Wednesday, April 27, 2011

Broad Participation Underlying the Database; Be Aware of Potential Profit Taking on Bernanke News

.
Summary

  • The GGT price index rose 0.67% on volume that was -4% below the 50d moving average.  -4% is within the "noise" of the market, so this was a good day in terms of prices.
  • The slopes of the pricing moving averages, which range from 5d in length to 65d, have now been positive for 4 consecutive days, with three of those days pointing upwards to "more positive" readings.  This is net bullish on the market.
  • The price change oscillator, which is a tool I use to determine overbought/oversold conditions, is unchanged at a value of 0.  This indicates that there is equal probability of a move up, as well as a move down, from this point (same as yesterday by the way).  Put another way, moving into stocks on the long side could have favorable risk/reward characteristics.
  • The GGT database strength indicator, which is an oscillator that moves between 0 and 1 and indicates stock participation in terms of prices and volume, has just moved to +0.862 from 0.695.  This is a large change for a single day and values above 0.8 are typically indicating overbought, so some caution at entering on the long side is advised.
  • The Intermediate-termed Elder Force Index timer is still in mixed mode.  Volume has not been high overall and as a volume-based timer, this one is not confirming the market in terms of price-volume.  December 2010 showed us that we can move upwards a significant amount without volume, so this is a datapoint more than a driver.
  • The slopes of the Long-Cash Ratio, which range from 5d in length to 65d, have now been positive for 2 consecutive days, with the last 5 consecutive days all pointing upward.  This indicates that the underlying database is participating in terms of volume and price, compared to historical levels, and that we should be moving long into the market.
Conclusions:  markets climb a wall of worry, and The Bernanke will be speaking, which will create volatility.  Overall, while we have some indications of a potential pullback, as of last night's data nothing suggests that this bull leg is in trouble.  I intend to buy the breakout off of a pullback, and I'm long VXX in the interim.

====================

Momentum

As a market timer, I'm interested in momentum.  One of the indicators that I've developed shows me overall momentum, relative to past history.  Here's the view:



As with all my charts/figures, right-click on the image to open in a new window or tab.

The chart shows that we are clearly in an upward trend according to the entire GGT database, measured in terms of prices and volume moving above historical thresholds where the stock price moved upward.  This is bullish, and while we certainly can reverse at any time, participation on the up legs has historically been healthy to our bank accounts.

Pricing Slopes

We're clearly bullish on time scales out to the 65d EMA on GGT price:



As you can see on the left side of the figure, we've been "green", which indicates a positive slope for the moving averages, for the last 4 days.  This means that on average, the prices of the database are moving upwards on multiple time scales.  This is important.

The right side shows us the "slope of the slope", e.g., whether the positive slope line is pointing upward or downward.  Out of the past 5 days you can see that we've been pointing upward 4 of the 5, which means that there is a net acceleration upward in day-over-day prices on multiple time scales.  This is important -- and it is bullish through last night's data.

Long-Cash Ratio Slope

The same presentation can be applied to the LCR, which gives us a combined view of price and volume behavior within the entire GGT universe:



Of particular interest is that we are green-green-green on multiple time frames -- this is bullish.

=======================

GGT + Effective Volume

A number of stocks continually are meeting this screen, jumping up and down, waving their arms.  According to the Active Boundary numbers they are still showing good value.  Here's the output of the screen:










 
These stocks have been performing well overall for the last few days.  Give them a careful eye.

==================

Remember, you are responsible for your investment decisions, and I am not.  Please do your diligence, and please take ownership for your actions.

Regards,

pgd


Tuesday, April 26, 2011

LCR Signals "All In" on the Long Side, Price System isn't Confirming (Neither is Force Index)

.
Summary
  • Monday's action resulted in prices falling -0.75% on volume that was -30% below the 50d average.  When I see such poor volume it simply indicates that we are on autopilot -- most likely due to the Fed's anticipated remarks on Wednesday.  Until Wednesday p.m., I do not anticipate any significant moves in the market.
  • My pricing change tool relaxed off of "overbought" at a reading of +14 going into Monday's market to "neutral" (+0) going into today's market.  This is telling me that (Fed minutes notwithstanding) entering long positions today should be okay provided "quality" and "high demand" stocks are the target candidates.  Put another way, I'm considering strength above yesterday's high, not pullbacks.
  • The Elder intermediate-termed Force Index timer is still mixed, and Monday's action did nothing to assist clearing this to a long signal. Until I get a signal either way, I'm largely in cash.
  • The slopes of the LCR system have all moved positive, which is a divergence from the pricing action of yesterday.  This tells me that the database is participating on the long side in terms of price and volume, and this is certainly an "all-in" signal.
Conclusion:  The Elder Force Index indicision has me cautious, as does the extremely low volume, but the LCR now signalling positive slopes for all time periods out to 65 days is a powerful long signal.

==================

Pricing Analysis




As can be seen above, the pricing system has been fully long for the past three days on all time frames from 5d through 65d.  The slopes of the pricing slopes did turn down, and this was indicated by the overall GGT index dropping -0.75%.   "All green" in terms of pricing is bullish -- historically, I have wanted to be long in the markets when the pattern above has existed.

Next, here is the LCR slope system:




What is remarkable about the presentation above is that the LCR slopes have all turned positive, despite the database price dropping on Monday.  Even on low volume, we were close enough to threshhold levels in prices and volume such that we "went over the edge", and the presentation above tells me to get my feet in the (long) market.

==================

Effective Volume

Today's combined GGT + EV scans returned a larger-than-normal list of candidates to review, which means more stocks are favorable for entry than not.  Here's my watchlist:





Many of these stocks are appearing multiple days here, due mainly to continued buying, so given that the pricing change tool is indicating a more favorable entry risk/reward ratio, I will probably enter selected candidates on strength today.

I do note that we DO NOT have a confirmed EV money flow indicator to either the LONG side or SHORT side.  The indicision of the money flow indicator gives me tremendous pause at entering major positions, so I most likely will only float "trial balloons" of 25% size or so.

=====================

Remember, you are responsible for your own investment decisions, and I am not.  Please do your own work, and please take ownership for your actions.

Regards,

pgd

Monday, April 25, 2011

My Bias is Bullish, but not all Indicators are Confirming

.
Summary

  • The slopes of the pricing moving averages are all positive and are pointing up, which can only be interpreted as bullish.
  • My price change oscillator is at the top of the "overbought" range at +14, indicating today is not a good day to enter stocks long, as the chance of a pullback in the next day or two has increased significantly.
  • The Short-Term Long Cash Ratio (LCR) change timer has transitioned LONG
  • The VTI timer, which is an ETF based on the movements of the short-term LCR timer, has confirmed the movement.  Placing a position on VTI today, even though the price change oscillator is overbought, is something I'm considering.  The equity in this timer since September 2008 is at $1.52 / dollar invested.
  • The Elder Force Index timer, which is an intermediate-length timer (at least 18 days if not more), is in mixed mode.  This means that we do not have strong dollar-volume participation in the market, and that while we certainly can go up from here (remember December?), the chance of gains from here are less.
  • The slopes of the LCR moving averages are just starting to turn positive.  For this bull to be sustained, we need these to all turn positive.
Conclusion:  the bias is bullish, but several indicators are having a hard time confirming this bull leg.  I intend to be cautious.

