| Prudent Trader Newsletter |

August 5, 2006

Character & Qualities of a Trader

Market & Sector Review
Is it Time for Gold?
Largest Changes In Raw Numbers (21 Days)
This Week's Economic Reports

Character & Qualities of a Trader

To a large extent, the Prudent Trader web-site, like most others that deal with the market, concentrate on the intellectual sphere: all the things we can know and understand with our mind. We concern ourselves with concrete, rational, and scientific ideas, the ideas of technical and fundamental analysis, economic principles, and trading strategies. For sure, these tools, and the mental ability to apply them intelligently are absolutely essential to success as a trader or a speculator. But success as a whole, as a human being, takes more than a good brain. It also takes character!

Webster's dictionary defines character as "the complex of mental and ethical traits marking a person." Ethics are evident in the code of values that guide a person's actions and choices. Do you choose honesty over lying, integrity rather than hypocrisy, productiveness over idleness? The process of making choices and decisions may be intuitive and hard to explain, but it always begins with your own personal sense of morality and ethics - your character.

Personality on the other hand, again from Webster's: "(1) the complex of characteristics that distinguishes an individual; (2) the totality of an individual's behavioral and emotional tendencies; (3) the organization of the individual's distinguishing character traits, attitudes or habits; (4) their disposition."

The reason trading is so difficult is that you cannot lie, hide, or rationalize failure. Reality is what it is. In most, if not all other profession's failure can be rationalized. A lawyer might say he had no case, a doctor might say he did all he could it was "in the hands of God", but in both cases they get paid. However at the end of a trader's report period, be it a day, a month, or a year he will either show plus or minus capital. There are no excuses, traders don't get paid for failure.

"The symbol of all relationships among (rational) men, the moral symbol of respect for human beings, is the trader. We, who live by values, not by loot, are traders, both in matter and in spirit. A trader is a man who earns what he gets and does not give or take the undeserved. A trader does not ask to be paid for his failures, nor does he ask to be loved for his flaws." Ayn Rand, The Ayn Rand Lexicon (New York: Meridian, 1988)

This is the essence of trading. Understand it, accept it, or pass on this profession!

Market & Sector Review
Is it Time for Gold?

In the 1970's (a period in the markets I believe we are reliving), a period of extremely high interest rates and inflation, a new Wall Street cliché became popular: "Put 10% of your portfolio in Gold and hope it goes to zero". The theory behind the cliché was simple; if your gold holdings declined sharply the remaining 90% of your portfolio would probably advance handsomely. The Gold was insurance against runaway inflation and disaster. In the 1970's we had high oil prices (although those prices were but a third of now) but more importantly oil was essentially rationed, only being able to purchase gas on certain days of the week depending on the digits in your license plate number. In the 1970's there was unrest in the Middle East (there always seems to be unrest in the Middle East), the U.S. was bogged down in a war in Vietnam and a cold war with the Soviet Union. Eerie similarities to today!

While Gold then was considered an inflation hedge, today is seems to me, to be considered a currency. Trading more or less opposite the value of the dollar (with an inflation component) than with any inflation numbers, although it has been tracking oil prices pretty well. Long time readers know that I have been a bull on Gold since this site was started in 2002 believing we are in the midst of a decade or more secular bull market. Bull markets have substantial corrections, shakeouts, even mini bear markets, one of which we may have just witnessed. This begs the question is it time to get back into Gold?

The new gold ETF's can be used as an excellent proxy for the metal itself since that is what they hold. Arbitrage holds them in line with the physical metals price (1/10). Both GLD (streetTRACKS Gold Shares) and IAU (Ishares Comex Gold Trust) returned to my attention in the July 15 newsletter when they topped the most improved in relative strength as well as PPO report which appears each week in this newsletter. I have personally noticed that when a group or ETF first appears on that list, if there is going to be a move, generally the lead time is two to six weeks. When updating the site on Wednesday evening I also noticed that these two ETF's rank #1 and #2 respectively in relative strength over the last six months as well as over the last twelve months.

I would have preferred the correction went further, towards the $48 level; however we must respect the holding of the Fibonacci correction zone, circled above. The declining volume on the recent advance is bothersome.

Now let's switch to the daily chart.

On July 27 the Prudent Trader Momentum Model turned positive for the first time since May and the Accumulation Algorithm turned positive on July 31. The very high volume at the June low had previously suggested to me that the low will be tested and it may be one day. Of course it could have marked capitulation by the weak holders as well. The volume on the recent advance has also been lackluster and under its moving average. The picture at the moment is still in doubt and more base building may be required but Gold should definitely be watched at this point. For the benefit of newer members the positions of these algorithms as well as the position of Welles Wilder's Directional Movement and Parabolic SAR are updated each day in the Technical Indicator Tables under the respective heading of ETF's, Industry Groups, and Indices.

