Wishful thinking

I'm glad I did that analysis of a bear market a couple of days ago (last post). I don't know about you but I found it an eye opening exercise.  It showed me how hard it is to interpret what is happening day to day without the benefit of hindsight and how tricky the market is. It does all it can to blindside you as it winds down and doing all it can to take your money on the way. I'm hoping that my new support and resistance (S&R) timing strategy will help my to avoid most of the pitfalls. The backtests which I ran to check out my theoretical  performance suggest it will be a good guide. I plan to do comparative studies of how well VV timing strategies compare with my S&R method through the 2008-9 bear market and I shall report back.

So where are we now? I pointed out the volume spike that occurred on the 21st and showed how often a volume spike warns of a change in direction. Rather disingenuously I wondered whether the spike was a late signal of the pull back that had begun a couple of days previously. That was just wishful thinking on my part. I've pulled out of the market and I was looking for confirmation that I had done the right thing. Instead the spike was warning that the bulls would return to take advantage of the pull back. On the Friday the 21st and on the Monday the smart money merchants were squeezing shares out of nervous bears and they have enjoyed a nice little run up since.

I just sit and wait. There needs to be a further move up before my signal fires. Am I missing a run up? Yes I am. But it could still be a false dawn.

I rarely remember my dreams but last night I dreamt of how I should set about reentering the market. I wonder what that means?

Vector Vest Seminars

Did you notice that my fulsome praise for David Paul's Vector Vest presentation is now being used to endorse his seminars. I am delighted that VV consider my candid comments worth repeating. David ought to have an easy job selling what is the very best market analysis product I have ever come across. But people have a hard time recognizing a good thing when they see it.

Anatomy of a bear market

I’m so glad that I sold out. It was a tough decision even though I had a clear signal. Since I sold my shares they have fallen in value by 3.4%, 0.8% less than the DJI. The fact that they have fallen less suggests that they were quality shares. There were 4 winners and 14 losers. This is an endorsement of my strategy: when the going gets tough head for the hills.

The question now is will I be able to get back into the market at a lower price and start to make money again. This is why I like a powerful decline and not one that meanders with little rallies. It’s those rallies that get under your skin. They are a notorious feature of bear markets.

Let’s look at the anatomy of the 2008-9 down-turn you will see what I mean.

1. Starting the 28 December 2007 we had a strong 12% drop to 22^nd January.
2. Then there were six weeks  of vacillation
3. Until a gentle rally kicked in and recovered about ¾ of the loss in just over two months, in fact the top value in that rally coincided with the 71.8% Fibonacci retracement. Spooky
4. Then another two months and a bit of decline pulled the market down to 80% of its high i.e 20% of its original value had gone.
5. Then another couple of months of indecision
6. The next two weeks took another 20% off the markets original value
7. This sharp fall brought out bottom fishers in force, they had an uncomfortable 7 days as the market went up but gyrated violently before all their profits vanished
8. The bottom fishers had another go for six days and then the market bit them back and came down to 45% of its start value
9. Then there were two and a half months when bulls and bears pushed and pulled, with the bears coming ot on top
10. And finally the last hurrah as the last 10% was taken off the market; and the bear market was over down 52% 15 months after it began.

I recount all this, not because I believe we are in for another bear market of the same magnitude, but to remind myself that when the market decides to pull back it is very difficult to navigate the twists and turns. Without the benefit of hindsight it is, oh so easy to be misled.

I've run a test using my S&R timing for that bear period. (Go back a few posts and you will see how this research works) Using my more risky share picking search the portfolio yielded 93% pa in that falling market. There were, however substantial risks associated with that rate of return . On more than one occasion the whole portfolio was invested in just one share, which happened to do extremely well. There was also a maximum drawdown of 24%. A big strain on the nerves.

The more conservative of my share picking searches did much worse losing 28% over the period. Still better than the 52% that the market gave up.

I know that some people think that because the economy is poised for recovery there is little chance of a new bear market. My thinking is different. The stellar growth we have seen, means that a lot of good economic news is priced in already. 