====================

Slope Analysis

I use slope analysis of moving averages to give me an idea of how the markets are performing.  There are two key areas I pay attention to:
  1. slopes of pricing averages, which tell us how we are performing on an index level from 5d to 65d in length, and
  2. slopes of moving averages of the ratio of stocks with a LONG rating compared to those with a CASH rating, which tells me how well the stocks within the database are performing relative to price AND volume behavior ( I do believe to have a sustained bull that we need a few days of up prices on above-average volume ).
Here's the slopes of the pricing averages, as well as "slope of the slope" (right side):



As with all my images, right-click on the picture to open in a new tab or window.

What the image above shows, starting on the left red/green area, is that we just transitioned from a period where the shorter moving averages were all bearish, but the longer moving averages were bullish.  While the pain in your portfolio increases as the red flows from left to right, the fact that the 55d and the 65d slope indicators have remained green (bullish, positive) for the entire time of the presentation should key you in that we are still in an intermediate-termed bull leg.

The right side of the image shows us that the slopes of the moving averages are all pointing upward, and have been for the last 3 days.  In fact, Wed/Thurs a week ago showed an initial movement upward, followed by a down sequence Friday/Monday, only to be followed by progressively stronger days Tu-Wed-Thurs of last week.  This is a leading indicator, and the combination of the "all green" on the left side as well as the "all green" on the right side compels me to only consider the long side of the market at the present time.

Here's the same presentation, but now applied to the Long-Cash Ratio (LCR):



The LCR slope presentation is not nearly as bullish as the pricing presentation, but in general, it rarely is.  What is important above is that:
  1. we're seeing green starting to emerge in terms of the slopes of the LCR EMAs.  This must continue for this bull leg to find it's footing
  2. we're seeing strong performance in the "slopes of the slopes", e.g., they are all pointing up through the 65d period, which is necessary for the left side of the figure to continue to "grow green".
What concerns be in the above presentation is simply that we do not have the participation that we need in terms of volume.  How do I know this?  Simple -- LCR considers BOTH pricing and volume, whereas the previous discussion was concerning prices only.  Volume is lacking, and has been lacking, so this seems to me to be "artificial".  Whether this is evidence of related POMO money supply from Uncle Sugar is speculation that needs to be debated over your favorite beverage.

Conclusion:  from a slope analysis point of view, pricing signals are strong, but the underlying database is just starting to show some life.  The two are not in sync, and until they are (if they will be that is), I will be careful of this market in general.  "Being careful" means long positions in stocks that are moving to new highs on good volume.

====================

GGT Files

If you are a member of my GreekGodTrading Yahoo! group, you have access to files which represent detailed snapshots of stocks with respect to the GGT methodology, as well as Effective Volume.  I posted the updates for both stock and ETF files this past weekend, and there have been some subtle changes that you may find interesting.

In the file "GG_stks_21Apr2011_DashboardEV.htm", you'll see a complete listing of the GGT universe of stocks unioned with the EV universe of stocks.  Stocks listed on the GGT side but with no corresponding data on the EV side will have a "NA" indicated, simply showing that they have not yet been added to the EV universe.  Here's a summary snapshot:



Again, right-click on the image to open in a new window or tab.

If you open the file in Excel, you can use the filter function in Excel to select the stocks that have the best combined statistics.  For example, a screen that I like is the following:
  1. GGT Recommendation:  select only those stocks that are New Long, Aff. Long, or Long.
  2. EV:  select only those stocks with a Rating >80
This gives you a subset of stocks that are historically outperforming their previous behavior (due to criteria #1), and that have favorable EV characteristics with pricing behavior (due to criteria 2).

If you end up selecting any stocks with a LER Status of "Do not buy" (unlikely if Rating > 80), simply filter those out.  Same situation for Tot EV Status of "Selling continues" -- avoid those stocks.

I can only backtest to February 17, 2011 using this methodology but I will state that the quality and performance of hypothetical portfolios of these stocks has exceeded other types of buying strategies where EV or GGT status is not considered.

------------

Another major change that you will see is in the "GG_stks_21Apr2011_Dashboard.htm" file.  Again, if you open this file in Excel, you can use copy/paste functions to select symbol baskets.




You'll see that there are a number of portfolios listed:
  1. GGT Top25 Earnings Optimized Portfolio
  2. GGT GorillaTrades Optimized Portfolio
  3. GGT IBD50 Earnings Optimized Portfolio
  4. GGT Dow30 Earnings Optimized Portfolio
  5. GGT NASDAQ-100 Earnings Optimized Portfolio
  6. GGT Stocks Guiding Higher
Here, "Earnings Optimized" means that the indicated stocks must have appreciating earnings AND that the CEO/CFO is on record over the last 90 days indicating that they are guiding earnings, revenues, or both higher than consensus.  Typically, when the CEO/CFO makes such a statement, the stocks have positive earnings/revenue surprises 80% of the time, and more importantly, the stocks continue to guide higher the following quarter (which generally causes their price to increase).

To make one thing clear -- I do not have a subscription to GorillaTrades, but it's relatively easy finding the most recent portfolio simply by doing a Google search.

"Optimized" also means that I've done a risk/reward analysis on the stocks in the respective universes and have selected only those stocks with favorable risk/reward characteristics over the past 100 trading days or so.  This isn't to say that other stocks in the Dow, NASDAQ, etc. aren't appealing, it simply says that when traded in the basket shown, the stocks presented have the best balance of risk, reward, and diversification.

This leads me to the last column on this file, which you will see indicates "Recommended Allocation".  Simply, if you trade an individual basket, your allocation should be in the ballpark of what is shown.  This will balance risk, reward, and diversification, and prevent concentration in an area that is underperforming.

Finally, at the bottom of the file, you will see an area "GGT Stocks Guiding Higher".  This is a list of GGT stocks for which I have positive guidance data in the present earnings cycle.  I don't think that I have to describe what this means.   A CONSIDERABLE AMOUNT OF WORK has gone into generating, testing, and maintaining this list, and I ask that you NOT distribute this list, period.  I pay for the data, and if I find it out in the public domain, I'll simply pull the files and use them for my own consumption.

=======================

Stock Watchlist for Monday, April 25th

Here are the stocks that I am considering today:



This list is not a recommendation to purchase, it is simply a listing of stocks for consideration.  Please do your diligence, take ownership for your actions, and be respectful of the work and preparation that goes into producing the content in this blog.

