929 did nothing, resulting in the Great Depression of the 1930s. Socialism in European style is not an option here. However, Government policies under a Democratic administration are likely to become more liberal. The redistribution of wealth that McCain warned us about has already occurred. Some figures show that 90% of the wealth is owned by the top 2%. The bottom 50% of those working earn only 16% of total US income and will never be able to get themselves out of debt or send their children to college. Hopefully the changes of an Obama administration will help to lift the water level, so that we can all float higher. We come from two cultures 1) A Linear concept of success
where what is good for the individual should be good for the whole (cowboy approach) and 2) a concept of inclusion that is Circular, where what is good for the group should be best for the individual (tribal approach). A proper balance of these two concepts needs to be implemented through education and social programs. After all, we are all in the same boat of mutual dependency. Although the next four years will be difficult “Lift up your Hearts” to Hope, as we continue to solve our problems through inventiveness, a positive mental attitude and persistence.
Buy Low, Sell High
The chart below shows how markets have acted since 1929. As can be seen, there were only two periods where a “buy and hold” philosophy was applicable. The majority of the time, investors had to be more flexible to make profits. Over the last ten years (on average), investors have only broken even. This period could continue for a while yet, with a Dow of 14,200 and a S&P 500 1,500 top offering Resistance. As we continued to say over the last ten years “investors must become more flexible during the upcoming uncertain period, where proper selection and market timing, are the proper Investment Strategies”. In addition Exchange Traded Funds (ETFs) are preferable to less flexible Mutual Funds. Keep track of our Current Market Comments and Investment Strategy Letter at our website http://www.my-broker.com
Long Term Prediction:
Our interpretation and the implications of the below chart are as follows 1)We are hopefully completing a bottoming formation process, 2)We see approximately 3 to 5 years of continued volatile markets below 14,200, and 3)An eventual breakout above 14,200, indicating a future Dow above 17,000 to 22,000.
Carl M. Birkelbach
November 05, 2008
My market letters in 2009 showed (as seen below) the next Resistance point for the Dow was between 10,334 and 11,750. This strip of Resistance ran from 1999 till 2010. In January of 2010 this wall of worry Resistance level above 11,750 was shattered on the upside and a New Bull Market Phase has began.
In Investment Strategy Letter #567 September 2009, I said “we have a text book Head and Shoulders Bottom”. I outlined an upside objective for this upmove based on our old friend Head and Shoulders Bottoming formation, by doubling the base and picked the next top at approximately to13,000 to“13,500”. The Investment Strategy Letter #570 April 2010 called for a top in 2011 as just under 13,000. The Dow did rally to almost 13,000 in May of 2011 (as predicted) and then fell to 10,600 the same year As you can see, as with the Head and Shoulders prediction of a 14,200 Dow 2007 top , this Head and Shoulders stuff can be very useful. So that you can do this yourself a Head and S holders projections are made by doubling the difference between the neckline and the low as follows: by subtracting the neckline of 9794 (of the Head and Shoulder bottoming formation) from the bottom 6470 = 3324 and then adding it to 9794 + 3324 = 13,118.our upside minimum projection In early 2012 the Dow rallied again above 13,000. By using my original calculation in the Investment Strategy Letter #567 September 2009 and using an alternative 10,200 (the October 09 high) as the Head and Shoulders neck line, we come up with the maximum upside objective of 13,950. As the market is at 13,270 as this is being written, (March 2012) I believe that the Dow will find a large amount of Resistance between a Dow of 13,118 TO 13,950 area for 2012. A break above 14,000 for 2013 would put the Dow within striking distance of the all time high at 14,198. A break above that level would possibly end the sideway trend and change it to a New Bull Market. We Shall See! Let the market tell us whether to implement a Bullish or Bearish strategy. More about our methodology for formulating you strategy can be found in the next Chapter 4.
BELOW CHART OF HEAD AND SHOLDERS BOTTOMING FORMATION IN NOV 2009 SHOWING CALCULATIONS FOR PREDICTING MINIMUM AND MAXAMUM UPSIDE RESISTANCE POINTS BETWEEN A DOW OF 13,118 TO 13,950 USING A CORRESPONDING 9794 AND A 10,200 NECKLINE
9794 – 6470 = 3324 +9794 = Minimum upside projection of 13,118
10,200 -6470 = 3730 = 10.200 = Maximum upside projection 13,950
So, now what? What will the future bring? It is like the old Patty Page song says from the 1950s, “QUE SERA SERA” (“What will be will be” in Italian) For that (and so that you can start making future projections yourself) let’s look at the next chapters, which explains how to apply metrics to this methodology, how your internal dialogue can be collaborated with your charts,, the metaphysical nature of price movements, future projection alternatives and the Eight Fold Way To Investment Success.
THE METHODOLOGY All right! It’s time to get to our methodology and explain our dynamic investment strategy that can be tailored to your risk reward comfort level. This methodology will take a little work on your part. However, once you’ve done the Long Term analysis, changes will occur rarely and at major turning points. Chapter 7 outlines the major future Support and Resistance zones that should hold true for the next 10 to 20 years. The Intermediate Trend will take more of your attention. Of course, the Short Term analysis is a more active endeavor, but is an essential ingredient for achieving your investment strategy. (even if you are only long term oriented). We will look at the charts of the Dow Industrials, S&P 500 Index the NASDAQ Composite and look for the easy to determine Support and Resistance points and
RANK each with a
3 for up,
2 for neutral/up,
1 for neutral/down
0 for down.
