The Economy, Markets, and Profitable Insights

(How to More Effectively Put the Odds of Investment Success in Our Favor)

Introduction.
My Simple Two-by-Four Approach.
What We Will Need To Play This Game.
The Big Picture.
The Economy.
The Business Cycle.
Seeing The Market's Big Picture.
Three Classic Trading Strategies.
A Closer Look At Market Cycles.
Investment Wisdom.
A Closer Look at Miscellaneous Bits of Investment Wisdom.
Summary.

— Introduction —

If you are like me, you've grown up in a place and time where society has encouraged us to get a good education, to work hard, and to play by the rules. We're told, if we do this, we should be able to get a good job. Having a good job enables us to purchase the goods and services that we're conditioned to believe that we need to be happy and live The American Dream. We're also told to save and invest some of our earnings to meet our future needs, like buying a house, sending a child to college, to buy a farm, a ranch or some other type of dream business, or to just achieve Financial Freedom (i.e., to be able to retire). Starting or owning a small business is one way to invest for the future, but this approach is no slam-dunk guarantee of success. In fact, most small businesses fail. Alternatively, we can invest in our education and skills; and historically speaking, this approach has always paid attractive dividends. But if we ever want to stop working, we still need a way to save for retirement. Society says we need to turn to the banking system and Wall Street. The big problem with simple bank savings accounts, money market accounts and most CDs is that the rate of return almost never exceeds the rate of inflation after taxes. Sure, our savings will be safe (at lease safe to the FDIC Limit), but we will still lose purchasing power over longer periods of time. So, that leaves Wall Street, which often panders to our natural Lottery-Ticket mentality — we all want to get rich quick without having to investing too much time, money or effort, which is an approach that almost never works in real life. Conversely, getting rich slow-and-steady does work, and almost anyone can do it. Most start by investing in the latest hot (five star) fund or stock, only to find that they are buying-in near the top. That's what happened to me, and many others like me. Often, the only reason my investments were getting bigger was because I kept adding new money every month; and if I stopped adding money, I often found the value of my investments going down. It is not uncommon for new investors to find themselves buying high and selling low, the exact opposite of what we should be doing. Many give up, thinking "This game is just rigged against me." I did not give up, thinking "Others I've met were able to do this and I was going to figure it out." In time, I was able to figure out that much of what we're told and believe about trading and investing on Wall Street is just plain wrong or simply wrong for us in our particular situation. There's a reason why The Smart Money (the pros) make money on Wall Street off the backs of, well let's just say, not yet smart money. In this paper, I explain what does work and why, and what we need to know and do to more effectually grow our savings to meet our future needs.

— My Simple Two-by-Four Approach —

Let's start with my simple 2-by-4 Trading and Investing Methodology that introduces two goals and four rules to achieving those goals. First let me say that we need to always think like an investor but understanding that every investment begins and ends with a trade. We want to master the mechanics of trading to better achieve our investment objectives. To that end, I have two goals: A primary and a secondary; and a set of four simple rules that once mastered make it much easier to be successful in the market for tradable securities.

Our Secondary Goal should be to maintain CPT status in our Optimally Effective Timeframe (OET). Rate of return is a function of time and ability. A dollar made in a week has a higher rate of return than a dollar made in two weeks. Compounding higher rates of return causes our equity curve to turn up sooner and move up quicker. It is always best to make money as quickly as possible. But there is a big problem with this secondary goal, the quicker we try to make a profit, the harder it becomes and the more likely it will be that we are unable to achieve and maintain CPT status, which can cause our equity curve to turn down. In fact, way less than 1% of all market participants will ever achieve and maintain daily CPT status, and that is why most wannabes day-traders get wiped out. But anybody can achieve CPT status over an economic boom-bust cycle, most can grow to achieve quarterly CPT status, and some may be able to achieve monthly CPT status, if they think like an investor and properly apply the following trading rules. So, this secondary goal has us keep the bulk of our capital focused on our best OET, while we use a small percentage to probe the next slightly quicker timeframe (improve our trading skills). Once we start to realize CPT status in the next quicker timeframe, we can then slowly increase the size and number of our positions to yield that higher rate of return, while we start to probe the next slightly quicker timeframe. At some point, we will simply be unable to achieve CPT status in the next quicker time, and the current CPT timeframe will be our Optimally Effective Timeframe, the best rate of return we're capable of earning. But please understand that markets can change and so can our ability to master new skills that work in the current environment. So, our OET can and will change overtime. We need to adjust accordingly to always earn our best possible rate of return, which may require us to patiently hold a survivable investment in the next longer timeframe to maintain CPT status. It helps us to think in terms of our best average OET given current market conditions. It's okay to have an occasional drawdown when that investment is likely to yield an acceptable profit sooner or later in the next longer timeframe. Work to realize your best possible rate of return while maintaining CPT status.

Our Primary and Secondary Goals require us to earn money at the best rate of return the market and our skills permit. Learn, and in time master, the following rules and you too will be able to achieve these two goals.

1. Focus the bulk of your time and capital on a few dissimilar investments that are very likely to survive, that will pay a market rate of return to hold, and that are likely to see higher prices sooner or later because there is underlying economic growth. This is my Optimal Stop-Loss Mechanism. There is simply no need to take a loss in an investment that can survive market volatility, that will pay you to hold, and that is likely to yield a profit in due time. You cannot become a CPT if your trading strategy requires that you take a loss whenever the market turns against your position, which is likely to happen a lot. You simply must avoid positions that can result in any permanent loss of capital. Like the pros, we want to become a specialist in these survivable securities. Knowing how these securities support their market value and seeing how they acted under prior news and commentary allows us to better predict how they should trade in the future, and that creates a real competitive edge and the main reason the pros specialize. Furthermore, a big chuck of your CPT profit can come from income earned while waiting for an acceptable capital gain, and that's the primary reason to focus on securities that'll pay you to hold. Learn how to profitably trade around a few core positions. In this paper, we'll talk about examples of the various types of survivable investments that will pay us to hold and that are likely to show us a nice profit when properly handled.
2. Trade like a professional value investor. Buy low and sell high to book cyclical capital gains within the current or broader trading range (i.e., Buy at below-average Discount Prices and Sell at above-average Premium Prices as indicated by a simple MA). Market prices are forward looking, attempting to anticipate likely future prices, and therefore trade in an dynamic trading range that reflects the market's collective view of fair value (called a Support and Resistance Channel). These trading ranges exist in multiple timeframes and are subject to change as news and commentary hit the market. An S/R Channel can expand and contract, and can shift up or down over quicker timeframes, as prices cycle through their 52-Week highs and lows (between Major Support and Resistance). It's all this continuous price movement (volatility) that makes it so hard to buy the lows and to sell the highs. Prices can always go lower after we buy and higher after we sell. So, we need a way to improve our odds of success, to be a CPT in our OET. The answer lies in understanding that prices are likely to stay within the current quicker trading range for a little while, but that quicker S/R Channel will shift up and down within the next longer timeframes as new information hits the market, and all this channel shifting up and down is very likely to stay within the broadest fair-value trading range (Major Support and Resistance). So, success favors those that are only willing to be a buyer at discount prices (the lower half of the current and broader trading ranges as indicated by a longer-term MA), patiently waiting for prices to recover in the current or next longer timeframe, and then being a seller at premium prices or whenever it looks like the market is likely to take back an acceptable profit. We can learn how to work (convert a near-term paper loss) into an acceptable longer-term profit; and in time, we can learn how to grow our capital at an above-average rate of return. We simply must average out (lock-in) above-average yields whenever the market offers them up. We must understand that no one is able to consistently earn all that is possible — be okay with that. This is professional investment wisdom. Taking acceptable, preferably above average, profits when available and working to minimize the impact of unacceptable losses or, better yet, working (or waiting for the market) to convert an initial loss back into an acceptable profit is key to maintaining CPT status. Being paid to hold a survivable investment always makes it easier to realize an acceptable total return profit sooner or later. Being a CPT is crucial to realizing a positive compound growth rate, and that is key to capital growth in the market over time. And once you have enough capital, like the big guys, break that trading power into smaller parts thus allowing you to turn your individual buy low and sell high prices into two averages that can be managed and optimized in the current and in longer timeframes by profitably scaling in and out. Trade around a few core positions, taking quick above average profits when available and working to manage and optimize your averages relative to current market conditions when you must do so to maintain CPT status in your OET. This too is the professional approach. It's how many of the biggest and best traders (investors) operate, and it's how we too can grow (compound) wealth at an above average rate of return. In this paper, we'll talk about the mechanics of this approach.
3. Keep your operations in-sync with the health of the primary market trend. This is my Ideal Stop-Loss Mechanism. Market prices tend to trend up, down, and sideways, mostly within a broader (e.g., 52-week) trading range. We can use the current price action relative to historic patterns and a standard set of simple moving averages to see the broader (primary) trend and to gage the health of that trend. Simply put, a healthy trend is likely to continue, and an unhealthy trend is likely to reverse. In this paper, we'll talk about how to see the broader market trend, to gage the health of that trend, and how to play it.
4. Be About the Business of Growing Your Wealth. Maintain a Watch-List, and an associated iterative analytical and trading methodology. Using the three rules above, we want a simple, repeatable process that plays to our natural abilities to monitor Mr. Market's on-going activities. This is another time-tested professional technique and is the best way I know to grow from a Beginner to a Consistently Profitable Trader to a True Market Professional. We want to have a small list of ticker symbols to focus on (specialize in) and a simple iterative process to 1) find favorable trading opportunities, 2) plan-out each trade and then trade the plan, 3) track Profit & Loss (P&L) details so that we can know if it is now better to be a buyer, a seller, or to wait for better prices, and 4) learn from the results. Mastering this rule is the key to becoming a True Market Professional (i.e., someone who can make a living in the markets, preferably on their own savings).

This simply 2X4 approach has empowered me to attain CPT status in a consistent monthly average, my OET. It is rare that I have an unprofitable month; but when I do, it is because I'm taking a planned stop-loss that fortifies returns in subsequent months, thus making my Twelve-Trailing-Month (TTM) average consistently profitable. This approach has enabled me to reach our Financial Freedom Number (the amount of money we needed to earn every month on average to quit our jobs and just live off our savings). I will say more about these rules, why they work, and how to make them even more effect in the balance of this paper. But first we must address some basic information, to build a proper foundation to stand upon.

— What We Will Need To Play This Game —

There are a number of things we will need to have and know to be effective (to earn money) in this Wall Street Markets (trading and investing) game.

1. Wall Street Markets are primarily a mechanism designed to fund economic opportunity, to enable saving for the future, and to diversify risk. When a business (or one or more individuals) have a profitable idea that requires public funding, they tend to take their plans to one or more of the big investment banks (many have or had offices on or around Wall Street, and that's why the term Wall Street is now a metaphor for all the individuals and businesses that can legally operate to profit from the normal operation of our global financial markets). These banks and related participants can help them issue equity (stock) and/or debt (bonds) to raise the capital that they need via an Initial Public Offering (IPO). In business and finance, the term Capital means the money desired to pay for real property (e.g., office, plant and equipment) and intellectual wisdom and ability (intangible property) needed to start and operate a business venture. The other term often heard in this context is Labor, which is actually one of many resources (variable costs) going into the business to yield the presumed valuable products and/or services to be sold by that business to earn a profit, a rate of return on that investment. Once issued, these investable securities (legal claims against the issuer) are free to trade in the U.S. on SEC Regulated Markets (a.k.a., The Markets), thus allowing all savers to both invest in future economic growth and to diversify their risk exposure by owning a basket of dissimilar investments. Investors that buy stock are taking an ownership interest in the issuing business. These equity owners are entitled to a proportional stake in the future growth and earnings of that business, which can result in price appreciation of the stock; and some of the resulting earnings that can also be paid out as dividend income. Investors in bonds are basically making a loan, normally for a fixed period of time, and they will earn interest income until that loan is repaid. Government entities also issue bonds to raise capital to fund their new projects and continuing operations. The financial industry has also created an amazing number of derivative securities (e.g., options), the value of these derivative securities is based on the value of the underlying basket of Stocks, Bonds or Futures plus some number of financial factors that make them unique and presumably useful. It is best to master the underlying securities before investing any time and money in these tradable derivatives. I can assure you that if you are unable to be a CPT with one or more of these basic securities types, you are not likely to be a CPT when the investment calculus is complicated one or more new dimensions, like time (when you add an expiration date, you change the profit target from sooner or later to must see and take a profit before the expiration date or accept a guaranteed loss). Generally speaking, most derivatives are just not for beginners. However, there is one other type of derivative that is well worth our time and a great place to start. There are many businesses on Wall Street that are in the business of investing Other People's Money (OPM). They are Regulated Investment Companies (RICs) and they issue shares that have ticker symbols just like other stock companies, and about half of these shares trade all day long just like other stocks and bonds and can distribute periodic cash payments just like some other stocks and bonds. The other half only trade once a day, at the next 4 pm closing price. Most people know of these RICs by their generic street name, Mutual Funds. All of these funds are professionally managed and they allow investors to participate in the growth of our economic system without having to bear the risks associate with individual stocks and bonds; and some of these large, mature, diversified funds meet all of the requirements of Rule #1 above — Focus the bulk of your time and capital on a few dissimilar investments that are very likely to survive, that will pay a market rate of return to hold, and that are very likely to see higher prices sooner or later. All of the securities introduced above can be bought, held, and sold in a properly funded and permissioned brokerage account. To learn more about the operation, history, and strengths and weaknesses of Wall Street, consider William Cohan's book Why Wall Street Matters.

Warning: There are two less noble secondary purposes for the existence of Wall Street markets. These markets allow Wall Street professionals to get access to your savings. These professionals literally feed at your expense. You must pay to play on Wall Street. But you don't have to pay that much, and thanks to zero-fee trading commissions, you can now pay even less. But rest assured, Wall Street professionals have many ways to feed on your hard earned savings. Furthermore, Wall Street markets can provide a venue for individual entertainment and stimulus (e.g., a casino). If this is your primary motivation, don't be surprised if it costs you money, just like every other entertaining activity. If you want to make money on Wall Street, become a professional or just focus on the primary purposes bolded above.




2. Wall Street is very good at transferring wealth from the impatient, impulsive, and uninformed to the patient and methodical. That's why we need to understand that for the overwhelming majority, Trading and Investing is a Loser's Game! Charley Ellis says in his classic book Winning the Loser's Game, "In a winner's game, the outcome is determined by the correct actions of the winner. In a loser's game, the outcome is determined by the mistakes made by the loser." For most people, tennis and golf are examples of a loser's game; the winner makes fewer mistakes or fewer than average. There are clearly some professionals operating on Wall Street that can play a winner's game, but most professionals and virtually all non-professionals have to play the loser's game and their results will very much be a function of their ability to avoid making big mistakes, which are often caused by our impatient, impulsive and uninformed actions. If we want to grow and keep our wealth on Wall Street, we're going to have to get good at avoiding big mistakes and learn how to manage the small ones that cannot be avoided by having a patient methodology that puts the odds of success in our favor.

   Authors Note: I've been doing this now for over two and half decades and I know for a fact that it's not that hard to make a little money here and there, over and over again, and all this can compound to a very considerable sum in time; but I also have to acknowledge that all of my failures to grow real wealth have always been due to just a few BIG mistakes. Because investing is naturally risky, there will be losses; and not all losses can be avoided, but most can be minimized. The pros say that it helps to think of losses caused by normal market risks as a cost of being in this business, a business expense that can be managed. Furthermore, I believe that anybody can learn to make these small profits associated with small risks, but most become impatient and take on more risk to magnify their rate of return. Truth be told, most of us can learn how to get away with a little extra risk most of the time. Some of us can actually get good at managing bigger risks (i.e., learn how to play a Winner's Game). We're all subject to a lucky streak in bull markets, which begs the ultimate question. "Am I clearly able to play the Winner's Game?" Honestly, most should confess the answer is "No, my skills are not there, yet!"

   Warren Buffett likes to say, "I only have two rules." "Rule No. 1: Never Lose Money." and "Rule No. 2: Never Forget Rule No. 1."

   It's very important to understand that money lost by the beginner version of us cannot grow to support the retired version of us. Ideally, we should never put on a trade that can, sooner or later, result in a big permanent loss of capital (our hard-earned savings). I believe this is what Warren Buffett is talking about. We simply must avoid excessively risky trades and investments that can easily result in a permanent loss of our savings that need time to grow to fund our retirement goals. We should ask, "What's the likely average cost, worst-case cost, and what are the odds?" (We'll talk more about how to answer these questions later.) We only want to take on risks that are bearable and that we can manage, risks that can be justified by likely returns (i.e., the average loss is easily overcome by the average gain, and the worst-case loss will never kill our account and make us start from scratch again), because sooner or later the odds will catch-up with everyone, and a big risk can turn into a big mistake that can wiped-out months and sometimes years of savings and compound growth. We simply must learn how to manage the risks we take and avoid the risks that we cannot manage or afford, risks that can result in a big mistake.




3. We will need time, lots of it. Compounding can do amazing things to grow wealth, but it will take time and money. It's earning new money (capital growth) on top of prior growth from prior savings (the initial investment capital), one compounding period after another. Compounding starts slow, but after a few decades (e.g., two to three or four, depending on the rate of return) of continued regular savings and positive compounding, that savings growth accelerates to the upside and can make you truly rich, relative to your rate of consumption and the percentage of your earnings that you are able to save (i.e., learn to Pay Yourself First by saving 10% of each paycheck and living within the other 90%).
   
   It's never too early to start saving for retirement; and the later we wait to start, the more we'll have to save to catch up, which is the only effective way to catch up (don't make the common mistake of thinking that taking on more risk to realize a greater rate of return is the answer as that approach tends to yield greater losses, which makes the problem worse). At some point, we'll never catch up, unless we hit the lottery (an extremely unlikely to succeed retirement strategy, and buying multiple lottery tickets to improve the odds is simply a voluntary tax on those who refuse to understand the basic nature of mathematical probabilities and how an incremental increase affects the resulting odds — buying the first ticket takes the odds from no chance of winning to one chance in whatever the odds are, it's simply paying a dollar to own a now possible dream; but buying the incremental ticket has only a negligible improvement when the odds are incredibly low, as in the case of lottery tickets, it's truly throwing away good money after bad).
   
   It's amazing to me how many people come to Wall Street thinking that it's a quick and easy road to riches, and that all one need's is a good stock tip or a small piece of the next hot ticket. I can assure you, from first-hand experience, that this is a mistaken notion. The only thing that happens quickly on Wall Street is losses, which reminds me of the old saying; "The quickest way to make a million dollars on Wall Street is to start with two million." If you treat Wall Street like a lottery ticket, expect lottery ticket like results (i.e., a few will hit it big, but 99.9%) will lose all or almost all of their money); but unlike the lottery where everyone is playing the same (incredibly unfavorable) odds, on Wall Street the odds will always favor the patient and methodical, and those who are better prepared and equipped.
   
   Slow and steady over time is key to winning the Loser's Game. Unlike the lottery where just few will ever realize their desired riches and most will simply end up as losers, a patient and methodical approach, like what I'm presenting in this paper, can easily enable anyone with a decent job (or some other ability to earn money like a small business owner) to retire with the capital base needed to enjoy a retirement lifestyle similar to what they had while earning and saving. So, start as soon as you can, be a CPT, and allow compounding work its magic.
4. We will need investment capital, a lot of it! It takes money to make money. The best quality investments are naturally expensive because they are so attractive. This is simply a fact of life. Having investment capital is a prerequisite, it's the price of admission to this game. Furthermore, the more capital we have to invest, the easier it can become to earn even more while reducing overall risk thanks to increased diversification.
   
   Initially, commit to save 10% of your earnings and live within the other 90%. Use the simple Dollar-Cost Averaging (DCA) strategy to invest that 10% in a low-cost, total market index fund to raise the initial capital base (e.g., VBINX). This strategy tends to yield a cost basis (the average price per share, which is also the break-even price) on the investment that is lower than the average price seen in the trading range of the investment over longer investment periods, which makes it easier to harvest a positive rate of return, to be a CPT, in some future market up turn. This approach also gives us the time we need to master the wisdom presented here.
   
   Once enough capital is saved, it's actually possible to just live off of the yield from U.S. Treasury Bills, Notes & Bonds, which are defined on Wall Street as the The Risk-Free Rate of Return. We're talking about more than 10 million dollars depending on current interest rates and your cost of living or what I like to call "Your cost of happiness." For example, if we had $10,000,000 and invested in U.S. 10-Year Treasury Notes yielding something like 2% (in 2016), we'd be earning about $200,000 before taxes each year. But note that interest rates go up and down all the time, just like all other market priced investment; and that's why we need to understand the markets and how to effectively select and manage our investments. We will need to be able to handle a big, longer-term downward move, which could seriously reduce the amount we'll have to live on. Having a large capital reserve can greatly reduce the impact from adverse economic shocks, another annoying fact of life.
5. We must maintain a rational Main Street mentality when operating on Wall Street. Most people don't and as a result end up with poor investment results. Let's consider a made-up example to illustrate the point:
   
   Let's say that you're a newly minted college graduate and you've just accepted a decent job offer. Your dear ol' Dad gives you $10,000 as a graduation gift, and you decide to buy a new (to you anyway) car to get to work. You look around and find a small number of perfectly good choices and pick the best one (in your eyes). A few days later a guy says, "Hey, I'll buy that car for $11,000!" That would be a quick 10% profit. Will you take his offer? What if he had offered $9,000 (a 10% loss)? You might say "Sure!" to the higher offer and get your next best choice (Why not? I'm generally happy to let someone pay me $1,000 to take my 2nd best choice, especially when the difference is small.) or you might say "No thanks!" to both offers thinking "I bought this car to get to work, etc. and it's getting that job done." — most of the people I've met are busy and don't want to redo work they've already done to their personal satisfaction. Either way, both answers are examples of typical Main Street thinking — we're not going to jump in and out, just because the market price went up or down, when that jump leaves us in a less favorable situation looking forward.
   
   Now let's say that your new boss gives you a $10,000 401k contribution as a signing bonus. Dear ol' Dad says, "Invest that in a good Blue Chip mutual fund (e.g., an S&P 500 Index Fund) because they're very likely to survive and grow at an average 8% compound rate over time; and in thirty years that 10K bonus should be worth about $100,000." Let's say you take his advice, and after a few weeks or so you check on the fund and notice that it is up 10% (or maybe down 10%). Do you sell? Believe it or not, most retail investors will hold on to the 10% gain thinking, "I'll hold out for more of this and sell when it gets to 11% (or whatever)."; and sell the 10% loss thinking, "I can't afford anymore losses like this." It's important to realize that marketable investments trade up and down all the time, and that we'll need a strategy with favorable odds to succeed (more on this later).
   