Regards,

pgd


Thursday, April 21, 2011

NOT All Indicators are Confirming LONG; We Need Followthrough

.
Summary

  • Yesterday's (4/20) big move in the markets added 1.69% to the GGT price index on volume that was 3% above the 50d MA.  Given the state of lower volume being normal, this was a broad move with almost across the board participation.
  • ALL of the GGT price index slopes, 5d through 65d, are positive AND they are pointing upward.  This is bullish for stocks on the short-term and intermediate term.
  • My reward/risk tool, even with the large move on 4/20, is only at +6, which is suggesting more upside on a short-term basis.  Entering stocks on the long side should only be accomplished if they are breaking out with significant price and volume.
  • The Short-Term Long-Cash Ratio (LCR) Timer has moved LONG.  The tradeable VTI Timer, which is based on the ST-LCR Timer, is still in CASH.  This is a mixed message that needs to sort itself out.
  • My Elder Force Index Timer is MIXED.  The simple moving average (SMA) method of calculation is in CASH, the exponential moving average method is LONG.  IF YOU ARE CONSERVATIVE, then you want to pay attention to the SMA method.  If you are aggressive and nimble, then you want to pay attention to the EMA method.
  • Only the 5d and 8d slopes of the LCR are positive, the rest are negative.  This is NOT confirming an en masse jump into the market.  Given this, and supporting the bullish case for the aggressive investor, is that the slopes are all pointing upward, which is necessary for a bull to be sustained.
Conclusions for Thursday:  Futures are up as I write this, so we will open to the up side.  NOT ALL INDICATORS ARE CONFIRMING THIS BULL MOVE, so until they do, I will not commit monies to 100% positions.  25% trial-balloons are my focus.  Candidate stocks for review are below.

===========================

GGT + Effective Volume Stocks

Given that the climate is supportive of long entry into stocks, the following is a list of stocks that I am screening.  The list below HAS NOT BEEN SCREENED for specific patterns of EV; it simply is a listing of the most favorable stocks in both the GGT and EV universe.



As with all my figures, right-click on the image to open in a new window or browser.  Stocks with a "New Long" or "Affirmed Long" recommendation, combined with "Buying Surges", are especially attractive.

=========================

Remember, you are responsible for your own trading decisions, and I am not.  Please do your diligence, and please take ownership for your actions.

Regards,

pgd


Thursday, April 14, 2011

We are close to a sell signal, but are not there yet...

.
Summary

  • I conducted a seminar yesterday for High Growth Stock Investing; the video can be found here.  In the video I present evidence of why the markets are rolling over and why we should not initiate new long positions.
  • The Elder Intermediate-Termed Force Index Timer, when applied to the GGT universe of stocks, is 0.1% above the sell line using a simple moving average (SMA) method.  The exponential moving average (EMA) method has already been in CASH since close of business Monday.  If today's action is negative (futures are down -0.25% as I write this), we will have a confirmed sell of the long portfolio.
  • Effective Volume (EV) Money Flow (MF), which can be found here if you are a subscriber, is confirming a move to cash as of the close of April 11th (Monday), and if today's behavior is down, will move to a SHORT mode.
=================

Damage Control

I'm presently holding AA, CAT, DIS, FCG, GE, IYR, JPM, KOL, SLV and XLI.

IYR and XLI are Connors TPS trades and are performing as expected.

FCG and KOL are remainders of the Optimized ETF portfolio, and are both underwater.  FCG is down -4.18% into this morning's action, and KOL is down -2.39%.  FCG is within a Darvas box with a floor at $21.84, so it is not an outright sell on this metric alone.  Of course, the Elder and EV timers indicate that this should be unloaded.  EV on FCG has been deteriorating, so I'm seriously considering selling any intra-day bounce or the floor of the Darvas box, whichever comes first.

KOL is also within a Darvas box with a floor at $47.95, and it bounced off the floor two days ago.  Again, the timer models indicate sell, but the behavior in the box isn't a panic pattern.  Further, the EV charts, while showing some short-term selling, are showing longer-termed LEV support from institutionals.  I'm not as inclined to sell this position today unless it drops through the floor of the box and stays there on the 39m charts.

AA is being punished for "missing" sales, but in general, it's a solid stock on many fronts.  Short-termed EV has been selling, but overall, it still has considerable support over the past 40 days.  My sell price is $16.13, which is the top of the box that concluded on 3/18

CAT is another stock that is a great performer, but is being hit by perception that Japan will slow purchasing of CAT products, which is exactly BACKWARDS of what is anticipated within CAT.  It's bouncing around within a box with a floor at $97, but I can't let it fall that amount due to other money management rules that I have.  Hence, if it falls much further from the -5.51% loss that I presently hold I most likely will unload, e.g., if it falls and closes below the 50d MA on the daily it's time to unload.

DIS is a solid company that is performing well on the long term, but is not doing much of anything on the short term.  It's rattling around in a box with a floor at $41.25, which it has tested 3x, so unless it falls through the floor, I intend to hold.

GE has EV support but closed below the floor of my box yesterday, the floor being at $20.07.  Given this, I have to say goodbye to GE today.

JPM is a quality stock with a good dividend, but it got hit yesterday when Mr. D. made it public that we shouldn't look for an increase in the dividend any time soon.  Despite EV holding well, the stock closed below my sell point of $46.32, so I will say goodbye to JPM today.

I hold SLV in a speculative account and am up 12% since entry.  It appears that EV support is mostly from retail traders now, as the large folks are exiting and locking in their profits.  I will continue to hold, and my sell point is a close below $37.26.

=================

Contra ETFs and Shorting

I discussed contra ETFs in my video yesterday, and concluded that a few of them look attractive here, but only for trading and surgical strikes, not for any form of intermediate-length holding.

With last night's data, this position has not changed.

 Further, take a look at the following chart, which shows the VIX combined with a number of moving averages:



As with all my images, right-click on the figure to open in a new window or tab.

The figure shows the candles of the VIX and various moving averages.  I've placed vertical lines showing the dates when the VIX has closed above or below the ribbon.  Furthermore, you see the candles are colored red, blue, and green, which is Elder's system for buying/selling based on price action.

You can see that volatility is really low.  The VIX continues to close within a range, and overall, is not indicating a mass anticipation of increasing volatility.  This is BULLISH for the markets, NOT bearish.

I use the above chart as follows:
  1. When the VIX closes above the ribbon for the first time after having been long in the markets, ensure long positions are CLOSED.  We're not there yet.
  2. When the VIX closes below the ribbon for the first time after having been short in the makets, ensure that short positions are CLOSED.  Again, not applicable to our situation.
  3. The color of the candles influences my decisions.  A transition from a blue candle to a green candle typically will cause me to place trial entries in contra ETFs.    A transition from a blue candle to a red candle will cause me to lock in some profits, but keep the position open.
The chart is telling me to continue to hold my longs and not enter contra ETF or short positions.

=================

Trading Plan for Thursday

I intend to enter Connors TPS trades as the market makes new local lows.  I intend to unload GE and JPM.  I intend to sit pat on everything else unless my mental stops are hit.

==================

Remember, you are responsible for your own investment decisions, and I am not.  Please do your diligence, and please take ownership for your actions.

