17 posts tagged “price”

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.

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.

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).

Yield

There is a widespread belief that a corporation's growth is enhanced by a low dividend payout, based on the logic that the money not paid out in dividends can be reinvested in the corporation thereby facilitating its expansion. This is logical and essentially true, but is not as important as many believe. As we will clearly demonstrate in a later discussion of actual results, the total return (capital appreciation plus dividends) of the stocks on our Master List is about the same irrespective of perceived growth rates.

We like money in any form, and if it happens to come from dividends, that's just fine. In fact, it is so fine that dividend yield can be valid stock selection factor all by itself.

The problem with selecting stock simply on the basis of the highest dividend yield is that dividends (as with earnings) are not constant. A fat dividend yield could suddenly go poof if the dividend is lowered or omitted. This risk is reduced by the construction of the Master List, which attempts to confine interest to issues of demonstrated superior fundamental quality, affording both above average dividend protection and dividend growth.

In employing this method of stock selection, all you need to do is, at the time of a buy indication, review the Master List and select the issues that have the highest dividend yield and that have experienced a price decline over the chosen comparison time period. In the publication of this type of portfolio modeling, the Report uses a four-week price comparison to match that associated with the primary criterion and several of the ancillary criteria. As previously discussed, the actual time periods compared depend on individual preference.

Price

Although most elements of the financial media and analytical community are quick to dream up reasons to justify any price change, the fact is that many price shifts have no fundamental basis and are simply natural imbalances in demand/supply. Since our objective is to buy low and sell high, it seems logical to review the Master List at the time of a buy indication and select the issues that have experienced the sharpest percentage price decline over the chosen comparison period. This percentage price shift is so significant that price change in itself can be considered a valid method of stock selection.

In the published portfolio modeling, again using a four-week comparison period, at the time of a buy indication the issues on the Master List are reviewed to isolate those that have experienced the greatest percentage decline. Those issues that are down the most are chosen for purchase.

Again, the importance of the Master List comes into play. If a corporation turns into garbage, its stock is going to go down. If a corporation reaps fantastic profits, its stock is going to go up. In such instances, the price changes are the result of not a basic demand/supply price dislocation creating over/under valuation; the price shift is based on true underlying fundamentals. The Master List's design is to confine interest only to those issues of demonstrated superior fundamental quality, thereby allowing clearer focus on price changes that are not related by true underlying fundamental change. In other words, the Master List is a conscious attempt to isolate stocks that become more attractive as their prices drop.

Oversimplification?

The initial reaction to determining specific stock selection by these three methods might be that it is too simple to really be valid. No complex mathematical formulas are involved. There is no need for computer assistance. Neither is there a need for a staff of analysts or heeding the predictions of puffed-up gurus. And there is not even any need to pay much attention to the financial media beyond acquiring the necessary data to determine if a buy/sell point has been established as well as the specific stocks involved.

The fact of the matter is that we have found the market to be quite simple. It is often presented, and consequently perceived, as complex, but we have found its core to be nothing other than a straightforward, repetitive, man-made business.

Recognizing this basic, underlying simplicity and comparing it to the rantings of many analysts and media sensationalism, you can gain insight as to why the simplicity is widely overlooked by the majority and always will be. The majority within the analytical community will always attempt to present a reason to justify any price change, after it occurs, in the context of the reasoning being most easily accepted by clientele. Because of the assumed, widespread belief that all price changes are based on fundamental change, the consensus among analysts repeatedly ignores structural and/or psychological pressures that can create prices that are extremely divergent from underlying fundamental norms.

