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Marching in Parallel
AT A GLANCE: The remarkable parallel to the 1999/2000 holiday market continued with yesterday's sharp decline. The Price/Volume Charts confirmed their sell signals, but can come up with buy signals if there is a drop in volume while the markets rally. The negative indicators have grown in number while the positive indicators have slipped to just 3. Three distinct ways are available for the generation of a buy signal based on the Summary Index or the Quick Summary Index. There are several potential support areas just below, of which anyone of them could end this decline. The new Goodman Price/Volume Stock Selection System (GPS) selected one new buy from the S&P 100. The Goodman Price/Volume Stock Selection System (GPS) has just one new buy today:
It was selected for the GPS S&P 100 Portfolio, but not for the GPS NASDAQ 100 Portfolio -- even through Cisco is a member of both indices. Remember, the optimization parameters are different for each index. So I've been getting lots of great questions about GPS from readers. I try to respond to all your emails, and as we go along, I'll cover the topics of most general interest here in the reports. In the meantime, don't forget to review the lengthy write-up about GPS from Key Indicators for Investment Success, by clicking here. Today let's take a closer look at how GPS has produced its results in backtesting. For the last six months, I tallied the number of winning and losing trades, the average returns and the length of the trades. For context, the S&P 100 system beat its index during that period, returning 11.5% while the index returned just 4.8%. The NASDAQ 100 system beat its index too, returning 13.0% while the index returned 8.9% (by the way, none of these numbers has been annualized). In the S&P 100 system, there were twice as many winners as losers, and the average win was twice as great as the average loss -- with the overall average trade (combining winners and losers) returning 4.16%. How is it possible for all the trades taken together to have returned 11.5% when the average trade only returned 4.16%? Simple -- the trades were held for a short time: winners and losers were both held for only a bit more than a month. The large overall gain is the result of compounding gains over the entire period.
The NASDAQ 100 system showed slightly less than twice as many winners than losers. But the average win was almost three times the size of the average loss -- with the overall average trade returning 8.51%. Winners were held longer than losers (nice -- the system seems to let winners ride and cuts off losses). Overall, the average trade was held for almost twice as long as the average trade in the S&P 100 system. So the effect of compounding gains still worked -- an 8.51% average gain per trade compounded to a 13.0% gain for the whole system -- but the effect was not as pronounced as in the S&P 100 system which had shorter holding periods and more opportunity for compounding.
One frequent question I have been asked by readers this week is "How can I use GPS on a daily basis?" First, let me say what should be obvious: make sure that GPS meets your own investment objectives and your own ability to bear risk. And second, let me urge you not to be intimidated by the seeming complexity of three new portfolios we have set up to track the results of GPS. I'll explain their full workings in reports coming shortly. For today let me tell you how I am using GPS in my personal account and for accounts I manage for clients. It's pretty simple. I've mentally allocated a particular amount of money that I want to use for GPS. I invest 1% of the money in new buys that the program selects (and then I sell each stock when the system says to sell). This permits me to hold up to 100 stocks at any one time. Based on my backtests and my preliminary real-money trading experience with GPS over the last year, it seems that there are generally less than 70 outstanding buys in each portfolio -- and usually even fewer than that. Just in case I want to hold more than 100 positions at once, I hold my GPS trades a margin account. This will also permit me to short SPY and QQQQ when it is appropriate due to a Summary Index sell signal, rather than to go the expense of liquidating all trades that are in place. Also, note that the way I trade GPS generally leaves some cash in my account, any time I'm invested in fewer than 100 stocks. Depending on how much cash there is at a given point in time relative to the general technical condition of the market, I am free to invest some or all of it in SPY and QQQQ if I feel I need more equity exposure. By the way, I don't buy every single stock that GPS comes up with. I filter them with an eye to adverse special events that might be driving individual situations (for example, last year I did not buy Chiron even though GPS had it as a buy). Tomorrow I'll discuss other possibilities for using GPS. The parallelism that I recognized weeks ago -- between the current holiday market and that which occurred in 1999/2000 -- has truly been extraordinary. Let's hope it continues, since we are in for three advances this week if it does. However, it is most unlikely for this to keep playing out exactly the same way it did 5 years ago for much longer. There was a lot of damage to the indicators on Tuesday with 5 moving to negative and 2 moving from positive. The totals are 14 negative, 12 neutral and 3 positive. The Summary Index dropped to 10.55 from 11.05, and it will reach 7.6 in a week if there are no further changes before then. The Trend Indicator continues to advance and reached another new high at 12.66. Its Uptrend state continues.
