23 posts tagged “market”

The reason for some institution's refusal to sell their positions that have appreciated dramatically (and that are most vulnerable to decline) can be deeper than the impression desired by publishing the positions. Management's compensation is usually a set percentage of the market value of the assets managed. If a profitable position is sold, the gain may be subject to taxation and paid out to clientele as a capital gains distribution. This effectively reduces the amount of money being managed and the associated fees.

The problems associated with selling positions that have profited most can be particularly acute in small mutual growth funds that have followed the practice of "taking losses and letting profits ride" for an extended period. The result is that their portfolio consists of only a few issues. By having locked themselves into holding a few profitable stocks, the fund's value becomes a function of the value of the rigid holdings and has nothing to do with the overall ability of management.

Keep in mind that money managers are human beings with basic needs such as food and shelter, which require employment. Also recognize that, especially in the larger institutions, clientele are not aware of the identity of the individual analyst making the investment decisions. This anonymity is often strictly enforced and a prerequisite for employment.

In this environment, the individual analyst (whether a genius or an idiot) is under pressure to conform to the crowd. To be too good or too bad relative to one's peers involves risks of criticism or resentment with the associated occupational hazards. This effect is obvious to anyone familiar with the financial media. When an analyst (usually independent) becomes popular because of accurate forecasting and then stumbles, the mistake (even though the overall return over time has been far superior) is pounced on. On the other hand, a spokesperson for a large institutional analytical service that has consistently been wrong, but that is one of the crowd, attracts media attention when making forecasts without criticism of past mistakes.

Understanding the structural aspects of institutional investing practices and employment pressures, you would logically conclude that the average institution would underperform the market, with the underperformance magnified by the fees involved. Yup.

External

Aside from the difficulties associated with internal structure and characteristics, institutions have the added problem of dealing with their clientele. Discretionary clientele who do not properly understand the stock market, although they have entrusted their investment decisions to someone else, often have a tendency to self-destruct. This is particularly evident in mutual funds, whose investors are continually adding or withdrawing (redemptions) money. People tend to add money when the market is highand the mood optimistic. Redemptions tend to dominate when the marketis low and the mood pessimistic.

The institutions are forced to invest the money—that is what they arebeing paid to do. Therefore, with more money coming in when the market is high, the institutions so affected are forced to buy at relatively high levels. Conversely, when redemptions dominate and the market is low, the institutions are forced to sell at depressed prices to fulfill the investor'sdemand for cash.

From the professional standpoint, the process is marvelous. We knowwe have buyers at high prices and sellers at low prices because of the demands of discretionary clientele creating a supply/demand imbalance. When they are doing their forced buying, it creates underlying buying demand and we can raise our prices. When they are forced to sell, we know there is "overhanging supply," and we can lower our purchase prices.

This buy-high/sell-low behavior (required to fulfill clientele's wishes) is not limited to mutual funds. It can affect any funds that can redeem or add capital according to their client's emotions: bank trust departments, pension funds, and the like. An important exception is closed-end mutual funds where the capital base is fixed and the investor must buy/sell shares in the open market rather than affecting the funds' specific holdings.

The market is a business. The purpose of the business is to acquire the monies of others through the process of buying low and selling high. Because of the anonymous nature of trading structure, it is very difficultto specifically identify the individual to whom you are selling or from whom you are buying. Consequently, physical coercion to create losingbehavior among fellow market participants cannot be applied. People do not enter the market to lose. However, they must be placed in a situation in which they will willingly part with their money. The only way to elicit losing behavior is psychological pressure. The most effective tool for applying the pressure is a change in market price. Faced with "paper" losses, those vulnerable to the emotion associated with "apparent" losses will capitulate, accepting the loss in the form of cash to relieve thepsychological strain.

The discretionary manager is subjected to the same emotional pressuresas all other market participants. It is not uncommon for discretionary managers to buckle under the pressure and sell low in direct conflict with historical or statistical precedent to alleviate pressures both self- and clientele-imposed. Conversely, when prices are too high, the emotionallure of greed can stimulate buying when prices are most vulnerable to severe decline. Those who conduct themselves professionally are acutelyaware of the psychological effects of price on institutional managers and take advantage. Such advantage is possible only by strict adherence to a methodology that prevents being lured into the irrational (emotional) behavior of the crowd. This is easily accomplished by having predetermi_ned buy/sell points dependent upon market condition, not price in itself.

