Newsletter

November 11, 2006

Motivating Yourself

Market & Sector Review
The Election's Over, Now What?

Largest Changes In Raw Numbers (21 Days)

This Week's Economic Reports

Motivating Yourself

When everything is going according to plan and you are "on", you are in the most positive and highly motivated state you can attain. Your mind is set on it's path and you are in a state of total concentration and focus. Your mind is totally committed to what you are doing. The bad news however: This is not a state of mind you can just choose at will.

In any endeavor, the process of growth and achievement has four key elements: Goals; Actions; Awareness; and Change. Each one of these factors is crucial, but the foundation for the process is goals. Writing a few sentences or listing some things you'd like won't establish goals. Goals have no power until you experience them as real. You must experience them not as something you merely want, but as something you need to sustain life - like food.

Your mind is a supercomputer that you can program to experience a goal as a fundamental need. Then your mind (supercomputer) will do everything it can to drive you toward your goal, and the rest of the steps will follow much more easily: what you do, the output of your mind, it all depends on the input. The input is simply: what you perceive, how you process the information, how you look at reality with your conscious mind, and how you have trained or failed to train your subconscious mind to function. Free will really means that you can change the programming in your mind.

Emotions determine motivation. We are driven by two fundamental forces at the emotional level, the desire to attain pleasure and the need to avoid pain. When we want something, is it the "thing" we really want? What we really want is the change we think it will cause in our mental and physical state of being, that makes us want what we want. People who desire to lose weight do not care much about the actual "fat cells". They want to change the way they feel about themselves. What they really want is to feel in control of their lives, to feel healthy and live longer, to feel more attractive to others, to feel more energetic and excited about life.

A profitable trading record can and often does have more losing trades than winning ones. If this is the case, then obviously the profits from the good trades must be larger than the losses from the more frequent losers. The most common error traders make is taking profits too early and allowing the loses to run to far. The reason is simple: at the time we are not motivated by the rules, we understand them but we don't realize them. Why do we do this? The need to avoid the pain of losing, and of being wrong drives us to deny rules we know to be right. To execute the rules is painful, but not executing them will increase your state of dissatisfaction and deplete your trading capital. I think upon self-examination, you will find some form of the pleasure/pain paradox is at work when you are having trouble moving towards your goals in your trading account and in life.

Just as we feed ourselves food everyday, we often need to feed our minds motivational food, to keep our focus, direction, and attitude. You can accomplish this with books, or very popular audio listening material. The Quote of the Day section on the Prudent Trader site contains positive quotations by famous people, that can serve as motivational food.
Market & Sector Review
The Election's Over, Now What?

Last week I presented an academic study entitled: Gridlock's Gone, Now What?, which in its very basic form stated: the popular myth that the stock market loves gridlock, is just that, a myth. I watched an interview on Tuesday with one of the authors of that study on CNBC; he was asked, did that study take into account declines or advances prior to the elections to see if the market was actually discounting the results. His answer was simply, no, that is another question and I agree with that statement, it is another question. However, now that the people have spoken, what if anything can we deduce from that study that may help our future trading?

Quoting from last week's letter: "During gridlock periods, the small-company premium is absent; the return to the largest companies exceeds the return to the smallest companies by more than three (3) percentage points." Revisiting the academic study let's break down the market into ten deciles from the largest capitalization to the smallest capitalization companies and see what we find.

It's easy to see two interesting facts from the above spreadsheet. First during harmony, which will no longer exist come January, scrolling from right (largest companies) to left (smallest companies) note how the return increases as we move down the size deciles. During gridlock all the returns decrease from harmony, although still positive, with the notable exception of the largest companies. The premium granted to smaller companies disappears. Next look at the standard deviations during gridlock, volatility increases for every group. If the past is telling us about future trading: larger capitalization stocks should return better than smaller capitalization stocks. However, be sure to factor into your trading plan a potential increase in volatility.

Now let's compare graphically the movements of the largest capitalization stocks to the mid capitalization and small capitalization stocks during the previous bear market and this bull market. The entire bull market from the October 2002 or March 2003 lows depending upon your view has taken place under political harmony, that is The Presidency, House of Representatives, and the Senate all being controlled by the same party.

While certainly a handsome advance for this large cap index take particular notice the breakout to new highs was only very recently perhaps anticipating the election results. However now let's compare this performance with the S&P Mid cap and the S&P small cap index performance. Remember the period from 2002 through Tuesday's election was a period of political harmony.

The mid-caps as represented by the S&P Mid-Cap index outperformed the large cap DOW by 74% during this bull market run. The smaller capitalization issues represented by the S&P Small-Cap index outperformed the large cap DOW by 114%. And the small cap issues outperformed the Mid-Cap index by 23%. Now revisit the spreadsheet above and you'll better understand what it is saying.

I think also worthy of note: both the Mid-Cap and the Small-Cap indices broke out to new all time highs in the autumn of 2003 (three years ahead of the large cap DOW) and continued sharply higher through May of this year. In the mean time the DOW Jones large caps entered into a roughly two year sideways consolidation and only recently broke out to new all time highs. To put it another way, and old stock market cliché I use often: "It is not a stock market. It is a market of stocks!"

Will "the market" be different this time? While "being different this time" is always possible, it rarely is. The suggestion from this study for me is simply this: When trading from the long side, tend to the larger cap issues. That is to say that when the market is in rally mode the large cap stocks should lead and in down drafts the leadership should be the small caps followed by the mid caps.

What is not considered in this study is sector and or group participation. For that we will have to watch potential legislation, the likelihood of its passing, even overriding a veto. Initial reaction on Wednesday, for example: negative for the major drug companies and other health care issues, obviously anticipating unfriendly legislation.

I will be and you should watch closely sectors and industry groups, whether utilizing the Hemscott (MG) groupings or sector and industry specific ETF's. Footprints will be left as to what the "smart money" thinks will come to pass.
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.