We will do this for each on a Long Term, Intermediate Term and Short Term Basis. We will then determine an Investment Strategy based on this methodology. I am using the current charts at the time of this writing, but the process will not change. Remember if I give you a fish, it will only fulfill one meal for that day. However, if I teach you to fish you will be able to feed yourself every day. What if you don’t like to fish? Then stay away from the market and the water, you could drown.
THE OBJECTIVE PROBLEM SOLVED
The following Rating System will help you develop an investment strategy without you having to make a conscious decision about a market scenario. Predicting the future movement of the market is difficult. It is always hard to tell where we are in either a Bull Market or Bear Market cycle until it becomes obvious in hind sight. For example:
There are three alternatives of where we are in a typical Elliott Wave cycle above:
1) The Dow in 2008/09 crashed from 14, 198 to 6,450, the S&P 500 from 1,557 to 666 and the NASDAQ from 2,861 to 1,268. Were these bottoms a (C) and is the up move since, a new #1 cycle of Hope? OR 2) Are we already at the top of wave #1 and ready for a correction to #2 OR 3) Is the recent up move the top of (B) wave of an Elliott Wave A, B, C Bear Market and we still have to fall to (C) ?
The answer to the above dilemma is “I am not sure yet”. Maybe by the time you are reading this, it will be obvious. However, whenever you are looking at the current markets, the obvious is never obvious, until after the fact. Maybe investors will become optimistic and our economic problems will be solved and a new era of the promised Hybrid Age will occur and investors will once again become euphoric. Then again maybe investors’ confidence in the economy will turn from fear and panic if Europe falters, oil prices skyrockets etc. and the markets crash. Then again maybe the markets will just continue to move sideways as it has between fear and hope. The important thing to remember is that we are not responsible for the outcome. As good citizens we want prosperity to continue for ourselves and our family. However, being an optimist during a market decline won’t help either you or your family. As you will tell from Chapter 5, my internal dialogue is full of concerns (bull markets climb a wall of worry). However, my internal dialogue will not influence my technical analysis of the market. I will let the market tell me what to do independent of my personal opinion. You should do the same. To help you I have tried to make this Rating process as objective as possible. OK!
THE RANKING PROCESS METHODOLOGY______
The LONG TERM TREND
LONG TERM TREND ANALYSIS OF THE DOW
LONG TERM DOW RANKING: NEUTRAL/UP RANK (1)
The above chart shows two bubbles that burst with market declines. Using common trend lines we can touch the dot com bubble bottom and the housing bubble bottom at 7.197 and 6,470 and determine that the lower lows is a downtrend. When we use a trend line to touch the tops at 14,198 and 12,876 we can determine the lower highs are also a downtrend. However the trend since 2009 has been UP. Therefore the Long Term Trend of the Dow Industrials is Neutral with a downward bias. That is a (1) rating. FOR FUTURE PREDICTIONS we can see that there has been a tremendous Resistance Area between 11,790 to 9,614. IF 9,614 is broken on the downside, the ranking would go to Down (0). IF the Dow can break above is Resistance at 12,876 to 13,313 (see the last chapter) the ranking can change to Neutral/upward bias (2). IF the Dow can rise above 14,198 we would change the rating to Up (3).
LONG TERM ANALYSIS OF THE S&P 500
LONG TERM S&P RANKING : NEUTRAL/DOWN (1)
Like the Dow, the S&P 500 is in a downtrend (lower, lows) with tops at 1,576 and 1,370 and like the Dow the S&P has been in an uptrend since 2009. Like the Dow the trend since 2009 has been up and therefore has a ranking of Neutral /down (1). IF the market can break above 1370 we can change the ranking to (2). IF a breakout below 1000 would occur it would change the ranking to Down (0). There is Upside Resistance at 1,576. Unlike the Dow, the S&P 500 was unable to make a new high in 2007. IF the S&P can break above 1,576 this would change the rating to a strong Up (3).
LONG TERM ANALYSIS OF THE NASDAQ
Now for an analysis of the NASDAQ Composite Index.
LONG TERM NASDAQ RANKING: UP (3)
One can see immediately that the NASDAQ chart looks much different from the DOW and the S&P 500. The NASDAQ had its big decline in 2002 when the dot com bubble burst and only held 20% of its value. Although the following bursting of the housing bubble was devastating, a new low was not formed for the NASDAQ. In addition the market in 2011 broke above the old 2,861 high by a little bit, so the long term appears UP (3). IF the market breaks below 2500 the ranking would drop to (2), below 2300 to (1) and below 2077 to (0).
SUMMARY OF THE LONG TERM TREND RANKING
The overall rating Long Term Ranking for the markets is 5 out of 9
INTERMEDIATE TREND ANALYSIS (DOW)
INTERMEDIATE DOW RANKING: NEUTRAL/UP (2)
The uptrend line from 6,469 that began in 2009 has been broken on the downside. In addition there is a downtrend like that touches lower lows. However, there is recently a consolidation of upward and downward movement that a downtrend line touching lower highs that parallels the other downtrend line. It appears that this downtrend line has been broken on the upside and therefor I give the Ranking as Neutral/Upward bias (2). IF the market falls below Support at 10,404 the Ranking would change to Neutral/ Downward bias (1). IF 9,614 is broken on the down side the Ranking would be changed to Down (0). There is Intermediate Term upside Resistance at 12,500 where the old trend line intersects and at 12,875 to 13,313 above which would change the rating a rating of ( 3)
INTERMEDIATE TREND ANALYSIS S&P 500
INTERMEDIATE TREND S&P RANKING: NEUTRAL/UP (2)
As with the Dow the S&P 500 has broken below its upthend line established since the 666 2009 low and also as with Dow, it appears that the downtrend line in 2011, touching the lower highs, has been broken on the upside. This is enough of an upside breakout to confirm an Intermediate Trend as neutral/bias up (2). IF the upward movement continues above upside Resistance at 1,370 this would change the raking to UP (3). IF the S&P breaks below1074 the Ranking would change to neutral/down (1) and below 1011 to down (0).