The forced behavior of institutions provides one of the most important profit centers for the true professional.

When we developed our investment methods, we assumed that using P/Es based on projections rather than lagging P/Es would create a significant difference in results. Over the many years that this basic portfolio modeling has been published and applied in actual market endeavors (covering a wide range of market conditions and thousands of individual stock positions), to our surprise, that the results obtained by using earnings projections in P/E calculations has not (to date) resulted in significantly better results than using lagging P/Es. In other words, although the authors use projections in their analysis, lagging P/Es so far have provided almost identical results. Whether earnings projections or lagging P/Es are utilized, taking the calculations to two decimal points is necessary to maximize the number of buy/sell points.

Since P/E is a function of price, we must consider whether price (a much easier measurement, the week's closing price) can be substituted. The answer is yes, but there will be some (to date quite minor) loss of accuracy. For example, if a stock's earnings suddenly declined dramatically and the stock's market price also declined, the decline in market price might not be directly proportional to the decline in earnings. The price would go down, but the P/E (price now divided by lower earnings) might go up because the earnings drop was proportionately greater than the price drop. Watching for changes in price, without paying attention to earnings changes as well, will prevent your gaining a refined perspective of true supply/demand.

If you choose to substitute price change for P/E change, the accuracy differential can (in most cases) be compensated for by raising the required percentage of issues that must be down or up in price to 80 percent. There will be fewer buy/sell points derived by using price rather than P/E, but (to date) the price method would have identified all major buy/sell points. Consequently, the essential elements for an indication are:

BUY: 75 percent of the P/Es or 80 percent of the prices of the stocks monitored must be down.

SELL: 75 percent of the P/Es or 80 percent of the prices of the stocks monitored must be up.

A question is now raised: Would it not be easier just to see if the market averages had gone lower and take that (or the P/E of the Dow or some other average) as an indication? The answer is no. The averages can be misleading. They can be significantly influenced by dramatic price moves in stocks and stock groups that do not warrant consideration (that is, stocks not on the Master List) as an indicator of investment. An attempt to gauge market conditions by the average of a conglomeration of unrelated stocks brings in extrinsic factors that are unpredictable. Our stock selection is designed to make the most important extrinsic factor (earnings) predictable.

To attempt to incorporate past changes in market averages as forecasting tools for future changes can be done, but it requires extensive calculations, including degree of price change in relation to volume change for each stock involved. It results in lower levels of accuracy than achieved by our technique. In our method, the design is not only to achieve superior results; it is also designed to be as simple as possible. In our method to get a signal from our primary indicator, the degree of decline (what percentage decline in P/E or price occurred) is not a necessary measurement. For example, if 80 percent of the stocks monitored declined in price only 1/8 of a point from their previous price level, the essential criterion for a buy indication would be met. The ancillary criteria are designed to filter for the magnitude of the primary criterion.

Why (for the basic portfolio modeling techniques) do we not consider it essential to wait for some upward price movement to occur to ensure that the effect of selling pressure is gone? Conversely, why not wait for some downward price movement to occur to ensure that buying demand is gone? The reasons are twofold.

First, often when price reversals occur, they are very rapid, and a significant portion (sometimes almost all) of the anticipated price change can occur before positions can be taken.

Second, the authors are in the business of stock trading on a scale that involves many millions of dollars. We are not engaged in theoretical observations that include the naive belief that infinite amounts of stock can be bought or sold at the prices quoted. Stated flatly, for us to acquire stock in large amounts at appropriate prices, it is necessary to have adequate sellers; to sell stock in large amounts at appropriate prices, it is necessary to have adequate buyers. Real people and real money are involved. Stock purchased at acceptable prices is available only when sufficient sellers at the acceptable prices are in place; which is usually as prices are declining, not after the price decline. Selling stock at acceptable prices can be accomplished only when there are adequate willing buyers, which is usually as prices are advancing, not after the advance.

Our determination of buy/sell points is based on a logical understanding of the structure of the market and of the behavioral patterns of fellow market participants. We are not concerned with waves, angles, astrological configurations, or other such data, which by some magical force are presumed to be satisfactory indicators of future prices.

The purpose of our timing technique is to help facilitate our objective to take the monies of others in a repetitive, consistent fashion that minimizes risk in actual market endeavors. We have no interest in theoretica abstractions in that time so spent can only detract from fulfilling our of objective. At this point, we are attempting only to ensure acceptable accuracy in forecasting changes in the major market averages. The final goal is to develop profit consistency for our stock positions at the percent- age level we have chosen (90 percent minimal) within the average holding period we have decided to use (four to six months).