A buy signal can now happen in three ways. First of all there can be a further drop by the Summary Index below 4.5, with a subsequent advance back above that level. Second, there can be an increase in the number of negative indicators to 19 or more, followed by a decrease to 16 or below. Finally there will be a buy signal if the number of positive indicators starts to increase and reaches 7 or more from it current level of 3. Regardless of the method, when a buy signal occurs, if the Trend Indicator is still in an Uptrend we will increase the equity at risk to 200% in both the Technical Trading Model Portfolio, where we will buy SPY, and in Portfolio "Q", where we will buy QQQQ. In the Discretionary Technical Portfolio I may go as high as 100% equity at risk, up from the current 60%. Both the S&P 500 200-day moving average and the 50-day moving average continued to advance. The longer average reached 1129.81 while the shorter one closed at 1178.19. The decline has already taken out the most recent reaction low that occurred at 1194, but is very likely to take a bounce off the December 7 low at 1177.07, or it may bounce off the 50-day average at 1178.19. Furthermore, the 50-day average will rise to 1180 today even if the S&P 500 stays where it is. Bottom line, a bounce today will not come as a surprise and will continue the parallelism with 1999 for at least one more day.
The S&P 500 14-day Relative Strength Indicator (RSI) dropped just slightly below the important 40% level -- it closed at 38.9%. Today it will be under slight pressure to go lower because of the removal of a 2.39 point advance that occurred 14-days ago. However, two negative days will be lost on Thursday and Friday. Here, the parallelism is between the current market and the March 2004 high. We have been discussing this for weeks, and it seems to be coming true. However, there is still an escape if there is a substantial bounce for the rest of the week.
The Price/Volume Charts were pretty perfect in producing sell signals Monday and in confirming them yesterday. There is now an opportunity for them to produce clockwise basic buy loops by following the orange and green arrows. Here's the S&P 500 Chart.
The NASDAQ Price/Volume Chart can do the same thing. The volume will have to decline today while the market moves a little in either direction.
The Dow Price/Volume Chart did not make a valid sell loop because of the remove one day rule, but it can make the same buy signal that the other indices can.
I have extended the chart of the 1999/2000 holiday season through January 11, 2000 for comparison. At that time the equivalent week to this one, ended with three high volume advances. Should that occur this time, there won't be a buy loop.
The Smart Money Indicator (bright blue line) lost another 23 points and is solidly negative. I don't expect much from any recovery that does not bring this indicator up with it.
Fred Goodman, CFP, is a fee-only Certified Financial Planner based in Los Angeles. You can send him your questions and comments via email at Fred@MarketMonograph.com. Emails sent to Fred may be published on this web site edited for clarity and brevity, and including your name unless you specify anonymity or not for publication. The charts and commentary represent what Fred is thinking about the market and thinking of doing for his own account and for accounts he manages at the time of writing. Fred, his clients, or his family may have positions or make trades in securities mentioned in these commentaries. Mutual funds mentioned by Fred may be advised by institutional consulting clients of Trend Macrolytics LLC; Fred has no economic interest in such business relationships. There is no guarantee that you will profit from trading as discussed herein. You may lose money and both Fred and Trend Macrolytics LLC assume no responsibility for what you do or do not do with this information. Copyright 2001, 2002, 2003, 2004, 2005 and 2006 Fred Goodman and Trend Macrolytics LLC. 
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