Regards,

pgd


Monday, April 11, 2011

Continue to hold long positions; add on strength

.
Summary

  • Our price index fell W-Th-F, dropping on slightly-lower but average volume.  I consider this neutral to bullish, as the selling is not attracting higher volume.
  • The slopes of the 5d and 8d pricing EMAs have turned negative, which is a short-term shot across the bow.  However, everything longer than the 8d is still positive going into Monday's action, which is bullish for the market.
  • The pricing accumulator change tool is indicating a value of -14, which means that on a short-term basis, it is favorable to enter stocks on the long side.
  • Database strength has fallen to 51%, which is an incredibly low value for a bull leg.  Typically, we need to see movement up towards 70% in short order to continue to have a bullish outlook.
  • The short-term Long-Cash Ratio (LCR) Change timer has transitioned to CASH with Friday's close.  If you're holding a position in the VTI, now is the time to close it.  You're looking at a 2.21% gain if you close at or above Friday's ending price.
  • The Elder 13d Force Index timer, which is an intermediate-termed timer, is LONG.  Having said this, it isn't long by much, and any continued weakness in the markets would cause it to transition.  We're at a critical crossroads in terms of the Elder timer.
  • The Long-Cash Ratio has dropped significantly the past two days, falling -10% on Thursday and -22% on Friday, ending the week at 1.695.  This means that for every stock that has a cash recommendation, we have 1.7 stocks with a LONG recommendation.  The raw value isn't as important as the trend direction, so watch for continued weakness in the LCR.
  • The slopes of the 5d and 8d LCR moving averages have turned negative, which shows that the database is losing steam.  More importantly, the direction of ALL slope lines is pointing down, which is bearish.  We need these to point upwards soon for a sustained number of days if we are to continue this advance.
Conclusion:  We have mixed indicators, so we need to see some strong price + volume action this week else I think we'll pull back.  This being said, there is nothing in my crystal ball which definitively says that we should not deploy capital, so I will continue to do so.

================

Pricing Slopes

Take a moving average of a price.  Is it pointing upward?  If yes, the slope is positive and you're on the right side of the market.  Is it pointing upward more than yesterday?  If yes, you're making money today faster than yesterday.

This is the concept behind the following table:



On the left we have slopes of various-length moving averages, and on the right we have a measurement if the slope is gaining or losing momentum.  You can see that this Friday caused us to bleed on our sea of green -- two of our shortest-length slopes moved negative, which historically is a warning shot.  On the right you see the "slope of the slope", e.g., is the slope moving upward faster (green) or moving downward faster (red), on a day-over-day basis.  You see more red than green, so ALL of the pricing moving averages are under some serious pressure on the down side.

=================

Long-Cash Ratio Slopes

The equivalent analysis can be performed on the database in terms of stocks that are "healthy" (price and volume above historical levels) or "sickly" (price and volume below historical levels).



Of particular significance here is that we are seeing the same warning signs that we saw with the pricing table -- the 5d and 8d moving averages have turned negative.  The right side of the table tells us why:  the daily change in the slopes has been negative for three days running with these moving averages, hence they are breaking down.  Unless we see some reversal, this is not a good intermediate-termed condition.

=================

Price Accumulator Oscillator

The following graph shows us that buying when the oscillator is in the "green zone" can give us a better chance of entry and price appreciation.  Conversely, buying contra ETFs when the oscillator is at the top of the "red zone" can also have a good impact on our portfolio.



We are presently well within the green zone, and if the markets intend to move higher, this is a good time to buy stocks.  This being said, this indicator cannot be used in a vacuum, so I intend to enter stocks only if they are breaking out and the broader market is doing the same.

=======================

Candidate Stocks

Given that we're in a buy zone for stocks, we have to be prepared to enter candidates if they move higher.  The following is my RAW watchlist for Monday; I have not screened these to meet further entry requirements, so you'll have to do your own work there:



As with all my images, right-click on the picture to open in a separate window or tab.

======================

Trading Plan for Monday, April 11th

I'm presently holding AA, BAC, CAT, DIS, FCG, GE, GUR, HD, IBM, IDX, JPM, KOL, SLV, and XOM.  Here's a short view of what I'm seeing with these; note that ALL are in some form of GGT-long status:
  1. AA reports after the close tonight, and traditionally kicks off earnings season.  Effective volume looks good on the 8d and 40d scales, and overall price action has been bullish in this breakout.  Total volume is slowing though, so it bears watching.  It has typically held the 8d MA since this breakout occurred so I'm looking so see this maintained.  Adding to the position could be prudent if it clears Friday's high of $18.47.  
  2. BAC is struggling in terms of effective volume, and I may not tolerate any downside movement in this at all.  In review I should have never entered this position, as it is not performing to my standards.  I will exit the position today at $13.53 or above.
  3. CAT has just pulled back to the 17d and is on probation, and EV is holding relatively poor on the short-term scales as well as the longer-term scales.  What is does surrounding the 17d MA is important from here.  CAT reports in 18 days.
  4. DIS just closed below it's 17d and 50d for two consecutive days, which is not a good sign.  Longer-termed LEV is poor.  I will most likely unload it if it continues to break down.
  5. My buy point with GE was poor, but overall, I like how this one is performing.  I'd like to see LEV continue to increase from here.
  6. HD is gaining slowly but has poor LEV characteristics.  I'd like to see it move aggressively up from here, but it is not showing any strength. 
  7. IBM cleared a Darvas box that closed on 3/29 but hasn't moved upward since then.  It's very close to my mental stop loss of $162.74.  Volume appears to be waning, and LEV sponsorship is poor.
  8. JPM looks solid on may fronts and is a keeper.
  9. XOM looks solid in price and volume action, although LEV is relatively poor. I'll most likely unload it and wait for LEV to support the price movement.
  10. I hold SLV in a separate account and it is performing well, setting new highs daily and showing increasing volume.  Institutional support seems to be decreasing and retail support increasing, so my stop loss will keep moving up on this.  $37.26 is my floor.
  11. FCG continues to perform well in terms of price, and institutional support is growing.  A warning sign is that volume is dropping off, so this one bears watching.
  12. GUR continues to perform well on all fronts.
  13. IDX continues to perform well, but volatility is increasing, which is a warning sign.
  14. KOL has great institutional support and is pulling back to it's 17d MA.  I'd like to see it hold the MA and keep the LEV support; we'll see what happens.
If I see any breakouts that have good LEV support, I'll most likely move 25% into one of those positions.

================

Remember, you are responsible for your own trading decisions, and I am not.  Please do your diligence, and please take ownership for your actions.

Regards,

pgd


Wednesday, April 6, 2011

GGT Price and Momentum are Lofty; Staying the (Long) Course

.
Remember, I'm traveling today through Sunday in Knoxville.  Blogs/analysis will occur as time permits.  Due to my travels, there is NO face-to-face meeting this weekend.  Please log into one of the GGT Yahoo! groups and answer the poll to which day(s) are best for you to participate in an evening presentation.

==================

Summary

  • The GGT price index rose +0.29% on volume that was -5% below the 50d average.  << Yawn >>
  • The slopes of the 5d through 65d pricing moving averages are all positive and they are pointing upward, which is bullish for our bank accounts.
  • The Price Accumulator Oscillator moved from +4 to +6, indicating that we have more risk in the markets than the previous day by a slight amount.  Of larger concern to me is that we're incrementally creeping up, and the longer we stay at incremental change levels, the greater the chance of a larger move either way increases.  Since the oscillator is inching upwards, my hat is tipped towards a downside move, but of course, my crystal ball is as good as yours.  +6 is right at that threshhold where you don't want to enter new longs and new contra/new short positions start to become more attractive.  Remember, this is a SHORT-TERM (almost day-over-day) indicator.
  • The stocks in the database are about 80% of their strongest levels in terms of pricing and volume.  There still is room to move upward from here, e.g., there are a number of stocks that could move higher, causing this value to increase.
  • The short-term Long-Cash-Ratio Change Timer is indecisive, and is holding at LONG-CASH (0).  All it will take is one down day to trigger this to cash.  Conversely, an up day will most likely move it back LONG (+1), resetting it.  We're on the fence post with this one.
  • The intermediate-termed Elder Force Index Timer is LONG.  I intend to only purchase equities on the LONG side.
  • The slopes of the 5d through 65d LCR moving averages are all positive and are pointing upward, indicating that the database is converting to LONG-rated stocks faster than the bears can convert to CASH.  This too is bullish for our bank accounts, and indicates that we need to be on the long side of the market.
Conclusion:  Stay the present course on the long side.  As a whole, prices are moving upward and are accelerating, and on a day-over-day basis the GGT universe is converting more to LONG-rated stocks than it is converting to CASH-rated, which means it is easier to pick winners.