   Ask yourself, "What's the real economic difference between these two examples? In both cases, the underlying asset still retains the ability to meet the initially intended purpose; and by the end of this paper, it should be clear that if you make a good purchase going in, you should not sell for a loss just because the market now says "Your purchase is worth less than you paid." And in the case of the 10% gain, it might not make sense to sell that either, if a chuck of the profit has to go to the taxman and you don't have a better place (a plan) to invest the rest of that money. Please understand that most of what you're going to hear from Wall Street Talking Heads (over and over again) is just plain wrong (for you or worthless information from a practical Main Street perspective) and repetition does not make it right (nor useful, but may make it popular wisdom). Wall Street likes to generate a lot of sound and fury as it perpetuates its Fast Money mentality, and this has a tendency to make us anxious and confused about what we should do next. Just because Wall Street changed its mind about the price (perceived value) of our investment, does not mean you we're wrong to have bought that investment then, and more importantly, that we're are wrong to hold on to it now. It is critically important that we never forget that one of Wall Street's primary motivations is to get us (their retail customers) to buy or sell something because every time we make a trade they get a chance to feed off our account. When this happens, we need to turn off the TV (or whatever the source), relax and think about our real objectives, and ask, "Does this (trade) make sense for my situation on Main Street?" If not, why should it make sense for us on Wall Street where we have to go to buy and sell our investments? The same basic principles of business and economics apply to both streets. Right? (Just in case you're not 100% sure of the answer, check-out your local or favorite university, it does not have two different sets of classes on business, finance and retirement planning — one for Wall Street and different set for everyone else.) A much better set of questions might be, "Is this investment right for my reason to be on Wall Street?", and "Does the current market price help me reach that objective?"




6. We need to understand the Market's Nature. At the most simplistic level, the market for investable securities trades up and down in a range that reflects the market's view of likely future value, which seems to change all the time. Sometimes the market is willing to price securities at amazing high premiums; and at other times, at astonishing low discounts. Consider the following from Warren Buffett (a market perspective he got from his mentor Benjamin Graham, author of the definitive book on value investing The Intelligent Investor):

   Mr. Market

   To understand the irrationality of the stock prices, imagine that you and Mr. Market are partners in a private business. Each day without fail, Mr. Market quotes a price at which he is willing to either buy your interest or sell you his. The business that you both own is fortunate to have stable economic characteristics, but Mr. Market's quotes are anything but. For you see, Mr. Market is emotionally unstable. Some days, Mr. Market is cheerful and can only see brighter days ahead. On these days, he quotes a very high price for shares in your business. At other times, Mr. Market is discouraged and seeing nothing but trouble ahead, quotes a very low price for your shares in the business.

   Mr. Market has another endearing characteristic, said Graham. He does not mind being snubbed. If Mr. Market's quotes are ignored, he will be back again tomorrow with a new quote. Graham warned his students that it is Mr. Market's pocketbook, not his wisdom, that is useful. If Mr. Market shows up in a foolish mood, you are free to ignore him or take advantage of him, but it will be disastrous if you fall under his influence.

   Mr. Buffett cautions investors to never forget that stocks are simply a fractional ownership claim on a business and bonds are simply a loan to a business or government entity; and the rate of return on both investments depends on: 1) how much you pay for that investment (the cost to get in), and 2) on the future economic prospects and prudence of the issuer of that security (the tangible form of the investment). To be a successful investor, one needs good business judgment to understand the likely future economic value of an investment opportunity and the ability to protect oneself from the emotional whirlwind that Mr. Market unleashes.

   Benjamin Graham had another popular saying that is worth considering in this context:

   The Market is both a Voting and a Weighing Machine
   In the short run, the market is a voting machine; but in the long run, it is a weighing machine.

   Mr. Graham is basically telling us that over shorter periods of time, traders and investors buy and sell based on what they think near-term future prices are likely to be, and as a consequence actually drive near-term prices accordingly, which can seem a little crazy relative to the underlying realities. But over longer periods of time, thanks to actual earnings and economic reports, we're all better equipped to understand how well or poorly the businesses and governments that issued our investments are in fact doing — are they creating real economic value or not, and are they able to make the expected future payments or not? — and all that also drives market prices accordingly. So, market prices both anticipate and track the underlying economic realities of the entities that issue those investable securities.

   We can use fundamental analysis (how the business makes money) to understand what could be a good investment, and when it is better to be a buyer or a seller of that good investment (i.e., how to effectively take advantage of the Market's Nature). Unfortunately, mastering fundamental analysis is no simple task; it's functionally equivalent to earning an MBA in Accounting, Finance, and Economics. An alternative approach (assuming we can find a good investment — more on this later), we can use technical analysis (use the Market's Collective Wisdom as expressed in market prices seen over longer periods of time), to understand when it is better to be a buyer or a seller. Technical analysis is a skill that is much easier to master and can also greatly improve our odds of success.

   Ideally, we'd use fundamental analysis to find good investments, and to establish good working prices levels for buying at discount prices and selling at a premium, and then use technical analysis to optimize our actual buying and selling — the true professional approach. We'll talk more about all this later. But first we must get through the following preliminary stuff.

7. We're going to need a strategy (a methodology that puts the odds of success in our favor), and the self-discipline to work and refine the process. (This second part should be an iterative approach that yields incremental improvements but be careful not to break something that is already working. It is very easy to over optimize something for a specific market condition only to have the market evolve to a new condition.) We will need a set of rules for security selection and that also generates buy and sell signals. (Getting this stuff from anybody else is just a recipe for disaster.) The best-known strategy is simply to "Buy Low and Sell High"; and there are basically two major approaches:
   1. Use a Value based approach. The basic idea is to figure out the value of something, be a buyer at market prices below that, and a seller at prices above. It's a strategy that depends on us using some analytical process to establish favorable prices (e.g., fundamental and/or technical analysis), and then patiently wait for Mr. Market to offer up favorable prices. This is Warren Buffett's approach.
   2. Use a Momentum based approach, which is very easy to understand and a popular Fast Money strategy. The basic idea is to trade with the trend, Buy Winners and Sell Losers, and that naturally causes market prices to trend further Up and Down, which eventually creates several related cyclical patterns (more on this later). This is purely based on technical analysis, which quickly leads to the idea of get in and out with a profit before the trend reverses. It's a popular Wall Street strategy that depends on us being faster than average, which is very appealing to those who believe they're better than average, which is almost everyone before they learn the hard facts of life on Wall Street — 1) the average market participant is a professional that is way better trained and equipped than the average retail investor, and 2) once the short-term trend is obvious to everyone, that obvious momentum move is pretty much over and the Smart Money is getting out. In fact, they're on the other side of the trade with the last few to get in. This momentum-based approach can be very profitable when a little relevant market wisdom is applied to a reasonable timeframe. But most Newbies (the Uninformed Money) make the mistake of simplistically applying this approach to timeframes and/or securities they are ill-prepared to trade (we'll learn a lot more about the informed approach later in this paper).
   There are a million variations on these two major strategies, including an amalgamation of both, and it will take some time and effort to develop (learn) a specific version (or two) that we both understand and trust. I present some of these below, but you'll have to master a (your) take on the process. Be patient and persistent. Know that it can be done. Many others have done it and so can you!
   
   Note that just because the guy on the other side of your trade is a pro or a computer programmed by a team of professionals doesn't automatically mean that you can't make money. You can, but not without a methodology (a systematic strategy) that has favorable odds and the self-discipline to focus on and work to improve that methodology.
   
   Here's my basic strategy, which has four major parts. Part 1: Focus the bulk of my Time and Money on a few Dissimilar, Survivable Investments that will Pay me to Hold, and that are very likely to see higher prices sooner or later. This is a very good way to avoid a permanent loss of my savings. Part 2: Trade with the Health of the Broader Market Trend, an enlightened momentum approach. Part 3: Trade like a big Value Investor. That is, I want to only Buy at Discount Prices, Sell at Premium Prices, and I want to Earn Income while I wait; and to the extent possible, I'll also work to optimize two averages: My average price per share (the buy low price for the whole investment), and my average rate of return (the sell high price for the whole investment or any part therein). This is an enlightened value approach. And Part 4: I'll create a watch-list and a repetitive analytical and trading process. I'll use this four-part methodology (strategy) to become a Consistently Profitable Trader (CPT), thus allowing me to grow my savings at a compound rate of return. And once CPT status is earned in a longer and easier timeframe, I'll then work to reproduce these results in the next slightly quicker timeframe, thus allowing me to realize the best higher rate of return my skills and the market are willing to yield. This is another way of stating my Simple Two-by-Four Approach.
   
   Take this seriously. It's amazing to me how many people come to Wall Street with a video game mentality. If your primary focus is stimulation and sport, be prepared to pay a dear price for this form of recreation. Don't sacrifice a sweet retirement. Keep it Simple and Straight-forward (KISS); and never forget the reason we're operating on Wall Street (e.g., to own a share of our collective economic prosperity in preparation for retirement or whatever), and not to just pass the time.
   
   Warning: Getting into an investment is easy. The trick is getting out with a profit, which generally requires a fair amount of self-discipline and preparation (to figure out what favorable prices should be), and the patience to wait for your favorable prices; which reminds me of a couple of relevant saying, "There is a time to buy (when we see the right price) and a time to sell, but most of the time is just a time to sit on our hands (because current prices are just useless noise)." and "Hyperactive, Impulsive Trading Is Hazardous to Your Wealth." You should only be willing to make a trade when doing so puts the odds of success in your favor.
8. If we want to earn an above average rate of return, we are simply going to have to work for it. The actual rate of return realized is very likely to be a function of the effort put forward, where we are on the learning curve, and of course what the market is doing. This effort includes an iterative cycle of analysis of currently available data, some trade and investment planning based on the strategy selected, methodical execution of those plans, and then some post trade analysis of the results, which should yield incremental improvements in the process thanks to our natural ability to learn from our experiences. All this requires self-disciple, preparation, patience and persistence! If you're thinking this sounds like too much work, I'm thinking you're probably right. Stop here and focus your time and money on a broad-based passive index fund (like VBINX, which is a wonderful example of a survivable investment that will pay to hold and that is very likely to see higher prices in the future) and use the Dollar-Cost Averaging (DCA) strategy, which at best yields the actual market rate of return, whatever that is (a positive or negative value) going forward. DCAing a broad-based index fund also offers the added benefit of allowing you to spend your time on something more enjoyable.
   
   Note that markets can and will go both up and down. Prices will naturally trade in a broader market trading range. There will be times when we'll be required to patiently hold an investment that's underwater. We need to get comfortable with that. It's simply unrealistic to expect prices to only go up. There will be times when we'll need to patiently hold an investment that is underwater, and that's one of the main reason we want to focus on investments that will pay us to hold.
   
   In fact, buying with a value approach (buying low) often results in a near-term loss because it is very hard to buy the bottoms, but after a little patience, higher prices often follow. Alternatively, when using a momentum approach, we often see a near-term gain, but after a little more time we often see a loss because it is very hard to sell the tops. You might be thinking, "What's going on here?" If you read on, you'll see that when the broader market trend is up and healthy (a longer-term momentum approach), a shorter-term downward price move can actually be to our overall benefit (a shorter-term value approach). Timing trades near the tops and bottom is very hard, but it can be done in time when one works at it. It's like learning to surf. The waves come in off the ocean building a slop on the surface of the water that we ride down and into the shore. We just need to learn how to mount and ride the surfboard, and then let gravity do the rest. It will be rare that we'll be able to time these rides perfectly (ride the whole wave), but we don't have to. We just need to catch enough to justify the effort, and therein lies the analogy to learning how to time market tops and bottoms. We don't have to time the tops and bottoms perfectly. We just need to get in-sync with the cyclical rhythms, and then we catch (get) enough of these repetitive movements to justify the effort. And the best way to start is to learn to time the tides (the broader market or economic trend), which take hours (months) to come in and go out.
9. We are going to need a brokerage account to buy and sell stocks, bonds, mutual funds, and other types of tradable securities. Get the cheapest (low-cost) broker you can find. I like Merrill Edge and TD Ameritrade. We have most of our savings at Merrill Edge because they offer us 100 free trades a month (that can save me up to $695 per month, given that they (and most others want) about $6.95 or so per trade). We also have an account at TD Ameritrade because I think they have a better set of real-time tools; and I was able to negotiate a per trade rate of $4.95. Note that money spent on trading services and information is money that cannot grow in your account to fund your retirement. You will also need to Master these Tools of Trade — your broker's user interface, their online system for investment analysis, trading (buying and selling) and position tracking (monitoring the value of your individual investments and the size of your account — I've found that most brokerage interfaces are weak in this regard, and that it is generally better to use a custom spreadsheet to track and plan these details. I can give you a simple template to get started; but you'll need to customize it to meet your specific situation.).
10. One of my rules for retirement planning is Be about the Business of Growing Wealth, which basically suggests that we need to treat our retirement activities like a business. We need to be in the business of getting ourselves retired; and once our Financial Freedom Number is reached, keeping ourselves in that desirable state (another one of my rules for retirement planning). One thing every successful business has is a good set of books. Bookkeep is a fundamental part of running any business. These books allow us to understand our numbers, our Profit and Loss (P&L) profile, our expense structure, etc. Basically, everything a successful businessperson needs to know to properly manage their business, to understand how money is made and what expenses, that can be managed, are necessary to profit production. It's a fundamental truth that we can't manage what we don't know, and that we can't really know something until tracking and analyze the details.
11. There are basically two ways to make money on Wall Street:
    1. Earn a Capital Gain — A capital gain is realized whenever the proceeds from a sale of an investment exceeds the cost to acquire that investment; and that's the foundation for the old saying, Buy low and Sell high (or at a higher price).
    2. Earn Investment Income — Money can be earned from the ownership of income producing investments. Examples include dividend income from equity (stocks), interest income from debt (bonds), and rental income from real estate investments (REITs). These are all examples of being paid to hold; and over the very long run, a significant portion (about half) of all market returns are derived from investment income.
    Notes:
    • The sum of these two above is called Total Return; and that should be our primary motivation over time — to meet or exceed our planned profit objective for each position we put on; and once that objective is met, we simply must take some or all of that profit off the table (to book or lock-in that rate of return, to be a CPT) because what the market giveth it can just as easily taketh away.
    • Market professionals have other ways to earn money on Wall Street, but these actives are beyond the scope of this paper mainly because they are generally unavailable to the average retail investor.

12. Every trade requires two willing parties, a buyer and a seller. Actually, either one of those two parties can be comprised of a temporary group assembled on the fly to facilitate the trade (e.g., one big buyer wants to acquire, say a, 1,000 shares of XYZ, gets that order filled (executed) at a trading venue (a.k.a., an Exchange or ECN), by having three smaller sellers grouped together, say one who wants to sell 750 shares of XYZ, another who has 150 shares to sell, and one with just 100 shares). Now a days, all this is mostly done by computers, and one or both parties can also be computers too. Once the trade is executed, the details (ticker symbol, time of the trade, number of shares traded, and the price) are recorded as a legal public record (a.k.a. the Ticker Tape or just the Tape and Time & Sales), which can be filtered and viewed by any interested party (e.g., like on the CNBC Real-Time Ticker). The only details not recorded on the public record are the names of traders and their brokers; these are recorded on a private record for regulators and exchange managers to use in their oversight activities.
13. Current prices printed on the Tape are created by trades between willing buyers and willing sellers, that presumably both feel that making that trade is to their personal benefit, tend to be based on a momentary agreement of fair future value. This may not always be true in every random trade sampling, but given greater participation (more trading volume over time) is by definition always true because most trading volume is from savvy traders and investors working from a professional trading/investment plan that is based on professional analysis of the security being traded. But please note that current prices (trades) may not be rational given the underlying economic realities of the business that issued that security (e.g., the top of the Internet Bubble in late-2000 and the bottom of the Financial Crash in early-2009, the prices seen then were not a good indication of value realized just a few months and quarters later). Never forget that price is not always a good indication of future value; it is, however, always a good indication of market sentiment, which can be too bullish or bearish relative to likely future value. Note that we humans have an amazing ability to talk ourselves into beliefs that are not always true. When market prices become too extreme, it can pay well to be a patient contrarian sitting on a nice cash reserve — more on this later.
14. There are two basic order types that you will need to be familiar with. They are Market Orders and Limit Orders. A Market Order is a request to buy or sell at the best available price as soon as possible. A Limit Order is a request to buy or sell at a specific price or better, which may or may not be filled. Market orders are always filled (executed), and are used by traders and investors that simply must get in or out of a security position ASAP, and are willing to accept any price to get that fill. Buyers using market orders will get their orders filled at the best available Asking Price (a.k.a., the Ask and Offer Price) when their order reaches a trading venue in a First Come, First Serve order (using a FIFO Queue); and sellers using market orders will get their orders filled on the Bid. Limit orders are mainly used to advertise a willingness to make a trade, if the market (someone else) will do that trade at the specified (or better) price. A limit order can act like a market order when the limit price is the same as the best available price. When a buyer uses a limit order that cannot be executed when their order reaches a trading venue (because that limit price is below the current Asking price), that order is added to the Central Limit Order Book (CLOB) as a Bid using FIFO Queuing, and will get filled when (if) prices drop through that limit order price. Sellers using limit orders that are above the current Bid join on the Asking side of the CLOB, and will get their orders fill when (if) prices rise through their limit order price.
    
    Note: When you hear someone say something like, "Today there were more buyers than seller." or "The market was bullish today." Understand that this means there were more Market Orders to Buy then Limit Orders to Sell today. On balance, the buyers (the Bulls) were more aggressive and were willing to accept less attractive prices to get their trades filled (i.e., the majority of the trading volume today occurred at the Offer Price). These statements can be confusing to those just starting out and may be unfamiliar with Wall Street Lingo.
    
    Click here to learn more about the Anatomy of a Trade, other order types, and how the market advertises price quotes and records trade prices — a more technical look at the information above.
15. Market prices (trades) for an investable security naturally, and to some degree randomly, trade up and down based on the supply and demand for that investment (i.e., the current popularity of that investment). Buyers create demand by using market orders to force a trade, and sellers create supply when they use market orders. When demand is strong, more buyers are using market orders, prices rally; and when supply is abundant, prices decline. Click here to learn more about Supply and Demand. All investments naturally go in and out of favor over time. After every trade, subsequent trades are likely to drive prices either up or down; and given that follow-on move, one party to that initial trade will look smart and the other, well, not so much. Understand that the goal is not to look smart; it is to make money over time! Did you know that both parties to any single trade can actually end up making money and that both can also end up losing it too? It's true, and happens all the time. Let's not confuse short-term price movement with loner-term wealth creation and destruction. Just because we have a paper loss now, does not mean we're doomed to end up with a loss; and just because we have a paper gain now, it does not automatically mean that we'll end up with a bankable profit later. We cannot control market prices, and we should not allow ourselves to become giddy when prices move in our favor and fearful when prices move against us. Our emotions, if not kept in-check, are likely to cost us a fortune. We can, however, control what we choose to buy and sell and when we'll do our buying and selling. We can also choose to only make a trade when the odds favor making a reasonably attractive rate of return. We need to understand that prices will naturally trade up and down over time because the pros need prices to move, that's how they (we all) make money, and if prices will not move on their own, the pros know how to get prices moving. But don't confuse that for having control, the market is just too big and no one has unlimited buying and selling power, which is the force that drives prices up or down; but once that excess power is gone, prices will always revert to their natural equilibrium, where supply equals demand and where current price reflects the market's collective view of fair value. Just as a stone tossed into a lake can create a momentary impact on the lake's appearance, it's not likely to leave a lasting alteration, especially when that analogy is to the ocean, which is a much better fit, as the market for most tradable securities is huge. Finally, we need to also understand that if prices will not move up on good news, then prices will go down; and if prices will not go down on bad new, then prices will go up — a bit of wisdom understood by seasoned market professionals, and it's this type of common professional knowledge that makes the statement a self-fulfilling reality.
16. There are basically two ways to hold a position in a brokerage account — either Long or Short. Having a long (bullish) position in a security means that you own the security and are entitled to all the dividend or interest income payments made. A bull is an investor (a trader) who believes that prices will increase over time and is said to be bullish on or of the security. To get long a security, an investor (a trader) simply buys the security to open the position; and the position is closed when the security is sold, and thus realizes a capital gain when the cost to enter the position is less than the proceeds from the sale. This is what most people think of when they talk about investing. A short (bearish) position is the exact opposite of a long, it's a mirror image of that long position, and can even be the other side of an opening long trade. A bear is a trader who believes that prices will decline over time and is said to be bearish. To get short a security, a trader must first have the capital to cover the cost of position to avoid margin expenses, just like a long position. The only real regulatory restriction on shorting is the need to be in a margin account and to be able to barrow the shares for the trade. Note that some brokers will deny newbies the automatic right to put on a short, but most do not; and if they do, just ask them what they need to enable that capability. In most cases, to put on a short, a trader simply selects something like "Sell Short", "Short" or "Short to Open" as the trade "Type" or "Action" to be performed; if the trade types "Short" and "Cover" (or something like that) are not included in your list along with "Buy" and "Sell", then talk to your broker. Assuming you are able to select "Sell Short" as the trade type, fill in the rest of the order details, and then select "Okay", "Review Order", "Preview Order" or whatever your broker's order entry form requires to get the trade approved before the trade is submitted to an exchange. If your broker is unable to barrow the shares or there is some other problem with that trade form/ticket, that trade will be blocked by your broker's system until the problem is fixed. Don't hesitate to call your broker, if the problem is unclear or you're unsure about any aspect of this trade type; they're there to help you (and if they don't make you feel like that's the case, find a better broker, it's a very competitive business). Assuming all goes as expected and the trade is executed (the order is filled), the trader thus borrows (from someone who is already long) and sells (shorts) the borrowed security to the market (to someone else who wants to be long that security or is buying to cover their short) via their broker's trading interface as a single transaction. The cash proceeds from the trade are placed in a separate short-sale cash account, which can earn interest, and is primarily used to help cover the cost of the closing trade. It's as simple as that; and shorting the rallies in bear market can be very profitable. But please note that being short the security also means that you are also short all the income payments too (remember, it's the mirror image of a long) — when the investments makes a payment (e.g., pays a dividend), your broker will, without asking, take that payment out of your account and give it to the owner of the borrowed shares. The short position is closed: 1) when that trader buys back the prior sale (to-cover) the loan, or 2) when the original owner sales the loaned security (note that your brokers does this automatically, when the broker is unable to find another long to borrow, and does not have to ask your permission, you'll just get a normal trade notification), or 3) when your short position generates a margin call that cannot be met because that position has gone too far (up in price) against you, causing an excessive loss of value in your brokerage account. A short position will realize a capital gain when the proceeds from the short sale exceed the cost to exit (buy to cover) the original short sale. Because short sales are only allowed in margin accounts, there are tradable securities that actually go up in price when the underlying investments goes down in value, like Inverse ETFs, thus allowing bearish positions in a brokerage IRA. It's best to keep it simple, especially when you are first starting out; just focus on favorable trading opportunities in the direction of the broader market trend that are likely to survive and that will pay you to hold, thus making it easier to become a consistently profitable trader. There's nothing wrong with going to cash when you turn bearish on your prior bullish position or when there are no favorable trading opportunities. Holding cash is a valid (long) position, it's called waiting for a better opportunity, which I assure you will come soon enough, and when it does you'll want to have some cash to take advantage of that new opportunity.
17. The long-term average Market Rate of Return (according to Prof. Aswath Damodaran at NYU) of the S&P 500; is about 9% +/- a point or two, depending on the formula and timeframe you choose to consider. But note that the actual rate of return in any given year is far more volatile than that average; it swung as low as -44% in 1931 and as high as 50% in 1933; and recently we saw a low of -36% in 2008 followed by a number of up years to reach an all new high — yielding a very nice rate of return for those who owned investments that were able to survive the volatility and better for those who had cash and were also able to investment (buy more) while that market was putting in those scary lows (trading at super discount prices). These market extremes seem to happen just a few times in a lifetime and can be a real blessing to those who understand and are willing to exploit these rare opportunities.
    
