| Free Article |
How I Tell When the Market is "Going Up"
by David Van Knapp, author of
SENSIBLE STOCK INVESTING:
How to Pick, Value, and Manage Stocks
and
THE TOP 40 DIVIDEND STOCKS FOR 2010:
How to Generate Wealth or Income from Dividend Stocks
June, 2010
As frequent readers know, I use sell-stops to protect to the downside in my
Capital Gains portfolio. Rather than "hedging" positions, I use this very simple
approach to risk management. A sell-stop takes me out of a stock position at a
predetermined point of my own choosing. To me, that is direct management of
risk. Hedging (through the use of options and other strategies) takes time and
attention that I want to devote to other things in my life. I understand that some
investors have great fun (and claim to make some extra money) buying and
selling options as a form of risk management and also as a direct form of
investment. I believe them, but I am just not one of them.
I like to keep life simple, and simply being invested (in stocks) or not (in cash)
seems the simplest form of risk management there is. There is no indirectness
of derivative positions (options are derivatives). Frankly, every time a "level of
indirectness" is placed between me and my basic stock investments, I lose a
degree of confidence that I can intelligently understand what actually is going
on. The options pricing model that won a Nobel Prize also led to such blow-ups
as Long Term Capital Management's spectacular failure in 1998. And
derivatives are overwhelmingly implicated in the financial disaster of 2007-08
that we are still trying to dig our way out of. In each case, the derivatives were
employed (along with breathtaking leverage) by supposedly the most
sophisticated traders who understood them and the risk involved. I feel much
more confident in being able to figure out the direction of a direct stock
investment than of a derivative based on that same stock investment, or on the
market as a whole.
If my Capital Gains portfolio has cash, how do I know whether and when to
start re-investing the money? The simple (but vague) answer is that I like to see
the market "going up" for 2-3-4 weeks before I conclude that it may be in an
"investable uptrend."
In this article, I want to get more specific about what is an investable uptrend.
Here is how I have been doing that.
1. I start with Ned Davis’ definitions of a bull market. (Ned Davis Research
is a well respected independent financial research firm that provides investment
research and management to global institutional investors.) Their two definitions
of a bull market are:
Bull Market Definition A: Market rises 30% over 50 calendar days (which
equals about 36 trading days or about 7 weeks)
Bull Market Definition B: Market rises 13% over 155 calendar days (about
110 trading days or 22 weeks)
Clearly, the first definition is for a fast-rising, sudden upturn, while the second
defines a slow-but-steady rise. To my eyes, the second definition is too lenient.
So I toughen it up by requiring a 20% rise (rather than 13%) over the same time
period. I chose 20% because it matches the common definition of bull market.
So my modified "B" bull market is defined like this:
Bull Market Definition B (modified): Market rises 20% over 155 calendar
days (about 110 trading days or 22 weeks)
2. We must make investing decisions in real time, without the luxury of
waiting 22 weeks. I refer to these shorter decision-making periods as
"investable" markets. The question becomes, at what point will I decide that the
market (or an individual stock) is in an "investable uptrend"?
I answer this by taking the bull market definitions (A and B) and slicing them
into shorter time periods. I also add a requirement: that 2/3 of the trading days
have to be “up” days. What results is this:
Investable Uptrend for 2 weeks: A: A 9% rise with at least 7 positive days
(out of 10 trading days). B produces no signal, because the rise required would
be less than 2%, which seems meaningless.
Investable Uptrend for 3 weeks: A: 12% rise with at least 10 positive days
(out of 15). B: 3% rise with at least 10 positive days (out of 15). Since B is
more lenient than A, it makes A moot.
Investable Uptrend for 4 weeks: A remains moot. B: 4% rise with at least 14
positive days (out of 20).
Investable Uptrend for 5 weeks: A remains moot. B: 5% rise with at least 18
positive days (out of 25)
3. So, to summarize, here are the qualifications for an "investable
uptrend":
got hit in late January and early February of 2010. After a several-week
correction, the market reversed itself and started going back up. I made my first
purchase on March 4, after it had been going up for about 3 weeks. I bought
back in 10% chunks of the portfolio's total value spread over a few weeks,
always confirming that the investable uptrend was still intact. That allowed me
to participate in the market's run-up that ran from mid-February until late April.