========================

Momentum

I don't normally discuss the following chart, but we're nearing such lofty levels that it warrants attention.  As with all my images, right-click on it to open in a new window or tab:



The chart shows the GGT price index in red, and something called the GGT momentum index in blue.  I've artificially colored the areas on the chart where momentum was decreasing from a local peak to a local minimum, to make it easier to see where different periods influenced price behavior.  Of course this is all done in hindsight.

The first thing that should be evident is that price momentum can be waining yet prices can continue to move higher.  This is because we can still be moving upwards in prices, but doing so on a slower, day-over-day basis.  Again, using an analogy from yesterday, if I throw a rock upwards, it is losing momentum as it nears the apex of the arc, but it is still moving upwards until it hits the apex.  Same concept here.

What I find interesting is that during periods of consolidation in price, momentum is waining.   The converse is not necessarily true, but if we see momentum falling, it certainly is a warning flag.  Presently, we are continuing our increase in momentum, which bodes well for the present market.

I've artificially colored a zone at the top of the figure yellow.  This represents an area that is between the two largest momentum peaks of the past, and while we certainly can move higher than the last peak, we're entering an area that we historically have reversed within a few weeks.  

I watch this indicator daily, and if I see a reversal in momentum, I would view this as bearish on the intermediate term.  It doesn't mean sell, it simply means that locking in profits with tighter stops, or taking some off the table would most likely be my most prudent path forward.

================

GGT and Effective Volume Candidates

I received a number of notes yesterday about my methodology on using GGT and Pascal Willain's Effective Volume.  The short answer is that I screen for all GGT stocks with a LONG rating, then I apply EV screens from Pascal's "Pascal(A)" that he has on his web site.  I then look for the strongest active boundary, EV, LER, and thrust stocks that are common to GGT.  From here, I individually screen each for specific EV patterns on new accumulation, using both an 8d interval as well as 40d interval.  I use TradeStation, so I'm able to see very detailed, intra-day views of stocks.

Here's the dashboard watchlist for April 6th:



I've NOT screened this beyond what is described above; you'll need to do that work yourself.  As always, do your diligence, be responsible, and take ownership for your actions.

======================

Trading Plan for Wednesday

I'm traveling today so my trading will be limited to a few hours in the morning.  I wasn't as successful as I wanted to be yesterday in deploying capital.  By the time I was able to get to my desktop, the market had already dipped and moved higher than the open.  I don't chase signals, and yesterday is a good reason why I don't -- the markets gave up most of their gains by the end of the day, which would have resulted in losses across the board for me.

I'm holding positions in AA, CAT, DIS, FCG, GE, GUR, IDX, and KOL, and all are looking solid.  Given the present status of the Price Accumulator Oscillator (+6), I'll most likely NOT add to these positions today.

No further discussion required.  :o)

Good luck trading/investing for the remainder of the week!

=================

Regards,

pgd


Tuesday, April 5, 2011

Play the Long Side, Possible (very) Short-Term Consolidation, be Ready to Re-Enter

.
Remember, there is no face-to-face meeting this week, as I will be traveling to Knoxville on Wednesday - Sunday.  Please check the Yahoo! group poll and let me know the best dates for an electronic meeting, either next week or the following week.


==================
Summary

  • We are in a confirmed up trend.  I am working hard to deploy capital, and today's pullback will be another opportunity to enter the market.
  • The GGT Price Index was up +0.26% on volume that was weak at -22% below the 50d MA.  I'm not so hung up on volume (remember December?) but I'd like to see strong participation from both price and volume.
  • The slopes of the pricing moving averages are all positive, which tells us that we're in an uptrend and that we should be playing the markets long ONLY.
  • The Price Accumulator Change Oscillator moved from -14 on Friday to +4 yesterday with the close, saying that the reward/risk levels of entry are a bit poorer.  The way to play this is to enter a trial position of 10-25% when the end-of-day readings are below -5 (Friday's close was -14), then add to those positions when the market pulls back (today, if it continues lower, would be another day to enter another traunch, simply because we know the oscillator will move downward by the end of the day into the value zone.)
  • The Short-Term LCR Change Timer has moved from LONG (+1) to LONG-CASH (0).  This means that the markets are weaker in terms of the Long-Cash Ratio of the database.
  • The Intermediate-Termed Elder Force Index timer is completely LONG.  
  • The Long-Cash Ratio (LCR) has just completed it's 12th consecutive days of gains, albeit yesterday was only a 1% change to the upside.  Putting this in perspective, we did 12 consecutive days in February 2010 and 13 consecutive days in March 2009.  I think we're due for some profit taking, so like I wrote yesterday, I'm not surprised to see a bit of consolidation occurring.
  • All of the slopes of the LCR through the 65 moving average are all positive.  The database is expanding in terms of LONG-rated stocks, on time scales less than 66 days.  This means that it is okay to purchase stocks long (swim with the current).
  • Despite the slopes of the LCR all being positive, I'm showing "peaking" activity in the LCR, e.g., yesterday could not close higher than Friday's value.  The analogy is a rock that you throw upward.  Yes, it's moving upward, but as it reaches the peak height, it actually is slowing.  We are at the "peak height" point in this analogy as far as the expansion of the database is concerned, and this means that we need to be prepared for some consolidation.
Conclusion:  buy stocks on the long side and avoid stocks on the short side.  I'm intending to enter stocks on a pullback, and will be watching today for a characteristic "V" pattern in the broad markets ... sell off early, bottom, then reverse towards the upside.  If I don't see the "V" then I most likely will wait to the very end of the day to enter positions.

====================

Confirmation of this "Up" Leg

Take a look at the following chart (as with all my charts, right-click on the chart to open in a new window or tab):



This chart is constructed by plotting the GGT Price Index along with the 65d moving average of the Long-Cash Ratio.  If you recall, the GGT database is comprised of stocks that
  1. have above-average $-Volume (typically > $1Msh), 
  2. trade on the three primary exchanges, 
  3. have 50d average volume > 100K shares, and 
  4. all have share values > $1.  
Additionally, the Long-Cash Ratio is literally the ratio of stocks with a LONG recommendation to those with a CASH recommendation, with this recommendation being assigned nightly.  If we apply a 65d moving average to this value, then measure the slope of this average, we have the plot above.

What the 65d moving average does is help us understand the intermediate-trends within the GGT database of ~2400 stocks.  Note that this is NOT price, this is the amount of stocks changing from LONG to CASH and CASH to LONG on a given day, averaged over a 65 day period.  This tells us more about the ebb and flow of the markets in terms of sponsorship rather than the price appreciation, which while important (it's what we bank), is only part of the picture.