INTERMEDIATE TERM NASDAQ ANALYSIS
INTERMEDIATE TERM NASDAQ RANKING:/UP #3
The uptrend line from 1,268 that began in 2009 has been broken on the downside. As with DOW and the S&P 500 it appears that the down trend line touching the lower highs has an upside break out. In addition the NASDAQ has broken into higher ground above 2878 which gives the current ranking for the Intermediate Trend as UP (3). IF the market can break below 2876 resistance the rating could change to neutral upward bias (2) and below 2500 to (1). Below 2,077 support the rating could change to (0) Down
Summary Intermediate Term Trend Ranking
The overall rating of the Intermediate Trend is 7 out of
THE SHORT TERM TREND
SHORT TERM ANALYSIS OF THE DOW
SHORT TERM DOW RANKING : NEUTRAL/UP (3)
On a short Term Trend basis the market is showing some upside potential. Most significant is the upside breakout above the downtrend line from 12,751. Therefore the Ranking is up (3). IF the market trades below 11,600, the short term trend line, the Ranking would change to (2) and below 10,604 the Ranking would change to (1). Should the market trade below Resistance at 10,404 the rating would change to Down (0).
SHORT TERM ANALYSIS OF THE S&P 500
SHORT TERM S&P RATING: /UP (3)
On a Short Term Basis the S&P 500 is also showing some upward potential. Most significant is the upside breakout above the downtrend line from 1,356. Therefore the ranking is UP (3). IF the market break the trend line 1,210 we could change the rating to (2). IF the market trade below 1,101 the rating would change to (1) and below 1074 to (0)
SHORT TERM NASDAQ ANALYSIS
SHORT TERM NASDAQ RATING: (3)
Unlike the DOW and S&P 500 this market has broken above the downtrend line touching 2,862 and 2,643 and is trading above the old trend line touching 2,862 and 2,643. Now at 3000 and above Resistance at 2750 the Ranking is UP (3). IF the market trade below 2,600 the rating would change to (2) IF the market trades back below 2,750 the rating would change to Neutral bias up (1). If the market trades below 2450 the ranking would change to (0).
Summary Short Term Ranking
As of this writing the NASDAQ has traded above 2750 to 3000 changing the Ranking to (3). For an overall point total of 9 out of 9.
TOTAL SUMMARY OF ALL TRENDS
Out of a possible 27 points all Trends came out at 21
LONG TERM 5
INTERMEDIATE TERM 7
SHORT TERM 9
Below is an investment strategy for the average investor. OK! You got me. There is no such thing as an average investor. However, try and adjust the below strategy to your own situation. For instance, you can adjust the percentages upward or downward depending on you risk tolerance level. Also, if you your risk reward tolerance requires a 50% 50% split between equity and bonds, use the below scenario for only your equity portion. However it is important for me to point out that even if you are short term oriented, I believe an analysis that includes all three of the trends will yield the best results.
Below 4 100% Short
Below 9 – 5 62% Short
Between 9 – 14 50% Long, 10% Short
Between 15 – 20 75% Long, No Shorts
Above 21 100% Long
INVESTMENT SELECTION ANALYSIS
OK! After using the above methodology you should have an idea of what kind of an Investment Strategy you want to employ for your portfolio. Now, the next step is, were to put your money. One can do an analysis of each of your favorite stocks or the ones you own, using the methodology as we have done for the markets above. However, I think going with the ETF’s that match either the general market or a specific group is easier and safer. Individual selection can get tricky as you can be right about the market, but wrong about the stock. ETF’s offer diversification. This can protect you should something unforeseen suddenly happen to your individual selection. Technical analysis believes that all known facts are shown in the price. However, the death of a CEO, a weather related disaster, plant explosions, SEC investigations etc. cannot be foreseen nor will these things be necessarily be reflected in the charts. It is still easier to go long a stock than to short one. So in implementing a Bullish Strategy one can carefully use individual stocks, but going short is much more easily done with ETF’s. It is natural to not buy into groups and stocks that are leading the market as you may feel that the train has already left the station without you. It is also natural for you to want to be ahead of the crowd and find the bargains. As logical as this seems, it is not necessarily the way to successful investing. Upside momentum is very important to attracting more investors. You are not Warren Buffett. He has enough billions of dollars to wait out any immediate return. Go with the winners and be a winner and don’t forget to hold your winners and use a stop loss (as discussed earlier) for your losers. Hopefully, our methodology will take the judgment out of your internal dialogue (mine follows in Chapter 5) out of your analysis and will help you to find the correct investment strategy.
