Newsletter

October 8, 2005

Disappointment and Regret

Market & Sector Review

This Week's Economic Reports

Disappointment and Regret

A powerful market influence is fear and greed but fear and greed aren't the only emotions that influence our daily trading decisions. Two other emotions; disappointment and regret can also impact what we do. It is quite normal to feel disappointed when our trades fail to meet our expectations, and regret when we think that we have made poor decisions that could have been easily avoided. We often believe as traders that we must always be right and that trading outcomes must meet our expectations. These core assumptions should be questioned and by doing so you will be able to cultivate a peak performance mindset more easily.

Merely changing our perspective on this issue can change how we respond emotionally to trading setbacks. If we believe setbacks are rare, and that they are awful events, then we are going to be prone to experience extreme feelings of disappointment and regret. If we however understand that setbacks and losses are inevitable then the disappointment and regret are easily dealt with. We must remember that a single trade is just that, one trade among a series of trades. The only outcome that matters in the end is the overall performance across many trades and not the outcome of this trade.

You can control unpleasant emotions by taking the proper perspective. Humans tend to overstate the adverse effects of a dreaded outcome. And there are a few simple strategies we can use to control these emotions. If we control our risk on the trade, and plan it out carefully, the risk will be minimized and the actual potential loss will not be catastrophic. Once the risk is truly minimized, remind yourself "I'm making more out of the potential loss than it deserves; it is not going to be as unpleasant as I'm thinking it will be."

Minimize disappointment and regret by impersonalizing the trade. Think probabilities, "This is just one of many trades, its outcome means nothing, the big picture is all that counts." Remind yourself of the relative insignificance of this trade, you'll minimize the potential regret should you lose. Avoid over-interpreting the significance of a trade; a single losing trade (or even a few losing trades) doesn't mean that you have poor trading skills; it may just be a run of bad luck. There's no point in making the outcome of a trade symbolic of your skills as a trader. And, most importantly, never put your self-worth on the line with your money. You're a professional. The outcome of the trade should not influence the positive view you have of yourself as a person.

Market & Sector Review

Before we get into some market commentary I'd like to pass along something I read about this past week. I know from communication that I receive from members we have quite a diverse group which is truly exciting. Some prefer very short term trading while others prefer longer term investments and just about everything in between. Today I'd like to pass something along to the longer term types but something that can be used equally effectively by shorter term traders. When companies buy back their own stock! In a recent article in the New York Times and also mentioned in last weeks letter from Trim-Tabs: "Companies have been repurchasing their own shares at record levels, and there is no sign of the trend letting up." Howard Silverblatt, an equity market analyst at S&P estimates that they will surpass $300 billion this year, well above the $197 billion for all of 2004.

"Companies have more cash than they know what to do with", Mr. Siverblatt said. "The number is just huge, especially in an environment where it is cheap to get money. So companies have plenty of money to do buybacks." But what does this mean for traders and investors? In general, buybacks are good, they 1) represent a vote of confidence by management in the company's future and 2) all things being equal buybacks increase the earnings per share by decreasing the number of shares outstanding. In an unpublished study of 7,725 announced company buybacks conducted by finance professor David Ikenberry at the University of Illinois from 1980 through 2000, Mr. Ikenberry found that investors who held those stocks for four years earned a return of 15.6 percentage points higher than that of a similar basket of stocks from companies that might or might not have announced repurchases. This is fairly consistent with other studies published in the Journal of Financial Economics that focuses on stock buybacks. You can view those studies at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=686567

A word of caution though, not every buyback is significant. Not all companies that say they will buyback shares actually do, and in many buybacks - particularly among technology companies, are simply a way of offsetting the dilution that would otherwise accompany the exercise of stock options. According to David Fried of Fried Asset Management and editor of buybackletter.com "So many companies are doing buybacks, but they are not meaningful buybacks in the sense that they are big enough to give the company a reduced share count." Some of the huge and meaningful buybacks mentioned in the New York Times article: Exxon Mobil; Time Warner; Motorola; AutoZone; Intuit; and Cigna.

