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Newsletter August 19, 2006 Why Traders' Fail Market & Sector Review Advance Notice Largest Changes In Raw Numbers (21 Days) This Week's Economic Reports Why Traders' Fail Those of you, like I, who have been around the markets for many years have seen seemingly good traders all of a sudden self-destruct. They normally buy 10 contracts (futures, options etc.) and today they bought 100 or they normally buy 100 shares and today it was 1,000. When asked why, they usually respond I don't know, I just did. I have personally seen it many times, an individual taking a position much larger than normal and not warranted under any circumstance. I call it "the big idea", the one that will finally set me free. What causes an otherwise good trader, to one day just violate all his rules and then repeat that same mistake time and again without ever learning? The root of the problem is almost always some form of self-deception and rationalization. "Under periods of inner stress…a person may become alienated from his real self. He will then shift the major part of his energies to the task of molding himself, by a rigid system of inner dictates, into a being of absolute perfection. For nothing short of godlike perfection can fulfill his idealized image of himself and satisfy his pride in the exalted attributes that he has, could have, or should have." Dr. Karen Horney (1885-1952) Neurosis and Human Growth). The result is an ever-widening system of falsehood and evasions that take people further and further away from being able to identify and live with the truth. Therefore in the example above most often you will find they failed to ask themselves a vital question: what happens if I am wrong --very wrong? In other words, they badly misjudged or even failed to consider the risks inherent in their decisions. People base their decisions on perceptions as well as facts. They interpret facts and put them in context. Those interpretations and contexts are based on the decision-makers' belief systems, and psychological attitudes. The best way of finding these things out is to ask a series of probing questions. When making decisions ask yourself are you: analytical and quantitative i.e. an engineer or scientist, for example? Or are you intuitive and qualitative i.e. philosophers or psychologists? Are you an optimist or pessimist? Are you a systematic thinker, always looking at the interactions of units, or more linear, following events in sequence? Do you have any political bias? Do you see lurking conspiracies or do you accept the logic of historical accidents? Do your own ambitions and biases blind you, or are you eager to learn? Are you susceptible to herd mentality? These kinds of questions help account for the idiosyncrasies of decision-makers and thus build the necessary foundations for developing good decision-making scenarios. These subtleties often give rise to the gigantic illusion called false pride that hinders many traders. These concepts are so active in trading and in our society that understanding them will prove crucial in gaining self-awareness the first step in personal growth and change, especially for traders. Market & Sector Review Advance Notice -> the Prudent Trader Largest Changes Report Each week at the bottom of this newsletter appears a report entitled: Largest Changes in Raw Numbers (21 Days). Last week in the discussion of relative strength I explained that in the Ranking Reports we use a rate-of-change component of six and twelve months. In other words, in terms of relative strength which groups, ETF's, indices, and stocks have performed the best over the last six months and twelve months respectively. Often, but certainly not always, once something reaches the top of the rankings a good portion of the move is behind us. Most of you, I am quite sure would like to catch moves in their early stages, rather than chase them later. Enter the Largest Changes Report. The Prudent Trader Largest Changes Report measures the largest changes over the previous 21 trading days (approximately one month) by two distinct measurements: first by relative strength rate-of-change over the previous six months; and secondly by the Prudent Trader Price Percent Oscillator (PPO). The PPO is very similar to the moving average convergence/divergence (MACD), if you are not familiar with PPO Click Here. The Prudent Trader model is calculated in the same manner as the article, but uses non-standard time frames. For this weeks newsletter we will concentrate solely on the relative strength aspect of this report and utilize two examples: first on the positive side UTH (Holdrs Utility ETF); and secondly on the negative side MTK (streetTracks Morgan Stanley Technology ETF). This is not a comment on where these ETF's may be going in the future, it is a comment on what you could have noticed, and taken advantage of, in hindsight, by spending a few moments reviewing this report each week. Way back in the May 20 newsletter UTH first appeared on the most improved list in spot number 4. Likewise the Industry Groups Gas Utilities and Diversified Utilities also appeared as well as the Dow Jones Utility Average, the Philadelphia Exchange's Utility Index (UTY), and the Dow Jones U.S. Utilities Index (DJUSUT). Utilities are acting well relative to the overall market at least over the last month. With the apparent confirmation from utility industry groups and utilities indices is this ETF worth a further look? At the time (data is no longer available but if memory serves me) UTH ranked about 80th of 188 ETF's we currently follow in terms of relative strength over the previous six months. UTH as well as utility industry groups and utility indices continued to appear on this report every week until July 8 when they finally disappeared from these listings. There are a few things to notice on the above chart of UTH. First, even though the relative strength rate-of-changes were below zero, i.e. underperforming the market, they were improving very nicely; secondly, the daily calculation also improving and making a higher high prior to the first breakout above the May high; and finally the PT-Accumulation algorithm (available in the technical indicator tables, ETF) showing UTH under accumulation (since the end of 2005). Take a moment and pull up a chart of UTH, applying your favorite indicators, and take note of how they looked back in May. Would you be interested? MTK initially showed weakness back in December of 2005 appearing as the fifth worst showing over the previous twenty one days in the December 10 Newsletter, and remaining in the largest declines for three more weeks. Then it appeared again the same week as UTH above and again the following week. Notice that after the initial showing of weakness MTK declined slightly but then proceeded to rally to new highs. Of particular interest on this chart (in 20/20 hindsight of course) is how even with the rally MTK was losing relative strength, i.e. it was advancing but not at the pace of the overall market. Fast forward to the first quarter of 2006 when MTK seemingly broke up from a short sideways consolidation but relative strength went nowhere. It was performing with the market, nothing more, nothing less. Fast forward once again to the May 20 report when MTK again appeared on the most declined and notice all the technology component company it had. Now as before pull up a chart of MTK and scroll back to last December and last May, apply your favorite indicators, would you have acted then or shortly thereafter? If these situations were of interest you could always visit www.AMEX.com and pull up the component stocks of the ETF of interest, or you could search on site through the industry group or index component stocks. There may have indeed been an even better and more appropriate situation for you, in the underlying component stocks. In either case your attention has been properly directed. The purpose of this and all reports presented by The Prudent Trader should not be taken as signals to buy or sell. They are intended to direct your attention to stocks, indices, sectors that are in all probability undergoing a change of character, from bear to bull or vice versa. Take a few moments and check out the report below. A quick glance tells me my gold comments a few weeks ago may have been a bit premature, but then again break outs I was looking for never occurred. If you're a bull concentrate on the most improved, if you're a bear concentrate on the largest declines. Pull up some charts, apply you're favorite indicators and preferences and see if there is a possibility of a good trade coming shortly. 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.