And then the market has to deal with two more negatives. The flow of easy money (QE) is about to come to an end. And interest rates are bound to rise and then investors will have an alternative home for their money.

Pessimistic? We shall see. 

And now I don't know what to think...

Yesterday the Dow recovered very slightly but there were movements in both directions before it closed some 40 points higher. What captures the eye is the massive increase in volume. Average daily volume over the past 18 months has been about 150 m shares. On the chart I have marked the 300 m share level to highlight the days when volumes were over twice the average. I have then drawn the trends between those volume spikes. I've added the volume spike that occurred on 15th June last year to the series even though it did not quite make the grade. It was preceded by a couple of smaller spikes a few days before so maybe that made a difference. I've also included some smaller spikes that have signaled direction changes. I have coloured them in brown. They are there as a reminder that all volume spikes can be signals and should be taken seriously.

I have explained before that I have noticed that volume spikes seem to occur close to changes in market direction. When they occur I take note and am extra cautious, make myself ready to move. I have been surprised that we have not had one before yesterday. So now I don't know what to think. Is Friday's spike signalling the end of the pull back or is it a belated signal for a new bear market?

The theory behind the belief that these volume spikes are important is that they represent shifts in smart money. Big traders stock up on shares in anticipation of a run up in the market, or dump them, taking profits as they await a fall.

Friday's signal could go either way: Smart money might be readying itself for a last hurrah in the bull market,  a run up for an opportunity to sell everything at a higher price, or they may be taking profits on the remnants of their holdings before a real rout begins. I believe that these smart traders use techniques to manipulate the market on these high volume days to shake fearful traders out of their positions to pick up or offload shares at more favorable prices.

The fact that the market ended marginally up suggests that this might be a signal for the end of the down move, but on the other hand.....    I feel the need to be ready.

UK Vector Vest seminar

Yesterday I dragged myself into London, (how I hate the big city these days), to take a friend to David Paul's seminar on the new Vector Vest7 for the UK. The journey was well worth the effort. David described in sparkling clarity how he uses VV to make piles of money in the UK. I believe there must be subscribers do not make the most of this fabulous product. They see but they do not believe. 

If you are in that position. If VV has not paid for itself many times over, do your best to catch one of David's seminars and you will see how easy it is to use this fabulous product to transform your financial fortune. 

If you have friends who are struggling with the market bring them along. If they learn from the very simple, straightforward lesson that David offers in those two hours, they will be thanking you for ever.

As you will know, I use VV mainly in the US now, but I still make investments in the UK for my wife and I offer guidance to my daughter and son in law. After listening to David I shall take his ideas on board when I prepare to offer them advice. If you do make the effort I believe that you and your friends will spend a very valuable two hours in David's company. Even if you are already doing well you may well pick up that extra little gem of knowledge that will give you an edge. I know I did.

No surprise

If you've been paying attention, yesterday’s price move will have come as no surprise. Any hint of the end of QE is bound to hit share prices hard. It could get much, much worse. Depending on how important margin trading has become, market falls could turn into a rout. Today's modest recovery offers little hope that things will get better.

You will remember that trading on margin means borrowing money from brokers to buy shares. Where do the brokers get the money? From banks who have been seeking “low risk” borrowers for their cash pile. Where have the banks got the money from? They have sold their government bonds to the government. Those governments, in the UK and in the US, have developed an insatiable appetite for these bonds in a vain attempt to pump cash into the economy. So those banks have become flush with cash that they do not want to lend to businesses who they regard as “high risk” borrowers. Where does the government get the money from? Out of thin air.

So what happens when this begins to unravel? Share prices go down. Traders, especially those who have been buying shares with "other people’s money" rush for the exit selling their shares. They want to sell before prices wipe out their profits and they get into negative equity, risking bankruptcy. Some will be trampled in the crush and will end up unable to repay their loans. Banks will find themselves with non-performing assets and we will find ourselves in the middle of a new credit crunch.

