Newsletter

December 2, 2006

Everyone Needs Their Ego Fed

Market & Sector Review
How will we know?

Largest Changes In Raw Numbers (21 Days)

This Week's Economic Reports

Everyone Needs Their Ego Fed

The psychology of the market, as well as the psychology of the investor-speculator-trader, is of equal if not greater importance, than any market indicator.

According to a recent survey 97% of people feel they do not receive the praise, approval, and appreciation they deserve. Likewise 98% of people said they would perform better if they received more praise, approval, and appreciation. The government and business executives alike worry about low profits, inability to compete, and lack of initiative. You and I are concerned about how we get better cooperation from customers, employees, and family. How can we get other people to help us win our goals?

Your ego is your self. It is the most personal self-oriented part of your mind. Your ego is your underlying spiritual substance and regulates your mental state and self-esteem. It is by far the most sensitive part of your psychological and philosophical structure. A broken leg may heal in weeks; a damaged ego may never heal.

Just as the body needs food to sustain itself, ego food is mental nourishment that makes you feel better about yourself. Ego food takes the form of praise, encouragement, appreciation, and respect. It enlarges ones sense of self-worth makes them and you feel important. It also makes you and others feel useful and needed. Ego poison is the direct opposite of ego food. Ego poison consists of comments and actions that make you and others feel self-deprecated, unimportant, useless, "bad", "stupid", and "small".

What happens when we feed ego food? Ego food, when sincerely dispensed, will help you win friends, win employee cooperation, gain love and support from people closest to you. In short, help you succeed. In the business of risk taking, there are so many times you will temporarily damage your own ego, and create self-doubt. It's not you; it is the nature of the beast. If you practice giving sincere ego food to others, they in-turn will feed your ego at the times it is most needed.

At work, at home, in community environments people perform second rate because they feel scorned, overlooked, belittled, taunted, or punished. The result, they defend their egos by acting the role of saboteurs. Think about that for awhile, then the next time the opportunity presents itself decide whether you will feed ego food or ego poison? And also think about which you would rather receive, from your spouse, co-workers, friends, and fellow risk-takers?

There are two ways to own the tallest building in town. One way is to tear all the others down!
Market & Sector Review
How will we know?

Monday, this past week, for the first time in quite awhile, the markets displayed very broad weakness. Every major average was down, as were all 31 sectors I follow. Only four industry groups managed an advance: Gold (0.5%); Home Improvement Stores (0.26%); Toy & Hobby Stores (0.82%); and Trucking (0.34%). The weakness was extremely broad based. Is it a precursor of things to come? While perusing various message boards on Monday, I saw the bears came out of the woodwork, "The Top is in" was the cry. While it may come to pass that the top is in or very close, one day does not a trend make, regardless of how broad based the decline. While I see many things about this market that make me uncomfortable, I personally at this point in time, have no confirmation that a top, other than a short-term correction, is in place.

I have always wondered why traders, regardless of their time frame analysis, believe they can pick tops and bottoms on a reasonably consistent basis. What is the fascination? While I do not have statistics to present I believe this to be one of the biggest mistakes many traders make. If you sell out a long position because you believe we are at or nearing a top, your risk is opportunity loss. If however, you are attempting to sell short that envisioned top your risk rises dramatically. If your ego gets in the way of risk analysis, i.e. I'm right, the market is wrong; you'll most likely go broke in the not to distant future. Not necessarily on this trade or that trade, but eventually. Try and remember, even if you think the market is acting irrationally: "The market can remain irrational a lot longer than you can remain solvent".

This week let's take a look at the bigger picture; see if we can come up with some strategies to let us know when the next bear market is upon us. I'll not be looking at strategies to call "The Top", rather strategies that can be somewhat late; however they will keep us in the market for a major portion of the move. After all isn't that the objective? I'll use the S&P 500 index for this purpose; however, feel free to apply the same to sectors, groups, and so on. First a weekly chart; charts as of the close on Wednesday.

I have always been a bit of a Fibonacci nut and have a tendency to use moving averages in Fibonacci sequences, i.e. 3, 8, 13, 21, 34, and 55 as opposed to normally recognized moving averages. From an intermediate to longer term perspective the 55 week and the 55 day simple moving average seem to work well. Personally I use the 55 week (displayed on the chart above) as a good indication of the intermediate to longer term trend. It will not get you in at "the bottom" and out at "the top". What it will do is give you a perspective and keep that perspective for the longer term.

Looking at the above chart and going back to the top in 2000, notice the moving average did not turn until the end of November. Not at the top but nevertheless only some 18 weeks after the secondary attempt at the 2000 highs and within 11% of the top. Likewise the moving average, after a steep decline, turned up in July/August of 2003, some 40% below current readings and within 16% of the bottom. You could do a lot worse. This average has yet to turn down or even begin to flatten and corrections back to this average have been met with excellent support.

Key point, the 55-week moving average is still trending sharply higher. Therefore the bull market at this stage, corrections not withstanding, must be given the benefit of the doubt. We could be at "the top" it's just too early to tell. Now let's bring this down to the daily level.

The chart above has the 55-day moving average with Bolinger Bands off of the 55-Day moving average. First, looking at the moving average alone, notice how it turned south on May 17 at 1292, then turned up again about August 9 at 1260. Again not a perfect timing tool, but better than many guru's. If you follow the composite chart postings on Wednesday and over the weekend you would have also noticed the following: in late July/early August the dollar weighted advancing minus declining volume began making higher highs and higher lows; ditto for the S&P advance-decline line; a diverging buying power. Has anything changed since the July/August period? Not yet.

Another method I have been following for many years now, is the Investors Business Daily distribution days to determine changing trends. While not perfect, its record is admirable. Although some subjectivity is involved, basically if a major average closes lower than yesterday AND the volume is greater than yesterdays volume, a distribution day has occurred. Depending upon market volatility between three and five distribution days in a four week period signals an end to the trend. I calculate distribution days and display charts for many indices as well as 31 sectors, check them out sometime. Below are some of the major averages with distribution days plotted (red volume bars), and a box outlining a one month period. How many do you count?

While the coming test of the highs may fail, in my humble opinion it's way too early to tell. A test of the 55-day moving average, should it occur soon, would be an excellent point to commit more funds.

The moral of this newsletter: unless you're a very experienced trader, with a very short time horizon, avoid the temptation to call tops and bottoms, and concentrate your efforts on sectors, industry groups, and individual stocks; not averages.
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.