Because of the upward bias in the specific stocks we utilize, we do not need k the probabilities for accurate timing of the popular averages to be as high as those associated with the specific stocks. As discussed in the previous sections, our 95-percent accuracy rate with individual stock issues needs only around a 78-percent or better accuracy probability relative to the popular averages.

In actual market participation, decisions must be made quickly and without emotion. Our timing technique, therefore, must not be influenced by emotional "subjectivity," and it must be easily and quickly calculated to avoid time lags that would take away from maximizing the number of available opportunities.

Market timing is nothing more than reviewing statistically valid data to derive probabilities for future price moves. Consequently, because of the probability variances at any given time, not all buy/sell points are created equally.

The relative strength of any buy/sell point can be compensated for by altering the "investment level," that is, by varying the percentage allocation between stocks and cash.

At this juncture, our objective is to develop buy/sell points that meet our minimum requirements related to the purchase or sale of specific common stocks. Application to options, index futures and more speculative trading strategies require adjusting our timing probabilities upward from those that are the focus of this discussion.

Our discussion of the technique, at this time, is designed for the process of buying specific stocks, then selling. The basic elements are buy indications that increase the percentage of funds allocated to common stock investment (that is, increasing the investment level), a holding period, and then sell indications that would result in selling specific positions to adjustto a lower investment level.

This buy-to-sell aspect is stressed because you cannot assume the processcan be automatically reversed. That is, the same criteria cannot be used in reverse for short selling with the same degree of accuracy in specifi_cpositions—selling short on sell indications and covering (buying back the short positions) on buy indications. The reason it cannot be reversed automatically is because of the upward bias in the stocks we utilize. For accurate short sale techniques, alterations (to be discussed) are necessary to eliminate this upward bias.

In this discussion, we are going to fully describe the criteria that w_e actually use. Some of the criteria might appear rather complex, and the information to implement exact duplication might be difficult for many investors to obtain. However, after such detailed descriptions, greatly simplified methods within reach of almost all investors will be described. In fact, the basic timing method can be compacted so it takes less than one hour each week without any need for complicated equipment. Nothing is necessary beyond the ability to read.

The factors we use to determine buy/sell points are of two types: essential (or primary) and ancillary. There is only one essential factor, and it must be present for any buy/sell indication. There are twelve ancillary factors; any six (or more) must coincide with the essential factor to have a buy/sell indication.

The Master List, whether all the issues are being monitored or only the minimal acceptable number, forms the core of the indication. These stocks, with their relatively high degreeof earnings predictability, we use both to gauge forces within the market and to make specific investments.

In effect, we are functioning in a market within a market. We want to buy low and sell high. By confining interest to specific stock issues that have demonstrated fundamental superiority, we have chosen stocks that have an upward bias relative to the market as a whole. This bias in itself, however, is far from enough to meet our goals. We are very much interested in the relationships between demand and supply. We want to purchase when there are strong signs that selling supply might be exhausted. In other words, we want to buy soon before or in conjunction with the last period in which the sellers are dominant. Once the selling dominance has been eliminated, buyers can dominate and prices can advance. Conversely, we want to sell soon before or in conjunction with the last period in which buyers are dominant. When the buyers have exhausted their influence^, sellers can dominate and prices can decline.

The best indication of seller dominance is a downward shift in marketprice relative to earnings (the price/earnings ratio). Lower P/Es both provide stock at lower prices relative to earnings and indicate that sellers are using up their influence. Therefore:

• For a buy indication, it is essential that the P/Es of the stocks monitored are falling.
• For a sellindication, the P/E condition must be the reverse of that fora buy: It is essential that P/Es are rising to have a sell indication.

Since by the design of Drach's published Time Overlay portfolio modeling we are looking at the market weekly and comparing it to four weeks before to see the relative change, we are looking for upward or downward moves in P/E relative to the P/Es four weeks ago. The minimal acceptable level is that 75 percent of the stocks monitored have moved down or up in P/E from their level of four weeks before. If the percentage is less than 75 percent, there is no indication. To repeat:

• The essential factor for a buy indication is that 75 percent or more of the stocks monitored have declined in P/E from their level four weeks before.
• The essential factor for a sell indication is that 75 percent or more of the stocks monitored have advanced in P/E from their level four weeks before.