Big question? Who will bail out the banks this time round?

Are we now in a no win situation? Our choice: buy shares and watch their value plummet; or hold cash in the accounts of insolvent banks. Government bonds are also unattractive: interest rates are so low there is only one way they can go and that is up. This means the risk of lower bond prices.

There are no simple answers. We must watch and wait and be ready to act when opportunities arise. You all know where I stand: practically 100% in cash, no inclination to re-enter the market until I get a clear signal. I’m watching gold which is getting cheaper and cheaper. 

And today I might take the plunge and short US Treasury bonds.

If only....

I try to play the market for maximum profits. That cannot be achieved by a buy and hold strategy.

Most of my trading over the past 15 years has been on the FTSE so let’s have a look at the FTSE starting at the beginning of 2012. If you had bought a FTSE tracking portfolio you would now be sitting on an eleven per cent profit. However you would have had some heart stopping moments. After the first three months you would be patting yourself on the back having made almost 5%. But then in the next three months you would have lost all that profit and then some as your portfolio fell by 13%.

From that point on life would be sweet.25% profit in nine months. It would have been even better if you had held onto your money and waited to invest instead of making the rash decision to go in at the beginning of the year instead of losing 8% of it in your first six months.

Even with this terrific run there were some uncomfortable pull backs. For example there were a couple of weeks in November when you would have lost 5%. When things like that happen you need to ask yourself: “Is this a glitch? Or will it go on?” The stomach churning will be exacerbated by the fact that after that horrible fall at the beginning of your investment campaign you are now 2% down. Don’t imagine that these things don’t hurt and sap confidence.

Another 5% fall occurred starting in March of this year. This time it was not the size of the fall but the length of time that the market looked bleak. It was in the doldrums for over a month before making a spectacular 10% rise in 4 weeks. This was promptly reversed.

My point is that this was a very bumpy ride and there were lots of opportunities to turn an 11% profit into 56% by hopping in and out just four times at the right moments. And that is why I am working so hard to find a system which helps me get in and out of the market at the right moments without the benefit of hindsight.

I have not done too badly. I started trading in September 1998 and since then I have realised over 200% profit (this is not a compounded figure, it is based on the return I achieved on the capital I had to invest at the beginning of each year.) Over the same period the market has risen just 20% That’s 1.3% per year. I could have done much better. If I had just got the big waves right I would have made 250% Add in a few of the minor waves … You see where I am going with this.

And none of this takes into account the massive benefit contributed by share picking. I’ve cracked the share picking side of the equation but for all of the period I’ve been trading my timing has been based on guesswork. I hope I have now found the answer to getting timing right.

(I’ve used the FTSE in this exposition because for most of my trading period I have worked in the UK market. It also will help my UK readers who have to spend much of their time watching my analysis of gyrations in the US market.)

Summer time (when the living is dull) and a tarantella

The Dow broke up through resistance yesterday but pulled back towards the end of the day. It got nowhere near the buy signal level so no temptation to buy anything. The market has been moving sideways since the beginning of the month. Perhaps the serious traders have gone away for their summer holidays already. There's no point in doing anything when the market is like this. Just watch and wait.

The gold market is no better. It's sitting on a floor waiting for something to stir it into life one way or another.

That bond ETF I showed you on Friday seems to have come to the end of its fast trajectory and is trailing off too.

I have very little of interest to offer for the time being. Perhaps everyone sold in May and went away.

Here in stark contrast is a four and a half minute display of unflagging energy.

Lacking objectivity

A weakness in the methodology I use to create my timing list is that it is subjective. It would be more scientific, more mechanical, more reproducible if the timing signals were based on algorithms that could be programmed into a computer so they were objective. Untouched by human brain. I would prefer a system like that, like the various timing systems offered by Vector Vest.