To understand how an erroneous consensus can develop, place yourself in the position of an institutional analyst, keeping in mind that job preservation provides some nice things, such as food and shelter. Now let's say the market makes a significant move because of psychological and/or structural pressures that move prices well away from underlying fundamentals. You are asked to explain why. If you say you don't know, you look stupid to clientele (after all, you are being paid to know everything), and you risk loss of employment. Your image, as well as your future, might very well depend on providing an answer that is most easily accepted by your clientele, which have been conditioned by you and/or other analysts to believe that every price change is justified by a purely fundamental factor. Looking about at what the other analysts say is the cause of the price change, you simply repeat what they are saying and join the consensus. You are one of the group. Even if absolutely wrong, your retaining employment is enhanced because you are in full agreement with your peers (they can't fire everybody).

The sentiment among analysts is reinforced by most elements of the financial media which (in its attempt to generate sales) stresses uncommon events.

The sales structure of the securities industry is also a powerful force that is bolstered by the consensus among analysts and concentrated media attention. It is elementary logic that a sale is made easiest when the customer is predispositioned to making a decision.

The consensus among analysts plus media concentration plus the sales structure of the securities industry combine to create tremendous pressures that can make the exception appear to be the rule. Consequently, chasing price after the fact of price change creates a lure that ignores the market's underlying simplicity. It also ignores the basic logic that profit. ability requires being properly positioned before the fact of price change.

Keep in mind that our stock market participation is limited to the very select group of stocks on our Master List. In effect, we are dealing in our market within the overall market.

At any given time, each stock on the Master List will vary as to its relative over- or underpricing when compared to the others. When a buy indication occurs, we do not want to buy the entire list. We want to choose from the list the specific issues that appear to provide the highest probabilities for appreciation.

To accomplish this objective, as well as to demonstrate valid factors that can be utilized in specific stock selection, three separate methods (earnings, yield, price) are incorporated into our portfolio modeling and each method is followed in detail in the published weekly Report.

Earnings

The most fundamental value of most corporations is earnings, which can be measured relative to stock pricing by the price/earnings ratio. The higher the P/E is, the higher the relative pricing. Conversely, the lower the P/E, the lower the relative stock pricing will be.

Lagging P/E ratios (the current stock price divided by the last full year of reported earnings) are provided in the daily stock quotations published in most major newspapers.

The problems associated with using the published P/Es are twofold.

1. The earnings of most corporations are erratic and basically unpredictable. What looks like an attractive low P/E could suddenly skyrocket with lower earnings. To overcome this, one of the conditions for inclusion on the Master List is an established record of earnings predictability. Only by confining interest to stocks with demonstrated earnings predictability can the P/E selection method be viable.

2. The published P/Es are associated with past earnings and earnings change. This is why we use earnings projections that are somewhat time-consuming to generate. To repeat, although we continue to use earnings projections in our P/E selection technique, over the many years of this technique's publication there is not a significant difference in the results obtained using either lagging earnings or projections.

Having made a reasonable attempt to overcome the obstacles associated with P/E valuations, our objective during buy indications is to purchase issues that are trading at the most attractive (lower) P/Es. Each stock on our Master List has a history of P/Es; that is, the past P/Es are available, and you can see the high and low P/Es (the P/E range) that the stock has experienced. We go back seven years in determining the range.

Not all stocks or stock groups trade in the same range. Stocks that are viewed as having superior growth will trade in a higher range than those viewed as stodgy.

During a buy indication, we want to purchase issues that are trading in the lower portion of their P/E range, thereby providing higher probabilities for appreciation than those that are trading in the upper portion of their range.

In the published portfolio model concentrating on the P/E method, generally, during buy indications, a wide variety of stocks with different P/E ranges are selling at a similar low level. Since only a very limited number of stocks are selected, a mechanical technique to determine which issues are selected from among those in similar P/E ranges is employed. You simply select those with the lowest P/E, irrespective of the range. Consequently, this selection method tends to concentrate in low-P/E stocks. In addition to the selected stocks being in the lower portion of their P/E range, they must also be selling below their price four months ago.

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.

As background to this technique, remember one of the criteria for stock selection is institutional involvement. The issues utilized, therefore, are suitable for investment consideration by at least some institutions.