In the calculation of P/E ratios, both price and earnings are variables, that is, both change over time. In most financial publications, the P/Es listed are "lagging P/Es." That is, they are calculated by taking the corporation's earnings over the last four quarters (one year) and dividing the earnings into the current market price. Because earnings change and because one of the criteria for stocks to qualify for our Master List is earnings predictability, it is reasonable to assume that calculating P/Es using earnings projections covering the next four quarters (the next year) would be a more accurate gauge of the P/E shift, indicating that the stock was becoming (or is) under- or overpriced.

In Drach's publication, as well as in actual account management under the author's supervision, P/Es are calculated using earnings projections. Also note that the authors' P/E calculations are to two decimal points since this significantly expands the number of buy/sell points.

The primary criterion, be it P/E or price, will not always give a buy/sell indication. In fact, most of the time (and sometimes for very long periods) the primary criterion will not meet the parameters to form the preliminary basis for a change in basic portfolio modeling. The primary criterion (depending on which method—projected earnings, lagging P/Es, or price—is chosen) is by far the most time consuming aspect of our timing technique.

The ancillary criteria are designed to confirm or reject the primary indication. The ancillary criteria (aside from a few rare exceptions) will always be issuing a buy or sell bias. Without an indication from the primary criterion, there is no need to be concerned with the ancillary facets in basic portfolio modeling because there can be no change.

There are twelve ancillary criteria, which might at first seem too burdensome to calculate. However, most (if not all) can be determined by a casual glance at major financial publications (Barron's or The Wall Street Journal). A weekly review of the ancillary criteria can probably be attained within 10 minutes after the sources are identified.

For the ancillary criteria to confirm the primary criterion, a minimum of six ancillary criteria must be in place.

Institutional Cash Reserves

If all markets involve predator/prey relationships, to acquire the cash of others requires that the others actually have cash from which they can be parted. Because of the specific stocks we utilize, as well as the growing dominance of institutions in day-to-day trading patterns, those institutions against whom we compete are important sources of profit.

The term institutional cash reserves refers to the ratio of institutional holding of cash (or cash equivalents) to common stock. The higher the institutional cash reserves, the more money they have available for the purchase of stock. The lower the cash reserves, the lower the institution's ability to buy stock irrespective of sentiment. To emphasize the importance of this institutional cash:noncash ratio, it was all you needed to understand to avoid the crash of 1987. At the time, the institutions were so lured into the stock market and their cash reserves became so depleted, they could not support stock prices. It was an inevitable splat time because of the depletion of possible buying demand.

Institutional cash reserves are tabulated regularly by a variety of surveys that scan mutual funds and/or pensions (Lipper, Herzfeld, a wide variety of brokerage firms, and the like) and the results regularly published in major financial publications.

For our purposes, all we need to know is the change in the cash:noncash ratio relative to where it was four weeks ago (or the next nearest reporting period depending on the source utilized).

BUY: The cash amount has increased. We have isolated potential buying demand that can be lured into the market to push prices higher.

SELL: The cash amount has decreased. The institutions are depleting their buying power, making themselves increasingly weak (perhaps helpless) in providing price support and thereby allowing selling supply to more easily dominate and depress prices.

Public Cash Reserves

Because of the rapid growth of institution's dominating trading activity, it has become popular to dismiss the public as an important market factor. However, as we have discussed in detail in previous chapters, the public is a very important factor, not only because of the predictable behavioral patterns of individuals, but because of the effects these patterns have on the institutions in which the public has entrusted funds.

We monitor this group's cash status by the weekly reporting of the total assets of money market funds. Money market fund assets include monies from groups other than the public, but for our purposes the changes in money market fund assets is all that is necessary for this criterion.

The weekly money market fund asset figures are reported in all major financial publications. Our comparison period is four weeks.

BUY: The amount (gross, no ratio needed) has increased. This isolates potential buyers (buying demand) and the associated potential for higher stock prices.

SELL: The amount has decreased. The amount of potential buying demand is lessening, and selling supply can more easily become dominant to depress stock prices.

The two previous factors were designed to isolate specific participants and their ability to effectuate future behavior because of their cash/noncash position. The amount of money in the overall economy is also important and is influenced by the actions of the Federal Reserve.