I assume that Vector Vest has pulled out all the stops to create buy and sell signals, up and down calls, whatever you care to call them which work as well as they can make them. It’s what those guys do best so I assume they have done all they they can. But like all systems that are based on historical data they have a tendency to lag and the calls they the make can be late. I've tested my S&R system against theirs over lengthy periods of time, periods that have been chosen at random to avoid the benefit of hindsight creeping in and my timing list works better. (I do not claim that the tests have been exhaustive so the results must remain provisional).

The S&R system is subjective but signals are given as close to price action as possible. With this caveat in mind it is useful to see how judgement is used in drawing those all-important lines.  Luckily the last couple of days have provided an excellent example.

In the chart you will see my original resistance line coloured in purple. It was drawn joining three highs, two before support was broken on 31^st May and one after. That resistance line was broken on 7^th June and became a support line on the 11^th. Price action following that break was not strong enough to trigger an up signal. Also the break came after just 5 trading days so the “ten day rule" (see earlier posts) would have been triggered.

Subsequent price action has made me  re-draw the resistance line basing its trajectory on a mixture of highs and market close points. At present price action suggests that the market is respecting that resistance. We shall know later today whether it holds. But if it fails it is still only 9 days since the break of support so the “ten day rule” still applies."Stay out of the market, sit on your hands, better safe than sorry" is still the message.

Attractions of the bond market

I can’t stop myself from looking for opportunities. You will recall that I pointed out how interest rates are rising as bond prices fall. "That must present a chance to make money," I say to myself. Have a look at this chart. 

It has risen 10% since the 1^st May. It is an ETF that shorts 20Year US Treasury Bonds. Should I jump aboard or have I missed the boat. As Oscar Wilde put it“ I can resist anything except temptation.” And here it is doing a nice little pull back from its high giving me a new chance to climb on. My lips are smacking. 

Better not. I’ll do a bit more research and perhaps have a go text week. Phew! that was close. Keep those hands still.

Why did I not think of this before when I first spotted the rising interest rate? "There’s none so blind as those that will not see".

Rice and peas

This Caribbean recipe is a huge favourite around this house. Dead easy to make. I've adapted it from one I found on the back of a tin of gungo peas, (a sort of bean from Jamaica). You can make it with red kidney

beans or any other bean that’s dark in colour.

Chop one onion and fry gently in oil. The original recipe calls for a deseeded chopped chili to be added  but my wife cannot tolerate chili so I skip that ingredient. It still tastes great. I then throw in 300 gms of basmati rice and let it fry with the onions for a bit. You can add salt and pepper at this stage.  Just keep it on a moderate heat in the same pan. I then add a can of coconut milk and about a pint of vegetable stock. I then allow the rice to absorb the liquid and add water if necessary if the rice needs more before it is fully cooked. As the rice gets close to being cooked I add a tin of gungo peas or any other type of bean and the same quantity of frozen peas. The frozen peas bring down the temperature so the whole lot needs to kept on the heat till it is warmed through.

It’s ready in about 15 minutes and it’s delicious

A little lesson

I sit and twiddle my thumbs. It does not come easily to me and it does not make for very exciting blog posts. I could just type in "nothing to report" over and over. Instead I thought I would  explain a bit about Fibonacci and Support and Resistance (S&R). I don't really hold with Fibonacci but S&R is at the core of the new timing system which is going to guide my entry and exit from the market from now on. Rather usefully the chart of the Dow Jones has provided excellent examples of both systems over the past few days.

Fibonacci 

I'm pinching a lot of this stuff from Wikipedia but I summarize. If you want more just follow this link and this one.

Fibonacci lived between 1170 and 1250 so it was a while before stock markets came into being. He was a

mathematician. He recognized how much easier it was to work with the Arabic numerals than it was with Roman ones. He was lucky not to have attracted the attention of the catholic church for if he had, I have no doubt he would have come to a sticky end. As it was he advocated the use of the numbers 0-9 and the extension of that sequence by the use of place values. He demonstrated how useful this was in bookkeeping and other types of accountancy. 