This allows us a valid comparison: matching the results obtained by our methods with those obtained by institutional management over the same time period. Similar comparisons can be made by measuring the market performance that was (or could have been) obtained by following the recommendations of any broker or advisor as well as providing a valid comparison with popular market averages.

The reason for this is not to identify relative competence, but to eliminate a possible bias. If the techniques employed used little known stocks or information not widely distributed, it would detract from the validity of the results. That is, to enhance the validity of the techniques, the methods must incorporate data available to other investors during the same time period.

The timing techniques being employed use no special or inside information. All stocks utilized are well-known and widely followed. The information used in determining specific stock selection was (is) easily available.

Another aspect incorporated to eliminate bias is that the stocks utilized are usually higher-priced with relatively high trading volumes. This adds to the validity of the results. Methods using low-priced, low-volume stocks can be biased to the point of total invalidation. For example, low-priced, low-volume stocks could be easily changed in price by the action of a few individuals who through their own activities create price changes and the illusion that they have acquired actual profits. This illusion of actual price change has been used in fraudulent schemes where the investor is talked into buying a low-priced, low-volume stock from a crook who "makes a market" in the stock. The investor is unaware that the elevated price was made up at the discretion of the crook since no one else is interested in the stock. Seeing the appreciation, the crook sells the investor another stock with the same result, etc, . . . until the day comes that the investor wants to sell and there is no real market.

Crooks aside, percentage price fluctuations in low-priced stocks can often be dramatic on very low volume. Because of this, parallel (or even close to parallel) returns in actual practice would be impossible. Note that, because of this effect, many published advisory "services" that tout low price/low-volume stocks can be extremely misleading. For example, they could recommend a stock and then their followers proceed to bid up the price by their own buying. The service then identifies the price advance as an indication of the service's "ability" and may recommend sale at the higher price. The followers sell, thereby forcing price down in the same magnitude that their selling had advanced the price. The "service" looks good, but the followers could never obtain prices parallel to the service's recommendation because the appropriate prices were never really available. In other words, the followers bought high and sold low, while the service created the impression of success.

A malady shared by many analysts is selective memory loss. When they are correct, they become vocal to attract attention to their ability. When they are wrong, they shut up, and the error is forgotten. Another manifestation of selective memory loss is the "cover all your bases babble," i_nwhich market forecasts go something like, "If the market does not remain unchanged, it will advance unless a decline occurs." Such yappings are extremely common, but absolutely worthless to anyone except the analyst who, after employing selective memory loss, can point to any market outcome as proof of forecasting ability.

We, the authors, are in the market in real time. Our livelihoods are dependent on accurate price forecasting. There is no place for selective memory loss and associated nonsense. The results of our decisions are clear and crisp: Either we have acquired the money of fellow market participants or lost. Period.

In demonstrating the basic Time Overlay investment technique, we developed a format involving several controls making hindsight or omission virtually impossible and allowing the method to be easily used in actual market endeavors.

The specific application of the Time Overlay method is followed in a weekly Report which has been published continuously since January 1, 1977 by Drach Market Research.

The Report is prepared following the close of the last trading day of the week (Friday, unless a holiday when preparation is conducted on Thursday).

The Report is always mailed before trading begins the following week. This preparation and mailing sequence prohibits any possibility of waiting until the next week begins before presenting the forecast for that week.

The Report is very specific—no "if s." It states clearly and specifically to BUY, or SELL, or DO NOTHING. The text is devoted to an explanation of current positioning and outlook.

The Report uses only the week's closing prices. There are no qualifications to buy or sell if this or that happens. When a buy or sell decision is made, it is firm using the week's closing price. Period. No buy or sell decisions are contingent on anything that happens between publications of the weekly Report.

4. Watching for Ex-Dividend Dates.

Dividend payments, which are not considered in the published results, are an important source of income.

It is a general assumption that, when a stock goes ex-dividend (the day after those who hold the stock are entitled to the next dividend payment), the value of stock is reduced by the amount of the dividend. For example, if a stock's price is $40 and it pays a dividend of $1, at the time of the ex-dividend date the inherent value of the stock is reduced by the dividend amount $40 — 1 = $39.