CHAPTER 5 HAS BEEN LEFT OUT ON PURPOSE
EVERY GRAIN OF SAND
The Metaphysical Nature of Price Movement
Now you know about cycles, trends and resistance, support zones, our methodology and being neutral and non judgmental about your internal dialogue. In order for you to be able to listen to the market and let the market tell you what to do; I suggest you must take one more step. That step is to get in touch with the metaphysical nature of price movements. OK, don’t freak out I am not going to take you back to the 1960s and be your Shaman. Well, OK I will be your Shaman, but don’t freak out, this is really more scientific than it would appear at first glance. So, be open minded for a little longer Mostly everything around us in science and nature can be expressed through mathematics and numbers. If you a graph the numbers of any system, patterns emerge. There are patterns everywhere, from the cycle of the season, cycles of sun spots, the way trees grow, pine cones expand, sunflowers layer, the heart beats, bio rhythms etc. So what about stock prices? Yes, I think so! I believe that nature moves itself in law abiding mathematical relationships that reveal themselves in patterns, including the stock market.
After all, the word physics is derived from the Greek word “physis,” which means the essential nature of things. The science of physics is the search for the ultimate truth above in the cosmos and below in quantum particles. Metaphysics is the spiritual search for the ultimate truth of the divine forces above and below in the inner meaning of our soul. Science is moving toward the metaphysical world with its Quantum Theory, which reveals that space and time are only “perceptions” and that matter is no more than locked up energy and can only be expressed mathematically as a “probability”. The Heisenberg Uncertainty Principal explains that particles and energy become interchangeable because of our human interaction in trying to measure them. This is close to what the metaphysical and Zen philosophers have contemplated, that the external world does not really exist except as a perception through our human participation. Hindu and Zen Buddhist tradition says that the “ultimate truth” and hidden forces are hidden by a “veil of maya.” In order to reveal these hidden forces and lift the veil of maya, we need to examine the repeating patterns of nature and its law abiding mathematical relationships. These hidden forces can influence our emotions, our lives and the markets. None of this is anti Christian, anti Jewish, anti Moslem, anti Hindu or anti religious. Hopefully all religions meet at the “One divine source”. Sir Isaac Newton wrote that the highest aim of his scientific work was to give evidence of the “laws impressed upon nature by god”. Following is my vision and interpretation of how nature’s laws flow into forecasting price movement.
Scientists tell us that at the time of “singularity”, called the “Big Bang,” all matter and energy were at one time at one place and from one source. When the negatives separated from the positives, and nothing became something, a process was begun through which the building blocks of the cosmos and our bodies and minds were formed. We are the conscious result of that process from this one singularity. I propose that because we are part of this process, we are part of nature and reflect these inherent forces in our actions and in the marketplace. Price is the end result of all economic and psychological pressures and by examining the patterns of price movements, insights into the hidden forces may be explored. In the following, special attention is paid to the examination of these forces through the graphic presentation of price movements in the market as revealed through the Fibonacci Summation Series, the Dow Theory and the Elliott Wave Theory. Get in touch with these forces. Let them FLOW through you. The creators hand is in every grain of sand
William Blake famous lines were “To see a world in a grain of sand And a heaven in a wildflower Hold infinity in the palm of your hand And eternity in an hour.”
For those of you who don’t care about the “reasoning” of “why” go straight to the mathematical projections ratio at the end of this chapter.
“What is below is like what is above, what is above is like what is below” is one of the oldest known quotations from antiquity. It is attributed to Hermes Tresmgistus, (the Greek name for the Egyptian God Thoth), who’s book Tabula Smaragdina (Emerald Tablet) has been preserved. The Romans called this God Mercury. Tradition has Thoth and Mercury as the inventor of writing and the repository of all wisdom. Egypt is the source of much our ancient knowledge and has been the principal starting place for many a search for wisdom. There are those who believe that metaphysical truths of the ultimate reality of nature were revealed to Pythagoras and later to Plato (and Fibonacci) in their trips to Egypt. The history of mathematics, as it is tied to metaphysical philosophy and science, goes back to Pythagoras (580BC-500BC). Pythagoras is known for his geometric theory, his divine musical harmony of the spheres and his doctrine that reality at its deepest level is mathematical in nature. Plato (421BC-347BC) carried on these traditions and believed that metaphysical truths are intuitive to the soul and can be seen in geometry. He reportedly said “God Geometrizes” and inscribed over the entrance to his Academy “Let no man ignorant of geometry enter here.”
This philosophy that incorporates the divinity and the true nature of man continued in Spinoza (1632-1677) and in Teilhard de Chardin (1881- 1955). The Eastern civilizations seem more at home with these concepts as the sixth century B.C. Chinese Zen philosopher Lao Tzu said in his Tao Te Ching “the laws followed by the Tao were not laid down by any divine lawgiver, but were inherent in its nature.”
Fibonacci, Dow and Elliott
Following is a review of three individuals who saw the divine law of nature functioning in revealing ways: The works of Leonardo Fibonacci (1170-1240) and his Fibonacci Summation Series, Charles H Dow (1851-1902) and his Dow Theory and R.N.Elliott (1871-1948) and his Elliott Wave Theory reveal a mathematical symmetry inherent in nature which can be seen graphically in the price movements of the markets.