The figures relating to available money supply are provided weekly by the Federal Reserve and reported by all major financial publications. The money supply calculations include various categories (M-1, M-2, and M-3 being the most popular in gross form). Because of the various components of the money supply categories and changes in the economy, there is an ongoing debate within the financial community as to which measurement (with a myriad of adjustments) is the most accurate. For the purposes of our basic market timing, time and brain cells need not be wasted in agonizing as to which "M" (money supply measure) is chosen. One need only be concerned with sticking with the M originally chosen. We use M-1, which is basically the amount of cash in circulation.

As a criterion in our basic timing method, we compare the gross (not ratio) amount of M-1 to its level four weeks before.

BUY: The amount is increasing. More money is coming into the system, a portion of which can be lured into the stock market in the form of buying demand. In addition, the increased amount of available money helps the overall economy to expand.

SELL: The amount is decreasing. The withdrawal of money from the overall economy creates cash needs, on which investors draw against their stock holdings (because of the liquidity) before selling most other assets. This selling supply can function to depress prices. And the lessened money supply is often a good indication of a coming constriction in the broadly based economy.

Gold Price

The stock market, as with any other market, is constantly in competition with other investments. Gold, because of its history and physical nature relative to paper money, is a good indicator of relative popularity. Real estate, collectibles, and other "hard" commodities could probably be substituted for our gold criterion; but we have selected gold for its liquidity (with the metal being actively traded in markets throughout the world).

Again using a four-week comparison, we simply look at the net change in price for our indication. We use spot prices, but futures can be substituted as long as the same contract month is being compared.

BUY: Gold is up in price. This can be a good indication that stocks have become unpopular and undervalued. When the gold price declines and the metal disappoints investors, their buying demand can more easily shift to the stock market.

SELL: Gold is down in price. This can indicate stocks have become overvalued and can precede a reversal in investor sentiment, creating increased selling supply in the stock market.

Bonds

There is an inverse relationship between bond prices and interest rates. Higher bond prices mean lower interest rates, and lower bond prices equal higher interest rates.

There is also generally a very strong, direct correlation between stock and bond prices. Higher bond prices are usually accompanied by higher stock prices, lower bond prices by lower stock prices. The bond/stock price relationship is logical. Higher interest rates (lower bond prices) increase corporate costs borrowing and as such function to reduce earnings. Higher interest rates, because of the increased cost of capital, tend to slow the overall economy which can adversely affect corporate sales and consequently have a negative effect on corporate profitability. Within market structure, higher rates increase the cost of margin buying, which reduces buying demand.

Periods during which stock and bond prices diverge usually involve high levels of investor emotionalism. If sentiment is extremely pessimistic, high-quality bonds become viewed as safe havens and buying demand increases, adding price support for bonds while stocks falter. Conversely, during periods of extreme euphoria, bonds can become viewed as providing returns too low relative to stocks, creating selling supply in the bond market; this lowers bond prices while stock prices are advancing.

Our concern with the bond market in our timing model is the most common, direct price relationship. Using a four-week comparison period, our indication for this criterion is the next change in bond price down or up—we are not concerned with the magnitude of the differential. We use long-term U.S. Treasury bonds.

BUY: Bond prices are down. Interest rates have moved higher, probably depressing stock prices and making a price reversal more likely.

SELL: Bond prices are up. Interest rates have moved lower, possibly having an unsustainable elevating effect on stock prices and increasing the chance for a reversal.

Our previous criteria were designed to get a general idea as to our opponent's ability to participate in the market (cash or the lack of it), as well as some insight into the effect of alternative investment types.

We will now turn our attention to what is actually happening within the stock market. The two most important variables are price and volume. If volume is increasing as prices are advancing, it is indicative of an expanding number of buyers coming into the market. This can also indicate that the buyers are depleting their power and will eventually no longer be able to maintain price support. Conversely, if volume is expanding as stock prices are declining, it indicates that those selling out will eventually lose their force (depleting selling supply), which can allow prices to reverse.

In calculating this criterion, we want to know if the cumulative volum_e over the last 20 trading days is greater or less than the cumulative trading volume of the preceding 20 trading days. This is accomplished by adding up the total volume on the New York Stock Exchange over the last 20 trading days and comparing the total with the volume the preceding 20 days. Forty days of data are needed. Calculating this criterion takes only a couple of minutes: adding the newest day and deleting the latest in an ongoing total. For most indications all you need to do is look at a chart of recent volume (available in most major financial publications) by which significant changes in volume can be quickly and easily identified.