Note: I do not use sell-stops in my Dividend Portfolio. I prefer other
approaches to risk management in executing a dividend growth strategy.
by David Van Knapp, author of
SENSIBLE STOCK INVESTING:
How to Pick, Value, and Manage Stocks
and
THE TOP 40 DIVIDEND STOCKS FOR 2010:
How to Generate Wealth or Income from Dividend Stocks
June, 2010
As frequent readers know, I use sell-stops to protect to the downside in my
Capital Gains portfolio. Rather than "hedging" positions, I use this very simple
approach to risk management. A sell-stop takes me out of a stock position at a
predetermined point of my own choosing. To me, that is direct management of
risk. Hedging (through the use of options and other strategies) takes time and
attention that I want to devote to other things in my life. I understand that some
investors have great fun (and claim to make some extra money) buying and
selling options as a form of risk management and also as a direct form of
investment. I believe them, but I am just not one of them.
I like to keep life simple, and simply being invested (in stocks) or not (in cash)
seems the simplest form of risk management there is. There is no indirectness
of derivative positions (options are derivatives). Frankly, every time a "level of
indirectness" is placed between me and my basic stock investments, I lose a
degree of confidence that I can intelligently understand what actually is going
on. The options pricing model that won a Nobel Prize also led to such blow-ups
as Long Term Capital Management's spectacular failure in 1998. And
derivatives are overwhelmingly implicated in the financial disaster of 2007-08
that we are still trying to dig our way out of. In each case, the derivatives were
employed (along with breathtaking leverage) by supposedly the most
sophisticated traders who understood them and the risk involved. I feel much
more confident in being able to figure out the direction of a direct stock
investment than of a derivative based on that same stock investment, or on the
market as a whole.
If my Capital Gains portfolio has cash, how do I know whether and when to
start re-investing the money? The simple (but vague) answer is that I like to see
the market "going up" for 2-3-4 weeks before I conclude that it may be in an
"investable uptrend."
In this article, I want to get more specific about what is an investable uptrend.
Here is how I have been doing that.
1. I start with Ned Davis’ definitions of a bull market. (Ned Davis Research
is a well respected independent financial research firm that provides investment
research and management to global institutional investors.) Their two definitions
of a bull market are:
Bull Market Definition A: Market rises 30% over 50 calendar days (which
equals about 36 trading days or about 7 weeks)
Bull Market Definition B: Market rises 13% over 155 calendar days (about
110 trading days or 22 weeks)
Clearly, the first definition is for a fast-rising, sudden upturn, while the second
defines a slow-but-steady rise. To my eyes, the second definition is too lenient.
So I toughen it up by requiring a 20% rise (rather than 13%) over the same time
period. I chose 20% because it matches the common definition of bull market.
So my modified "B" bull market is defined like this:
Bull Market Definition B (modified): Market rises 20% over 155 calendar
days (about 110 trading days or 22 weeks)
2. We must make investing decisions in real time, without the luxury of
waiting 22 weeks. I refer to these shorter decision-making periods as
"investable" markets. The question becomes, at what point will I decide that the
market (or an individual stock) is in an "investable uptrend"?
I answer this by taking the bull market definitions (A and B) and slicing them
into shorter time periods. I also add a requirement: that 2/3 of the trading days
have to be “up” days. What results is this:
Investable Uptrend for 2 weeks: A: A 9% rise with at least 7 positive days
(out of 10 trading days). B produces no signal, because the rise required would
be less than 2%, which seems meaningless.
Investable Uptrend for 3 weeks: A: 12% rise with at least 10 positive days
(out of 15). B: 3% rise with at least 10 positive days (out of 15). Since B is
more lenient than A, it makes A moot.
Investable Uptrend for 4 weeks: A remains moot. B: 4% rise with at least 14
positive days (out of 20).
Investable Uptrend for 5 weeks: A remains moot. B: 5% rise with at least 18
positive days (out of 25)
3. So, to summarize, here are the qualifications for an "investable
uptrend":
- 9% rise over two weeks, with at least 7/10 days positive
- 3% rise over 3 weeks, with at least 10/15 days positive
- 4% rise over 4 weeks, with at least 14/20 days positive
- 5% rise over 5 weeks, with at least 17/25 days positive
- Etc.
got hit in late January and early February of 2010. After a several-week
correction, the market reversed itself and started going back up. I made my first
purchase on March 4, after it had been going up for about 3 weeks. I bought
back in 10% chunks of the portfolio's total value spread over a few weeks,
always confirming that the investable uptrend was still intact. That allowed me
to participate in the market's run-up that ran from mid-February until late April.
Note: I do not use sell-stops in my Dividend Portfolio. I prefer other
approaches to risk management in executing a dividend growth strategy.
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