The Fibonacci Summation Series, Ratio and Spiral
Leonardo Fibonacci of Pisa, was an Italian mathematician who in 1202 after returning from Egypt wrote Liber Abaci (Book of the Abacus). The book introduced to the Western World the numeric system we now use (it replaced Roman numerals) where the position of a number determines if it is a 10 or 100 etc. He also introduced the symbol of 0 to the western world
In addition to this great gift, Fibonacci in this book answers a problem about the creative reproduction function of rabbits in endless generations by introducing a sequence of numbers to become known as the Fibonacci Summation Series. In the Fibonacci Summation Series (Figure 1) each new number is the sum of the previous two 1,1,2,3,5,8,13,34,55,89,144…and so on. This sequence repeatedly shows up in nature in the most surprising connections. In one instance, the botany law of phyllotaxis, has leaves growing from a plant stalk in the Fibonacci pattern. Sunflowers, daises, pineapples and pine cones also grow in swirls that obey the Fibonacci Series.
|Figure 1: THE FIBONACCI SUMMATION SERIES1+1=2; 2+1=3; 3+2=5; 5+3=8; 8+5=13; 13+8=21; 21+13=34;
34+21=55; 55+34=89; 89+55=144
The Fibonacci Series also tends asymptotically toward a constant ratio of 1.618 if we divide each number into the one immediately following it. The ratio had begun to gather special meaning even before the 15-century Italian mathematician Jonathan Kepler gave it the name “Divine Proportion”. The Encyclopedia Britannica also calls this the Golden Ratio (Figure 2) and is algebraically designated by the Greek letter Phi. While not as popular as Pi (the Greek symbol used to represent the ratio of the circumference of a circle to the diameter, which is 3.1419265…) The ratio of Phi also shows up in nature as previously mentioned, prophylaxis, the Nautilus sea shell, the velocity of electromagnetic radiation, the Planks constant and the charge of an electron
The Golden Section (Figure 3) is found in Euclid II, 11* by dividing a line into two sections, so that the shorter is to the longer as the longer is to the whole. Thus one would find that this ratio is .618. The Golden Section is an important concept in both ancient and contemporary artistic and architectural design and is considered the most aesthetic proportion. Many of Leonardo Da Vinci’s and Salvador Dalai artistic works are in these proportions. Kepler called the “divine proportion” together with the Theorem of Pythagoras, the two great treasures of geometry A thing of beauty and as Keats says “Beauty is truth”
A rectangle becomes a Golden Rectangle (Figure 4) when the sides of which are in the ratio of 3 to 5 (0.618), which is viewed by many as the most pleasant to view esthetically speaking. If a Golden Rectangle is subdivided and this process is continued and the circular arcs connected, a logarithmic Golden Spiral (Figure 5) is formed which is similar to the form of snails, animal horns and the spiral of our own Milky-Way galaxy. See The Divine Property by H E Huntley, The Geometry of Art and Life by Matila and Stocks, Wheat and Pharaohs by William O’Connor.
Figure 3: The Golden Section
Figure 4: The Golden Rectangle
Figure 5: The Golden Spiral
The Golden Ratio in the Great Pyramid, Euclid and the Quantum Theory
There have been attempts to associate The Great Pyramid of Cheops (2500 BC) with messages that its builders were trying to pass down to future generations. There is a myth that these messages were passed down to the Egyptians from a more advanced civilization, that Plato in his Timaeus called Atlantis. The largest of all the pyramids is The Great Pyramid, built by Khufu (Greek-Cheops), the second king of the fourth dynasty. Made of some 5,750,000 tons of stone blocks, it is the biggest building ever constructed. As a vehicle for communication it certainly was more reliable than the Great Alexandria Library which reportedly held the written knowledge of our far ancient past. Literature recorded the Library’s destruction by fire in Shakespeare’s Anthony and Cleopatra. The Greek historian Herodotus (484-425 BC) was told by temple priests that The Great Pyramid was built in such a way that the area of each of its faces was equal to the square of it height. The shape of this construction yields some interesting properties. For instance, one half the base of The Great Pyramid divided into the apothem is equal to our old friend Phi.
Measured in pyramid inches:
913 1/2 = 4565.5;
7387.15 / 4565.5 = 1.618
Figure 6: The Great Pyramid
The Kings Chamber in The Great Pyramid also reveals the Golden Ratio. If one were to split the two squares of the Kings chamber in half and swing the diagonal down to the base, the point where the diagonal touches the base is 1.618 in relation to the side of the square. It also appears that each flat face of The Great Pyramid was designed to represent one quarter of the Northern hemisphere. The height is to the perimeter at the base, as the radius of a circle is to its circumstance or the pole is to the earth’s circumstance. This happens only in The Great Pyramid. Also of interest is that the measurement around the base in pyramid inches equals 365.24 (if one divides by 10) which is the exact average of a solar and sidereal year. Maybe the builders were trying to tell us something.
Figure 7: Euclid’s Regular Partitioning Problem
It was reported by the Wall Street Journal (12/9/96) that two teen whizzes found the answers to Euclid’s “regular partitioning” problem presented 2,000 years ago. The problem states, given a line any length, devise a universal geometric method for subdividing it into any number of equal parts. The answer turned out to use the Fibonacci summation series. Even the sub atomic level incorporates the Golden Ratio. The April 1981 Scientific America displayed a graph of elementary particles of the Quantum world which showed a cubic symmetry that responded to the Golden Ratio. Some of these things can be explained away as coincidence. However, the evidence indicates a correlation between the Fibonacci Summation series and a deeper reality.
The Publication of Elliott and His Disciples
R.N. Elliott believed that all of nature’s activities acted and reacted in a form that reflected a law-abiding mathematical relationship that repeated in cyclical rhythmic form. Elliott used the previously discussed Fibonacci Summation Series and its application for pattern and ratio to explain price movements. Elliott believed that this rhythmic regularity was central to and part of creation that could be observed in the price movement of the markets. In cooperation with Charles J. Collins, Elliott explained his theory in The Wave Principal published in 1938 and in 1939 Elliott published a series of articles in the Financial Word Magazine. In 1946 he published Natures Law. Reference to the works of Elliott after his death in 1947 were relatively obscure with the exception of A Critical Appraisal by A. Hamilton Bolton in May 1960 and references to the Theory in his Bank Credit Analysis.