For this criterion to be given any consideration, volume must have increased. The amount of the increase is of no concern. If the volume has decreased, this criterion is not considered to have given any indication.

For the price component of this criterion, the net change (plus or minus) of a popular average will suffice. The amount of the change is of no concern, just the direction. Using a four-week comparison period, we use the New York Stock Exchange Index because of the large number of issues forming the measurement. The Standard & Poors 500, Dow Jones Industrials, or other popular averages could be substituted.

BUY: Volume is increasing as prices have declined—an indication that selling supply is being depleted.

SELL. Volume is increasing as prices are advancing—an indication that buying demand is being depleted.

NO INDICATION: Volume has decreased.

Volatility

The faster prices are going down, the faster sellers are getting out, and the higher the probability that the excess selling supply will soon diminish and allow buying demand (higher prices) to dominate. The faster prices are going up, the faster buyers are using up their money supply, and the higher the probability that selling supply can soon dominate to push prices lower.

In the past, we have incorporated beta measurements as one of our volatility criterion, but these calculations were time-consuming and difficult for many investors. We are now substituting a very simple measure of volatility rather than the more time-consuming beta comparisons. The simplified method can be applied without any loss of accuracy.

Remember that, by confining specific investment interest to the stocks that qualify for our Master List, we are effectively participating in a market within a market. When purchasing stocks, we would prefer to invest in those that will outperform the market. When selling, we want to get out when the chances are that our stocks will go down at a faster pace than the overall market. Consequently, it is to our benefit to have some idea as to how the stocks we follow are doing relative to the broadly based market. If our stocks are relatively depressed, to us they represent better values. If our stocks are relatively overvalued, they would appear more vulnerable to decline.

To determine the relative over- or underpricing, we compare the percentage price change of the stocks we monitor to the percentage price change of the NYSE Composite Average. Any other broadly based market "average" could be substituted for the NYSE Composite.

Using a four-week comparison, the percentage of advance/decline of the popular average selected is calculated and compared with the average percentage advance/decline of the stocks we follow. Whether this ancillary criteria develops a buy or sell indication depends on what direction the popular average being followed has taken.

If the NYSE Composite has declined.

BUY: If the stocks we follow have declined more than the Composite average.

NO INDICATION: If our stocks advanced or declined less than the Composite.

If the NYSE Composite has advanced.

SELL: If the stocks we follow have advanced more than the Composite average.

NO INDICATION: If our stocks declined or advanced less than the Composite.

It is always helpful to know the mindset of the competition: the crazierthey become, the easier the task of separating them from their money.

In the old days, the best measurements of the speculative public sector's behavior were odd lot ratios and cumbersome calculations associated with price/volume shifts in low-priced stocks. Thanks to the advent and popularity of listed option markets, we can now use put:call ratios as an easily observed substitute, taking only the time to flip to the proper page of Barron's to get an insight into this sector's current behavior. The purchase of call options is an indication that the buyer anticipates higher prices. Conversely, the purchase of put options indicates that the buyer forecasts lower prices.

Because of a lack of knowledge, the reluctance to sell short, or whatever, the volume of call buying generally exceeds the volume of put buying. Therefore, the two opposing elements cannot be considered equal in their volume: Calls are more popular. Consequently, it is the change in the ratio of put:call volume that is important to us as a measure of nonprofessional sentiment. Whether you use the volume of listed options associated with specific stocks, or those associated with market indices, or a combination, you should get the same results as long as the measurement is consistent. We use the total volume associated with individual common stocks plus the listed options on market indices (averages).

A somewhat more refined analysis involves the changes in option premiums, that is, the amount that the option's market price is above its intrinsic value.

Whether volume, premium or a combination is used is of little concern because the results are almost invariably parallel.

In determining this ancillary criterion we use a very simple comparison of the current ratio (and/or premium) with that of four weeks ago.

BUY: Put volume (and/or premium) has increased disproportionately to calls. This can be indicative of excessive pessimism, reducing overhead supply and allowing prices to advance more easily.

SELL^. Call volume (and/or premium) has increased disproportionatel_yto puts. This can indicate excessive optimism, making the market more vulnerable to decline.

Advisory Sentiment

We consider put:call relationships as measures of the sentiment of the public speculative sector. To gain a measure of the feelings within the analytical community and the effect on the institutional sector, a variety of services survey analysts and report their findings. These services vary in their clarity, most dividing analytical sentiment into three categories: bulls, bears, and neutral (or "correctionist").