He also popularized a sequence of numbers that had first been described by Asian mathematicians and he gave that sequence his name. The sequence runs 1,2,3,5,8,13,21,34 and so on. You've already guessed how it works, each number is the sum of the previous two numbers. Fibonacci used it to predict population growth in an idealized rabbit colony.

What is amazing about the sequence is how often it appears in nature. The branches on trees, the leaves on a stem, petals on flowers, segments of a pine cone regularly develop in numbers that are found in the Fibonacci sequence. 

Another interesting characteristic is that the ratio between each pair of sequential numbers in the list converges to a ration known as the golden mean: approximately 61.8%. This ratio is widely used by artists and architects to create works of art and buildings exhibiting outstandingly fine proportions. The ratios between other numbers in the sequence also converge to  fixed values.

Stock market watchers, at a loss as to how to predict changes in direction in prices in the market, have adopted Fibonacci ratios to make their guesses as to when the market will turn.

On the chart of the DOW you will see that I used a Fibonacci sequence to predict, reasonably accurately the turn in the market from up to down. I drew a line between the latest high and the latest low. Helpfully my charting program calculated the Fibonacci ratios between the top and bottom of that price movement and, low and behold, when it got to that magic 61.8% the market stopped rising and began to fall. 

I have to confess that I'm not a true believer, but sometimes it works. And when you've got nothing else to help you, you might as well give it a go.

S&R

On the other hand I do believe in support and resistance. There are programs which generate S&R lines but mostly they pick up horizontal lines.which are based on previous highs and lows. Like the one I drew at 14869 which acted as a stop for that last fall in the market.

A series of diagonal lines, linking a combination of daily lows or closes marked the support of the market as it rose to its high point. When it then broke down a new support line, which started at the new low held the market up for five more days until it was broken on 31st May. By then a new resistance line had formed which kept the market on a downward path until it was broken just five days later. And now that resistance line has become a support line and has helped the market in its efforts to move higher again.

This development of S&R shows how we can interpret market movements from day to day. The S&R lines guide our thinking very effectively. As the price movement approaches a support or resistance line we can infer that a change of direction is likely as price action bounces off the line and returns to direction of the prevailing trend. If instead price action moves on through the line we can infer that the trend has changed.

At present we appear to have entered a period of market indecision with trends lasting just a few days at a time. By contrast the last uptrend continued, pretty much unbroken, for over 100 days. It was kept in play by a whole series of support lines. There were short periods when the trend hiccoughed, either because there was a small pullback, too unimportant to count as a downturn, or because the trend accelerated and a steeper support line needed to be drawn. 

The point is that these support and resistance lines can be drawn as they develop and they are valuable as guides to entering and exiting the market.

At present the message is stay out of the market and wait for a clear up signal before making any new investments.

Short change

Times like these caused me to give up writing my blog last time. I sit and I watch with no money in the game. No profits, no losses. I have to remind myself that the reason I've pulled out of the market is: no losses.

I have conducted a few new backtests and, reluctantly, I've convinced myself that I am doing the right thing. I have taken my S&R timing list and tested what would happen if I bought contra ETFs (that is Exchange Traded Funds that are designed to go up when the market goes down) whenever there was a down signal and vise versa. 

I've tried this every which way, with stop losses , without stop losses, with restrictions on repurchases when positions get stopped out and without. I have tried using Vector Vest’s contra ETF watchlist to inject variety into the selection, and I've tried plain vanilla with a watchlist that just contains DXD and SDX (which mirror the DOW and the S&P). And I have tried a couple of Vector Vest’s own timing lists.

The answer is always the same. You can’t make money on the short side of the market. That’s not quite true. If you know in advance that you are in for a really big fall then you can make money, quite a lot of money, but how do you know in advance that the fall is going to be big?  You could do it by instinct but that’s plain gambling.

The results bear out the outcome of my own clumsy efforts to make money on the short side of the market. I’ve ALWAYS lost.

I’m not saying it can’t be done. I’m saying I can’t do it and now I’ve shown myself why it’s so hard. Best sit on the side-lines and wait till the market promises you an easy ride by going up.