In 1978 Robert R. Prector and A.J. Frost published the Elliot Wave Principal. In the early 1980’s Prector was the primary guru of Wall Street with his market letter The Elliott Wave Theorist having predicted the ‘Bull Market’ of the 1980’s. However, he predicted a ‘Tidal Wave’ collapse of the stock market for the 1990’s which didn’t happen until 2000 and 2007. The application of the Elliott Wave Theory to predict the future direction of price movements is obviously subject to varying interpretations. Proctor was early. With this unfortunate and incorrect prediction, reference to the Elliott Wave Theory have once again become obscure. During the 1990’s investors didn’t need to pay attention to fluctuations, as it became a ‘no brainier’ to just buy stocks or a mutual fund and to hold on.
The Elliott Wave Theory
Elliott observed that primary trends of bull cycles of price movements have five major impulses (Fig. 1) with three moves up, interrupted by two corrective moves down. He also observed that each primary trend of a bear cycle has three impulses, with two moves down and one interrupting corrective move up. It should be keep in mind that in counting waves, Wave #3 can never be shorter than wave #1 or #5. Wave #2 can never go lower than the top of wave #1. Elliott described cycles in great detail and how they could be broken down into smaller cycles. Each cycle works within the frame work of a larger cycle. As shown in Figure 9 – top, a major cycle consists of five major moves up with a correction of three moves down.
ONLY IF YOU LIKE DETAIL WORK
The five major moves up could be broken down further (see Figure 9 – middle) into five minor moves up and three minor moves down for a total of 21 waves and a correction of five minor moves down, three minor moves up, and five minor moves down for a total of 13 waves.
Breaking that cycle down into great detail (See Figure 9 – bottom) we would have a 21-13-21-13-21 wave cycle up for a total of 89 waves with a correction of 21-13-21 waves down for a total of 55 waves. Each wave can be broken down further into smaller waves. This method could be carried on infinitum. As a tip to simplify this process one should consider charts where every line represents a month when looking for the Primary Trend, weekly charts for Intermediate Trends and daily charts when examining minor trends. Sub Minute trends can only be seen in intra day activity. Charts below are from my Introduction to the Elliot Wave Principal.
Names and Designation of Elliott Cycles
GRAND SUPER CYCLE GSC I to GSC V
SUPER CYCLE SC I to SC V
CYCLE C I to C V
PRIMARY ((I)) to ((V))
INTERMEDIATE (I) to (V)
MINOR I to V
MINUTE 1 to 5
MINUETTE A to E
SUB-MINUETTE a to e
The largest cycles Elliott addressed were Grand Super Cycles that lasted several hundred years. Operating within the Grand Super Cycle are Super Cycles that last approximately 55 to 89 years. Within the Super Cycles are Cycles which last 21 to 34 years. Within the Cycles are Primary Cycles which last from 5 to 8 or 13 years. Within the Primary Cycles are Intermediate Cycles which last 2 to 3 years. Within the Intermediate Cycles are minor cycles that last about a year. Minor Cycles are completed about every month while Minute Cycles are as little as two days and as much as 13 days. Sub-Minute Cycles can be measured in hours.
I have proposed that there are “hidden forces” within nature with repeating patterns and law abiding mathematical relationships and that humans, as part of nature, reflect these inherent forces in our actions and in the market place and therefore in price movement. So, if this is true, why don’t you hear more about Fibonacci? There has been some recent sighting in popular books, movies and magazines. The best selling novel “The Da Vinci Code” uses as its theme the search for the “Holy Grail” of certain “truths” that were handed down to us from antiquity (through a secret society) from Pythagoras and Da Vinci and was suppressed by the early church. The novel cleverly uses the Fibonacci coded messages in giving clues in the quest.
There is the film Pli by Darren Aronosky tells the story of a man possessed by the Golden Ratio, and saw patterns in nature and the stock market that eventually drove him mad. A
Also, in the October 12, 2009 New Yorker Magazine there was a long story called “The Secret Cycle” features the Fibonacci Golden Ratio 1.618. Quoted in the article was a market timing analysis Bill Erman who said “termites build the perfect mounds and bees their perfect hives and spiders their perfect webs, all around the world without being conscious of why or what they are doing. Mankind is constructing the geometrically perfect market. The charts are our termite mounds”.
One only rarely hears reference to Fibonacci as a forecasting tool on CNBC.
Forecasting Future Price Movements
Just as a scientist uses mathematical probability in interpreting the Heisenberg Uncertainty Principle, the technical analyst can use the Elliot Wave Principle and the resulting Fibonacci Ratio in forecasting the “probability” of price movement. These projections can be used in conjunction with Resistance and Support Points outlined in Chapter 2 & 3 and 4. The fact that Tao and Dow are pronounced the same is merely a coincidence, or is it? All this is cause for further research.
In the meantime, one must be internally “at peace” to listen to the market. Don’t forget to enjoy Beethoven’s “”Ode to Joy.” Beethoven was deaf at its first performance and never heard it as you can. However, I believe he could feel it internally. So, let your search for the “hidden forces” become internal. “The trend is your friend.” Listen to that internal inner voice within, until you can come in tune with the “harmony of the spheres.”
Forecasting Future Price Movements
The scientific reasoning behind the projections can be found in the response of a spring being pushed down and then released. It’s an action-reaction response. The ability of to spring upward (or downward if depressed upside down) is in direct proportion to its suppression and the response capability of which the spring is made of.