    Economically speaking, the stock market rate of return is based on the sum of three or four factors:
    1. The growth rate (a positive or negative value) of the business that issued the stock under consideration.
    2. Plus the dividend yield (cash payouts from current operations),
    3. Plus or minus any change in the market multiple (the P/E), which is the speculative premium that investors demand for an uncertain future — When the market feels bullish, P/Es will expand (a risk-on environment); and when the market feels bearish, the price multiple contracts (a risk-off environment).
    4. Plus the rate of inflation (some text books excluded this from shorter-term calculations, but it is a real longer-term factor).
    
    A business is basically a money machine. it will generate sales (the top line revenue figure on an income statement). A good business will have a revenue figure that excessed the cost to generate those sales, and the difference is consider profit (the bottom line net income figure). These profits can then be used to reinvest into new growth opportunities or some of these can be given to the (stock) owners of the business in the form of cash dividends, stock dividends, stock spinoffs or stock buybacks. Businesses that are in growth mode tend to reinvest some or all of those profits in the business. Growth occurs when consumer demand for the goods or services exceed the company's ability to meet that demand and as a result the company hires more worker and/or gives the existing workers new tools or training thus enabling them to be more productive. Mature businesses that have already seen their big growth phase and just have a relatively stable demand for their goods and services attract investors by paying out some of those profits from current operations. So much the market rate of return in items A and B above will depend on where in the life cycle the businesses is. But let's never forget that the actual observed market rate of return is ultimately based on the market's ever changing consensus view (belief) about what each of these components is likely to be in the next scheduled report or some future average thereof. If you're a short-term trader, it's all about correctly anticipating the market's view of future value, which is no easy feat. But we don't have to get all this right to profit from our investments, we only need to apply my Simple Two-by-Four Approach and the patience to wait for Mr. Market to show us favorable prices.
18. There is a large body of standardized wisdom about business, economics, finance, and human nature that can be applied to trading and investing; and the more we know, the better equipped we become to identify lower risk opportunities to make money on both Wall Street and Main Street. We do not have to master all or even some this wisdom to make money on Wall Street. Let's just assume that many, if not all, large institutional investment managers and advisors (the Smart Money) have to one degree or another mastered some of this knowledge and are able to effective apply it for their own benefit and for the benefit of their investors; and when they do so, their trades are recorded on the ticker tape for all to see. Let's also take as a given that we are all creatures of habit, with a tendency to repeat actives that yield pleasure and to avoid behaviors that causes pain. It is in fact possible to learn how to see (figure out) what the Smart Money is doing with their money. We simply need to look at what they are doing, then model that behavior, and then (ideally) figure out why it works. In time, we can even develop the skill to figure out what the crowd is likely to do next. It's this last skill, in the author's humble opinion, that is by far the most valuable; and is an ability that just about anyone can master, given enough time and attention to relevant details. Just as we can learn to anticipate the behavior of others in our lives, we can develop a feel for a few individual securities, the group they trade with, and even the whole market by simply choosing to focus (specialize) on a few market ticker symbols, which can greatly improve our odds of success. But even if we can't figure it out, we can still apply the model when we see that it works, and we choose to avoid activities that do not yield the desired result. For example, I don't have to understand why hot water comes out of the hot water tap when I turn it on, I just need to know that turning that knob yields hot water and the other cold. Understanding why this works can help me fix the problem when expected results fail to materialize. We'll take a closer look at how we can see what the Smart Money is doing and why in subsequent paragraphs.




19. We can use simple statistics to understand and draw profitable insights about economic and market data. One of the easiest ways to analyze these data sets is to plot or graph the data on a histogram or chart over various timeframes. Seeing how the data evolves (and in the case of economic data, is revised) over time can give us real insights into what is happening now; and once we learn some of the following relationships, we are better equipped to predict what is likely to happen next, and that is a huge advantage when it comes to investing for our future (check out the book The Visual Investor, by John Murphy). A price chart is a specific example of how we can analyze trades (market data) recorded on the ticker tape (we'll learn a lot more about this later). Although it helps (check out the Khan Academy's Statistics and Probability), we do not have to master statistics to find lower risk investment opportunities; we just need to understand that our brains are very good at finding exploitable patterns in familiar data and that coupled with the knowledge that some of the data exhibits the following tendencies:
    1. Some data (both economic and market) have a cause and effect relationship and/or simply tend to show-up together (i.e., the data has a dependency and/or a correlation) meaning that if we see one thing, we're likely to see the other thing too.
    2. The data can be analyzed in various sample sizes (e.g., timeframes) and these groupings can help us better understand what is likely to happen in the future. For example, larger sample sizes (more data) tend to be more meaningful than smaller sample sizes. We can use information from the bigger (slower) samples to exploit aberration in smaller (quicker) samples.
    3. The data tends to trend (generally move upward, downward, or sideways) in every sample size (timeframe). A sustainable (fundamentally well founded) trend is likely to continue, and an unsustainable trend is likely to reverse (because it has gone too far and is no longer representative of the fundamental forces driving the broader trend as seen in bigger samples sizes).
    4. The data tends to cluster (average) around a trend line and the distribution (the spread or width) of the data indicates the range and nature (tendency) of sample data. Most economic data and market prices tend to have an almost normal distribution (a bell shaped tendency), meaning that most of all future readings are likely to fall within three standard deviations. However, it is important to understand that there can also be some occasional extreme events, deviation away from the mean. But those extreme deviations tend to be very short lived. Assuming that there are no real and prolonged changes in the underlying forces driving the data, which is almost always the case, the new distribution will return to the prior or some new normal distribution mean that is very likely to resemble the prior data signature. To be technically correct, researchers have found that virtually all market prices have a log-normal distribution, and it is their rates of return that have a normal distribution. Note that a normal distribution can have some negative values, but it is extremely rare, if not impossible, for market prices to become negative. I've found that if you focus on survivable market indices and blue-chip investments, both their market prices and their rates of return have an effective normal distribution with some fat tails. Or simply put, don't be surprised to find that the future tends to generally resemble the past when it comes to investing in securities that are backed by large and mature economic forces, and don't be surprised when their prices occasionally go to trading range extremes before returning to a broader average.
    5. Related data can be analyzed using different statistical techniques and that allows us to see a divergence in that data, which make it easier to see if the underlying forces driving a trend or clustering are still supporting the current pattern or signaling a change (a good time to go to cash and/or prepare for the next likely pattern).
    6. Past data can show us what is possible, the nature of the data (everything above), and the historic odds of various events in the past, which can be a very useful guide for the future. But we should never assume the future will always be like the past. It's true that what has happened in the past tends to generally happen again in the future, but never forget that every moment in the future is unique and anything can happen. We need to also consider the odds and consequence of the unlikely occurring (think, what will I do then?) because every once and a while (and especially when we're learning) the unexpected happens (and then we're forced to test the effectiveness of our recovery plan).
    
    As traders and investors, these insights are worth a fortune to those who can learn to spot and play these naturally reoccurring patterns in the data as they give us an exploitable edge (i.e., put the odds of success in our favor). We simply need to learn to think in terms of probabilities, learn which groups of data have a dependency and/or a correlation, and then to only put our savings at risk when we're more likely to realize an attractive risk-adjusted rate of return. Investing time to master these Quantitative skills will surely yield a very impressive rate of return.
    
    In the authors (not so) humble opinion, the statistical wisdom identified in this paragraph may well be the most valuable information presented in this paper. However, this statistical wisdom can only be as good as the data and the methodology surrounding the analysis. Given that, I recommend Annie Duke's book Thinking in Bets and related YouTube lecture. Annie talks about learning how to make good decisions in the face of uncertainty, to be a proper truth seeker and to be data driven. She advocates objectively seeking all available information and using that to make decisions, and then learning from the experience. Do more of what puts money in your pocket and less of the alternative.
20. "What are the odds and what's the risk?" In a number of points above I've referred to understanding the odds and not taking on too much risk. But how can we know the odds and risk? Truth be told, we can never know the future for sure. However, on Wall Street many professionals and amateurs alike use simple statistical (quantitative) analysis of prior performance as an indication of likely future odds and risks because the future tends to be much like the past (variations on a familiar theme). If we use enough historic data (applying the Law of Large Number), we can get a good feel for what the odds and risks were in the past. We can then use this data to project into the future with the clear understanding that anything that is possible can still happen and sometimes does, and we need to factor all that into our plans. We can use a Monthly Chart to better understand the historic possibilities (BTW: If your investment or the index that it is designed to track cannot fill a Monthly Chart, then it may not be a survivable investment, which breaks my Simple 2-by-4 Rule #2 above.). Furthermore, we need to understand that this historic data is pretty much unreliable when it comes to saying exactly when something is likely to happen, but it can be very reliable about what can happen again, given enough time and assuming a little common sense and maybe some of the wisdom in the paper. We can use this historic information to make informed choices about the best way to invest our time and money. It's one good way to play to favorable odds and avoid unacceptable risks.
    
    If you feel that you do not have the time (or talent) to do all this historic market research, refer to Ken Fisher's snarky book Markets Never Forget where he and his team have done the work and documented the results.
    
    Once we have a good understanding of the historic odds and possibilities, we can then sort the alternative possibilities into three basic categories or scenarios: The first are those that are unlikely, but do happen and are very costly when they happen. These are what low-cost insurance was designed to address (e.g., your house burning down), and some on Wall Street will say that buying cheap Put Options is like buying insurance for your portfolio. But I know from first-hand experience that when it comes to trading and investment choices that need put protection, it's best to just avoid these or do this through funds that are run by manager(s) that have a track record of success in this area. The second are those alternatives that are likely (are frequently seen on longer-term charts) and have favorable risk/reward profiles, and these should receive the bulk of our time and capital. Look for trading and investing opportunities that will pay off when these alternatives do show up again (e.g., those opportunities that adhere to my Simply 2-by-4 Approach and that I talk about below). All other alternatives are just not worth much time or capital because the odds say when these likely event do happen the risk and the reward are both minimal (just no big deal) or alternatively are just so unlikely and if they do ever happen we've got much bigger problems than our savings (e.g., The economy (the whole market) or a major sector will crash and never recover, this has never happened — Note that there have been some individual businesses and a few smaller groups of similar businesses that have failed and never recovered, but those failures actually fall into the first category above, which need to be avoided or played through diversified mutual funds).
    
    Like Ken Fisher and his staff, many professional investors use a rigorous fundamental analysis of the businesses and the associated supply-chains that they specialize in to firm up their understanding of what is likely to happen and all that goes into their estimates of likely results, and thus guides their actions in the market. We can use charts (called technical analysis) to see what the big (smart) money is doing (more on this later). It's called the Wisdom of Crowds, which are amazing correct most of the time. This, of course, does not guarantee future results. We can use historic chart patterns to look for repeatable and predictable behavior. Once again, we can't always know when a pattern will happen, but we can know that it can happen sooner or later based on historical odds. We should focus our attention on investments that are backed by large, mature businesses (e.g., members of the S&P 500) because they support a high degree of predictability. Having a reasonably good and long business track record (the Law of Large Numbers) is a great way to get a feel for likely future odds and is also a good way to reduce risk. Given that data, we can use quantitative techniques (statistics, as suggested above) to firm up our understanding about a specific investment, the business backing that investment, and all the competitive alternatives. On Wall Street, these quantitative measures show the historic odds and the distribution (the spread) of these reading are a measure of the variance (a.k.a., volatility), which The Street likes to call The Risk. So, on Wall Street the odds and risk are just an example of applied statistics. And now for a Main Street perspective: I, like many others, prefer to view risk not in terms of volatility, like many on The Street, but in terms of a permanent loss of capital, a Buffett like perspective. I actually see the prior view (volatility equals risk) as a confusing and misleading definition because that suggests that volatility is something to be avoided. We should actually see volatility as something good, because volatility offers us multiple opportunities to buy low and sell high, one of the main reasons to be on Wall Street. Like Buffett, I prefer to see the latter view (risk as a permanent loss of capital) as something very bad and that must be avoided as much as possible. And that's why I say it's best to focus on survivable investments, because they're likely to see market volatility without exposing us to excessive risk — a permanent loss of capital. Because unexpected bad things can and do occasionally happen to good people and good businesses, it's best to focus on investments that are able to survive bad news, and that can take steps to reduce overall risk and improve their odds of recovery to yield future success.
    
    Large, mature Mutual Funds and most Blue-Chip businesses tend to have the wherewithal to survive and overcome problems that impact every business from time to time. Small and start-up businesses should be avoided or at least not given more the just a very little bit of our total investable capital because these are Wall Street's versions of lottery tickets. (And what happens to also most all lottery tickets? They become worthless or worth a lot less money!) Leave these risky lottery tickets to the pros. It's best to focus on investments that are backed by large, mature businesses with a long track record of success. Note that the bold prior statement also applies to mutual fund companies, which are in fact businesses that are in the business of investing other people's money, which are in fact some of the safest (low risk) ways to participate in future economic growth and wealth creation for our future needs like retirement.

The balance of this paper looks at The Big Picture, The Economy, The Business Cycle, Market Cycles and other related historic patterns and various bits of trading and investing wisdom to better identify low-risk, high-odds trading opportunities in support of becoming a Consistently Profitable Trader (CPT), the Primary Goal of my Simple 2-by-4 Approach. A CPT is someone who can grow the size of their brokerage account over time because they can (initially) learn how to avoid making big mistakes (trades that can result in a permanent loss of capital) and in time develop the real ability to effectively manage trades that can yield an above average compound rate of return on their savings, and the only reason to put precious time, effort, and investment capital at risk of a loss. To learn how to intelligently visit the intersection of Main Street and Wall Street.

— The Big Picture —

Prices for investable securities naturally trade up and down over time. The big problem is that it is very hard to know where prices will go next. Generally speaking, there is a fair amount of randomness and even a little madness in the Markets for investable (tradable) securities (every investment begins and ends with a trade). It can sometimes seem like the Markets are just a Crap Shoot that have no social or economic value. Wall Street Markets can sure be a gambling venue, if we approach with that or some other counterproductive mindset. Alternatively, if we approach the Stock and Bond Markets with a rational, confident, and prudent business mindset, it becomes possible to appreciate the real social and economic value introduced above — to save for the future and to diversify risk. Wall Street Markets allow us all to both take advantage of longer-term economic growth and to also take shorter-term advantage of natural random price swings and occasional irrational trading behavior. This apparent madness (irrational trading behavior) is often due to short-term psychological factors associated with our own unchecked emotions (e.g., fear, greed, and sensation seeking), and our collective ability to talk ourselves into beliefs that are detrimental to our financial health. These are beliefs that are not always true or relevant to our particular situation (as first documented in 1841 by Charles Mackay in his ground-breaking book Extraordinary Popular Delusions and the Madness of Crowds — Yes, the markets have changed a lot since the 1800's; but human nature, not so much). We need to learn how to invest with the crowd when the crowd is acting rational, to trade against the crowd when the crowd is acting irrational, and to understand how to recognize the difference.

Markets like to march to a popular narrative that can drive prices to unsupportable extremes. For example, when the broader market trend is up, the market talking heads like to tout bullish stories that tend to drive that uptrend further along. The opposite is also true when the trend is down. But sooner or later, that trend will become overdone and need to correct to better reflect the likely underlying economics. If we apply appropriate financial wisdom and some rational analysis to available information, it's not that hard to see the big picture, to understand the collective Message of the Markets. We want to take advantage of prices that can help us reach our financial goals. We want to trade with the broader market trend when that narrative is likely to be true and not overdone. We also want to ignore the Message of the Market when that narrative is likely to be false, when prices have run too far (e.g., when prices fail to move up on more good news or fail to go down on move bad news). Unfortunately, the message of the markets (i.e., prices and related economic data) is not always clear (especially in the short-run) and even when the message is clear, it is not always right, and it is always subject to change. However, in the long-run market prices are ultimately a function of real economic growth, which is ultimately a function of greater economic output to meet a higher consumer demand for more or better goods and services. This increase in output is ultimately derived from more hours of work or more productively per hour of work (i.e., more people working and/or working with better tools and techniques). In the figure we see U.S. economic growth over a recent 35 year period (in terms of U.S. GDP, click on the figure to see a larger, current version) and of the biggest and best part of the U.S. stock market (the S&P 500, ticker $SPX just above GDP). Notice that market prices are a lot more volatile than the level of economic productivity, and yet both sets of data run from the lower-left corner to the upper-right or from less economic productivity and market value to a whole lot more. If we look, we'll find the same basic picture over even longer periods of time and in almost every civil society that is not being impacted by natural disaster or war. Why? Just as ants, termites, and other species have a natural ability to work together for their collective well-being, we humans also have that ability and are further blessed with the natural ability to create and grow complex, organic economic systems (i.e., a synergistic, bottom-up, dynamic system of informal arrangements, as opposed to a top-down command and controlled system, which we can also create, but can easily yield less productive results in a world of constant change). Economic systems tend to foster specialization, property rights (an ability to say "That is mine!"; and because it is mine, I will take care of it — a real economic good), and a willingness to exchange of goods, services and ideas for the mutual benefit of the individual participants. These are all basic human evolutionary traits, as perhaps best told by Matt Ridley in his lucid book "The Rational Optimist" subtitled "How Prosperity Evolves". These are basic moral and economic principles originally compiled and presented as a system by Adam Smith in his first book The Theory of Moral Sentiments and his second (and better known) book ...the Wealth of Nations. These two are no easy read as they were written in old 1700s English. Fortunately for us, Russ Roberts in his book How Adam Smith Can Change Your Life has given us a very readable modern translation of Smith's wisdom on the various ways that we can choose to interact with each other to achieve both prosperity and happiness. Much of Smith's wisdom has been reiterated, clarified, and expanded upon by countless others in their time. A notable example would include Rose & Milton Friedman in their book Free to Choose and the subsequent 1980 Television Series, which had a profound impact on my early personal development. Simply put, we have the natural ability to learn, to cooperate with others for mutual benefit, and to be or get good at doing something and that specialization tends to generate a surplus that we can then trade for everything else we need and want. It's the beauty and benefit of free markets, which are not perfect, far from it, but on balance have done more to lift the average standard of living than any other system known to date. I believe the biggest threat to free markets and the resulting prosperity is the popular utopian concept of inequality is bad and the mistaken belief that government can fix that problem — it cannot, as history has clearly shown. Winston Churchill said, "The inherent vice of capitalism is the unequal sharing of the blessing, and the inherent vice of socialism is the equal sharing of the miseries." We simply have to accept that life will always be unfair and unequal (even identical twins that can start life as equals, never end up as equals, they each grow up and live different lives). There will always be someone else who is richer, better looking, smarter, or just willing to work harder. We will never all be equal. Furthermore, free markets require the acceptance of a meritocracy, where individuals are rewarded for their better ideas, harder or smarter work, and ability to capitalize on available opportunities. Free market prosperity also requires a degree of goodwill and trust that others are not automatically out to prey on us, and all subsequent trade and cooperation depends on a real exchange of integrity, which tends to yield greater opportunity and economic growth in the future, a virtuous cycle for all those willing to engage in this honorable exchange as ultimately guided by consumer (buyer) preferences and producers (sellers) ability to deliver satisfaction. Furthermore, sustainable economic growth is a primary objective of almost every rational consumer and producer because that growth creates wealth and material comfort for them (and everyone else too) as a careful examination of history has also clearly shown. Unfortunately, there will always be some who fail to understand this concept of enlightened self-interest, and thus the need for the rule of law, the police, and the courts (all things that a government can do effectively enough) to handle those individual cases that cannot be properly handled by free market choices.