Many an analyst's outlook is ambiguous: "If the market fails to advance or decline, it will stay even, and so on, and so on . . ." This is of no use in practicality, but it does help in job retention because the analyst cannot be wrong.) Most surveys also incorporate a great deal of subjectivity in their results. In addition, the surveys can be biased by a lack of adequate sample size, an overweighting (lack of randomness) of investment techniques utilized by the analysts selected for the survey, and a lack of method for compensating for changes in the analyst's forecasts between surveys.

Despite these shortcomings, the surveys (especially during extreme conditions) can be useful. If overly optimistic they have likely followed their emotions and have bought, possibly exhausting their buying demand and allowing prices to descend more easily. Conversely, when pessimism prevails, the analysts have likely sold, thereby reducing overhead supply which can allow prices to more easily advance.

The selection of the survey to be utilized is not important because, when dealing with adequate sample size, their results are generally parallel. Several are followed by Barron's weekly, you need to do to see the survey's results is flip to the appropriate page. The survey selected should be consistent, that is, use the same survey for each weekly comparison.

As previously mentioned, these surveys divided the analyst's sentiment between the percentage of bulls, bears, and "other." We only look at thepercentage of bulls, comparing the current reading to that of four weeks ago.

BUY: The percentage of bulls has decreased. This can be an indication of pessimism and a reduction in overhead supply, making an advancemore likely.

SELL: The percentage of bulls has increased. This can indicate that increasing optimism is depleting buying power and making the market more vulnerable to decline.

By its very nature, the business of reporting is to describe events after they have occurred. This is fine. However, when applied to financial markets, descriptions do very little to enhance profitability which requires being properly positioned before the price change occurs. As a business, reporting depends on sales, which are made to customers attracted to the product being sold. That attraction is a direct function of sensationalism: the more sensational the news event, the greater the attraction. When it comes to the stock market, the most sensational event is dramatic price change after the fact that the price change occurred.

Price change occurs because of demand/supply imbalances created by the conscious buy/sell decisions made by market participants, the majority of whom have a long, well documented record of the being wrong during pricing extremes. They are engaged in either panic selling or emotionally induced euphoric buying. In reporting the sensational pricing extremes, most reporters find themselves forced to justify the pricing: high prices "justified" by some positive event, and low prices "justified" by some negative event. To do otherwise entails the risk of looking stupid. After all, if you saw a reporter who said prices have risen dramatically because of bad news (or conversely prices have fallen because of good news), your natural reaction might be to categorize the reporter as a fool. Even if the reporter knows that pricing extremes are at nutland levels and very likely to soon reverse, job preservation can take precedent over reason.

Now, let's combine the media's after the fact reporting of price sensationalism with the sales aspect of the securities industry and its effect on a typical misguided investor, Mrs. Shnook. She is greedy, and she and her hubby have some bucks. Mrs. Shnook sees, reads, or hears about sensational price gains in the stock market and seemingly logical reasons given to justify the gains. When hubby comes home, she shows him the news and their greedy brains consummate as one. The phone rings; it's JoeBroker, letting them know about the news. They already know why it is all wonderful, having seen it themselves through the media. Joe has little problem selling a customer who is already preconditioned to buy. In go Mrs. Shnook and hubby's money, and they are happy to be there. Watching their stock purchases go up on paper, they have no intention to sell as the ride looks as though it can never end, and they can count up how much their worth has appreciated. Glee.

But, then, as with every period of excessive overpricing in the market's history, a decline eventually ensues. When the downmove occurs, the glee associated with counting paper profits turns into discomfort as the paper profits change to paper loss. As the decline becomes sensational, the Shnooks turn to the news, which reports negative rationalizations after the fact of price change. Their greed turns to fear and they call Joe to whine. Joe replies, "Well, you saw the bad news. Gosh, what a surprise!" With little coaxing, they sell at a loss, happy to relieve themselves of the pressure of watching their presumed wealth fade. Joe gets another commission.

As with every overly discounted condition throughout the history of the market, prices eventually advance. The Shnooks, of course, don't like the market after taking a loss. However, chances are that they will be back the next time sensationally high prices occur, fully believing the news rationalizations. They will think the market is "different," get their greed juices flowing, and plunk down their bucks again. Heh. Heh.