This reduction in the stock's market price is logical. In our example, the corporation paid out $1 of its value and the corporation's worth is reduced accordingly. This is even accounted for in stock quotations. As in our example, if the stock closed at $40 the day before the ex-dividend date and closed the next day at $39, its day-to-day price change would be printed as no change.

Our experience with the stocks we monitor has been that, in depressed conditions (when we often are doing our buying), the market price of the stock does not always descend by the amount of the dividend payment. Our reasoning as to why this occurs is purely theoretical. We suppose that, because of the superior quality of the issues on the Master List, during depressed market conditions when many people are frightened, there is a "flight to safety," which can function to prop up our stocks. In other words, buying demand picks up in our stocks relative to the broadly based market because of their image of safety created by their demonstrated fundamental quality.

For whatever reason, when two stocks appear equally attractive for purchase, some advantage in total return can often be achieved by selecting the one with the nearest ex-dividend date.

5. Combining the Time Overlay Models.

The three methods of specific stock selection (earnings, yield, price) function independently. One of the reasons for this is academic—to demonstrate that each method by itself is valid in determining stock selection.

In the actual implementation of the Time Overlay modeling, we have found that better results can be obtained by concentrating purchase on stocks that qualify best in all three categories. For example, a stock may qualify very well for the yield method, but may be well down the priority list in the price method. In combining the methods we do not take the average of a stock's rank in each category, which might appear to be the most logical approach. The reason is that there is too much weighting to the earnings and yield selections which often overlap. What we do is rank each stock for each method and then take the lowest rank for each issue. Then, we concentrate on the stocks with the highest low rank. To date, we have found that this combining can add to both profit consistency and expanded return.

6. Loss Reduction.

As previously discussed, the weekly Report, which applies the Time Overlay portfolio modeling to current market conditions, functions in a purely mechanical format. There is no allowance for subjectivity because it could function only to invalidate the results.

The losses, which at the time of this writing comprise only around 4 percent of the concluded positions, are often forced because of the mechanical structure, and we have found that this losing percentage can be significantly reduced.

Keeping in mind that the Report's structure only allows for changing positions in the model portfolios during outright buy/sell indications, recall that losses occur for two reasons.

At the time of a sell indication:

1. The specific stocks selected for sale to reduce investment level appear the most overvalued relative to the stock selection method but still might return high probabilities for future appreciation.
2. The stocks have been deleted from the Master List, which causes them to be sold first irrespective of their ranking when compared to the other holdings.

When incorporating rotation, quite often when a stock has been deleted from the Master List, it will have already been sold profitably between the predetermined buy/sell points in the published portfolio models. In other words, the published models are holding the position because an outright sale indication has not occurred, but the rotational application has sold the position profitably and now will not repurchase the stock because of its elimination from the Master List.

The Master List is extremely selective, and sometimes a stock is deleted because of only a very minor change in underlying fundamental quality. In fact, in some instances a stock can be kicked off the list briefly for a closer look at its condition and then be reinstated, in a sort of probationary period as its quarterly Report is reviewed. Under these circumstances, there is no reason to abandon the stock even though the Report's mechanical modeling will automatically kick it out. In actual theory, we will retain the stock as a holding (but not purchase any more of it) when it is close to qualifying for the list and compare it to the others when selling as though it still qualified for the list. This is significant in eliminating the forced sale effect.

We will not, however, wait forever for a stock to remain in a probationary phase. If the stock has not requalified for the list after two consecutive quarterly Reports, we will sell it.

Note that, of the very few positions the mechanical structure of the Report sold at a loss, 75 percent have so far subsequently doubled in value after being sold from the Report's selling price. In our own experience in actual Time Overlay portfolio management, which has involved many times the number of individual stock positions in the published models, at the time of this writing we have experienced only 12 losses, and most of those have been minimal (less than three points).