The graph above shows when the slope of the 65d MA of the LCR has confirmed moves, as well as some other key dates that are fresh in your head.  When the value clears above the pink zone, the day-over-day change is positive, e.g., the database has more stocks entering LONG-rated recommendations than CASH-rated.  This is important -- we want to move to the long side when this value is positive, and generally, we want to be 100% invested on the long side when this value is clearing from the pink zone (below 0) to above the pink zone (above 0).

A few observations that I found interesting:
  1. On 3/15/11 the slope of the 65d LCR hit a minimum.  Of course, we would not have known this until it cleared into positive territory on 3/30, but we certainly would have seen the positive nature of the move between 3/15/11 and 3/29/11.  This, in fact, combined with other indicators, gave me confidence about this move.
  2. It certainly is possible to move upwards in price with the 65d slope line below 0.  What is more telling is that as the slope line is moving downward, from any region, there appears to be a direct correlation between price declines in the database as well as a decrease in the LCR slope value.  We obviously would not want to purchase stocks while this 65d LCR slope value was dropping.
  3. Once the slope value stabilizes after falling, at any level, it appears that we have an opportune time to enter the market long.  Psychologically, this would be hard, because we've been falling and nobody knows if the present stabilization point is a pause to more decline or a reversal, but at this level, it would be a good opportunity to enter 10-25% of a position as a trial balloon, and ensure that good money management techniques are employed.
  4. Look at the values of the 65d LCR slope line the past two days -- we've seemed to have peaked at a local high.  Given that futures are lower as I write this, I expect to see some form of pullback today in the 65d LCR slope line.  The magnitude of the pullback in the markets will determine whether the 65d LCR slope line only drops a bit or a significant amount, and we won't know this until the market closes tonight.
Conclusion:  while the Price Accumulator Change Oscillator is indicating a +4 (a tad more risky to enter the markets than this past Friday), the overall trend is upward.  The slope of the 65d LCR average is telling us that we've hit a local peak, and that we can expect a short-term pullback.  We should be prepared to enter further positions on this pullback, and because the 65d LCR average is in positive territory (with other indicators, of course), we should attempt to deploy as much capital as possible on the long side of the market.

To address the question of which stocks to consider, my raw watch list, for consideration today, is a mixture of strong GGT stocks as well as strong Effective Volume stocks.  Here's my dashboard:



(Right-click on the image to open in a new window or tab).

Of course, I make no representations of the above watchlist to your particular situation, so as always, do your diligence, take ownership for your actions, and be responsible with your capital.

====================

Trading Plan for Tuesday

I'm presently holding AA, CAT, DIS, FCG, GE, GUR, IDX, KOL.  If I see the characteristic "V" shape in price action during the day I'll continue to add incrementally to these positions.  With no "V" I'll most likely wait and see what the market does near the close of the day.

I've filtered the GGT/EV watchlist above to those stocks with favorable LEV patterns (not shown above, you'll have to do this yourself).  I'll be watching for the characteristic drop in price throughout the day but increasing LEV sponsorship, showing accumulation on price weakness.

==================

Regards,

pgd

Monday, April 4, 2011

Abbreviated Summary for Monday, April 4

.
There is no face-to-face meeting this week, as I will be traveling to Knoxville on Wednesday - Sunday.  Please check the Yahoo! group poll and let me know the best dates for an electronic meeting, either next week or the following week.

===============

Summary

  • GGT volume seems to be returning, compared to the 50d MA.  Last week we observed trading volume at -20%, -19%, -9%, -6%, and -2% on the day-over-day basis.  I does appear that participants are rejoining the party, albeit slowly.
  • The slopes of pricing moving averages are all bullish on time frames from 5d through 65d.  This means that day-over-day and on multiple time frames you are making money in your accounts.
  • Surprisingly to me, the price accumulator change oscillator moved DOWN on Friday to -14, it's lowest possible reading.  This indicates that reward/risk levels are favorable for entry on the long side of the market for Monday.
  • The short-term Long-Cash-Ratio Change timer, and it's sister the VTI timer, are both long and have been since 3/18.  It's too late to chase this signal, so I would wait.
  • The intermediate-termed Elder Force Index timer is long, and has been since 3/21, although it hit a rough patch on 3/22 and 3/23 and took some time to sort itself out.  Overall, it is safer to purchase stocks on the long side -- shorting will just get you in trouble right now.
  • The Long-Cash Ratio closed Friday over 2.0, the highest level since 2/18.  This is bullish overall.
  • The slopes of the Long-Cash Ratio moving averages are all bullish on time frames from 5d through 65d.  The database is expanding in terms of the numbers of stocks with a long recommendation, and this is a much better time to buy stocks.
  • A bit of a crack in the bull ice is simply that the strength oscillator is at 86.9% and indicates that fuel is running out.  I wouldn't be at all surprised at some form of a pullback this week, but today probably isn't the day it will start.
Stay the course on the longer-term, and on the shorter term, simply be mentally prepared for a bit of a pullback for a day or two while folks lock in profits.  I already did on Friday ...

=================

Trading Plan for Monday

I raised cash on Friday given uncertainty of holding over the weekend (Japan, oil, Middle East), banking over 1.5% on my portfolios for the week, so I'm looking to get back into the market.  I'll enter positions that look attractive and are breaking out but will retain 50% cash in my portfolios, allowing these new positions to move upward yet pullback sometime this week, which will permit another entry.

Regards,

pgd

Sunday, April 3, 2011

Optimizing the DOW 30, for April 1, 2011

.
Optimizing the Dow

Earlier this week I distributed some internal notes to GGT subscribers which outlined concepts on picking stocks out of major indexes with the intent of beating the index but not taking on a huge amount of risk in the process.  The following describes this process a bit more.

* * * * * *
Here are some terms that you will need to understand, at least in basic concept:

Risk-Free Asset:  think Government bonds, typically 3 months in duration.  The principal in guaranteed, as is the rate of return.  For all intensive purposes the variability of returns is 0.  As of this writing I'm using 0.25% as the annualized rate of return for risk-free assets.

Volatility:  many people equate risk and volatility as the same thing.  They are not, but one does approximate the other over various time frames.  Typically, they are directly proportional -- as volatility goes up, risk goes up.  As you will see, this does not mean that gains go up in direct proportion; it's possible to have incredibly high risk but overall poor return in a security, which obviously is a bad place to have your money.

Return or Excess Return:  "Return", by itself, is how much gain you have on a security in some particular time frame.  "Excess Return" is the same thing, but you subtract the return of the Risk-Free Asset described above.  In most of my plots I will plot "Return", as we are most familiar with it.

Correlation:  this is a mathematical value between -1 and +1 that describes how well two securities, or a security and an index, move with respect to each other.  If something has a correlation of +1, they move exactly the same, e.g., if the broad index S&P500 goes up 1%, the ETF SPY will also go up 1% by design, and the correlation is +1.  Conversely, if two securities are negatively correlated with a value of -1, then if the S&P500 goes up +1%, the ETF SH will drop by -1%, again by design, because they have a correlation of -1.  Stocks and bonds tend to be negatively correlated between 0 and -1, stocks (in general) are positively correlated with other stocks and their correlation is generally between 0 and +1.  When two securities have a correlation of 0 they do not move at all with respect to each other.