Assuming no catastrophic change in the world as we know it, we're very likely to see a continuation of this growth pattern as more and more people on this planet seek their version of the American Dream. Investors in a diversified portfolio can expect to earn the market rate of return as the economy continues to grow, which is likely to be about 8% averaged over longer periods of time. There is an understandable connection between economic reality and the market for investable securities issued by businesses and various government entities that we can buy, sell, and hold in a brokerage account. These are securities that allow anyone with investment capital to benefit from this type of economic growth, if we do not pay too much for that participation; and when we do, we'll have to wait for the underlying growth to catch up with the premium paid, which presumes the bits of the economy supporting the value of the security in question can in fact grow in time to generate an appropriate rate of return to justify the higher risk premium. Note that not all business ventures succeed and grow, and that not all business and government issued debt provides the promised rate of return. Alternatively, if we demand too big a discount, we run the risk of not being able to participate at all or find ourselves settling for investments that are on their way to becoming worthless or just worth a whole lot less. All this leads to the one big question facing everyone in the market, "What to buy or sell, and when to do the buying and selling?" Unlike many seasoned investment professionals, fundamental analysis, a prerequisite to rational security selection, especially when considering narrowly focused business ventures, is generally beyond the abilities of the average retail investor. However, there are investment strategies that allow amateur investors to take both direct and indirect advantage of reasonably safe investment opportunities offered by professional money managers that can perform the work required to realize attractive risk-adjusted rates of returns. A direct investment is one that is completely controlled by us. An indirect investment is managed by someone else for a fee, and allows us to take advantage of an investment professional's ability to effectively manage (invest) other people's money. At the simplest level, retail investors can just own [save by simply Dollar-Cost Averaging (DCA) into] a broad market index fund (e.g., VBINX) that passively earns the market rate of return with one of the lowest costs of participation or a top-quality actively managed fund with a great long-term track record (e.g., VWELX) that offer the opportunity to outperform the market average after paying a higher cost of participation; and both offer the lowest possible investment risk because of the broad diversification, which allows us to bet on almost the whole economic system. There are two big problems with the indirect approach: 1) we'll have to pay these pros a percentage of our wealth to work for us and that can have an amazingly large impact on our ability to grow wealth, and 2) there are natural conflicts of interest — these pros may not always put us (their client's interest) before their own, even if they're required to do so by law. Alternatively, there are direct investment strategies; many are the same as those used by these pros; and some, like the DCA strategy above, exploit natural market volatility. These strategies enable savvy retail investors to earn an even better rate of return than the simple indirect approach because we're earning the percentage paid to the pros in the indirect approach. Furthermore, savvy retail investors may be able to avoid most or at least some of the big losses associated with major economic contractions, but unfortunately these strategies will require effort (preparation and self-discipline) and generally requires more capital too. If you think you've got what it takes, consider the following information that suggests what investors need to know and do to more efficiently manage their own savings to earn an above average rate of return.

— The Economy —

Believe it or not, everything that happens on Wall Street begins and ends with the economy; and we need to have a good handle on that. Watch Ray Dalio's How the Economic Machine Works on YouTube. Take a class on macroeconomics (e.g., Kahn Academy's Macroeconomics or Principles of Economics by John B. Taylor, if still available, if not ask me for a copy) and/or reading a book like Ahead of the Curve or A Concise Guide to Macroeconomics or just browse the web. To properly exploit the following information edge, it helps a lot to have a grip on how the economy works and what are the primary data points to monitor.

Leading, Coincident & Lagging Indicators

Leading indicators (like market prices for stocks and bonds) are forward looking and tend to move before the actual economic activity they anticipate. For example, new or a change in standing purchase orders and building permits predict changes in the economy (because they are forward looking) and consistently turn before the economy does, but are not always accurate (e.g., getting a permit to build a home, but that does not always mean that the house will be built, see the list on page 82 in Beating the Business Cycle). Coincident indicators, like GPD and commodity prices, change at approximately the same time as the economic condition they track (e.g., building materials purchased and hours worked to build the house). Lagging indicators follow an event (are backwards looking) and signify completion or something earned (e.g., getting a Certificate of Occupancy for that new home indicates that it is now built and safe to live in or a credit rating update). Click here to learn more about Leading, Lagging and Coincident Indicators.

The chart above is a little busy and it may be hard to see the details. We'll get a better (more current) look at this and other economic and market data via the web links below and in My Weekly Review. In it, I address the Leading, Coincident, and Lagging relationships that I understand. We need to train our mind and eyes to see the data and understand the significance of the market message communicated by that data. This ability to master these relationships between data and investable securities can be worth a fortune as we move through time. Given a set of data that has a strong leading, coincident, and lagging correlation, when you see a leading indicator move up or down, it is just a matter of time until the coincident and then lagging securities do the same. It's one way to buy low and sell high to earn a capital gain with favorable odds of success.

Where can we find useful charts with current Leading, Coincident, & Lagging Indicators? On FRED, the U.S. Federal Reserve Economic Database (FRED). I like the Lewis-Mertens-Stock Weekly Economic Index (LMS) Weekly Economic Index (WEI). It is updated weekly. But it seems to be a hybrid leading & coincident index data, not a true leading, as it is constructed from a composite of both kinds of data. I'm using it as Leading Economic Index (LEI) because it claims to use higher frequency (weekly) samples and because it seems to act like a very good leading indicator.

It is important to look at this data in multiple timeframes. Zoom in (1Y) to see what is happening now, and then zoom out (e.g., to 5Y and then to Max) to see where we are within the bigger picture. Please understand that this data, like all economic data, is subject to revision. It comes out as an initial estimate and is then revised until it becomes a very accurate historic record. So, these data sets have their own version of a leading, coincident, and lagging revision relationship that we can learn to use. It helps a lot to understand the business cycle process (the next section below) and where we are within the big economic picture. Don't focus on just any one reading. See the direction and magnitude of the revisions. Try to also see the trend of the broader data, where we are within the range of historic spread of that data, and how that relates to what is likely happening within the big economic picture (where we are within the boom-bust cycle).

Another great source of specific economic data is from www.TradingEconomics.com. Refer to The Trader's Guide to Key Economic Indicators for information on how to understand all this economic data. Given that consumption (consumer spending) accounts for about 70% of GDP, many think it is best to focus on economic indicators that track employment, and there is great value in following this data. But the biggest factor affecting employment, investment, and therefore the boom-bust cycles is overall business confidence about the future as indicated by the Purchasing Managers Index, and the costs of doing business. Interest rates (the cost of borrowed capital and the price of bonds), cost of raw material inputs, and labor rates are three big factors affecting the cost of doing business and funding growth opportunities. I think it's good to start with GDP Growth Rates and by extension Productivity, Business Confidence, Consumer Confidence and by extension Employment, and Price Inflation. In my opinion, less important data sets that can also affect GDP growth include Housing and Construction, International Trade, and Government Spending. I say less important because market prices generally move less on these reports. Taxes is the last data set to consider and can greatly impact economic results, but these rates tend not to change that often. The links above take you to a major economic indicator in a set of related indicators. It's advisable to become familiar will all of these economic data sets. When looking at these data, never focus on any one data point (report), as each report is subject to revision and clustering. The economic data tends to be revised a few times after the initial report as more data gets recorded. Furthermore, and like many other aspects of life, economic activity rarely occurs at a smooth and even rate. They tend to cluster (show up in clumps), a feast or famine phenomena. It's not uncommon for activities, sales, and projects to be pulled forward, thanks to economic incentives, and to be pushed out and delayed for many reason, including cash-flow and financing difficulties. Instead, focus on the direction (the broader economic trend) of the data relative to where we are in the business cycle and ask, "Is the overall rate of change economically sustainable (i.e., does it support a continuation of the current economic trend, or does it suggest that a turn is likely in the boom-and-bust cycle)?" Also take a look at related data. Does it support or refute the prior conclusion? Being able to correctly answer this question greatly improves the odds of success. Recall that we want to trade with the health of the broader (economic) trend because that trend is very likely to continue, and an unhealthy trend is likely to reverse or at least correct.

Every weekend, I review the week's economic news, the latest updates and prior revisions, and the associated market price action. I have a process that generates a web page report for that week. I display the latest report on one screen window and the prior report on another. Thus, allowing a side-by-side comparison. Working my way through the report standardizes my analytical process. Seeing and analyzing the changes has been very supportive of my ongoing success. That is, being able to better understand if current prices are likely to be a true or at least reasonable indication of the likely underlying economic grow or current market prices in need of a correction (a reversion to the mean or even the other end of the broader data spread). Note that all market and economic data have a natural tendency (a trend component and a spread component — the range of data points spread around a broader trend average). These are tendencies that we can see, understand, and exploit (i.e., give us a favorable edge when properly applied in the market).

— The Business Cycle —

In the long-run, the health of the economy is the most fundamental factor affecting the profitability of almost every business; and by extension, the profitability of securities issued by that business and by related governments. It's not that hard to understand and follow the general health of the economy. First we must understand that the economy naturally goes through boom-and-bust (recovery-and-recession) Business Cycles along the long-term growth trend; and therefore, security prices also cycle through premium and discount values relative to the average underlying fundamental (economic) realities of the businesses that issued those investable securities.

Market price trends lead the current economic trend; that is, traders attempt to anticipate the future. They buy securities they believe are going higher, and sell issues they think should be going lower; and as a result, they adjust current market prices accordingly — adding a premium to bullish prospects and a discount to bearish expectations. Why? If a rationally informed investor owns a security and does not have to sell in a bull market, that investor knows that holding the position is likely to result in future capital appreciation, so a willing buyer has to pay a premium to incentivize the owner to part with some of their likely future gain; and in a bear market a rationally informed owner knows that holding is likely to resulting in a capital loss, so the owner has to accept a discount to induce a willing buyer to take that apparently risky position.

There is a natural positive feedback mechanism between forward looking prices and current economic realities. For example, when market prices are bullish, business owners and managers are naturally more willing to risk capital on projects that can yield growth in future earnings (bigger profit margins), and when these projects are well conceived and implemented, the result often is real earnings growth, and thus advances the current economic uptrend; and when market prices are bearish, owners and managers become defensive and work to protect capital, which tends to retard future growth, which propels the current economic downtrend.

There is a natural problem with forward-looking prices. Current prices can sometimes get too far ahead of economic realities or just get it wrong — economic surprises do happen, which results in price corrections stimulated by scheduled and unscheduled news reports and commentary that do not confirm current market expectations. It's this relationship that explains the paradox of how market prices can both lead and lag economic realities. That is, shorter-term price trends naturally lead by attempting to anticipate the economic news; but when that anticipation is wrong, prices correct to quickly reflect the new perception of the economy.

Big professional money managers understand the relationship between a business's fundamentals and the market's expectation of future value, as expressed by a dynamic range of prices, given all the information that is generally available. These large fund managers (a.k.a., the Smart Money, Whales, and Elephants), in terms of skill they bring to the market and the size of the portfolio they manage; they tend to be some of the very best investors in the market and their multi-million dollar salaries reflect that reality, which is money that is drained from the fund they manage (i.e., the fund's expense ratio). Money naturally flows towards the better operators on Wall Street. These whales have the wherewithal to hire a superior team of analysts and traders. They gather all available information and factor that into a proprietary set of valuation models that indicate a fair-value price range for each security they cover and make a market in by virtue of their willingness to always buy at some discount and sell at some premium. When their position size is small and cash reserve high, they do not have to see much of a discount to become a buyer (referring to the figure "Phases of the Business Cycle" or any longer-term price chart, they buy when prices are below the Long-Term Trendline); but when their position is larger and/or cash reserve is lower, they'll need to see a much bigger discount to resume their buying (Economics 101). They will then patiently hold until prices uptrend and show acceptable profit opportunities. They understand that bull markets ultimately produce periods of overvaluation (excessive premiums — the Peak in the figure) and bear markets generate pessimism and excessive discounting (the Troughs). Their primary objective is to trade with the health of the broader market (economic) trend affecting the value of the securities they specialize in, to be a patient buyer at discount prices, a patient seller at premium prices, and to earn the Market Rate of Return on these securities they hold. (Hum, that sounds like a good strategy for investment success; but how can the retail investor take advantage of this wisdom? — Stay tuned.)

These large professional fund managers have to be patient to avoid creating an enormous supply and demand imbalance that would temporarily push prices to their detriment. Their buying (and selling) can easily drive current prices up (and down) to a price level that cannot be justified by the underlying fundamentals. In fact, every once in a while we'll see a dramatic drop in prices caused by a whale cashing out at any available price to be able to jump into some presumably much better opportunity or to just meet some other sudden need for cash; and as a result of their selling, stimulate others to sell too. There's a bit of a herd mentality on Wall Street, where traders and investors will buy or sell just because others are doing so presuming that others know something they don't. But once all that selling is exhausted (once everyone who could and would sell has done so) prices tend to gradually work (trend) their way back to the prior trading range or a new trading range if the original selling was caused by a real change in the underlying fundamentals. Whenever there exist a supply and demand imbalance (the difference between the current number of shares for sale and that to be purchased), prices naturally adjust to correct that imbalance — excess demand (when the market wants to aggressively buy) causes prices to rise and that brings in savvy sellers who want to take advantage of premium prices and that halts the rise and thus corrects the imbalance; and when supply has the upper hand (the market is aggressively bearish and wants to sell) prices naturally drop to attract buyers who are only willing to buy at discount prices and that halts the drop and corrects the imbalance. These whales prefer to be patient and tend to do their buying and selling using limit orders at favorable prices. We're not very likely to ever get access to their proprietary information and plans; but we can easily see the results of their collective operations (their buying and selling) on a chart as these whales scale (average) in and out of their positions at discount and premium prices.

In the chart above we see that market prices in orange move before (anticipate) the underlying economic boom-bust activity in blue. At the top of that chart, we see the sectors that tend to be in favor at the time, which should confirm the move in the broader index. We can work this via sector ETFs.

— Seeing The Market's Big Picture —

Markets are naturally chaotic. Like other chaotic systems, there are apparently random states of disorder and irregularity. From these chaotic systems, we often find emergent systems. Patterns of synergistic behavior that cannot be found in the individual components of the system, just as random air particles can self-organize into weather patterns, like a hurricane. We can use market charts to find and see emergent patterns, patterns that can reoccur at irregular intervals. We may not be able to accurately predict the next occurrence, but we can predict that it will happen sooner or later and when it does, take profitable advantage of it.

Our brains are very good at finding patterns and assigning meaning to the patterns we see. Wall Street lore has identified an amazing number of patterns, and it is often useful to learn about these. But that knowledge is not required, and a foolish reliance on some of these can in fact result in a serious loss of capital, just as livestock can be trained and lead to slaughter. I'll identify some of the standard patterns that are well known and that help me to understand what's happening, to comprehend the Message of the Markets (what forward-looking prices and backward-looking economic data are saying about likely future outcomes). It helps to understand that it doesn't really matter if the patterns we see are real or imaginary or are just self-fulfilling prophecies. Just as in other aspects of life, we need to find and focus on those repetitive patterns that can result in favorable outcomes (pleasure), avoid those patterns (of behaviors) that results in losses (pain), and simply ignored the rest as just so-much-noise and a drain on our valuable time. Let's take a look at some of the standard patterns that I've found to be profitable.

The Markets generates a ton of data every day, and we can train our ourselves to effectively analyze this data to better understand the Message of the Markets. First, we need to understand that the message is basically saying two things: 1) things are likely getting better (trending up) or getting worse (trending down), and 2) the market's collective belief about fair-value prices, which is also known as the current trading range, a Support and Resistance (S/R) Channel (recall our talk about big savvy buyers and sellers stepping in to correct supply and demand imbalances whenever prices are too much of a discount or premium based on their superior analysis). This trading range can also be thought of as a measure of uncertainty about that projected future, a statistical margin of error — the more shorter-term prices deviate away from a sustainable broader market trend, the more likely they are to revert back to that longer-term mean (recall the Statistical Analysis Techniques identified above). Second, we need to develop an ability to not only understand the message, but to also use it to effectively grow the value of our savings (e.g., when Chicken Little is running around saying "The sky is falling.", our best course of action is not to panic, but to study the facts with an open mind and then to take advantage of the best opportunities available at that time; and furthermore, once we realize that the Chicken Littles of the world and their Cheer Leading counterparts on the bull-side have a habit of getting the crowd whipped up and acting irrationally, we can develop a strategy to more effectively deal with these reoccurring patterns, and that's thinking like a professional and a topic for some of the paragraphs below).

One of the very best ways to analyze economic and market data (to understand the message) is to visualize that data, or some aggregation thereof, on a chart over time. Our brains are very good at seeing patterns in the data when presented visually. This is called technical analysis. There are many good books and websites addressing the subject, like The Visual Investor and Chart School. Charts make is easy to spot the market Trend, the first part of the market's message. Charts can also help with the second part of the message, which has two components, Support and Resistance, which creates an S/R Channel, which is a trading range of fair value prices. Support is created by large, well-informed professional value investors taking advantage of discount prices, which exist near the lower end of this channel, and Resistance is created by these same savvy investors taking advantage of premium prices near the top. These Support and Resistance (S/R) levels often look like pivots or waves on a chart [notice the trend reversal patterns (∧ & ∨) in the idealized charts below, these are pivots where the balance of power changes between the bulls and bears]. These pivots are also called peaks and troughs, as seen in the figure above; and the short-term trends into these pivots are called rips and dips. A dip into a trough is a bottoming pivot pattern (∨) on a chart; it's a short-term price trend reversal going from downtrend to uptrend as prices bounce off Support (a short-term market realization of available discount prices, and as a result new bullish buying pressure overpowers the prior excessive bearish selling pressure, and thus creating support and the pivot pattern on a chart). A rip into a peak is a topping pivot pattern (∧) and is a bounce off Resistance (premium prices) where new selling pressure overpowers the prior excessive buying pressure. A primary or broader market uptrend is defined as a pattern of higher pivot highs and higher pivot lows, and a primary downtrend has a pattern of lower pivot lows and lower pivot highs. These pivots in an up or down trend can be referred to as Minor Support and Resistance because in the future we're likely to see support and resistance reoccur in that price range but the odds of that level holding (causing) a primary or broader market trend reversal are relatively low, it would not take much to break that S/R level. We can see examples of Minor S/R pivots in these Up and Down Trend figure. Buy the Dips (buy support in a broader up trend) and Sell the Rips (sell short rallies into resistance in a broader down trend). These trends are likely to continue in the current timeframe until they run into Major Support or Resistance, which is an S/R level that is much more likely to hold and cause a primary trend reversal because a clear majority of traders and investors believe the current trend is overdone, gone too far, and cannot be justified by likely expected economic news and commentary (recall the "Troughs" in the figure above of "Phases of the Business Cycle"). When an uptrend runs into Major Resistance, we're likely to see a classic Head and Shoulders topping reversal pattern (refer to the idealized figure of a Head and Shoulders Top), and when a downtrend runs into Major Support, we're likely to see an Inverse Head and Shoulders. Note that all of these idealized figures are designed to communicate basic technical concepts that can be seen in longer-term charts of the major market indices. But real life is noisy and messy, and these patterns are generally not so clean and clear, especially in real-time and in shorter timeframes. We need to develop the ability to see and trade these technical patterns as they develop because doing so greatly improves our odds of success. Major Support tends to exist at or near the lowest pivots found on daily, weekly and monthly charts and are some of the very best low-risk buying opportunities. Unfortunately, Major Support also tends to have a lot of fear and bearishness associated with it. The best time to buy is on the next higher low on lower volume (the inverse right shoulder). Major Resistance tends to exist at or near the highest pivots found on the same longer-term (monthly, weekly, daily) charts and it is generally best to lock-in some or all of your profits at or before reaching that level (the head). Warning: Major Resistance tends to have a lot of good news and giddiness associated with it, and often prices will fail to make a new higher high on any subsequent good news, just as the last group of buyers jump in. Major Support also occurs when more bad news fails to create a new lower-low, as the last group of sellers panic out at any available price. All this reminds me of the old maxim, "The bulls make money (by going long the uptrend in anticipation of good news) and bears make money (by shorting the downtrend in anticipation of bad news); but pigs and chickens get slaughtered (holding out for even better prices and by buying the good news and selling the bad)!" It is critical that we properly understand both parts of the message of the markets. Most new investors (traders) mistaking focus too much on the first part of the message (the trend), often focusing in on the prior (historic) trend without properly considering that it's the future trend we need to get right, and that requires a greater degree of insight into the fundamental factors driving the broader market trend. Furthermore, most newbie completely ignore the second part of the message (the degree of uncertainty) as expressed by the width of support and resistance channels in longer timeframes, which is just as important as the trend in that timeframe. It's important to understand this two-part message of the market and the associated patterns (in the idealized charts above) exist in multiple timeframes. The big value investors understand that the more prices deviate away from a sustainable broader market trend in the short-run, the more likely they are to correct (be overpowered by bigger forces operating in bigger timeframes).

Prices will naturally trade up and down in a range, called a Support and Resistance (S/R) Channel that reflects the market's collective view of fair-value. Refer to the line chart above which shows an inflation-adjusted cap-weighted composite index of all historic U.S. stock prices. The red arrow line indicates both the direction of the broader market trend and the average price of all this volatility over this extremely long period of time. The two black dashed lines indicate the approximate size of the S/R Channel seen in this timeframe. We should be able to see an S/R Channel like this in every timeframe. As we reduce the size of our timeframe, looking at smaller and quicker intervals of time, we'll see a natural reduction in the size (from top to bottom) of this S/R Channel. Note that the smaller and quicker the S/R Channel the more likely it is for these channels to quickly shift up or down in response to new information. There are many ways that we can draw these channel (trend) lines, and based on those choices, these charts can lead us to different conclusions about what is likely to happen next. It's self-evident that the future tends to resemble the past. Even though life tends to be just variations on a theme with just enough surprises to keep things interesting, there are no guarantees and anything possible can still happen. So, we need a trading and investment strategy that favors us given this economic behavior, like my simple Two-by-Four approach above. These charts can help us to see what is happening now and what has happened in the past. But the further into the future we project our view of this information, the greater the likelihood of a surprise. A good or bad surprise can happen at any time; and these surprises will force us (the market) to reconsider what is known about the past, the present, and therefore the future. It is best to draw these lines like the pros. The pros can still be wrong, but at least we're looking at the data through the same professional perspective. Let's now consider an example Daily chart of the Wilshire 5000 Total U.S. Stock Market Index (refer to that chart). The sample size is one day. Each bar on this daily chart summarizes the trading that occurred on that day. Can you see the S/R Channel? It is unmarked, but we need to train our eyes to see these S/R Channels. Project a set of roughly parallel lines that connect most of the tops and bottom, like in the example chart that has Suport and Resistance labled. The market assumes that premium prices exist near the top of this trading range and that discount prices are near the bottom, based on all the information currently known or believed over the timeframe under consideration. All well-informed investors want to buy low (at discount prices) and to sell high (at premium prices). So the pros try to do their buying and selling just inside the bottom and top ends of this channel. Their goal is to get their orders fill as close to channel edge without missing the next pivot reversal. It's that collective professional activity that creates this trading range. In this context, our goal should be to get some of this price action. But don't worry about getting it perfectly right, the whole trading range, just get some and be a CPT. We could draw in these channel lines and some trading systems do this automatically; but the problem with that is that it encourages us to believe that these lines are fixed, are really there, and that they will always contain all future prices. They are not fixed, are not really there, and they will not contain all future price. History suggests that the bigger and bigger the S/R Channel (trading range), the more and more likely it is to contain most of all future prices, but no S/R Channel will contain all future prices. History also suggests that the more and more prices deviate away from the broader trading range average (S/R Channel mean), the more and more likely they are to return sooner or later; and this is called Reversion to the Mean. Consider the trading around Oct 13 of 2015 on this chart when prices dropped below the green 200-Day Moving Average (MA), which was and is for the majority of time seen on this chart, the relative lower end of the primary S/R Channel seen in this timeframe. I don't recall the news or commentary that caused that break of support and the subsequence sell-off; but clearly there where others who were happy to jump in and take the other side of those trades and the subsequent additional buying pressure overpowered the initial selling pressure and pushed prices back into the prior channel. We see this and variation on this theme all the time. Traders who bought in the channel and then sold on the break, simply locked-in a loss; but those who kept their heads and had a plan to deal with all this, mostly likely locked-in a profit and maintained their CPT status. It's important to understand that these S/R Channels can expand and contract based on overall market confidence. They can also shift up or down as surprising news and commentary hits the market. It helps a lot to have a trading and investment staratgy that has favorable odds in a market with these natural tendencies, like my Simple Two-by-Four Approach above.