Fibonacci power

It looks as though the S&R approach is calling the market correctly. Broken support has presaged a decline. It is very evident on the FTSE.

The Dow looks a little different. Yesterday the 61.8% Fibonacci held it down. (Sometimes those horoscopes are spot on). And today futures are indicating a 120 point fall to 15112 That would place it on the broken resistance line. It would be ironic if that resistance turned into support. We shall soon see.

As far as I’m concerned I’m hoping for a continuation of the fall. The bigger the fall, the bigger the bounce. A big bounce is what I need to recover the losses I made when I misguidedly, tried to short the market and to buy some gold as a hedge against renewed inflation.

Reading the runes

The Non-farm payroll came in slightly better than expected and the market moved up strongly. It has now recovered close to 61.8% of its move down from the peak. 61.8% is a Fibonacci number, one of those magic numbers that market watchers like to think dictate changes in the market. It's superstition, a bit like reading horoscopes in the papers, but there is something that impels you to do it.

My sell signal was triggered on Thursday and a new resistance line was broken on Friday. However, the move from break of support has only lasted four days so I will need ten days of upward movement before I re-enter the market according to the new ten day rule added to the S&R system. (See the last few posts for an explanation).

Those of you who have been paying attention will know that I have been anticipating this down signal and disposed of most of my shares before it was confirmed. A system is all well and good but emotions tend to get the better of me. I can't be sure that the same will not happen on the way up (i.e. I will buy too soon). But for me fear is a stronger emotion than greed so I may be able to control myself better.

When I started trading I developed a share picking system for the UK market. Repeated back tests on share picks that were made by the system in the past confirmed that the system yielded an typical annual rate of return of around 30% pa if shares were bought and held through any but the worst downturns. But I could never relinquish control of my portfolio and hand it over to the system entirely so I have had to live with an annual rate of return of just 17%. Emotions are funny things and its hard to keep them under control when you're dealing with something as important as money. You think you know best and your heart rules your head.

Nevertheless the system means that I have a guide for what to do. I'm not sitting here wondering will the market go up or will it go down? That is a question to which no-one has the answer. Never be duped and don't get swept into the arms of a would be guru who says he knows it all. What the system does instead is that it tells you what to do once you know which way the market is going. Nevertheless I will hazard a guess that the next move will be down. I'll admit to reading the horoscope and believing that "tomorrow is a day when you will have to act with caution" because I was born under a wandering star.

London Pride 

I had the huge pleasure yesterday of taking my two grandchildren (5 and 8 years old) to the London Aquarium. Not the best aquarium I've seen, that was in Hong Kong, but good enough.

As a country bumpkin I was staggered by the sheer mass of people that thronged the South Bank and the variety of languages that I heard spoken. It would have been an easy place to loose the two little people who were in my care. But they behaved impeccably.

They never strayed too far. They held my hand when we crossed roads. They stayed well away from the platform edge on the Underground. They did not fight with each other or bicker. They did not wine about things they wanted. They chose and ate their lunches. And when we got home, six hours later, they were able to tell their mum all sorts of things they had learnt about fish.

That was even though in the mean time they had played in the sand pit that is provided for children on the South Bank and had climbed on the massive stone plinth of Nelson's column in Trafalgar Square. That has successfully morphed into a massive playground for children of all ages.

I must have bought up my daughter well for her to have brought up two such lovely children.

Non Farm Payroll

Today should be an interesting and key day on the US market. At 1:30pm London time, (8:30am Eastern) the US Government will publish its employment figures(aka Non-Farm Payroll). They have been trailed for most of the week. On Monday the Purchasing Managers’ Index gave a positive signal, suggesting that the market was in better health than had been thought. On Wednesday ADP, an independent research outfit, released figures that showed an improvement in employment though a smaller improvement than had been expected, yesterday unemployment claims were down, in line with expectations. Today the actual employment number will be released.