Capital Allocation Line:  if all your money is in a risk-free asset, then your return is the risk free asset return and the volatility is 0.  If all your money is 100% in one security, then your return is that security's return, and the volatility (risk) is the volatility of that security.  Hence, the line connecting a security's return/risk value to that of a risk free asset represents all the combinations possible for owning the security (100%), owning a portion of the security (e.g. 40% security, 60% risk-free asset), or owning 100% of the risk-free asset.  Typically, the line connects the risk-free-asset return (volatility = 0) to the return/risk of an index that you are comparing to.

Efficient Frontier:  In the Capital-Allocation-Line (CAL) description above, where we have the choice of 100% in a risk-free asset, some percentage X in the risk free asset and the balance (1-X) in a security, or 100% in the security, the CAL describes a curve called the Efficient Frontier.  In this two-security case (one risk-free with 0 variance), the Efficient Frontier is a straight line.  In the case where no risk-free asset exists, two securities combine to have variable rates of return as well as variable levels of risk.  This rates of return and the risks are related by the term correlation as described above, AND ARE NOT LINEAR (a straight line).  The more securities that are introduced that have positive and negative correlations, the more "bullet shaped" or "hyperbolic"-looking the Efficient Frontier becomes.

Portfolio:  a combination of securities, and as I use it in my work, all have variance (risk) > 0.  This means that while I'll compare to a risk-free-asset, I'll not actually invest in a risk-free asset in my portfolio until I understand how my portfolio behaves (more on this later).  The basket of 30 stocks comprising the Dow Jones Industrials is considered a portfolio.

Tangency Portfolio:  You'll see this below in a figure, but it represents where the Efficient Frontier of all securities being considered intersects the Capital Allocation Line.  The point of intersection represents the best possible combination of return and risk, given the alternative of simply investing in an index AND a risk-free asset.  At the point of intersection, which is where the line is tangent to the curve, you are 100% invested in stocks in some ratio that represents an optimum reward/risk level.  More on this below.



The diagram above was taken from the Wiki link on Modern Portfolio Theory.  Here, they use "Standard Deviation" on the x-axis, where I normally use "Volatility".  The two are related -- all things equal, standard deviation is the square root of volatility.  Many people use either term interchangeably, which is mathematically incorrect, but the concepts are equivalent.

Starting on the left of the figure above, where Standard Deviation = 0, we have the Risk Free Rate (RFR) as described above.  As we introduce a security to the equation -- just 1 -- we have a choice of some proportion of our money in the RFR and some remaining proportion in the security.  This is described by the "Best Possible Capital Allocation Line".  It is assumed that the single security being considered has a rate of return greater than the RFR -- why would we invest in the security if we could get a higher rate of return at no risk by investing 100% in the RFR?  This guarantees that the line moves from the lower left of the figure towards the upper right.

The golden dots of Individual Assets shows their performance, over some period in the past, of Standard Deviation and Expected Return.  Let's make this more concrete in the figure below.




Here, I'm using the RFR (risk free return) = 0.25%, and you see two stocks:  AA and IBM.

  • The unmarked yellow diamond in the middle represents some arbitrary portfolio ratio between some percentage in AA and the remaining percentage in IBM.  In this case it was 50/50.  Note that the yellow diamond is ON THE BLUE CURVE.
  • The blue curve is constructed by running through all the combinations of owning IBM and AA.  This is why you see that a 50/50 ratio between the two stocks falls on the blue curve.   It is a coincidence that AA lies on the Efficient Frontier of these two portfolios; that is not normally the case. 
  • The red line is the CAL that connects the RFR and the unknown portfolio.  At the point of intersection (purple diamond) the percentage in IBM and AA is unknown, but common sense would tell you that if the yellow diamond is 50/50, and AA is to the right of the yellow diamond and IBM to the left, that the intersection of the two lines is where we have "more" in IBM and "less" in AA.
It's important to understand that above where the CAL intersects the EF curve (purple diamond), RISK IS GETTING WORSE FASTER THAN GAIN IS IMPROVING.  YOU ARE TAKING ON MORE RISK FOR A SMALLER AND SMALLER INCREASE IN GAIN.   If you hold a 50/50 ratio between AA and IBM, you are accepting more risk than you should!  If we want to be 100% invested, e.g., no cash, then the best reward/risk point is where the purple diamond is located, e.g., where the CAL and EF intersect.

The obvious question now is how to find the exact amounts of the proportion where we are 100% invested in AA and IBM but not taking on more risk for some desired gain.  I'm not going to go into the details here, but download this presentation if you are interested in more details on how to solve the two-security problem as well as the n-security problem.  This presentation forms the basis of how I'm doing what I'm doing now.

Of course, you could say, "I want 30% gain out of these two stocks", then put a constraint in the system and it would come up with the ratios to get there.  For just AA and IBM, you'd be looking at a 1-year volatility of greater than 24% ... what's YOUR ulcer index?  Alternatively, you could say "include the RFR amount so that I have THREE positions -- RFR, AA, and IBM", and it would generate those proportions.  The choice is completely up to you.

Note here too that past performance is no guarantee of future performance.  If the behavior observed is the result of the past 252 trading days, then we have a reasonable expectation that day 253 will perform within some boundary of the performance of the previous 252 days.  The same goes for 260 days, as well as 290 days.  All this means is that we have to re-evaluate periodically, and other literature that I have suggests that we should rebalance at least quarterly, and some of my own work shows that rebalancing monthly should suffice to keep us on track.

=============

So, with the background established, let's take a look at the DOW 30, Yahoo! symbol ^DJI.




The figure above shows the Efficient Frontier for all the stocks of the Dow 30, complete with their historical volatility and return over the past two years.  
  • Again, I'm using the risk-free-return value as 0.25% per year, based on 3-month Treasury notes.
  • The unmarked yellow diamond represents the portfolio performance with 100 shares held in each stock (arbitrary).
  • The close proximity of the yellow diamond and the purple diamond is pure co-incidence; if I weighted the stocks by equal dollar value the yellow diamond would have moved to a different location on the blue curve.
The important concept in the picture above of the Dow 30 is that there are numerous stocks which have poor return and low volatility (not so dangerous but would underperform over the long haul, e.g., KFT and TRV), poor gain and higher volatility (dangerous, still underperform and would give you ulcers, e.g. INTC and PFE), and higher gain/higher volatility (generally desired if you are going after risk).  The key here is to understand which stocks we would want to consider if we were to "beat the Dow Jones 30 Index"...