Every day, while there is a market venue open for trading, market related trading information (e.g., trading prices and the number of shares traded called volume, and related news and commentary) streams continuously out for all to see and analyze. We can arbitrary summarize all that price and volume data into consumable packets of information that can be shown on a histogram called bar chart. like those seen in this Daily chart. Other example sample sizes include, but are not limited to, 15-minute bars on a 15-minute chart, hourly bars, weekly bars, and even monthly bars on a monthly chart that shows the really big picture. All these timeframes (charts) are simply a statistical aggregation (a standardized summary) of data streaming continuously from the market. That is, we can use our computer systems to take this stream of trading information and break that all down into fixed sample periods called bars, where each bar indicates the high, low, and optionally open and closing prices for that sample period, and that can be displayed on a chart that enables the trained-eye to quickly read the Message of this Market in this Timeframe.

All these sample periods (timeframes) exist simultaneously (i.e., charts within charts and S/R Channels within Channels, a noisy, erratic, quasi-fractal relationship of cycles within cycles). For example, there are four 15-minute periods (bars) in an hourly period (the associated bar seen on the related hourly chart). Also note that larger (bigger) sample periods (as seen on weekly and monthly charts) have bigger price ranges than those seen in smaller (quicker) sample periods or timeframes (like on daily, hourly, and even quicker charts). The shorter the timeframe, the more random the price movements are, a noisy Poisson Distribution, as buy and sell orders hit the market in random clumps creating temporary supply and demand imbalances. In all timeframes there will be visible price trends and S/R levels created (driven) by news and commentary about the economy, the market and related sector indices, and the various securities that comprise the indices, which can all be charted (studied to find divergences in the related data and see Fibonacci Retracements as prices trend between bigger S/R levels and thus define smaller S/R levels). R.N. Elliott was the first to write about this market behavior of cycles within cycles (he called it waves within waves); and Frost and Prechter's book Elliott Wave Principle: A Key to Market Behavior may be the definitive textbook. I can personally see this wave behavior from time-to-time, but I believe the market is just not that well-structured all the time. It is way too easy for some surprising bit of news or commentary to perturb this behavior. But once surprising news or commentary is priced in, we often do see market prices resume a revised version of this Elliott Wave behavior until the next surprise hits the market. The pros understand stuff like this and you can learn about it too and in time you should develop the ability to see cyclical patterns like this too. But you don't have to learn it all to make money. Just learn how to be a CPT and let compounding do the heavy lifting. Of course the more of this technical trading stuff that you can master, the better equipped you'll be to become a CPT in the next quicker timeframe and to enjoy the higher rates of return available to compound in that timeframe.

The shorter the timeframe (e.g., 1-, 5-, & 15-minute charts) the more the price action will be dominated and to some degree manipulated by professional day-traders and their super computers. But the longer the timeframe (e.g., hourly, daily, weekly & monthly charts) the more the price action will be dominated by big value-based fund managers who are focused on the underlying economic realities of the business. That is, the bigger the timeframe the greater the market participation, the bigger the S/R Channel, and the greater tendency of the participants to take a longer-term view of the business, and therefore a better reflection of the likely future value of the securities issued by that business. All big moves naturally start in smaller timeframes, but most pivots seen on shorter timeframes are likely to be minor in nature and the associated trends are likely to reverse just after becoming clear. It's generally best to start with longer timeframes where the patterns (S/R Levels and Trends) are easier to see and more likely to be true (a better indication of the future). It's much easier to become a CPT in longer timeframes, then work to become a CPT in quicker timeframes to realize a better rate of return. But understand the quicker the timeframe the harder is becomes to maintain CPT status because you are trading against better and better trading systems.

The market trend of an S/R Channel (trading range) will attempt to lead (anticipate) the broader economic trend, as best indicated by the popular 20-, 50-, and 200-period simple Moving Averages MAs. These MAs can be thought of as automatic trend lines, and they naturally smooth out the noise created by shorter-term price volatility. The 20-period is the short-term trend, the 50-period is the intermediate-term trend, and the 200-period MA is the long-term trend line. Some professional investors also like to include the 100-day MA on their daily chart; but it is technically the same as the 20-week MA on the weekly chart (5 trading days in a week times 20 weeks is 100-day MA). I like to keep it simple and standardized on each chart. I find the prior three (the 20-, 50- & 200-Period MAs) to be about right in all timeframes and for just about all tickers. Instead of trying to shove it all into a daily chart, I find it is best to use multiple timeframe charts (e.g., monthly, weekly, daily, & hourly) to better see the size of the various trading ranges in each timeframe and to see the perspective of those professional operating (specializing) in each timeframe. As prices approach these MAs, we tend to see natural S/R Level stalls and bounces. Future trend reversals (pivots) are more likely as prices approach an MA that is also at or about the same price level as a prior pivot reversal. Savvy investors assume that relative premium prices naturally occur above the 200-day MA and relative discount prices exist below this MA. They use longer-term MAs to set their trading bias (bullish or bearish). For example, if prices are trading above the 200-day MA, they only look for bullish investments opportunities; and they use a break below this MA as their final stop-loss trade to harvest profits. Note that many professional traders prefer the 50-period MA; but like the 20-period, these quicker MAs tend to be too whippy for developing investors. These pros know that all securities trade around their broader market averages, as seen in longer-term charts (e.g., monthly, weekly and daily), when not being driven by specific news; and that trends in longer timeframes tend to overpower trends in short timeframes. News and commentary naturally cause corrections and adjustments in these S/R Channels. The pros use technical analysis to see the broader market trend, the health of that trend, and to spot prior support and resistance levels, which indicates likely, lower-risk, buy and sell opportunities for limit orders that facilitate their plans to scale (average) in and out of their positions as shorter-term S/R channel move up and down within the S/R channels seen in bigger timeframes (longer-term charts). We can trade and invest like the big professional investors too. I do my planning to scale in and out based on what I see in the various timeframes. I try to make capital gains as quickly as I can, in the quickest S/R Channel timeframe that I can be a CPT. But when Mr. Market surprises me, I'm also happy to be paid to wait and to manage my averages as prices shift up and down in bigger timeframes. So long as my operations are in-sync with health of the broader market trend (how prices are trading relative to longer-term MAs in longer-term charts), making an acceptable total return on the current position is just a matter of time and effort. Feel free to try other MAs on your specific tickers; but I think it's best to see things the way most professional traders and their computers see things. If it helps, feel free to include the 100-day MA on just your daily chart. Bottom line, you want to do more of whatever puts money in your pocket and ignore or avoid things that cost you money; and never forget that it is easier to realize CPT status in longer timeframes.

Refer to the Candle Stick Chart of the Wilshire 500 Total Stock Market Index (ticker symbol $WLSH, click on the chart to see a current chart). From a broader timeframe perspective, it is in a healthy uptrend, current prices naturally trade above and bounce off or near the popular 20-, 50-, and 200-period MAs as they advance in anticipation of changes in the underlying economics. In a healthy up trend, it is common to see slightly higher (above average) volume on the advancing bars and slightly lower volume on the counter-trend bars. It also common to see much bigger volume on major trend reversals (e.g., Sep 19 & Dec 19, 2014). When prices get too far away from these MAs, the trend becomes less healthy, looses steam, and generally put in a quick counter-trend pull-back to test support off a rising MAs before resuming the primary uptrend. A healthy uptrend has a pattern of higher pivot highs and higher pivot lows, and tends to have current prices trading at or a little above these MAs; and a healthy downtrend has a pattern of lower pivot highs and lower pivot lows, and tends to have current prices trading at or a little below these MAs. This example chart has all the major pivots marked with their relative high or lows prices. The primary trend become less healthy and more likely to reverse as prices and the 20- and 50-period MAs get spread-out vertically (e.g., Nov 24), and is very unhealthy when we see near-vertical price action on much bigger than average volume (e.g., the week of Oct 13). By adding RSI and MACD technical indicators to our chart, we're better equipped to see the health of the trend as it gains and loses momentum, to see when prices are overbought (e.g., RSI in the week of Nov 24) and oversold (e.g., RSI in the weeks of Oct 13 & Dec 15), and to spot unhealthy Divergences (we'll take a closer look at these last three technical topics in context below, and but it might be best to first consider the excellent, free, professional instruction offer by StockCharts.com — as my old Prop Trading Mentor use to say, "You don't want to show up to a professional gun fight with just a pocket knife.", ideally we want to be able to read charts like the pros). These healthy and unhealthy patterns can be seen in just about any other chart or timeframe, and we need to learn how to spot them and how to play them (i.e., we need to learn how to improve our odds of success).

One of the first things new traders are told or they eventually learn the hard way, "The trend is your friend." and "The easiest way to make money is to trade in the direction of the broader market trend." and all this trend trading naturally powers the current trend forward. But human nature being what it is, it doesn't take much for short-term traders to push the current trend to an unrealistic extreme (i.e., the rate of change in prices cannot be justified by any sustainable rate of change in the business that issued the security or the broader economy). Whenever current prices and the 3 popular MAs get spread out vertically on a chart, prices a subject to correction (e.g., in late Nov. of 2014 and then again a month later, prices correct to test support near the rising 200-Day MA). A large and mature economy like in the U.S. seems to be able to grow at a slow and steady rate of something like 1 to 4% annually and can do this for a very, very long time; but growth rates at much above 5% or when growth accelerates too quickly, create natural economic imbalances and instabilities (this is actually true for any rapid rate of change, recall the old adage "How to boil a frog."). At best, these instabilities can lead to diminishing rates of return or at worst can cause an economic crash, like in 2008. Whenever prices move too far and then fail to move future on more good or bad news, the trend is likely to reverse. The market will always find some reason to justify a normal correction (a sharp pull-back toward an MA, as repeatedly seen in the chart above or in just about any other chart using these professional settings); and when prices get way too far ahead of the fundamentals, we're very likely to see a primary trend reversal and that trend will likely continue until it too becomes overdone. The easy money is made trading with a healthy broader market trend and the big money can be made trading against an unhealthy trend. But this later trick requires real skill to pull off and can be very costly when done with too much capital in the learning phase, but it's a professional-level skill that is well worth the time and appropriate capital control to develop.

The health of the Broader Market Trend is indicated by the price pivot patterns relative to the popular 20-, 50-, 100- & 200-period Simple Moving Averages (SMAs or just MAs), volume, and a momentum oscillator (like RSI or MACD) on the monthly, weekly, daily, and hourly charts (refer to the CandleStick Chart of the Wilshire 500 above or any longer-term chart using these MAs, and with industry standard settings for Volume, RSI and MACD as seen in the chart above). Also, on longer-term charts, like monthly, weekly and daily, use logarithmic price scaling and all intraday charts use arithmetic (linear) scaling. A healthy trend has:

1. A rate of change that is sustainable as indicated by the spread and slope of current prices and these three MAs. A slow and steady rate of change can grind on for a very long time, but a rapid move up or down is unsustainable.
2. Prices tend to bounce off the 20-, 50-, & 200-period MAs. An uptrend has prices above these MAs and finding support when price drop to a rising MA, and a healthy downtrend has prices below the MAs and finding resistance when rallying to a declining MA.
3. A healthy up trend has a pattern of higher-pivot-highs and higher-pivot-lows, and a healthy down trend has a pattern of lower-pivot-lows and lower-pivot-highs.
4. We tend to see slightly higher volume in those price bars moving in the direction of the broader market trend then those moving in the counter trend direction, and
5. RSI is between 50% and 70% when the trend is up or between 30% & 50% when the trend is down.
6. RSI and MACD are not showing a divergence, a loss of momentum.

An unhealthy trend has one or more of the following:

1. Near vertical price movement (a wide range bar preceded by a number of slightly smaller bars in the same direction) on increasing volume to reach something above the average volume. This is the classic sign of blow-off top or bottom, which is often followed by a much lower volume on a (failed) re-test of the prior high or low. The failure to make a new lower-low or higher-high creates the classic head-and-shoulders reversal pattern (above).
2. RSI is above 70% (overbought) when the trend is up or below 30% (oversold) when the trend is down.
3. A divergence between RSI or MACD and current prices. This is the classic case of the dominate group (bulls or bears) simply running out of ammunition (power) and that we're in need of a correction before continuing in the direction of the broader market trend.
4. A somewhat unorganized sideways movement (a basing pattern), where current prices and the three MAs begin to intertwine with numerous false breakouts and breakdowns as volume dries up. In due time, which could take a lot of time, there will be a real breakout or breakdown, generally in the direction of the prior broader market trend, on real volume, with the best entry being on a failure to re-enter the prior basing channel.
5. The market or stock is charting CRAP [Can't Recognize A (favorable) Pattern]. Trading a crappy, sloppy, aimless pattern (market) tends to be a costly waste of time and money.
When you see CRAP, it's best to just sit on our hands or (better yet) go find something else to do.

Classical technical analysis says, "Favor the longer-term trend over the shorter-term." and that's why we should always start with longer-term charts first, but all long-term changes start in the shorter-term; so, we must figure out which applies now (i.e., "Is the latest short-term move the beginning of a major turn or just so-much-noise?"). The best way to answer this question is to consider the health of the broader trend because when that trend becomes unhealthy it becomes more likely that a stronger shorter-term trend will be able to create a primary turn in the broader trend.

Read Technical Analysis 101 on StockCharts.com, and look at as many charts as you can. View each ticker on your Watch-List in multiple timeframes (e.g., on weekly, daily & hourly charts). See how these charts evolve over time. Initially you we see a lot of CRAP. But in time your brain will surely develop the ability to see these favorable patterns, to understand the Message of the Markets — the broader market trend, the health of that trend, and the trading range in each timeframe. CRAP tends to be more common in shorter timeframes when there is a lack of economic news and the markets are dominated by professional day-traders. When you see CRAP, always refer to the next longer (bigger) timeframe. If there's a favorable trade in the current market, that's where we'll find it; but it may require some patience to wait for a favorable entry or for a near-term entry to reach a favorable exit. Patience is one of an investors greats assets (i.e., having an ability to wait for Mr. Market to deliver favorable prices), and is the key to mastering Rule 3 of my Simple Two-by-Four Approach.

— Three Classic Trading Strategies —

Let's review the three classic trend trading patterns below. These are all promoted by Wall Street Talking Heads, talk that's designed to get us and keep us trading. Every time we make a trade, Wall Street gets to feed on our account thanks to trade commissions, fees and slippage. Let me also point out that learning how to profitably do the following in quicker intraday and daily chart timeframes is very difficult; but not so hard in slower timeframes, like on a monthly and weekly.

1. The first strategy is a basic Trend or Momentum Trade (a.k.a., trend following). The basic idea is to buy winners and sell loser with the assumption that whatever is/was working will continue to work. Go with the broader market trend, as it thrusts forward. We enter (or add to) a position after prices have corrected (after retracing), putting in a pivot (e.g., finding support in an uptrend), and begin to trade with the primary trend again, and thus pushing the primary trend forward, as seen in the idealized (Up Trend) charts above. Stay-in (hang-on) until the up trending pattern breaks by hitting our stop-loss exit. Thus earning most of what the market is willing to offer up. As prices thrust forward, in the direction of the broader market trend, we ratchet our stop higher, like under the next higher support level (pivot) or some appropriate faction of the current Average True Range (ATR). I prefer to think of ATR as Average Trading Range, but I didn't get to name that indicator. I like to start with a third ATR as my first stop advance, then a half, and so on. Market prices need wiggle room. There is some skill required to know what's a good trade-off between allowing the trade enough wiggle-room to stay in and when there's too much profit at risk to allow the market to quickly take it all back. It pays to specialize, to know how a particular ticker behaves. Also refer to the candlestick charts above and below that show prices bouncing off a rising MA. Buy a bounce off the rising MA. Profitably exit when the primary trend shows signs of reversing by either going vertical on bigger-than-average volume or when the trailing stop-loss is trigger. Some bigger traders like to sell a little, booking profit on the thrusts into near-term resistance, and then buy back in on the next retracement into support. This is the basic idea and there are a million ways to play it. Find what works for you in longer timeframes and then try to reproduce that success in quicker timeframes. Start small, earn CPT status, and then add size slowly.
2. The second basic strategy is called a Mean Reversion, S/R Channel or just Swing Trading. This trade is based on the belief that prices are most likely to remain in the current trading range, thanks to natural reversion to the mean (i.e., market trades spend most of their time scattered or swinging around the average price). The basic idea is to carve out whatever profit exist within that trading range (S/R Channel). The entry is basically the same as the first trade above (trade in the direction of the broader market trend), except that we have a fixed profit and loss target (two preset exits), each set before we enter the trade. The profit target exit is the other side of the current trading range or channel, and the stop-loss exit is a break of the entry side of the channel.
3. The third strategy is called a Breakout (a new uptrend after a price consolidation) or Breakdown (a new downtrend) Trade on surprising news or commentary. This is a trading strategy made popular by Richard Dennis and his Turtle Traders. As noted above, most prices trade in a range, a basing pattern (a sideways trend), and this third classic trade has us enter on a break of a narrow S/R Channel (a price consolidation), ideally on a successful test of the prior S/R level conversion on the break, with a profit target much like the first trade above (i.e., whatever the market will yield) and a stop-loss on a subsequent failure of the entry test. Note that many of these Breakout and Breakdown Trades fail and are just a shift up or down of the current S/R Channel. The primary reason for a failure to run is that most market prices have some rationale connection between price and expected future value and the big move generally requires a passionate disagreement between two very active groups, the bulls and bears that specialize in that market. The few that tend to work (i.e., really run long and hard) are already popular momentum trades or just thinly traded stocks (i.e., not that many shares available to trade) thus making it easier for the dominate group of pros to push around for a little while. Until you've mastered the first trades two above, it's best to avoid these breakout and breakdown patterns as these plays are no beginner's game.

All three of these popular trading strategies are much easier said than done, especially in shorter timeframes; however, it's generically not too hard to learn how to play (consistently profit from) the first two when applied to longer timeframes (i.e., convert these trades into more of an investment strategy). Note that number three above (the breakout or breakdown trade) becomes a number one (a trend trade), when the break is real (i.e., is fundamentally well founded), and we enter on the first pull-back (e.g., buy the dip). Learn how to master the first two trading strategies above in longer timeframes, and then try to reproduce CPT results in slightly quicker timeframes because rate of return is a function of time with better rates occurring in quicker timeframes, which is a primary reason why most try shorter timeframes first, a classic beginner mistake. To better understand technical analysis and the professional trader's perspective, consider taking Corey Halliday's Start Trading Socks Using Technical Analysis, Parts 1 & 2, and Advanced Technical Analysis, Parts 1 & 2 offered on Udemy.com.

If you find yourself losing too much of your capital trying to trade these simple patterns, it is very likely due to one or more of the following reasons:

• You're not trading with the broader market trend as seen on longer-term charts,
• You're not trading a healthy (sustainable) trend (e.g., the trend has already gone too far and is now reversing or basing out),
• You've not yet mastered protective stops and the old trader's maxim of Cut Your Losers Short and Let Your Winners Run, or
• Your timeframe is just too quick for your ability (you're effectively unequipped to out-trade the professionals that specialize in that security in that timeframe; furthermore, try not to confuse the ability to get lucky now and then with the real ability to consistently grind out a positive rate of return over time, which becomes harder and harder as you reduce the size of your trading timeframe).

Only an Idiot would seriously expect to beat a professional short-term trader at their own game on their home court. Don't be a Trading Idiot. Please understand that very few will ever develop the skill needed to effectively grow the size of their brokerage account as a short-term trend trader (i.e., an ability to effectively play the Winner's Game). That's the bad news, and one of Wall Street's dirty little secrets. Most professional day-traders make their livings by specializing in just one security or a small number of similar securities and by mastering just one strategy or a few variations on that strategy, which enables them to out-trade most retail wannabes most of the time and by legally front-running the Elephants. Their chart reading abilities allow them to see what the big fund managers are buying and selling, and they get in front of that short-term trend. They also know how to plant or exploit news and commentary in the popular media. Learning to succeed as a day-trader requires a very specialized set of tools and talents, and very few will ever be able to enjoy the amazing proceeds over time because it's probably the most competitive arena open to lions, lambs and jackals alike.

But wait, there's good news too! An investor (a longer-term trend trader) who understands the information presented in this paper can grow their wealth in the markets, by first learning to invest with the big (smart) money (to trade with the Elephants) by focusing the bulk of our time and capital on large, mature funds managed by these Elephants (and that gives us a real hold option, which allows us to avoid all or almost all of these little trading stop-losses while avoiding most big mistakes); and then learn to trade against these Elephants (learn how to use charts to see where these Elephants are doing their buying and selling), who are just too big and slow to compete against smaller traders using the same tactics (small traders can generally get in and out quickly without impacting market prices).

Most professional traders are paid to trade, and they have to trade every day. You do not. Some days are better than others (i.e., some days have a clear trend and other days are just CRAP). They have to trade every day; and their trading and tactics can sometimes move prices to ridiculous extremes in that timeframe. As a retail investor, we can wait for trading opportunities that favor our growth. Let's the pros beat each other up and just wait for them to bring favorable prices and trends. Only make a trade when doing so puts the odds of success in our favor.

First learn how to keep your operations in-sync with broader economic trend, the boom-bust business cycle. Learn to exploit the natural benefits of Dollar-Cost Averaging (DCA) a mutual fund (an example of a survivable investment), which does not always require a stop-loss when the short-term trend turns against your position (i.e., when a quick break of the entry level occurs). In fact, we can use that counter trend move to improve our odds of success by reducing our cost-basis (the average price per share, which is also the break-even price of the investment). DCA works because it tends to generate a cost-basis that is below the average price seen in the trading range (the S/R Channel) over longer holding periods, which makes it much easier to harvest a profitable investment in a future cyclical upturn. Warning: Only do this with securities that are very likely to survive the business cycle. Survivable securities are issued (backed) by large, mature businesses (that have been operating for at least a decade and the ticker can fill a monthly chart), enjoy a naturally diverse asset allocation and/or a geographically diversified revenue stream, are run by seasoned managers with a high degree of integrity, have a viable business models going well into the foreseeable future, and they operate under western (GAAP) accounting and legal standards. Once again, large, mature mutual funds are an excellent example of a survivable investment.