As traders and investors you need to do some value research on companies that announce buybacks to determine if they are meaningful or not. If they are then as both traders and/or investors when you look at buy and risk points consider the fact that when these companies buyback stock they will not chase the price but they will be buyers on corrections/setbacks hopefully providing support at some point underneath your purchase price.
Last week I laid out the overall bullish and bearish case and stated the bearish case both fundamentally and technically appeared much stronger than the bullish one. I wondered however just why this market had not collapsed in the face of what surely everyone knows. I did note that the sentiment appeared to be strongly bullish and if the bears could not press the market then we must be looking forward to something good (I don't know what). I have always been a big fan of sentiment at extremes, i.e. markets bottom with extreme pessimism and they top with extreme optimism. In my almost 40 years or so around the markets this has always been the case but I am well aware that no indicator works all the time. At the moment it appears as though that's not working this time. We will have to see if there is something that transcends this appearance in the near future, maybe yes, maybe no. In any case there is going to be a lesson here for me and I look forward to learning from it. At the very least I will try and understand better how this seeming to me, conundrum, resolves itself. Luckily the confusion, at least to me, kept me mostly in cash, perhaps lost opportunity on the short side but that is quite O.K. there will always be opportunity. What a fascinating game this is!

While I have been out of town the last two days and haven't had a chance as of this writing to do the analysis, I am wondering how much of this weeks dramatic slide is the result of Oil, not the commodity price per se, but the energy stock slide, is responsible for the slide in the indices, as it was mainly responsible for the rise? Most of the major averages are capitalization weighted and many energy companies are heavy weights depending upon the average you are looking at. Interestingly enough, Friday morning I ran a little program which merely calculates the 5 day percentage change in stocks and ran it against the 4577 stocks that closed above 10. Of the 4577 stocks 1,112 or 24.3% were up in this down market which goes back to the 80/20 rule I have talked about often. Of those 1,112 up stocks 40 were up more than 10% while the major averages declined in the neighborhood of 3%. I also noticed when looking quickly through this list that some energy stocks were down in excess of 20% over the last 5 days, (if anyone is interested in this list I will be happy to email it to you, just ask).

It is also interesting to note that it was in the August 27 newsletter that many of the energy groups and ETF's began appearing in the most declined in terms of Relative Strength and Prudent Trader PPO calculations. I am finding these reports are giving excellent albeit very early indications of potential trend changes. Appearing as a picture in the newsletter it is very easy to right click on the picture and save it to your computer for future reference. It is indeed "A Market of Stocks."

Let's take a look at the damage, if any that occurred to the S&P 500 and attempt to come up with some possible scenario's for the future. First take a moment on your own, remembering this is October, go back and look at how often significant lows happen in this month, 2004; 2003; 2001 (in September); each of the years 1997, 1998, and 1999. This was not true in the bear market in 2000, so nothing is 100%. If we reach a low point this month there is a tendency for the market to rally for weeks and sometimes months. If this were to happen this time and carry us back up to the highs and perhaps new highs my conundrum mentioned above will be resolved as we may then get the excessive optimism I've been hoping to see.

When analyzing the market or charts your time perspective is extremely important. If you are a very short term trader the top certainly appears to be in, however if your time perspective is a little longer, I think it's too early to make that conclusion, even though it appears we now have a series of lower highs and lower lows, this also happened in the March/April period then turning around to new highs. If you isolate the two time periods the market action looks erily similar.

While many appear to be focusing on the McClellan Summation Index which has been steadily heading south, I often prefer to look at the oscillator for potential turning points utilizing divergent analysis, key word potential. Such a situation appears to be developing now and the obvious question is: are we to get just a short term rally and then down or are we about to reverse. My personal opinion right now is for a short term rally, a retest with possibly new lows and a larger divergence in this excellent breadth oscillator. Time will tell!

While this is always a fun exercise, at least for me, unless you trade exclusively the indices, concentrate your time on stock selection. For those that wished to continue following my personal strategy on the metals stocks and ETF, charts appear below the weekly biggest changes report with notes. I have exited 40% of GLD, retain 60% and have liquidated 20% of AAUK, retain 80%. This is NOT the way to trade it is merely a way I often do, if it helps someone else that's great.

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.