Mr. and Mrs. Shnook went for an emotional ride along the road to loss (buying high and selling low)—and chances are that they will do it again! In this simplified example, it is helpful to reinforce three points.

1. The buy/sell decision process was the result of a chain reaction: media sensationalism after the fact of price change, with accompanying "justifications" for the change, followed by emotional preconditioning, followed by the sales pitch of the securities industry.
2. The victims liked it. They didn't like the end result of loss, but they enjoyed feeling the greed when they bought and relieving tensions associated with fear when they sold. After all, as adults they made the conscious buy/sell decisions.
3. They will likely do it again because the next wave of sensationalism stimulating their greed will be accompanied by different reasons for price "justification." The market will appear to have changed, creating the same lure and providing the same end result. History clearly attests that every time the stock market has become exceptionally over- or underpriced, with the associated sensationalism, the pricing reversed direction—often quickly and dramatically.

So the media are among our closest allies in eliciting irrational behavior among our opponents. The criteria are simple.

BUY: A leading nonfinancial newspaper (or network evening news program) finds the stock market so sensationally bad that it makes the front page of the paper (or the lead story on TV).

SELL The same publications (or program) find the market so sensationally wonderful that it makes the front page (or the lead TV story).

It can easily be seen that this strict adherence to only making buy or sell decisions once a week introduces a significant constraint: Better prices may be available during the week rather than confining the buying or selling to only one price during that week, the week's closing price. However, this is how the Report is structured. In effect, it is only looking at the market once a week at the week's closing prices to determine if any changes are warranted in portfolio modeling.

Obviously, this constraint is not necessary in actual market endeavors. In a later section involving how to expand return, we will address how this constraint can be easily overcome.

The Report follows three different portfolio models based on the three previously discussed methods of stock selection: earnings, yield, and price. Each model functions independently of the others, even though they are basically interrelated by the technique's design.

As mentioned previously, not all buy/sell indications are of equal strength. At this juncture, our concern is describing basic format structure.

Whenever there is a buy indication, five stocks are selected for purchase in each category (earnings, yield, price) using the simple stock selection techniques. The price (the week's closing price) is listed with each stock specified for purchase.

Between the time specified for purchase and the time specified for sale, the stocks are listed in the Report as "Open Positions" and the date specified for purchase. No position can be forgotten.

When a sell indication occurs, those positions selected for sale are listed with each position detailing the percentage profit/loss and time the position was held. The positions sold are then deleted from the Open Positions, and the results are incorporated into an ongoing summary of results published in each weekly Report.

Using this rigid format, each stock position is followed continuously from the time of purchase through the time of sale. With no possibility of hindsight or omission, the technique's validity is carefully documented.

4. The results summaries do not include dividend payments. The results are accordingly understated.

5. The percentage profit/loss calculations for each specific stock position take into account transaction costs in the following manner.

Inherent in the Time Overlay techniques because of the timing criteria, stocks are almost invariably purchased during declining markets and sold during advancing markets. This is by design. As such, there has always been some price decline after purchase and some price advance after sale. In other words, because of the published format's construction, stocks have never (to date) been specified for purchase at their exact low price and have never been specified for sale at their exact high price. The minimum price differential is quite specific and is incorporated into the Report to more than offset reasonable transaction costs as follows (providing 1/8th increments for each $12.50 of stock price):

For example, if the Report specified a stock for purchase at 35, by design the stock should trade at least 'A less, 34%. If the stock went to 40 andselling was indicated in the Report; by design the stock should sell at least ^IA higher, 40¹/4

In this example, the result recorded by the Report would be to purchase at 35 and sell at 40. By using the differential, the actual result would have been to purchase at 34⁵/8 and sell at 40^1/4.

This pricing differential is another constraint that need not be experienced in actual market endeavors.

6. The published portfolio modeling, is purely mechanical, totally objective, and void of any subjectivity. The published modeling will only alter model portfolio structure (buy or sell) when the primary and ancillary criteria are in agreement on a timing signal. The buy/sell signals are therefore predetermined by market conditions. Because of the modeling's design, under no circumstances will there be any change in portfolio structure unless the predetermined conditions for a buy/sell signal aregiven. In other words, the models have absolutely no concern about events between the predetermined buy/sell points.

It is mandatory that the published models function on a purely mechanical design. The injection of subjectivity would function to invalidate the published results.

This is a very significant constraint which, can be easily overcome in actual market participation.