Over shorter periods of time, the size of the economic pie is pretty much fixed and short-term traders have to fight over the pieces, and market functionaries will feed off both the winners and losers alike; but over longer periods of time, the size the pie can and will grow, easily overcoming transactions costs and market inefficiencies, and that's where the slow and easy money will be made by patient investors who hold survivable claims against that bigger pie. To grow your account as a short-term trader, you not only have to be better than average, you have to be far better than average to also overcome transactions costs, market inefficiencies, plus the cost of a competitive trading system and high-speed information, which can add up to a considerable sum of money that can easily exceed a thousand dollars a month. Successful short-term traders have to be able to win the winners game and be able to bear the associated costs until they reach that level of performance, if ever. But let's not curse these professional short-term traders. They are actually a savvy investor's unwitting prey. Because they are natural trend traders and they will, sooner or later, push the current trend to ridiculous (cyclical) extremes. They also provide the liquidity we need (they're almost always willing to take the other side of our trade). It's these two endearing qualities that make it easy for a patient investor to get in and out at favorable prices (near primary trend reversals at major support and resistance levels). It's all about learning how to take advantage of Mr. Market's foolishness.

— A Closer Look At Market Cycles —

A Bull Market in stocks begins before the Economic Cycle bottoms out (refer to the idealized diagram Sector Rotation Model, which identifies the market sectors that tend to do best in the various phases of the business cycle). Notice that the stock market (the red cycle) bottoms well before the economy (the green cycle) bottoms out, while going into Full Recession. This is because the market is, once again, forward looking and the economic data is backwards looking.

Bull markets are born in despair, grow amid skepticism, mature in optimism, and die amid euphoria. — True market wisdom from Sir John Templeton.

These business cycle trends are very long lived, often running for years; this is because of a positive feed-back mechanism that powers the current trend forward until it is clearly overdone, and even though the data is backwards looking, knowledge of the current economic trend and this cyclical relationship can still be a profitable guide to the mostly likely future market trend. Wise portfolio managers keep their operations (long or short) in-sync with the health of the broadest market (economic) trend, and when that trend turns against their position they close or a least greatly reduce the size of that position, understanding that a relatively small stop-loss now is far superior to a slow longer-term reduction of wealth and thus frees up buying power to invest in more productive prospects.

Economically sensitive securities, like stocks (e.g. VTI) and corporate bonds (VCIT), do best in times of economic expansion (Early Recovery); and the best time to start these positions is in Full Recession. Start buying (averaging into) economically sensitive issues when the economy looks completely busted. This is when these securities are ready to move up in prices because weaker businesses have already gone out of business, survivors are taking market share, and interest rates have already come down and have stabilized at or near longer-term lows, and all this is good for surviving businesses going forward. From a technical (chart) perspective, this is when prices fail to go down on new bad news. Once the economy starts to recover, reduce the size and duration (average time to maturity) of portfolio bond exposure before interest rates start to rise (a rise in interest rates means a drop in bond prices and the value of bond funds — the worst time to be in bond funds is just before rates start to rise because prices will drop). Investing in shorter duration tenors (similar debt securities with the same length of time to maturity) will drop less while still paying the advertised yield and providing a hedge against surprises. The term tenor describes the length of time remaining in the life of a financial contract This is a time to "buy (stocks in) the dips and to sell (into) the rips" or simply just be long stocks (especially in taxable accounts) until the market shows signs of topping out.

Assuming no catastrophic major economic event or a string of significant minor events, the stock market will naturally top out after interest rates have risen to near longer-term highs to better compete with stock returns, to cool off an unsustainable rate of growth, and excess inflation. At an economic top, the economy is reaching full or near full production, and resources (like labor and commodities) will have become scares and expensive. Recall that market prices are anticipatory (forward looking), so market prices will top-out before the economy tops-out; but there will be times when the market incorrectly signals a top. At a real top, news of great stock market returns will lead popular media reports, money market funds will be paying nice yields (e.g., better than 3%), and businesses will be reporting their Best News Ever. But stock prices will be unable to put in new higher-high. We'll see a Head and Shoulders topping pattern on longer-term charts. On new good news, prices will open up in the morning, but will close near the day's low. This is because big professional investors are now selling stocks to the last group of retail investors, who are finally convinced that it is now safe to get in; and we're all starting to think, "Making money in the stock market is easy!" and "Maybe I can do this for a living." At a stock market top we're likely to see an inverted yield curve, which indicates trouble ahead. An inverted yield curve is always preceded by a flat yield curve But not every flat curve results in an inverted curve. Let's that flat curve be your warning signal, especially when market prices fail to make a new higher-high on more good news.

U.S. Treasury Yields

The U.S. Treasury yield curve is the interest rate structure running from short-term bills, through intermediate-term notes to longer-term bonds of similar quality debt, like U.S. Treasuries. Normally, shorter-term debt has lower rates relative to longer-term debt because the longer the time to maturity the greater the risks associated with that type of investment, and therefore the higher the rates need to be to attract new investors. [By-The-Way: The term "Tenor" is often seen when looking at the market for debt securities. It refers to a specific class of debt securities in their time to maturity (e.g., a batch of new U.S. 10-Year Treasury Notes at issue have a tenor of 10; but after 5 years, those notes will have a tenor of 5, the same as a batch of new 5-Year Notes). Tenor is an easy way to identify an identical set of securities when looking up a price quote.] Inversion (often referred to as the "2-10 Spread") is caused by the government pushing up short-term rates to cool of economic growth and big professional investors rotating out of stocks (harvesting profits) and averaging into longer-term government bonds (buying bonds bids up the prices, which pushes down yields). When we see this inversion, we want to Swim with these whales (trade like these big savvy professional investors) — it's best to harvest our long-term stock gains (average out) and start buying (averaging into) top-quality government or agency bonds or bond funds in the intermediate range (5-, 7- and 10-year notes). Try not to worry about selling the perfect shorter-term top in stocks and buying the perfect near-term bottom in longer-term bonds, that is an almost impossible task. There's an old saying, "Price take the escalator up and the elevator down." Once it's clear the top is in, everyone will want out and that's when prices drop like a rock. Try not to be in that crowd. You simply want to be in-sync with the bigger, longer-term boom-bust cycle, just like the big guys.

	A Normal Yield Curve (e.g., August 14, 2002, which is the red line on the blue-white chart shown to the right next to the associated stock chart of the S&P 500) rises from 3-Months Bills (3M on the very bottom left of the x-axis or time scale of the chart) to 30-Years Bonds (30Y on the bottom right) and is generally good for both stocks and corporate bonds. Note that StockCharts.com, which generated these charts, identifies the shape of the curve in the lower right corner of the chart (in this case "Normal"). This normal yield curve indicates that as time to maturity is added to the debt, so is the cost of that debt (the interest rate shown on the y-axis).
	A Flat Yield Curve (5Y to 20Y; e.g., Jan. `00; a.k.a., a Humped Curve) is not good for stocks nor corp. bonds, and prices tend to base out and down, and are often very choppy. This is a good time to harvest profits and generally raise cash because every Inverted Curve becomes Flat first, but not every Flat Curve becomes Inverted.
	An Inverted Yield Curve (short rates are higher than long rates, e.g., Aug. 2, 2000) is bad for stocks and good for government bonds, and signals the start of a new bust cycle (a bear market in stocks). An Inverted Curve often leads the next downturn by 6 to 12 months, depending on how strong the economy is running. A strong economy will take time to cool off, but a weak system can quickly fall off a cliff as investors dump their stocks and flock to the safety of government bonds. Note that banks and other lenders fundamentally make money by borrowing short and lending long. This means that they take in deposits that earn a relatively small yield (checking, savings and money market accounts, and most CDs are all examples of shorter-term bank borrowing) and they lend money at higher (market) yields for longer periods of time and they earn the difference, which is called the spread. As the yield curve flattens and then inverts, leaners lose this ability to earn the spread. So easy money dries up, and the economic fire is starved of fuel.

The credit cycle boom and bust factor needs to be considered. When money is cheep (rates are low) businesses often find it easier to justify growth projects and acquisitions, expecting new sales revenue to cover the cost of the debit while yielding an attractive rate of return for taking on the risk. If all goes as expected, there is real economic growth and value creation; but if the expected sales do not show up as expected or an economic downturn is sooner and/or deeper than expected, the excess debt can cause a firm to file for bankruptcy. Bankruptcy is always bad for bond holder, as they lose all future interest payments and only get back pennies on the dollar; and is almost always (~99% of the time) deadly for stock holders that hold out for a White Knight, which is often talked about, but almost never shows up until the assets are being sold to pay the debt holders. When a firm declares bankruptcy, it's almost always best to sell sooner than later to avoid further losses; the investment has already gone bad, don't wait to see it go from bad to worse. Note when one firm in an industry group declares bankruptcy, the market will often sell every firm in that group, which can be an opportunity to buy the best of bread at discount prices, which is likely to survive (if they do not have too much debt) and take sales (market share) from the bankrupt company. Beware of securities backed by companies with excessive debt loads (i.e., Debt-to-Equity Ratio greater than average for the industry group in that part of the boom-bust credit cycle). It's best to avoid young, smaller companies because they may not have what it takes to survive this cycle. It's best to own these through mutual funds.

Fundamentally speaking, bear markets are caused by RSVP — Recessions, Shocks, (excessive) Valuations, and (stupid) Policies.

• A Recession is a general slowdown in economic activity caused by consumers and producers (businesses) reducing their overall level of spending and investing; and it is usually a self-inflected wound and requires real leadership to change the herd mentality (believe it or not, folks can talk themselves into believing a recession is coming, increase their savings, thus reducing expenditures and cause the actual recession feared) and/or the structural problem causing the economic weakness. Since WWII, half of all the recessions were caused by the FOMC raising rates too quickly or keeping rates high too long; and the last time that happened was in the early `80 where Volcker did this on purpose to break the back of inflation. All other recessions where caused by bubbles popping, which is arguably caused by the Fed holding rates too low for too long. Recessions are not caused by the calendar, they are caused by economic activity or the lack thereof. They are almost impossible to predict, and the stock and bond markets have accurately predicted about half.
• A Shock is a negative economic surprise, like an earthquake or a terrorist attack that destroys a significant portion of the economy. A big shock or a batch of smaller shocks while the economy is perceived to be venerable, which causes businesses and consumers to go into survivable mode (become defensive) can result in a recession, which is generally proceeded by a bear market in stock. It is very much a confidence game. Stock and Bond market prices, two leading indicators, can change economic perceptions from bullish to bearish (from Risk-On to Risk-Off) and vice versa.
• Excessive Valuations, as measured by P/Es, which is basically the number of dollars an investor is willing to pay for a dollar of growth. A popular measure is the Rule of 20, which is the sum of the market multiple (P/E of the S&P 500) plus the rate of inflation should not exceed 20. Alternatively (and perhaps better), we can compare the current P/E for an individual index or security relative to the long-term averages and economic alternatives. Excessive valuations caused by investor euphoria are classic indications of a market top.
• Stupid government Policies tend to be the straw that breaks the camel's (the economy's) back and is the last primary cause of an economic downturn. There are two types of policy changes that can affect the economy on the margin, fiscal and monetary policies. Two classic examples of dumb fiscal policies are protectionist laws (e.g., tariffs) designed to help a deemed necessary business or some underdog sector, and excessive regulations that attempts to protect society, but ends-up causing more pain than it relieves. In both cases, the intention sounds good, but the overall long-term result is negative, they both simply fail the cost-benefit test. Classic examples of dumb monetary policy include moving interest rates up too quickly (the economy and society can adapt to just about any change when that change happens gradually and is well telegraphed) and holding rates down too long, which tends to result in a rapid acceleration in rates to undo the problem created by excessively cheap money (when money is cheap, any dumb idea can get funding, and it is never good to fund too many dumb ideas). There's an old saying that's worth remembering, "The Fed will raise rates until they break something in the banking system.", and then they must lower rates. Thus, helping to promote the classic boom-bust cycle. Economically healthy monetary policy should meet the bond market's expectation with a small lag — believe it or not, the big bond investors and traders really are the smarts guys in the room. I believe the best thing the FOMC can do is: 1) be the lender of last resort (to keep otherwise economically viable banks and businesses from going under due to a sudden lack of confidence), 2) to be the banking system supervisor, which should also require the removal of all unfit senior managers (banks make money by barrowing short-term, think customer deposits, and lending longer-term on leverage, earning the spread between normally lower shorter-term rates and higher longer-term rates, but that leverage can be the source of the next banking problem when not properly supervised, plus banks also earn related banking fees), and 3) be the senior economist in the room (to calm markets and to help everyone understand the big picture — it's natural and healthy for the economy to go through big, slow-rolling boom and bust cycles). According to Milton Friedman, monetary policies work with long and variable lags. The other big policy mistake is going to war. The cost of going to all-out-war (win or lose) has killed more economic systems (civilizations) than any other cause, a historic fact that we're doomed to repeat. The hall markets of a pre-recession environment are lower market prices that are due to lower bottom-line (EPS) profits because of lower top-line sales or falling profit margins (higher costs) and lower business investment that is due to a loss of business confidence because of a loss of clarity about future sales prospects and/or a disruption to normal supply-chain business relationships.

Technically speaking (chart analysis), minor trend reversal tend to happen when RSI is overbought or oversold and, a primary (major) trend reversal is likely when chart indicators (like RSI and MACD) are showing divergences. Even though prices are making a pattern of higher-highs and higher-lows in an uptrend (refer to the idealized Up Trend figure above), these technical indicators (RSI and/or MACD) are not, thus signaling a loss of momentum. The market for the security being analyzed is losing buying power, few are left to drive prices even higher, and prices will fail to move up on good news because large savvy fund managers (the Whales) are selling and thus creating major resistance. This is when prices actually do fail to make a new higher-high (refer to the idealized Head and Shoulders Top figure above). It is a time to seriously reduce the size of economically sensitive positions (stocks and corporate bonds). In fact, it's good to start averaging out when we see the divergences on longer-term charts. It's always best to sell when we can and not when we have to. Try to be out well before prices establish the first lower-low. Trying to sell the top is a fool's errand. Once it becomes clear to the market that the primary trend is turning (or worse has turned), there will be a race to the exit and that will propel the new downtrend forward. There will likely be an initial fading of the new selling surge as a few die-hard longs try to take advantage of new lower prices (thinking that they can still buy the dips), thus creating the next lower-high (the right shoulder) and thus signally a new bear market trend. In the subsequent bear market (refer to the idealized Down Trend figure above), every new lower-high is an opportunity to sell (short) economically sensitive issues like index ETFs (and to cover those shorts in the next or some future dip, a lower-low). In a bear market, it is the time to own top-quality defensive issues, like government bonds (e.g., VGIT) and maybe XLP & XLU, which do relatively better in times of economic contraction. Bear markets tend to end with a near-vertical downward price move on above average volume followed by a snap reversal back up, a classic Inverse Head and Shoulders pattern. This pattern is created by amateurs selling their longs because they're afraid of losing everything (panic selling), longs on margin are forced to sell by their broker to avoid losing more than the value of their account, and professionals are selling short to ride the downtrend down. It's all this selling that causes the high-volume near-vertical price action. But at some point, the selling will become exhausted (everyone who has to sell or wants to sell will have already done so) and the vertical price movement will start to slow down; and it's at this point that the big savvy traders start to pile in on the long side (creating major support) and that forces the shorts to cover (more buying). It's all this new buying that causes the new primary uptrend to be created, often leaving a bottoming tail after three or more red (down) bars on the chart (refer to the figure of a bottoming tail after a number of red bars and a topping tail after a number of green up bars). This paragraph has been very technical, a bit idealistic, but nonetheless, a description of what actually happens time and time again! Another one of Wall Street's dirty little secrets. Now that you understand what happens and why, learn how to see these patterns in real charts. Unfortunately, real life and real charts are messy (very noisy). Understand that your broker will not allow you to trade the middle of the chart. You have to trade the hard-right-edge as real-time trades create historic price patterns, which mean you have to develop an ability to see these patterns as they are being created, and to have a plan for what you'll do if the pattern runs its likely course and for what you'll do if the pattern fails to develop. It is this ability that separates the pros from most other market participants; but nonetheless, a valuable trading skill that can be developed by armatures with a fair amount of self-discipline, perpetration and practice.

Just as there are broad economic business cycles, there are a number of smaller (quicker) market cycles that re-occur with amazing predictability because they are cycles driven by the calendar. Here are a few examples:

Many companies pay a dividend and the bigger the dividend the more likely we are to see an exploitable cyclical swing, assuming that no other news is driving the price action. For example, there are a number of mature high-yielding blue-chip stocks (like Dow Components: AEP, CSCO, CVX, DD, FE, GE, HD, INTC, JPM, PG, PFE, SO, T, UPS, & XOM) that naturally cycle through their intermediate term Support and Resistance Channel every quarter. Prices tend to rally a week or so before a stock goes Ex-Dividend (or just Ex-Div — begins trading without the latest dividend payment, meaning that the money that was on the books of the business as an assets is now a liability). On the open of the Ex-Div date the stock will generally gap-down (drop down on the open relative to the prior closing price) by the amount of the dividend and will often sell-off for a few days after that. Furthermore and much to my amazement, there's another repeating pattern associated with these cash payments. Stocks that pay big dividends also tend to rally on the pay dates, as if may investors suddenly see new money in their account, they track down the source, realizing that they just got paid to hold a stock then use whatever cash they have (like that dividend payment) to buy more of (reinvest in) that very stock. Warning: The most important thing to understand about dividends is the payout ratio. A good business is basically a profitable business, and the dividend should be a reasonable (sustainable) percentage of the bottom line profits (a.k.a., Net Income) given to the owners of that business. Beware of high payout ratios (e.g., above 75%) as these are subject to being cut in cyclical downturns, which could cut a stock's price in half on the day of the announcement. Notable Exceptions to the Warning: Exchange-Traded Funds (ETFs), Closed-End Fund (CEF), Real Estate Investment Trusts (REITs), and Business Development Companies (BDCs) are all Regulated Investment Companies (RICs), which are basically publicly traded businesses (stocks) that are in the business of investing other people's money and have to pay out at least 90% of all income earned to avoid paying corporate income tax — their profits flow to the owners who have to pay the tax bill.

As a general rule, large, mature ETFs are great examples of naturally survivable investments; but there's a fly in this ointment. ETFs are pro-cyclical. When they are in favor, traders and investors buy the ETF and that extra buying pressure tends to create a spread between the price of the fund and the NAV of the fund (the actual Cash Value of the underlying investments in the fund), meaning that there is an arbitration opportunity — Whenever two things that should have the same value, but don't for one reason or another, big money managers can buy the cheaper of the two and sell the more expensive until the two are equal again. It's easy money for large money manager that have very low trading cost and also have an arbitration arrangement with the fund managers. This is why ETF NAVs track the underlying cash value so closely. When an ETF is popular, money naturally flows into the group or sector of that the fund is focused on and that uptrend causes even more money to flow in until it's clearly overdone. The opposite is true on the bear side. Meaning that retail investor need to avoid the natural temptation to buy a big winner (a fund that has already had a big move up) and sell after a big move down (if the group or sector has a future, meaning that whatever good or service they produce will still be consumed in the future, it will come back into favor sooner-or-later). Note that traditional open-end funds are also pro-cyclical (but they do not have the same arbitration mechanism); however, buying a 5-star funds just forces the fund managers to buy high and in time sell low. Closed-end fund are not as naturally pro-cyclical; but because of their high-distribution yield, they have a natural tendency to lose value when purchased after favorable mention (click here to learn how I invest in these — simply put, only buy CEFs when they are out of favor and sell when you've realized an above average total rate of return).

The quarterly earnings reports is another calendar cycle that is easy to master. Companies report their earnings on an annual and quarterly basis and this drives another amazingly predictable pattern of behavior that can be exploited by savvy investors known as Earning Season and Warning Season, where the first tends to be bullish and the later tends to be bearish. Earnings Season begins in about the second week after the end of the prior quarter when (unofficially) Alcoa (ticker AA) reports after the market close. Assuming no other news is driving the action, prices tend to be bullish and will often rallying into the actual earnings report in anticipation of better than expected news and guidance. Actually, the move is driven by the old adage, "Buy the rumor and sell the news." After the report, prices tend to sell-off because most companies just barely beat the market's expectations. The most import part of any earnings report is the forward looking guidance, which can be much better than or worse than expected and that can create a new price trend, either up or down respectfully, which can often start by a big gapping move up or down (respectfully) that is filled (a quick counter trend move that often fills the gap just created) before resuming in the initial direction. Warning Season, the other part of this quarterly cycle, is the last two weeks of the quarter up through the beginning of Earnings Season and (as indicated above) tends to be bearish. It is very easy for the bears to push prices down because of the lack of bullish news and the suspension of normal corporate buybacks. Most investors will forgive a missed good news warning, but the lawyers are quick to file suites when a bad news warning is missed. Furthermore, businesses tend to be in quiet mode as they preparing to report their numbers as they do not want to be accused of unfairly disclosing material information (Reg. FD requires fair disclosure).

The other category of calendar cycles is driven by periodically schedule economic reports and industry conferences. Click here to see the current calendar of scheduled economic reports. As for all the various industry conferences, let me say: 1) The few that I've studied tend to rally before the conference, jump around based on the news, and then sell-off as the hot money moves on the next thing making news; and 2) it's best to learn about these by learning more about a few specific blue-chips that you like and understand.

To learn more about all these quicker cyclical patterns, refer to The Little Book of Stock Market Cycles and/or The Almanac Investor, both by Jeffrey Hirsch. The pros know about these calendar patterns, they do their part to create and perpetuate them, and we can learn to exploit these too. We can easily see these cycles on weekly, daily, and on hourly charts (it pays to always see the market in these three timeframes) as prices trade up and down through the various S/R levels (based on prior pivots) and the various price trends seen in each chart timeframe. Notice how the various issues tend to trend up into the scheduled event and then sell-off after the event, when no specific bearish mood is leading the popular news.