The below calculations are based on the process used in analyzing the Fibonacci Golden Ratio. The .618 phi ratio has been in predicting future stock price movements. These projections can be used as future objectives or as future Resistance and Support zones.
I have found that using the following ratios some to offer the best projections for future price movements 50%, 61.8%, 100%%, 1.382%, 1.618%. Fifty percent and 100% is a national average found in nature. I use 38.2% which is the ratio of any Fibonacci number to itself and two places to its right 34/89 = 38.2FIBONNACI UPWARD PROJECTIONS
FIBONACCI DOWNWARD PROJECTIONS
UPWARD PROJECTIONS I have found that in using the upward projections there is usually the greatest Resistance at between the 50% and 61.8% area. If the price breaks above the Resistance at 100% (a normal Resistance area from Chapter 2’s double top). The usual upside potential is for a 150% to 161.8% up move. Further upside moves to higher area are usually confirmed by measurements of set backs on the way up.
DOWNWARD PROJECTIONS Likewise in using downward projections there is usually the greatest support 50% and 62% area. If prices break below the Support areas at 100% (a normal Support area from Chapter 2 double top) the usual downside potential is for a 150% to 161.8% downward move. Further downside moves to lower areas are usually confirmed by setbacks on the way down. Don’t worry! Practical applications are in the next Chapter and it will all look a lot easier.“I can hear the ancient footsteps like the motion of the sea. I can see the master’s hand in every leaf that trembles, in every grain of sand. Behold this chain of events I must face. Every grain is numbered like every grain of sand”
Dillon. Every Grain of Sand  Euclid II, 1 let a line AB of length L be divided into two segments by the points C. Let the length of AC and CB be a and b respectively. If C is a point such short line b:a be a:b then c is the golden section of AB
UP AN DOWN, ALL AROUND THE TOWN
OK! I know! After the last chapter you need to take another leap of faith to get past your skepticism. But this stuff works. I have been dealing with these projections since I was 16 and yes, a lot of the Elliot/Fibonacci projections are more obvious in hind sight that trying is analyzing them in the present. Elliott/Fibonacci projections don’t have to be the answer to all your problems, Consider this methodology of Fibonacci Projection as just another tool in your tool box for obtaining financial independence. Use these projections in conjunction with conventional Support and Resistance methods. When you get a confirmation using both methods you can feel more confident. Once again, I am using the current charts at the time of this writing, but the process will not change for the current situation. Learn the process 1) Look at the market trend using 10 year, 3 to 5 year and 1 year to 3 months charts to determine the Major, Intermediate and Short term Resistance and Support points of the markets, 2) Rate and rank the market using our rating system in chapter Four. 3) Adjust your Investment Strategy to your own Risk/Reward tolerance and expected holding period, 4) Continue to follow the market and adjust new Support and Resistance points, projections and ranking as the market changes, 5) Be at peace with yourself and others. That is in the next chapter.
But first in order to graduate, become familiar with making Elliott/Fibonacci projections. Following are the practical Long Term applications both up and down.
DOWNSIDE ELIOTT/FIBONACCI PROJECTIONS
THE DOWNSIDE SUPPORT ZONES FOR THE DOW
DOW JONES INDU. FUTURE AVERAGE DOWNSIDE SUPPORT ZONES
|1st Support||2nd Support||3rd Support||4th support||5th Support|
|X 38.2%||X 50%||X 61.8%||X 100%||X138.2%|
As can be shown above Support for the downward correction of the up move from 6,469 to 12,875 has Fibonacci support at 10,428 (now at 10,404). Close enough to consider Support held at this level. If this area should eventually be broken on the downside the next Fibonacci Support area is 9,672 which is the July 20th conventional support area outlined in Chapter 4. Further downside Fibonacci support is just below 9,000 at 8,916 and of course at the old 2009 low of 6,469. That low or below would mean a major disaster has occurred in the economy. The next Fibonacci support area is 4,022. So if the market falls, it must stop at 8,916. Below that level is big trouble! A full Elliott wave major ABC correction is at 4,022.
THE DOWNSIDE SUPPORT ZONES FOR THE S&P 500
S&P 500 INDEX FUTURE DOWNSIDE SUPPORT ZONES
|1st Support||2nd Support||3rd Support||4th support||5th Support|
|X 38.2%||X 50%||X 61.8%||X 100%||X138.2%|
The S&P 500 broke below the 1st Fibonacci Support Level in 2011 at 1,101 and fell to a low of 1,074 but not below its current 2ed Support level. This chart shows a weaker condition than that of the Dow which held its 1st support area. Next Fibonacci support is at the same July 2011 Support area as outlined in Chapter 4. Further downside Fibonacci support is at 935 and of course the old 2009 at 666. So as with the Dow, if the S&P drops below the old low, a move to 397 would complete at major ABC Elliot wave correction.
NASDAQ DOWNSIDE SUPPORT ZONE
NASDAQ FUTURE DOWNSIDE SUPPORT ZONES
|1st Support||2nd Support||3rd Support||4th support||5th Support|
|X 38.2%||X 50%||X 61.8%||X 100%||X138.2%|
Unlike the S&P and like the Dow the NASDAQ held above its 1st Fibonacci Support zone. As with the S&P and Dow there is confirmed Fibonacci support at the July 2011 low now at 2,270. This is the same support area outlined in Chapter 4 using conventional methods. Further downside Fibonacci Support is at 2,079 and 1,888 and of course at the 2009 low of 1,268. As with the Dow and the S&P a market break below the 3rd Fibonacci Support Level would indicate big trouble for the economy. Below that the next Fibonacci Support Level is at 649! A move to 649 would complete a fall major ABC major trend correction. It is interesting to note that all three Markets are at support zones that could be a base for a NEW Bull Market.