The bullish indicators mentioned above may be early, they often have a tendency to be early, but they are suggesting this market is readying itself for the next bull leg. The last time I talked about Gold I mentioned (If I remember correctly) that spring and summer is the seasonal weak period for Gold while the fall is seasonally a strong period. Here is a chart courtesy of Moore Research Center, Inc showing the seasonality of the Gold market.

Notice how Gold has a seasonal tendency to bottom in the July/August/September period. I interpret that chart in this way, if we did not witness the low in June we will soon. What should be your vehicle and how potentially should you proceed?

GLD & IAU Exchange Traded Funds (ETF) holding physical Gold.
GDX A new ETF that holds Gold and Silver Mining Stocks, the stocks contained in the AMEX Gold Miners Index (GDM).

Search for Stocks within Groups (135) – Gold Mining
Search for Stocks within Mining Indices – XAU; GDM; HUI. Available on Site!

Unsure if Gold is ready? Believe it soon will be? As of the close Wednesday August 2 the following Gold Miners had relative strength percentile rankings of 90 or better: AEM; AUY; GG; GLG; GOLD; LIHRY; NG; SA; & VGZ. Goldcorp (GG) is considered by many to be the low cost producer, let's take a look at the chart and see if we can come up with a strategy. Editors Note: This is not a recommendation to buy or sell GG; this is an example for educational purposes only!

It may be advisable depending upon your circumstances to buy in units. A unit can be 10 shares or 10,000 shares but will represent somewhere between 20% and 25% of your total commitment to a stock. Purchase unit one on the breakout outlined should it be accompanied by a good increase in volume, preferably above the moving average. If the initial purchase proves profitable then wait for the first correction and buy the second unit on a breakout above the previous high (again if it's accompanied by a good increase in volume), and so on until you've accumulated your desired position. Initial risk would be somewhere under 24. If the 24 level is broken on a closing basis then here is how I would place my stop. Subtract the low from the high on that day, then subtract that total from the previous day's low and that becomes your stop.

This may seem like a rather large risk to many traders, however if you're only holding a 20% position it may not be. When analyzing risk, the dollar amount of risk should be calculated on your total portfolio size, not one stock. Let's suppose you normally carry five stocks in your portfolio with equal dollar amounts committed to each. In this example GG would represent a 20% total commitment of funds, and a 20% initial unit purchase would therefore represent a total portfolio commitment of 4%. If you have a $30,000 account, for example, the $850 risk on 100 GG is only 2.8% not 26%. Now is the risk to large? Probably not! When you add units 2 through 5 your risk parameters will be moved accordingly. Learning to assess risk properly (not just technical analysis break points which are often too obvious) is essential to long term success in this business. This is one man's humble opinion, I hope I have stated it well, but if you have any questions please send an email and I'll attempt to clarify.

If that strategy makes you uncomfortable then here is another that maybe will make you comfortable. Consider insurance! As an example: suppose you buy Goldcorp (GG) on or just after the breakout (let's say $32.5), you bought one unit which I will assume to be 100 shares at $32.50 x 100 = $3,250 plus commission. At the same time you purchased a January 2007 Put option, exercisable at $32.50 per share at a 10% premium, price would be $3.25 (I am assuming prices that may or may not be factual at the time, you can do the math later, this is just an exercise), price $3.25 x 100 = $325 plus commission. Total capital outlay is $3,250 (100 shares) + $325 (1 put option) = $3,575 or a cost basis of $35.75 per share. The price of GG now has to exceed $35.75 before you become profitable. Your risk is now predetermined as you have the right to put your 100 shares at 32.50 anytime between now and 1/19/07. Risk is $325 plus commissions, does that suit you better? It's disaster protection just in case some scientist discovers a way to make Gold from coal, but you can sleep at night and there is no need for stops. This is but an alternative strategy depending upon your outlook and psyche.

"Put 10% of your portfolio in Gold and hope it goes to zero" may not be a bad idea; in fact it could be a very good one!

Largest Changes In Raw Numbers (21 Days)

This Week's Economic Reports

Have A Great Week!

Bill

Disclaimer: Trading in securities, of any type, may not be suitable for all individuals. The contents of this newsletter are not a solicitation to buy or sell securities. The opinions expressed are solely that of the author. You must do your own research, contact your own financial advisor for suitability of any investments. Data gathered is from sources believed to be reliable, but NO guarantee as to their accuracy is made.