Another type of market cycle to be aware is driven by the relationship among various parts of the economy. There are market group and sector cycles that have leading and lagging relationships, just like the stock market and the economy. It's beyond the scope of this paper to address all the various relationships here, but reading Intermarket Analysis: Profiting from Global Market Relationships by John J. Murphy and/or Intermarket Analysis and Investing: Integrating Economic, Fundamental, and Technical Trends by Michael E.S. Gayed is time and money very well spent. (Note that all the books listed in the paper are required reading to become a true professional portfolio manager (i.e., be able to effectively invest large sums of other people's money), but I'm not convinced you have to study them to earn an above average rate of return on a much smaller retirement fund — consider this insight that was given to me by an old pro I was fortunate enough to talk with many years ago, "I can't always tell you which stock or group will go into or out of favor next, but I can sure tell you that, if they can survive the vagaries of the market (think most big mature blue chips), they will all go in and out of favor, and the major support and resistance cycle swing seen on longer-term charts is a very exploitable trading pattern."

And there's yet one more type of cycle that prices tend to work their way through — periods of low volatility (relative tranquility) as prices grind higher and high volatility (major uncertainty). There's another old saying that applies here, "Stocks (or whatever) take the escalator up and the elevator down." Recall that prices naturally trade in a range (a support and resistance channel) that reflects the market's collective view of fair value looking forward. There will be times when the market is able to talk itself into thinking that we have relative clarity, a good handle on what's likely to happen; and when this is the case, prices wiggle and giggle in a relatively narrow range as P/Es tend to expand and cause prices to drift higher, a risk-on environment. But then something unexpected happens and everything we thought we knew is called into question; and prices start to jump around and are no longer trapped in a narrow range (the S/R Channel expands, mainly because Support drops). In times of perceived uncertainty savvy investors need a bigger discount to motivate them to take on more risk and the whole market is suddenly willing to take a lower premium to lock in a profit, and all this causes P/Es to contract and price feel heavy (want to go down). After a, generally extended, period without new surprises the market gets comfortable with the New Normal and volatility contracts into a new period of tranquility and economic expansion.

Retail investors can actually earn an above average sustainable rate of return without too much effort when they realize that the economy naturally goes though boom-and-bust business cycles; and so do market prices, in a noisy, erratic, quasi-fractal pattern of market cycles leading economic cycles, and of trading range cycles within cycles (larger cycles in Monthly Charts, slightly quicker and smaller cycles in Weekly Charts, and much quicker and even smaller cycles in Daily Charts, etc.). Like the pros, we can learn some of these cyclical patterns and that's gives us a statistical edge that we can exploit. But even when the pattern breaks (i.e., does not go as we expect), we can still make money by just focusing the bulk of their time and capital on a few tax-efficient, different (market sector) funds run by big, mature fund companies that track the market as various groups and sectors cycle in and out of favor (i.e., trade in a longer-term S/R Channel — just be a buyer near cyclical lows and a seller near cyclical highs as seen on longer-term monthly, weekly, and daily charts). Once this feat is mastered, investors can possibly do even better by selecting slightly more volatile issues that payout higher yields and by working with weekly, daily and hourly charts, but this will require a lot more time, effort and self-discipline (i.e., successfully applied investment wisdom).

— Investment Wisdom —

Successful investing is anticipating the anticipations of others. — John Maynard Keynes.

We can use basic investment and economic wisdom (like that introduced above and found in books like A Random Walk Down Wall Street and The Investor's Manifesto), current economic data and applied technical analysis to become better anticipators and in time raise the capital base we'll need to live on in retirement. All successful investment strategies revolve around the following principles, which yield the benefits of Modern Portfolio Theory (MPT) and Capital Asset Pricing Model (CAPM) (you don't have to learn MPT & CAPM to enjoy the benefits of this Nobel Prize winning financial wisdom, just learn how to apply the following principles):

1. Methodology: Develop and maintain a Watch-List and an associated Iterative Analytical and Trading Methodology. Having a repetitive process that is simple to understand and that helps us to identify and exploit favorable odds is the best way to grow from a beginner (a Trading Idiot) to a Consistently Profitable Trader (a CPT can create wealth at a compound rate) to a True Market Professional (someone that can make their living in the markets).
2. Security Selection: Focus the bulk of our time and capital on securities that are very likely to survive volatile market cycles and that will pay a market rate of return to hold while we wait to enjoy the benefits of natural economic growth. These are essentially securities that can survive boom-bust cycles and that are very likely to realize price appreciation in the next boom phase (e.g., big, mature funds that track a broader market index, like a Vanguard Total Stock Market ETF or a Vanguard Total Bond Market ETF). This is one of the very best ways to avoid making a big retirement mistake. Ideally, these investments should be best-in-class or at least above-average in quality (issues that can lead their broader market index higher). Unfortunately, the better the quality, the higher the price tag, and therefore the more you'll need to buy even a small position. Pick the best that the portfolio can afford to own. Become a specialist in these securities. Get to know how they are likely to act and react in predictable market cycles and situations. This first-hand knowledge offers a huge advantage. It is the best way to overcome our natural intolerance for risk in volatile markets and to ignore all that confusing noise coming from popular media channels.
3. Asset Allocation: Diversify portfolio capital among a few appropriate investment alternatives (e.g., cash vs. stocks, bonds, real estate, commodities & collectables; and other alternative allocations could include: large-caps vs. small-caps, foreign vs. domestic, active vs. passive management, growth vs. value, and cyclical vs. defensive). When starting out, it's best to keep is simple. Just own a money market fund to hold your cash reserve (your opportunity fund), a total stock market index fund, a total bond market index fund, and maybe also a broadly diversified real estate fund and a broadly diversified commodity fund. It may be best to avoid collectible, unless you have some clear advantage in that area. Bottom line: Own a truly diversified portfolio. This is another great way to avoid making a big retirement mistake, and can actually improve total return while reducing overall risk because it allows you to profit from natural market cycles, sector rotations, and economic surprises.
4. Market Timing: Trade with the health of the broader market (economic) trend, looking forward — We want to use the wisdom above to learn how to anticipate what is most likely to happen next (i.e., is the broader market trend likely to be up or down). It the broader trend is up, we want to buy (scale in) as close to the lows as we can, and then sell (scale back out) into the new highs; and if the broader trend is down, we want to short (scale in) as close to the highs as we can or just go to cash or find an investment that is trading near major support to go long. If you're short, buy to cover (scale back out) in drops to new lower support. The market timing goal is to harvest a big chunk of time in that broader market trend, an easier trade to master; and not necessarily to time every short-term top and bottom, a harder timing trade to master. But in time, it is possible to learn how to time a trade closer to the actual turn (closer to the tops and bottoms) of the current trading range; and once done, then learn to do the same trade in slightly quicker timeframes. But getting that trade perfectly right is not necessary to earning an above average total return, that comes from capturing one doable profit over-and-over again.

All we need to do is, Go with the flow (trade with the broader market trend) and take advantage of favorable prices (trade against deviations away from that broader market trend). Own a few dissimilar investments that are very likely to survive and that will pay us to hold. Use charts to see what the market is doing now and a spreadsheet to track investment details, and use both to plan out alternative possibilities, over-and-over again. In time, the process will become second nature, a deeply ingrained habit, that can be fine-tuned as needed. It will be like mindlessly turning the crank on a money machine.

Try not to worry about money left on the table. Capturing every last penny possible is an impossible objective and can only leads to frustration and costly over trading. Nobody gets to consistently earn all that the market can yield. It is impossible to consistently buy the lows and sell the highs, and it's a fool's errand to obsess on that goal. Understand that stocks will trade up and down all the time, and the first thing we need to master is becoming a CPT, an objective that is really not that hard to achieve in longer timeframes. Nothing favors the growth of an account like compounding a string of relatively high-yielding profits. Note that the market can easily generate a positive or negative 10% or bigger yield over relatively short periods of time. Whenever the market gives you a better than 10% rate of return, take it, and allow a string of these to compound. And when the market shows you a drawdown, like a 10% or whatever paper loss, work to overcome that or at least wait for Mr. Market change his mind and show you an acceptable profit. Note that this approach to buying when stocks are out of favor means that we might have to wait, maybe even a long, while before seeing a price recovery, which is why we need to focus on a few dissimilar, survivable investments, that will pay us to hold. Be patient, this type of investment will recovery and show a profit in due time. We simply do now want to take a loss that can show is a profit sooner or later. Even a string of low positive yields can cause a growth curve to turn up. So, we need find and only take trades that are very likely to yield a profit sooner or later, which means we need to patiently and wait for Mr. Market to show us favorable prices, and to book those profits when we realize them. When starting out, we must harvest profits whenever the market offers up an acceptable return relative to the current trading range and market environment, thus supporting our CPT status. It's a status that can be easily obtained when the proceeding information is applied to longer timeframes with an appropriate trading and investing methodology.

It helps, a lot, to be able to find and exploit favorable trading opportunities. But mastering market times is not easy. However, it can be done in time and with appropriate effort, and by using a repeatable methodology. Another skill that can easily be mastered and that can greatly improve results is to use a spreadsheet to track portfolio position P&Ls details (all trading entry and exit details, and all income and expenses to show real-time position P&Ls), so that we can know if we have an acceptable total return profit to harvest in the face expected bearishness looking forward. Most (all that I've seen) brokerage system are pretty good at tracking your capital P&L profile; but I've yet to find one that also tracks all your income and expense details associated with that position. We have to track these total return details. Doing this allows us to see the effect of income earned while holding, which has a significant impact on total return; and by tracking commissions and fees we're better able to see the hurdle that must be overcome just to reach break-even. Furthermore, by doing this ourselves we're better able to see not only the whole position, but how the various parts within the position can be reconfigured to book incremental profits as market S/R channels evolve. We can work to improve our rate of return, given ever evolving market prices. Use a spreadsheet and the associated chart set to plan out alternatives based on those details. The full chart set should include a current monthly, weekly, daily, & hourly chart to understand what's happening in each major timeframe. For each timeframe, ask:

1. What's the broader market trend in each timeframe?
2. Is that trend healthy?
3. Where do I see support and resistance?

1. Given my current P&L profile (my position size and break-even price) relative to the current market (the size and nature of the current timeframe trading range), what can I do to improve my odds of locking in another acceptable profit?
2. What will I do, if my current trading range shifts up or down, expands or contracts?

Simply put (and assuming survivable investments), when the boom-bust cycle favors stocks, every sell-off is a stock buying opportunity; and when the cycle does not favor stocks, every rally is a stock selling opportunity. The same is true for bonds, etc. This is the first timing skill to work on and, in due time, master — trading with the broader economic trend; and then work to master quicker market cycles. Be long up trending securities (issues that are likely to benefit from the upcoming phase of the business cycle), be short (or simply avoid) down trending issues, and be in cash when a healthy broader market trend is unavailable (the charts are showing you CRAP). Having a big cash account makes it easier to take advantage of the next favorable opportunity. Be a buyer (scale in) at discount prices (a bounce off support, the lower-end of the current trading range), and a seller at premium prices (resistance, the upper-end of the current trading range). Always start your technical analysis using longer-term charts, like monthly and weekly charts to better understand where the market is relative to the boom-bust cycle (to see the broader market trend), then use shorter-term charts to find buying and selling opportunities (to find deviations away from that broader market trend), like on daily and hourly charts (refer to Seeing The Market's Big Picture above).

Basically, we want to develop and use our Market Timing skills to maximize our rate of return on invested capital, and use Security Selection and Asset Allocation to minimize the impact when we get our Timing wrong. We cannot control market prices, but we can control our buying and selling, and what securities we'll specialize in. We only want to commit capital to opportunities that clearly favor the growth of our account, given our current abilities. When it comes to buying an investment (scaling into or adding to an existing position), we want to focus on above average investments (opportunities) that are trading at below average price (we want to take advantage of counter-trend moves in a healthy broader market trend); and when it comes to selling our investment (scaling back out of an existing position), there are two reasons to exit:

1. Taking profits — we want to sell at above average prices and at above average rates of return.
2. Preserving capital — executing a proper Stop-Loss trade. When it looks like the broader market trend is turning or is very likely to turn against us, we want to be a seller (to exit those ill-fated open positions). Only a Trading Idiot fights the broader market trend. And when the economic boom-bust cycle is ready to turn, get out! This Stop-Loss trade is a true Smart-Money trade.

In taxable accounts, it pays to wait for the market to offer up truly favorable odds, like being a buyer near 52-week lows or major support and a seller near 52-week highs or major resistance. It's often best to play the full economic boom-bust cycle to minimize the tax-burden, which reduces the rate of capital growth by reducing the size of the reinvestment.

Take comfort in the wisdom found in my Simple 2-by-4 Approach. Rate of return can and will improve as our skills and capital base grow. It is the benefits of a compound growth curve that is growing in our favor.

This tried-and-true formula has allowed me and many others to preserve capital (avoid real disasters) in bad times and to seriously grow (well above the market rate of return) our capital base (the size of our brokerage accounts) in good times. It is best to start while we are young and able to earn normal job income. Learn how to save 10% or as much as we can (learn to Pay Yourself First) and to live with the remaining balance. In time we should be able to acquirable the skill and capital needed to fund and sustain a comfortably retirement.

— A Closer Look at Miscellaneous Bits of Investment Wisdom —

If we get a quote from Mr. Market for any stock, bond or whatever security has caught our attention, we're likely to see five pieces of information: The Bid Price (the price a willing buyer will pay for our shares at a trading venue), the Ask Price (the price a willing seller is offering to accept for their shares), the Last Price (the price of the latest trade recorded on the Ticker Tape for all to see), and the 52-Week High and Low Prices (the range of prices seen on the Ticker Tape over that prior year). This should prompt us to ask, "How can a security trade for such a wide range of prices when the underling business that issued that security did not likely change all that much over that same period of time?" Maybe Mr. Market's quotes really are irrational and not the best measure of the value for that security. So, what would be a better measure of value? Some prefer to use a Price-to-Earnings Ratio (P/E) [e.g., the current market price of a share of stock divided by the prior year's (or next year's expected) Earnings-per-Share (EPS) for that stock]. Many savvy professionals prefer to use the Earnings Yield for stocks, which is just an inverted P/E (EPS divided by Price) because that makes it easier to compare the yield on a stock to the yield on a bond from that same business or other companies in similar businesses. Let's assuming a business (on the simplest level) is just a Money Machine [i.e., we invest some capital (e.g., money, intellectual property, etc.) into a repeatable business process and that business makes some money, it generates a profit, it Yields a Rate-of-Return over time on that invested capital, and that's money that can be used to first pay the debt (bond) holders (their periodic interest payments and then return the principal or the amount loaned to the business at maturity or some future date) and to reward the (stock) owners of that business (either in the form of dividends or by re/investing in new money making opportunities available to managers of that business) — that Yield is a much better measure of value because it is based on the relationship between market price and an ability of that business to make money]. Another MBA level way to view a value relationship is to think of the rate of return on (profit from) a business opportunity versus (over) the cost to fund that opportunity (i.e., the rate of return divided by the current bond market yield for that timeframe or whatever alternative funding is available). We do this to understand if the often variable rate of return (likely profit margins) from the proposed investment is worth the generally fixed-cost of capital given available investment yield alternatives. Bottom line, it's always best to invest in securities issued by businesses that generate Higher Yields (i.e., it's best to be a buyer at relatively higher yields and a seller at lower yields) assuming all other things are equal (which is rarely the case when we consider alternative investment opportunities; but is always the case when the only thing that is changing, is the Price of a specific security).

There are other financial ratios savvy value investors use to gage the profitability and the risks of a business. The first is Return-on-Assets, which is an indication of how profitable a company is relative to the total capital investment into that business — note that Total Assets (the value creation parts of the business) is equal to the sum of all the capital invested in that business, which is the sum of both debt and equity, it's an accounting Balance Sheet relationship. The second is Return-on-Equity, which is an indication of profitability relative to just the (stock) owner's investment in the business (the lower-right-hand part of that same Balance Sheet). Another ratio is Debt-to-Equity, which shows how much of the capital investment is due to debt, which can kill a business when a cyclical downturn naturally reduces a business' ability to generate the cash needed to meet its debt obligations. I recommend Chris Haroun's Introduction to Finance, Accounting, Modeling and Valuation offered on Udemy.com. If you want to take your investing to the next level, to be a true fundamentally based investor, you have to be able to understand a business' SEC filings, you need to understand Basic Accounting, which is the language of business and means you need to learn how to read basic accounting statements. The primary instruments are the Balance Sheet, Income Statement, and Cash-Flow Statement. These financial ratios (and many others) all come from these accounting statements. Historically speaking, forensic accountants, the pros that know how to slice and dice these statements, tend to detect financial shenanigans in the footnotes of these SEC filings — C-Suite Managers of publicly traded companies have to report the facts that can affect the valuation of the business that they run in a GAAP format, but there is a lot of room for interpretation in the GAAP guidelines and the best way to comply with the legal reporting requirements while still obfuscating the truth is the report the evidence in a murky footnote. Being able to comprehend the financial documents of a publicly traded company is the professional approach to understanding a business and therefore be better informed as to the likely future value of an investable security, and another way that the pros protects themselves from the emotional whirlwind unleashed by Mr. Market. When considering these and other measures of value, it's best to look at the trend relative to time and to competitors to understand if the business is getting better or worse.

If all the math seen in the prior two paragraphs is a bit too much for you, then use a Monthly chart and only be a buyer when prices are trading in the lower half of the trading range seen there (the multi-decade S/R Channel). The lower half of this trading range is where the market perceives discount prices and the upper half is where premium prices exist. Fast-money momentum traders and the uninformed will drive prices (advance the current trend) into the waiting arms of savvy value investors that can do the fundamental analysis and math and are willing to wait for the favorable prices that exist near the channel extremes. By the way, if your stock ticker or the index that your fund is designed to track cannot fill that long-term monthly chart, you may not be looking at a survivable security. Market prices for most survivable investments tend to have a normal (bell shaped) distribution over longer timeframes, and most future prices are very likely to fall within that prior Major Support and Resistance Channel; plus stock prices, unlike bond prices, will tend to have their S/R Channels drift upwards over time thanks to economic growth and inflation. This bit of wisdom is more than useful, it's very powerful for those with longer investment horizons and for those with the patience to wait for favorable prices; But it's important to also remember that the future is unknowable and that anything possible can still happen, and then what will you do? Do you have a plan for the extremely unlikely? Don't use this powerful wisdom to justify an otherwise excessively risky trade that can result in a big mistake. Being more of a buyer in the lower half of the broader trading range and more of a seller in the premium half is the foundation of successful investing, and the primary reason Dollar-Cost Averaging (DCA) works. And once you've achieved CPT status trading a Monthly chart, try to reproduce the same results on a Weekly chart, and so on.

An economically appropriate asset allocation, as suggested above, would have us focus the bulk of our time and capital on issues that are likely to do better in the upcoming phase of the current business cycle. For example, riskier issues, like small-caps funds and high-yield (junk-bond) funds, tend to do better coming out of a Market Bottom (i.e., Full Recession in the idealized Sector Rotation Model diagram above); and blue-chip issues, like large-cap stocks and top-quality corporate bond funds, tend to do better as prices rally into Market Tops. But life does not always go according to plan, plus there's a lot of sector rotation that occurs in every phase of the business cycle. Having an uncorrelated (or at least loosely correlated) Asset Allocation is a great way to reduce risk and improve total return in any portfolio. It's a great way to profit from market and economic surprises. It's also a great way to play all those seemingly random cycles within cycles within the business cycle. Note that the time to enter (scale in) is when an issue, group or sector is out of favor, but seem to no longer go down on bad new; and the time to exit (scale out) is when that security, group or sector receives favorable attention in the media and you've got nice profit to harvest — also notice that if prices fail to rally on good or favorable news and commentary, it's a clear sign that the pros are selling and so should you. We see this pattern all the time — a stock, group of stocks or an industrial sector will make a big move, trending up or down for months, and be the focus of the popular media for weeks with prices trading at a 52-week (or an all-time) high or low, but a year later we see a big reversal; last year's big winner or loser will often be the next year's big loser or winner, assuming that the businesses have a survivable business model. This rotation model extends across all markets. For example, International securities often lag the U.S. Market; but more importantly, these issues, like bonds and natural resources (commodities), are loosely correlated to U.S. stocks and give us an opportunity to build a more diversified asset allocation. By focusing a smaller portion of our time and capital on a few other loosely correlated issues that can survive volatile market cycles and that will pay a market rate of return to hold (like SPY for U.S. Large-Cap Stocks, IWM for U.S. Small-Cap Stocks, EFA for International Large-Caps, TEI for International Small-Caps, GGN for Gold and other Natural Resources & PKO for Bonds — these are ETFs and CEFs), as markets (and market sectors) cycle through bull and bear trends (the Sector Rotation Model diagram above identifies the market sectors that tend to do best in the various phases of the business cycle, click here to see a video about Sectors Summary tools, and here for other models).

On the subject of appropriate asset allocation, let's not forget about Cash, which is completely uncorrelated to all other asset classes. It's the opportunity asset class. The market presents opportunities all the time, but we need to have ready cash to take advantage of these. Just remember, it's generally easy to get into an investment; but not so easy to get out with an acceptable, risk-adjusted profit. Consider the professional approach to investing — think of all possible outcomes, assign a probability to each outcome, plan-out your operations for each possible outcome (including the unexpected outcome, which tends to mean close the position and re-evaluate), trade your plan, and revise that plan when presented with new information. A healthy cash account facilitates this professional approach to investing.

I can't always tell you which stock or group of stocks or bonds (whatever) will go in or out of favor next (honestly, I don't think any market guru can with any consistency, but with specialization we can grow an ability to get some of these right). But I can tell you, for sure, that all (one or more at a time) will cycle through their longer-term S/R Channel. Without exception, sooner or later, and to one degree or another, all mature issues in every groups and sectors will rotate in and out of favor over time — will trend down, be out of favor, find a bottom (major support), which assumes survival, will trend back up, be in favor, find a top (major resistance), and repeat the cycle over-and-over again. Why? It's the nature of the economy, the underlying factors driving the patterns seen over time, and by extension the data. All we need is a way to understand (analyze) that data (and with specialization we can grow an ability to better understand the data) and a strategy that puts the odds in our favor. We don't have to try to pick the winners and losers or time the tops and bottoms to make good money; we only have to find a few survivable securities that will pay us to hold, and a set of likely (limit order) prices that can exploit the data's nature. For example, we can do our buying near the lows (off support, preferably major support, as seen on longer-term charts), and do our selling near the highs (or whenever we've earned an acceptable, above average profit). We want to capture the lion's share of most of these seemingly random cyclical moves, whenever they occur. Once our limit orders are setup, we only have to wait for the market to come to us and tell use which security to play. You don't have to know the first thing about economics or fundamental analysis, just enough technical analysis to find likely support and resistance levels (an ability to see the big picture). Does this sound like a profitable strategy? I can assure you that it is a time-tested winner, most of the time! But trust me, no strategy is fool proof. Knowing a little economics and other market wisdom (like that presented in this paper) will help, a lot, when the tenor of the market changes and throws a monkey wrench (or wooden shoe) in your precious little money machine. Please note that a good strategy (trading plan) also addresses what to do when we see monkey wrenches flying — the Wall Street talking-heads like to say, "Just get out and re-evaluate the situation", which is not a wholly bad idea, but we may be able to find a better stop-loss strategy ... keep on reading.