Although we find the basic Time Overlay method satisfactory in achieving our objectives of profit consistency and return, several factors can significantly increase return in actual market endeavors.

1. Rotation.

The published models are very strict. They will only change positions during outright buy/sell points that can only occur on the Report's publication date. The models completely disregard price movements between the predetermined, published mechanical buy/sell periods. Almost invariably, better prices are available at times other than the instant of a published buy/sell indication.

We know, by the results derived over the many years of the modeling's publication, what the average percentage return per position is by strictly adhering to the published buy/sell points. We also know that each stock selected has an equal chance of concluding profitably irrespective of price fluctuations between the predetermined buy/sell points. If we can get equal or better prices than those of the published models between buy/sell points, there is no reason not to capture gains before an outright sell signal.

Knowing that prices fluctuate, we can attempt to take advantage of the intervening price movements by rotating our positions. For example, let's say there is a buy indication and two stocks (A and B) appear equally suitable for purchase, and both are selling at 20. We purchase stock A. Rather than wait for a sell signal, we decide that we will take our profit if we realize a 10-percent gain. The 10-percent profit would capture a return greater than that averaged by the published models for individual positions. (Any parameter can be used, it is a matter of personal preference). Now, let's say that our stock (A) advances to 22, meeting our 10-percent objective, and that stock B has stayed at 20. We do not want to reduce our investment level because there has not been a sell indication. We sell stock A, taking the profit and move to stock B. Then, let's say stock B goes to 22 providing us our 10-percent profit, and stock A has fallen back to 20. We sell stock B and rotate back to stock A, and so on, until there is an indication to sell out entirely and/or reduce the investment level.

In actual managed accounts, the rotational process is utilized and, to date, without exception accounts incorporating rotation have outperformed the published Time Overlay models. During exceptionally volatile periods, the incorporation of rotation can create very active trading. However, during such periods and/or during extended market cycles, the use of rotation can dramatically improve results.

2. Optimizing Rotational Selections.

In the previous rotation example, the rotational selections were made from stocks selected at the time of buy indications without consideration of the other issues on the Master List.

This is an unnecessary constraint. It is possible that, at the time a purchase is warranted because of a rotational sale, there might be a stock on the Master List that is a better bargain than any of those selected at the time of a buy indication. In actual rotational trading, we move to whatever stock appears most undervalued from all those on the Master List, irrespective of whether they are being held as open positions in the published modeling. This wider selection generally expands return.

3. Delaying Buying.

The published modeling is designed to be early. That is, lower prices are available after buy indications and higher prices are available after sell indications. As discussed, this is necessary to assure that compensation has been made for transaction costs and to provide sufficient price latitude so that the method can be duplicated in actual trading.

At the time of a buy indication, each specific stock selected has an equal chance of concluding profitably. Price fluctuations between the predetermined buy/sell points are of no concern to the strict models because nothing is going to happen between the buy/sell points.

Price fluctuations (both up and down) between the predetermined buy/sell points can be significant and, since each position has an equal chance of concluding profitably, there can often be some advantage in waiting until after a buy signal and then selecting issues that are demonstrating relative discounting. For example, let's say that there is a buy signal and two stocks (A and B) are selected, each at a price of $20. Instead of buying one immediately, we wait and see that stock A is remaining at $20 and stock B has declined to $18. We then buy B because it is relatively discounted, having an equal chance of being above its initial published purchase price as does stock A when specified to be sold.

In our real time application of the Time Overlay portfolio modeling, we do not wait until after a buy indication to begin expanding the investment level. Although better prices become available after the buy indication, we usually get them anyway because of the rotational aspects. In fact, because of the rotational advantages, we are often a bit more aggressive in our investment level than the Report. However, for those wishing to avoid the sometimes rapid trading associated with rotation and/or the added analytical time, delaying buying and emphasizing the most discounted issues can often significantly increase return.