UPSIDE ELIOTT/FIBBONCCI PROJECTIONS
DOW JONES INDUSTRIAL AVERAGE UPSIDE RESISTANCE ZONES
First let’s look a minor Elliott projection and measure the 2011 high and low of 12,876 and 10,771. (12,876-10,771 = 2105 x 1.38 = 2905 + 12,876 = 15,781). So, if the market breaks above 14,198 the Dow could meet its first resistance at 15,781.
However we are blesses with making some major Elliott projections, as we had an historic drop in 2007 from 14,198 to an historic low at 6,470 in 2009. This historic drop can give us measurement for the long term future as follows:
|1st Resistance||2nd Resistance||3rd Resistance||4th Resistance||5th Resistance|
|X38.2%||X50%||X61.8%||X 100%||X1 61.8%|
Should the Dow break above its old 2007 high of 14,198 the upside potential can be at Fibonacci Resistance Zones of 17,150, 18,062, 18,974, 21,926 and 26,701. This would indicate that a new Bull Market and the Hybrid Age has arrived. Even though I don’t tell the market what to do, it would be better for all of us than the Downside scenario. If we do enter a new Bull Market the next up move could be to at least a Dow of 21,000!.THE S&P 500 UPSIDE RESISTANCE AREAS
S&P 500 FUTURE UPSIDE RESISTANCE ZONES
As we did with the Dow, let’s also look at a minor Elliott projection for the S&P. The minor high was 1370 in 2011 and the minor low at 1070. (1,370-1,070=300 x 1.38 = 414 + 1,370 = 1,784. As can be seen below, the major Elliott projection approximately agrees with this projection. It is a good idea to make minor and major Elliott projection whenever you can to see if they can confirm each other. The more confirmation, the surer you can feel about your projections.
|1st Resistance||2nd Resistance||3rd Resistance||4th Resistance||5th Resistance|
|X38.2%||X50%||X61.8%||X 100%||X 161.8%|
Should the S&P break above its old 2000 and 2007 double top of 1,576 the upside potential would be a Fibonacci Resistance points of 1,702, 2,031, 2,132, 2,486 and 3,044. As with the Dow, this would indicate a new series of Bull Market could be beginning. It would also mean that we have somehow solved our economic and environmental problems.
NASDAQ UPSIDE RESISTANCE ZONES
NASDAQ COMPOSITE INDEX FUTURE UPSIDE RESISTANCE ZONES
|1st Resistance||2nd Resistance||3rd Resistance||4th Resistance||5th Resistance|
|X38.2%||X50%||X61.8.%||X 100%||X 161.8%|
The 2009 low of 1,268 was higher than the 2007 low of 1,108. However, a new high in 2011 failed to have any follow through until 2012. Upside Resistance is at 3,469, 3,658, and 3,845 and around the 2000 recovery high of 4,300 and of course at the all time high at the 5000 level. After that, it’s the stratosphere, without much air to breathe or to hold the balloon up. The NASDAQ has the biggest potential for the upside in a new Bull Market, because it fell the most. Like a spring, the bigger the compression, the bigger the expected bounce. It’s just like science.
I know the downside projections are distasteful for you to see and the upside projections are much more palatable. However, it is very probable that one of these scenarios will play out to the full extent. Eventually the Great Sideways will end. The variable for the next BIG movements are being played out as we watch and will result in either a huge move on either the upside or the downside. I think it will be on the upside. That’s because the market collapsed in 2009 into a typical bottom cycle ending panic and the next logical move is a NEW Bull market. Remember, Bull Markets triple and more. However, hubris can be dangerous when you are speculating in the markets. So, I have shown you both sides and it is for you to let the markets show you what to do. I have shown you how to listen. Never think you are investing. The markets are too volatile for you to believe that. If the markets rise again, as I think they will, don’t get overenthusiastic. Bubbles draw you in, as with the recent real estate debacle. Most people are in the market through mutual funds. The problem with mutual funds is that you can only participate on the long side of the market when it goes up. When the market goes down, you are told to hold on and that the markets always come back. Why go through that pain when you can avoid it, by playing the upside and the downside to make profits. There will be another big drop in the market in the future. Market cycles go through greed and fear in a repeating patterns which is recognizable to those that now how to listen to the markets. If you can only go long securities in mutual funds and the professionals can go short, as they did against worthless mortgage bonds, it will once again be like feeding anchovies to the sharks. Don’t listen to the financial industry. They feed off you. Think for yourself. Let the markets tell you what to do.
Most people are only in the grandstand watching the game and have no input in the conclusion. We can cheer, but that won’t make any difference in the economy or world events. What will make a difference in your family’s financial success, is how and when you place your bets. Make sure you bet on the winner and not your favorite team. As it is in professional sports, the players are in it for the money. Be as a cold hearted money player, just as the professionals are. What did the mobster say to his victim in the movie Godfather just before he killed him? “Sorry it’s only business.” That does not mean to be cold hearted in your personnel life. Just making a killing won’t make you happy and the money won’t last long, unless you are in the right frame of mind to be deserving of receiving abundance. That brings us to our last chapter of putting the cherry on top of your cake. ‘Don’t worry, be happy’. Follow our mythology to wealth and happiness.
CHAPTER 8 IS UNDER A SEPARATE TITLE: THE ZEN OF INVESTING (ABOVE)