Predicting how the market will react is tricky. In theory a good number, indicating improving economic health, should be good for the stock market. In these perverse times it will probably have the opposite effect. A poor number will be hearten buyers. They will interpret it to meant that the Quantitative Easing program will continue for longer. The supply of cheap money will be unabated and they can continue to buy. The expectation is for a very modest change, but the ADP number would suggest that the number could be below expectations. Result: we could see the market spike upwards. Not long to wait and then we’ll know what the numbers tell us and how the market will react.

Support and Resistance (S&R)

The core of my new timing system for buying shares is S&R and the last few days have given good examples of how well S&R works.  It is the latest break of support that has provided me with a signal to exit the market. A new horizontal support line (which I drew a couple of days ago) has brought the pull back in the market to a halt. Time will tell whether this is temporary or longer term. If it proves to be significant, i.e. the market resumes its rally my ten day rule will come into play and I will have to wait until a the market has been above a new support line for ten clear days before I can start buying again. This will keep me out of the market during any whippy period that develops. (See 2^nd June post under the heading “But in the mean time”)

More backtesting

I haven’t screwed up the courage to go back and create a longer timing list so I can backtest further but I have broken down the results achieved over the past 5 years by Picker b) (see that same 2^nd June post under “The big bucks come from share picking” and “Stop press”) to provide a year by year result. The years run from March 24 to March 23 each year. (Date picked at random.) The figures come out as follows:

	S&R timing list/Picker b)	DJ Industrial Average
2008/9	100%	-38%
2009/10	167%	41%
2010/11	90%	13%
2011/12	21%	8%
2012/13	33%	12%

Remember that this is a very aggressive picking system. Often finds few or no shares that match its criteria, shares so there are periods when there is little spread of risk. Shares are never held for more than 4 weeks and most are in very small companies. On the other hand the timing system and its failure to find shares  has kept us out of the market for most of the ghastly year 2008/9. This is not a system for the faint hearted but the results are extraordinary.

New Label

During the next couple of days I shall create a new label. “Vector Vest Research” will quickly bring together all the posts which report on the development of my Vector Vest trading system. You will be able to find it in the label cloud to the right of the posts.

What happened yesterday?

As luck would have it, the day after I called the down in the US market it bounced up again. Why this change of mood? It was down to an unexpected fall in the manufacturers' purchasing managers index (PMI). for short. In the US it went down to 49 from 50.7 while the market expected it to change little at 50.6.

The PMI is calculated by asking a fixed number of purchasing managers in a variety of companies whether they expect market conditions to improve, deteriorate or stay the same. Their answers are digested and out comes a number. If it is higher than 50 then it shows that a majority of those managers expect an improvement and da di da di you can guess the rest. The theory is that sitting in the purchasing chair of the company this group of people have the clearest idea of how the real economy is moving.

So what happened? The index fell and now more than half the respondents say that things in the economy are getting worse. "Whoopee!" says the stock market and up it shoots. 'Why should it do that?' you ask yourselves. It's all because of QE (Quantitative Easing). If the economy is weakening then the Federal Reserve will postpone the planned tapering of output by the money printing machine. More free money and more inflation of stock prices.

It looks as though there will be a bit of follow through of the increase in the index today. But I remain comfortable, for the time being, holding no shares. I will be miserable if the market continues upward and I

will wish that I had waited for my down signal which was over 100 points lower than yesterday's close.

A friend asked me where my second picture in yesterday's blog came from. (The first was the very last scene of Some Like it Hot.) The second came from Gold Diggers of 1933, one of my all time favourte films. Have a look at this clip. Wait for the advert to end, sit through the credits, and you will be treated to Ginger Rogers as you have never seen her before. You'll also see an early Busby Berkeley sequence. Loads of girls, lots of teeth, lots of legs.

End of the road

To me, Friday looks a lot like the end of the road. There are a couple of support areas nearby which may hold back the slide. But Friday's weakness came at the end of the day, and the day was 31st of May. That suggests that the last of the smart money has come off the table and the appetite for buying has gone.