Take a look at this next graph:



Here, I've drawn artificial lines over the optimum location where the CAL intersects the DJ30 EF boundary. These lines divide the figure into quadrants -- let's take a look at what each quadrant tells us.
  1. Quadrant I.  These stocks have above average gain than our optimum point, which is what we want, but above average volatility, which is what we do NOT want.  Despite this, we expect that higher volatility (risk) means that we should have higher gain, and these stocks meet that criteria.
  2. Quadrant II:  There are no stocks here, by definition, because the origin (crossing of the two axis lines) lies directly on the Efficient Frontier boundary, and there is no combination of stocks that gives us higher gain than the optimum point but lower volatility than the optimum point.  Of course, there are stocks that fall into Quadrant II -- but they are NOT part of the Dow Jones 30.  These would be GREAT stocks to find, relative to the stocks in the DJ30, because they would boost gain but lower risk.  Note that for future reference, we want stocks that have historically returned more than 20.9% over the last year and have volatility below 13.1%; this is where the "optimum" point lies.
  3. Quadrant III:  These stocks have lower volatility, but poor gain.  There is no way that adding these stocks to a portfolio can increase gain -- all they can do is reduce portfolio volatility AND reduce gain at the same time.  They may be candidates for balancing reward/risk, but in general, they are to be avoided.
  4. Quadrant IV:  These stocks have above average volatility and below average gain than our ideal point. Again, adding these to a portfolio cannot result in any form of increase in gain, all they can do is lower it.  Furthermore, adding these to a portfolio cannot reduce volatility, all they can do is increase it.  Hence, stocks in Quadrant IV MUST be avoided.
What you should conclude here is that stocks in Quadrant I are the only stocks we should consider once we know their relative volatility and returns, compared to a target weighting.  As we search for our basket of stocks we would love to have stocks that fall into Quadrant II, but for now, that subset is empty.

What we need now is a method to select only those stocks that perform well.  Enter the Sharpe Ratio.

The Sharpe Ratio gives us a metric to evaluate individual stocks in terms of return, risk-free return, and volatility.  The optimum CAL/EF point has a 12-month return of 20.88%, a volatility of 13.10%, so using the risk-free rate of 0.25%, we have the SR = (20.88 - 0.25) / 13.10 = 1.58 [just as a point of reference, this is an amazing SR value.  If we were to consider multi-year time frames the value would be much less, because we would be including the drawdown period of 2008/early 2009 combined with much higher volatilities and RFRs.  This shorter time frame is justified on many fronts, but namely, it is based on work conducted by RiskMetrics].

With a basket like the DJ30, and when restricting ourselves to just those stocks in Quadrant 1, we're left with 15 total stocks out of the 30.  Let's simply get a benchmark of what those stocks, when properly combined and weighted, will reveal in terms of our previous results.



The figure above shows all 15 stocks of Quadrant I, combined as a portfolio.  Note the location of the purple diamond:  25.08% return, 15.97% volatility, and a Sharpe Ratio of 1.55.  Given that the original portfolio had a return of 20.08% and a volatility of 13.1%, yielding a Sharpe Ratio of 1.57, we have achieved nearly the same reward/risk ratio (1.55 vs. 1.57) while improving the gain 5% per annum.

We can say that for data through April 1, 2011, that we if restrict our investment decisions to this basket of 15 stocks of the DJ30, we can significantly improve our returns over investing in the ETF DIA without introducing significant risk to the portfolio.

I understand that 15 stocks still is a high number of stocks; the obvious question is whether we can further increase our gains while not taking on any additional risk, or at a minimum, keep the Sharpe Ratio constant near a value of 1.55 to 1.57?

We know that uncorrelated assets, when added together, reduce volatility.  It's not unreasonable to conclude that if we start with the highest return asset (AA, to maximize gain with n = 1) and then select the most uncorrelated asset shown above (HPQ), and repeat this process, slowly adding the next uncorrelated asset to the portfolio while watching how far off we are from our target Sharpe Ratio with n =15, we can make a reasonable estimate at the marginal contribution of each asset towards our target Sharpe Ratio.

To do this, I generate a correlation matrix of how each stock behaves compared to the other stocks.  Here's the matrix for the 15 stocks:



In the chart above, it's obvious that AA when correlated with itself will return a 1.0.  Since AA has the highest return, we can see that the stock with the lowest correlation to AA is HPQ @ 0.35.  We can create a portfolio containing just AA and HPQ and take the measurements.  Once we have this, and knowing what our target at n=15 stocks is, we can then determine the error.  This is called a marginal contribution analysis.  Here's the table:



The table is constructed by taking AA+HPQ and determining the composite return, volatility, Sharpe Ratio, and known error from our goal of n=15.  In this case we see that the n = 2 combination, comprised of AA and HPQ, which are the two poorest correlated stocks to be considered, result in over 18% error from the target return/risk ratio.  This obviously is unacceptable and I never would trade such a portfolio.

Next we add HD, so that the portfolio looks like AA+HPQ+HD.  You can see how "Error from Goal" improved from 18% to just under 10%, and this is due to diversification with n = 3 stocks.  You also see an entry in the column "Marginal Contribution", which simply shows that the Sharpe Ratio improved 10.2%.

Continuing, you see the trend.

What is important here is that at n = 11 stocks we are less than 1% from our target reward/risk ratio when n = 15 stocks.  At n = 11, returns with the basket shown above are about 26.0%, with 16.6% volatility.  The Sharpe Ratio only improves 0.54% by adding 4 more stocks to complete all the stocks that were in Quadrant I, so we have effectively reduced the basket from n = 30 to n = 11 and have taken on incremental risk while significantly adding return to the basket.

* * * * * * * * * * *

But wait!  There's more!

Simply jumping in to this basket of stocks is detrimental to your portfolio's health.  If we take the top 11 stocks as listed above and put them on the GGT dashboard, we get the following recommendations:



Here, we see that 3 of the 11 stocks are not being recommended for entry at the present moment.  Correspondingly, it is prudent to wait until these flash a New Long signal, at which time I would evaluate entry.

* * * * * * * * * * *

The final aspect of this is to determine the relative weightings of positions.  This is NOT a equal-dollar-into-11 -stocks; each stock is position-sized based upon relative gain and volatility within the portfolio.  For April 1, here are the allocations of the 11 stocks:



Note that JPM indicating 0% allocation is not a typo.  The Efficient Frontier calculations, with this set of stocks, have established that JPM does not add anything in terms of return or risk reduction when bundled with these other stocks AND given their recent behavior.  This is a bonus ... and then there were TEN stocks!

These allocations will be valid for the month of April unless I discover an error (always possible, as this is new work and I don't have anybody looking over my shoulder that I can bounce ideas/calculations off of).

=====================

Summary

I've presented a considerable amount of material here which represents several weeks of work.  Results are preliminary, but I feel that we can use this methodology to meet/beat indexes.  The question is whether this is able to be put into practice.  What have we learned?
  1. The concept that there exists an optimum reward/risk ratio given a set basket of stocks.  We can find this optimum reward/risk ratio using standard tools.
  2. The concept that we can eliminate under-performing stocks in a given basket, based upon historical return and volatility, and improve the basket performance (in hind sight, of course)
  3. The concept that we can selectively pick stocks from a subset of stocks that comprise an index and improve our chances of outperforming the index without taking significant additional risk.
  4. That we can take these new candidates, apply GGT timing methods, and the result will improve overall performance because we will not be participating in the stock when it is underperforming.
Of course, it must be stated again that we cannot predict the future, and because of this, we must rebalance.  Presently, it appears that monthly rebalancing is all that will be necessary in order to implement this strategy.  This is subject to change, further testing is required.  For now, it appears that it will work "good enough".

====================

As always, you are responsible for your own investment decisions, and I am not.  Please do your diligence, and please take ownership for your actions.

Regards,

pgd