The after-the-event news reports tell of the market's expectation of good employment figures at the end of this coming week as the cause (good economic news speeds the end of QE) but  it is more likely that it was the continued rise in interest rates that caused the sell off.

I like sharp stock market falls, as long as I have ditched the bulk of my holdings and am sitting on cash. Lower share prices mean that there are bargains are to be had. The big danger is that, with no holdings and loads of cash, I will succumb to the temptation to fiddle with 'interesting' opportunities. A good way to lose money.

But in the mean time

Remember I was struggling with backtesting my Support and Resistance (S&R) timing list. 

My problem was that I had found some excellent strategies which yielded fabulous returns over the period November 2008 and May 2013 (about four and a half years). But  they had unacceptable levels of drawdown. Drawdown is the money you risk losing when the system makes decisions that lose. The maximum drawdown levels were over 25%. Why is that bad? Just imagine that you start your investment programme just when the market falls into one of these holes. Bang goes 25% of your fund.

After a lot of thought and work I finally found an objective method of eliminating the worst drawdown culprit that occurred in autumn 2011. So I’ve added  “The Ten Day Rule” to my system. When a down signal is followed by an up signal after less than ten days then that putative up signal is ignored as are all subsequent up signals until an up signal is followed by a clear run of ten days. At that point it counts as confirmed up and the system can restart buying and selling as normal.

The additional of this rule reduced the maximum drawdown from over 25% to less than 20%. Unfortunately I could

not conceive a system which would eliminate the next largest drawdown . The only way to deal with the problem is human intervention. I am the one who is trading, not the system. If the system starts churning out unacceptable returns it is up to me to put it straight. The risk is getting it wrong, but, as the last line of the film Some Like It Hot has it: “Nobody’s perfect.”

A by-product of all this work is that I feel more relaxed as my portfolio falls into losses. The results of the tests prove that there’s a lot more money to be had if I stick to my guns.

The big bucks come from share picking

The other thing that has been brought home to me is that share picking is the way to make the really big bucks. Share picking has been the core of my approach to the market for all the years that I have been playing the markets. I have made money, but I have struggled to find a timing method that tells me when to get in and out, I have had to guess. Now, with the tools provided by Vector Vest, I think I have found and tested a reliable timing system.

However, without share picking techniques that underpin my activities my returns would continue to be decent but unexciting (my average over 12 years has been 17%pa). I have tested VectorVest’s unisearches extensively and have picked two top performers. Let's call them Picker a) and Picker b). Picker a) returns consistent results and it usually finds shares that meet its criteria. Picker b) is more wayward and often it finds no shares, so I have to wait with nothing in the market or just a couple of shares instead of the ten which normally spread the risk in my portfolio. 

Using the S&R timing system picker a) produces a 44% pa return with a 19.6% maximum drawdown. Picker b), using the same timing testbed yielded an annual rate of return of 220% pa for those four and a half years with a maximum drawdown of 27.5%.

Longer periods of backtesting are still needed. The further back I go the more reliable the results and the bigger the range of market conditions that the test encounters. But essentially I am ready to go. One part of my portfolio will be run using Picker a) and a smaller part will be tried out on riskier but potentially more profitable Picker b).

Making money is all down to doing your homework.

Stop press

I spent yesterday extending S&R timing back to March 2008. I now have just over 5 years of tests for my picking and timing systems. More importantly I have included a period of serious slide in the stock market.

Between March 2008 and November the DJI fell by 32%. Including this period applied a more stress to the tests. As I would have expected Picker a) struggled more than during the ugly down . As a result, it yielded 23% pa when tested from March 2008 compared with the 40% from November the same year.

The big surprise was Picker b) which yielded a staggering 319% pa. when tested from March. Here's a chart which shows how and when the money was made.

A note of caution in reading these results. Vector Vest focuses on the average rate of return when it reports on backtests i.e. the total return divided by the number of years. In fact the total is achieved by compounding. The compounded rate of return is a more modest but nevertheless eye watering 75% pa.

I have not finished my work and will run my tests back further but now I have a plan of action.