The popular media likes to talk about the direction of the current trend and the difference between recent highs and lows or the year-to-date gain or loss. These talking-heads like to promote a fast-money trading mentality, by suggesting how much could have been made or saved if only investors (newbie traders) could buy the bottoms and sell the tops. It is important to understand that everyone has an agenda to promote. The media wants to whip-up the reader's, listener's and viewer's emotions to get and keep them tuned-in for the sale of further ad space and time. The professional money managers and commentators want you to invest through them or buy their newsletter or service. As a result, many retail investors (newbie traders) act as if making money is all about quickly spotting the current trend and then beating the crowd in and out via market orders; and as a result, many look for some information or fast-trading-system advantage. They tend to be one-dimensional traders, focused on the current short-term trend in only one timeframe (e.g., a daily chart), and they tend to spend way too much time and money trying to time tops and bottoms and buying an information edge (e.g., newsletters and tip sheets; if these sources had real market value, the originators would be secretly applying that knowledge in their own brokerage account or running a hedge fund) in hopes of hitting a home run trade — this is a fool's errand, a Snipe Hunt, a Loser's Game — Winning requires making fewer errors than the competition (i.e., avoiding real losses). As Charles Ellis points out in his book Winning the Loser's Game, it is extremely unlikely that retail investors will ever make any real long-term money over time playing this game. Understand that professional day-traders and their computer systems account for more than 75% of all the trading volume; and they're the ones with the real information and speed advantage. Even if you are better than average, you are just not going to consistently out-trade the real fast-money pros (the real average trader by volume), which is what it take to be CPT. So how do the big (successful) fund managers make money (earn alpha) in this environment?

Large professional fund managers scale in and out of their various positions. They understand that price is not always a good indication of value and tend to trade against current market sentiment (e.g., when the market is bearish, trending down, and creating discount prices, it's these large value-based investors taking the other side of that fast-money trade, one small trade after another and thus avoiding the risk of tipping their hand — there's a big buyer in this bear market). They only make a trade, generally via limit orders, when a trade is likely to favor the growth of their account (i.e., by buying at discount prices and selling at premium prices). They (or members of their team) specialize on a few investments (study the market's nature, now and in the past) and do their homework (fundamental and technical analysis) to gain an information edge (a better understanding of likely future value), and then only play strategies that have favorable odds in the current market environment. They know that tops and bottoms can only be seen on charts after the fact, and that once the current trend becomes clear it's also likely to reverse, that markets do tend to generate similar cyclical patterns, but every moment in the market is still unique and anything possible (no matter how unlikely) can still happen. It's all about being well informed, managing their risk exposure, and playing the odds in a methodical, repeatable manner. Making real money is all about being able to consistently generate one profit after another, over and over again, and not about finding the next home run trade. They understand that it is more that possible (often likely) to capture a judicious amount (but not all) of any cyclical move in an S/R Channel (the area on the chart between the tops and bottoms, the current trading range) when appropriate tactics are applied; but attempting to capture too much of the whole move requires excess risk and can easily generate diminishing returns. Furthermore, these pros realize that one has to be in the market to earn the market rate of return, and that prices can always go higher or lower, and when they do go higher or lower, these savvy investors are being given the opportunity to take even greater advantage of the available premium or discount (by scaling further in and out because they've held in reserve some of their trading power) and thus helping to create the expected correction and setting up the next cyclical swing. These experts are multidimensional, they trade using three or more chart timeframes. For example, if they are trading a daily chart, they'll use a weekly and monthly charts to spot major support and resistance levels, they'll use the direction and spread between current prices the major MAs on these chart (as introduced above), and also use economic data to anticipate and evaluate the health of the broader market trend; and if the trend is healthy (likely to continue), they'll then use counter trend moves on the daily chart to buy at available discount prices and to sell at available premium prices, as prices pivot back towards the broader market trend on a quicker timeframe (e.g., an hourly or 15-minute chart; refer to Triple Screen Trading in Trading for a Living). Professionals methodically work to beat their professional objectives (e.g., to beat their benchmark index or their targeted rate of return with a low Sharpe Ratio) by:

1. Maintaining an information edge thanks to specialization and by applying an objective analytical process.
2. Using trading strategies that have a time-tested record of yielding favorable results.
3. Seeking the lowest possible cost of participation (the less they have to pay to play, the more they can keep and grow at a compound rate).
4. Managing risk by trading with the health of the broader market (economic) trend.
5. Managing the portfolio's averages (e.g., the average price per share (cost-basis) of each position in the portfolio and the average risk-adjusted rate of return on the various parts of the portfolio). They are always looking for opportunities to improve these averages (e.g., They use discount prices to scale into their positions and use premium prices to scale back out once their object has been reached, thus allowing them to capture most of the cyclical move as their various positions rotate in and out of favor). They understand that when you are being paid to hold a position with a discounted cost-basis, it is only a matter of time until each position reaches its planned objective or a least an acceptable profit.

With one exception, we can earn an 8 to 12% total return by simply trading like (with) these large professional fund managers. We simply need to focus our time and money on a small, diversified collection of survivable securities that will pay us to hold. We can develop an information edge over time by staying focused on the same small list and learning to effectively apply the information presented above and elsewhere. Be buyers (averaging in) at discount prices and sellers at premium prices when a trade favors our capital interest (i.e., when we have an information edge). We can use the time-tested ideas introduced above, and current economic and technical information to plan and drive our operations. The one exception, some professionals use leverage to magnify their returns, which is money that's generally borrowed from our broker and is also known as Margin. If you're not a Consistently Profitable Trader (CPT) who's able to monitor positions in real-time, you should not be using leverage. When the market turns on a leveraged position, if not handled properly, that position can quickly lose (sometimes even more than the) principal investment. Note that we cannot unconditionally hold a leveraged position when the market turns against that position because our broker has the right (and responsibility) to close that position, without notice, and well do so before any loss eats into the their capital — the borrowed money, which means the borrower alone (you) eat all the losses. Retail investors should stay off margin!

Wall Street talking-head say, "Never average down!" and this may seem to be a direct contradiction to what I'm advocating in this paper. But this is really not the case. Our primary goal is not to out trade the professional shorter-term trend traders (the fast-Money crowd). It's to be a better investor by out trading the professional longer-term fund manager. First let's understand why they say "Never average down."

1. They have to cover their legal asses. They know most retail traders and investors hear or read about some hot story stock and jump in, often near the top when the pros, who talk up these stories, are now selling to harvest their gains. Furthermore, many (and almost all newbies) use margin, and using margin to average down a hot momentum position forces that aspiring short-term trader to sell low because of a margin call, which puts their broker at legal risk, if they do not advise their clients to "Never average down."
2. They want you to trade because every time you put on a trade, they get a chance to feed off your account (thanks to commissions, fees & slippage, which are all costs of being in this business; but you don't have to pay too much as these are manageable costs). When you sell to do a stop-loss (a cost of being a trend trader), and the stock recovers (most survivable investments also trade in a larger or bigger S/R Channel), you jump back in (kicking yourself about being scared out or some variation on this theme, right?).
3. Every investment has a real possibility of going to zero. The truth is that any investment can become worthless or worth a whole lot less, and we'll need to plan for this possibility. The real question is, "How likely is my position to become worthless and what can I do to manage my risk exposure?" The answer has been addressed above, and I repeat and summarize it below, because the talking-heads put a lot of pressure on us to Trade like a Pro, Let your Winners Run, and Cut your Losers Short and we all want to believe that we can trade like the professional short-term traders and be better than average. Please understand that being able to trade like a pro does not mean you can make money like a pro. These are two very different things; and I hope that you do not have to loss too much of your hard earned savings to realize this fact.

Second, let's get clear on what I am advocating — The Main Strategy — is to avoid most, if not all, of those shorter-term trading stop-losses that can just kill an account over time by being a longer-term investor (a CPT) that can use shorter-term trading tactics to improve on the market rate of return:

1. Assuming that our operations are in-sync with the broader market (economic) trend, which is mostly up over longer timeframes (note that the following tactics can be reversed when the broader market trend is down, just reverse the words Support and Resistance, and the words Long and Short).
2. Focus on a few diversified securities that are very likely to survive volatile market cycles (i.e., very unlikely to become worthless and very likely to recover in time) and that will pay us to hold, like most large, mature, well-diversified CEFs and ETFs (and in time, a few large mature blue-chip stocks trading near major support, but only after mastering the strategy with these funds). Leave all other issues to the pros that manage these survivable funds.
3. Only start new Long positions at discount prices. Preferably off major support, but these opportunities are rare; so we generally have to settle for a drop to or a bounce off near-term support, given that we have to be in the market to receive the benefits. Only use a fraction, say 1/5th, of the capital committed to the position (this is another reason why it take money to make money, without taking on too much risk). Hold the balance in reserve.
4. If prices go as expected, we're free to harvest an acceptable rate of return once earned and then wait for the next opportunity to start anew, thus creating one compound interval after another within our account; or if we seem to be riding a sustainable broader market trend, we can sell half or some part of the open position in a rally to near-term resistance and then use those proceeds to buy back in on the next drop to near-term support; or we can just hold using an appropriate trailing stop when market conditions allow.
   • In taxable accounts we'd prefer to hold long enough to realize favorable tax treatment — hold for a year and a day or longer; but never let the tax-tail wag the investment dog.
   • We never want to allow the market to convert an acceptable profit into a loss. When the market environment (the odds) turn against a profitable position, close or reduce the size of that position; thus freeing up cash for new opportunities and locking-in some or all of that acceptable profit. Note that new opportunities happen all the time, but we'll need cash to take advantage of these.
   • Ideally, we want to hold until the market gives us an above average total return, say anything at or above 10 to 12% or whatever the current market environment will support, take it and then look to repeat the process again.
5. If prices go against us, we'll use the reserve capital to manage our cost basis (scale in at lower more favorable support levels). The requires real patience. When prices break support and drop into a lower or bigger channel we need to give the market time to digest the new selling pressure from all those Longs that had their stop-losses triggered somewhere below that broken support level and all those new Shorts that decided to pile-in too, which will have to buy (presumably at lower prices) to close their new position. There is never unlimited buying or selling pressure, and sooner or later prices will find a new support level. When prices find that new support level, we want to take advantage of that. In time we should develop a feel, thanks to specialization, for where the next lower support level should be and target a limit order to pick-off a bounce just off that new support level. The goal is to keep our average price per share below or at least as close as possible to current market prices (the current trading range) as possible by making each additional commitment of capital work that much harder to pull our basis closer to the current S/R Channel, thus allowing any move in the right direction to be an opportunity take an acceptable profit or a minimal stop-loss when the economy is ready to enter the next bust cycle phase.

We need to think like longer-term investors that can depend on economic growth to yield Beta (the Market Rate of Return) and that can also use shorter-term trading tactics (the skill to earn Alpha) to enhance our total returns when these market opportunities present themselves. This is a strategy that just about anybody can do, if they are willing to work for it; unlike trying to be the next super-star, fast-money, professional trader, which is something very few have any real chance of ever becoming. The primary stop-loss we want to take is when the market and economic data suggests (a credible message of the markets) suggests that the broader market trend (the business cycle) is ready to turn against our position. (Sure the security may survive a big drop; but why sit on a growing drawdown when that capital can be put to better use elsewhere?) We'll use this strategy, a set of charts (weekly, daily, and an intraday) and a spreadsheet to plan out our investment. We want to literately answers the question, "If I make this trade (buy a bounce off or a drop into support, as indicated by a prior pivot low, a rising MA or an oversold RSI indication), what will I do if price goes as I expect — rally to resistance (at what likely price can I harvest my profits), and what will I do if prices drop through this support level and advance to lower support levels on the way to major support?" I plan to buy each level in greater size to pull down my cost-basis, thus making it easier to realize a nice total return in a likely future upturn. Once an investment is planned out, trade that plan — use limit orders and/or price alerts to execute the plan. Take comfort in the fact that this strategy, proper planning and execution puts the odds in our favor, and that sooner or later we'll realize our targeted rate of total return. This is called Trading our Timeframe's Support and Resistance Channel.

There will be times, from time-to-time, when a best-of-bread blue-chip stock (or its sector ETF) is a very good buy. These opportunities tend to occur when a stock and the sector it trades with is out of favor and has been so for a while, but no longer goes down on more bad news (i.e., the group has already made a big move down and is now testing major support — There's an old saying that applies perfectly, "Never try to catch a falling knife, it's always best to let it hit the ground and vibrate a little before you reach for the handle."). This dogs of the dow or S&P 500 (deep-value based) approach can result in some amazing returns when that position is held to the other extreme. The sector's leading (best-of-bread) stock is the kind of issue that can pull that sector back into favor; but it will take time, a lot of it, if the position is started too soon after a big fall. Another slightly less attractive example would be when an appealing stock or sector is hit by surprisingly bad news (or commentary) and has a huge sell-off on the day the news hits the tape. In this case, it's best to apply the "Three-day Rule." — Give the stock (or sector) time to wash-out. Let all those who'll need to sell, do so. Put another way, let the falling knife hit the ground, find real support, before starting a new long in the stock (or the best-of-bread stock in that sector). This second opportunity maybe another buy the dip play or it may be a dead cat bounce play because this case can easily turn out to be the beginning of a new bear phase in a stock (or sector) that was in a prior market leading bull phase. The difference generally boils down to the nature of the drop (sell-off). If the drop was to a rising MA, we're probably looking at buy the dip. However, if the knife cut through the rising MAs, we're probably looking a a dead cat bounce towards an MA before find new resistance, that was prior support. Honestly, it's hard to pick the perfect bottom and sometimes is just best to buy a little early and add to the position when better or other favorable opportunities present themselves. If the initial buy looks like a mistake, use bigger intervals of time and price when scaling further in (assuming my Simple 2-by-4 Approach above). But if you find yourself breaking these rules, consider taking the loss and chalking-it-up as another expensive lesson of what not to do. Alternatively, risk can be reduced by using the sector ETF, but the reward will also be reduced too. The strategy will require the ability to see (understand) when the market has driven prices to an unsustainable extreme (be selling at ridiculous discounts relative to longer-term economic prospects) and the ability to build and manage a big position in a security that can and will not only survive that extreme market sell-off, but can and will lead that group to the other extreme (a new longer-term top). This is how the big-money pros make that big money, and we can do that too. It only takes a few of these big money trades in a life-time to create a wonderful, life-long retirement account, and it can be done with the knowledge present here, enough investment capital, and just a few survivable investments that will pay us to hold.

Let's take a deeper look at Compounding. It's the mechanism that should allow us to generate the large capital base we'll need for the big trade described above. In the ideal sense, it's earning new money on top of prior earnings from prior savings, and is the real (not so) secret to wealth creation (and destruction). We normally think of compounding as being something that happens at regular intervals because interest and dividends are normally paid at regular intervals, assuming those cash payments are then reinvested to earn even more, thus creating a non-linear (upward sloping) growth curve over longer periods of time. Compounding can also occur at irregular intervals too (e.g., buy stock XYZ for $10 per share and sell it later for $11 to earn a 10% holding period rate of return, then use all the proceeds from that sale to buy back in at $10 and later sell again for $11 — or simply buying support and selling resistance along the broader market trend over-and-over again). Each profitable trade (capital reinvestment) completed over variable timeframes is also an opportunity for compound growth. And for those who prefer a Buy-and-Hold strategy to minimize the tax burden, stocks (and by extension stock indices) are able to grow at a compound rate, during the boom-phase of the economic/market cycle, when the underlying business(es) is(are) able to grow or create value at a compound rate, thanks to that business retaining earnings and reinvesting in profitable growth opportunities and/or buying back shares (making each outstanding share worth more because of the greater claim on that business). The two most import things to understand about compounding is: 1) it is the mathematical magic that creates wealth over time when a string of reinvested payments (profits) are run together one-after-another, and 2) a string of losses, one-after-another, yields compound wealth distraction, and is the primary reason why we need to trade like a longer-term professional investors and not like the popularly touted short-term, fast-money, professional traders (a Loser's Game for all but the best-of-the-best).

The following two statements are both true: 1) It is much easier to realize a positive rate of return over longer timeframes. 2) Better rates of return are realized by positive returns earned over quicker (shorter) timeframes (and the inverse is also true — a string of quick losses can grow at a compound rate too and can dramatically reduce the size of a brokerage account, and that is why most shorter-term trend traders get wiped out, they endure a number of small stop-losses while trying to get a win large enough to overcome all those little losses, transaction costs and other cost associated with being in the business and still realize a rate of return that justifies the risks taken). So please do not confuse better rates of return with easier. Many do, and that's one of the main reasons so many are attracted to trading. Many buy into the Wall Street marketing hype that likes to talk about some of the amazing rates of return realized by some pros in the market, pros that can effectively play the Winner's Game, and they says things like, "You can trade like a pro too, if you trade with us and ..." We all like to think, "We're better than average." and "I should be able to out-trade the average market participant." Please understand that Wall Street needs new investors and trader to make their big short-term profits, and they do a lot of marketing to attract that new (dumb or just uninformed) money. There's a reason why more than 95% of all new traders eventually quit after losing all or almost all of their trading capital, it's very hard to be a Consistently Profitable Trader (CPT) when your focus is on getting a home-run hit (e.g., finding quick trading profits from big break-out or break-down moves that require a stop-loss when ticker show a small loss). Please understand that most tickers spend most of their time in a trading range, and when most tickers break-out or break-down, the current trading range is just shifting up or down, or maybe expanding now (becoming more volatile) and will soon settle down to a new tighter trading range that may be higher or lower. A Consistently Profitable Trader understands this reality and employs strategies that take advantage of the natural behavior. They're focus is on hitting singles and doubles over-and-over again. Most CPTs only takes trades that are very likely to yield a positive total return sooner or later; and that's why a CPT is able to consistently generate wealth in their targeted trading timeframe. A year, quarter, month, week or a day are all examples of trading timeframes; where yearly is the easiest timeframe to earn CPT status and daily CPTs have the potential to earn some of the very best rates of return. Problem is, very few will ever be able to realize weekly, much less daily CPT status. Most of new traders, who can and have earned some money in the market, tend to eventually end up losing it trying to out-trade the market because they confuse short-term random success with real trading skill. Please understand that the average retail market participant is not going to out-trade the real pros, and that it is just a matter of time before the pros drain your trading account, just as it's a matter of time until a Vegas Casino wins almost every unskilled dollar put a risk. Don't play that short-term trading game (until you've earn short-term CPT status)! Alternatively, your primary goal should always be to make money over time (to be a CPT in whatever timeframe you can master). Initially work to achieve year-after-year CPT status, a very doable objective when you use the wisdom presented above; and then work to reproduce CPT results in slightly quicker timeframes, like quarter-after-quarter, and then in time maybe month-after-month. If you can achieve CPT status month-after-month you will have realized a goal that far exceeds 85% of all market participants; and week-after-week is really super-star CPT status and way better than 95% of market pros. It's amazing to me how many new traders act like they believe they can just do this — beat the market at its own game. Sure, no one is ever going to have a perfect record (prices go up and down all the time, and so will the value of our portfolio), but having a perfect trading record is not the real goal. The real goal, once again, is to grow the size of our portfolio over time, the definitions of a CPT above. If we plot the size of our equity on a graph (a chart), we should see an uptrend something like the idealize uptrend figure above; and ideally, we'd like to find and exploit our optimal positive rate of return, which initially is going to be over the longest timeframe. Initially our equity uptrend line will be closer to horizontal than vertical, but in time we should see it curve up as our rate of return improves and as compounding kicks in. Start by learning how to capture the long-term market rate of return; for example, just own a broad-based market investment like VBINX, which passively yields a balanced exposure to both the stock and bond markets. This initial approach is best when you are just starting out via dollar cost averaging because you do not yet have enough capital (cash) saved to effectively invest. During this preliminary phase, you should study the information presented above and the real-time data; use that to plan and trade a paper portfolio. In time you should have some real capital saved up and you should also be developing a feel for the market, and that is when you should enter the second phase — learning how to eliminate much of market's long-term negative returns. Start small (only invest a small portion of your savings) in just three funds like VMMXX, VTSMX, and VBMFX, which provides exposure to a money market fund to hold cash for future buying opportunities, exposure to just the whole stock market and just the whole bond market. As you demonstrate real positive results, increase the size of your exposure to this actively managed part of your portfolio. The idea here is to learn how to exploit the market's boom-bust cycles (longest-term S/R levels) with real cash. Paper trading is good as a planning tool, but it is not the same as having real cash exposed to risk. The big question at this time of your personal growth is, Who is managing your account? The Trading Idiot or someone who has the self-discipline to use an simple strategy that has a time-tested positive track record, to methodically analyze the market for favorable trading opportunities, to plan out each trade, to trade that plan, to track the P&L details, and to learn from the results. Once you start to see some real positive results (i.e., your account is growing in both good times and bad, and you are starting to feel like some of that growth is in fact due to your effective operations), then use a small percent of your growing capital base to see if you can reproduce these results in slightly quicker intervals. You can also try to using more effective securities like CEFs and ETFs, which trade all day (the three Vanguard open-end mutual funds above only trade once per day, at the next 4 PM closing price). If and when your new, quicker operations prove to be less effective, as they will initially and from time-to-time, take a step back and recapture the prior success in a longer timeframe. Understand that markets evolve over time, and shorter-term strategies that worked in the past may no longer work as effectively in the future. Learn to be flexible and to adapt to changing times. The goal in this later (mature) phase is to find and exploit your Optimally Effective Timeframe (OET), where you can earn your highest possible rate of return by exploiting S/R levels in quicker timeframes; but there will be times when bigger (longer) timeframe trends or corrections will impact your quicker timeframes, and if you're focused on survivable securities that will pay you to hold, you can scale in and out using LIFO accounting to more effectively work your invested capital to better manage the average price per share (cost basis) and the average rate of return for each part of an open position, which also improving the odds of realizing a lower tax bill on the early trades just like a big professional value-based fund manager. Plus at this time, every investment held for a year and a day or long enjoys the lower Long-Term Capital Gains Tax Rate and LIFO improves the odds that this can happen. Be patient and persistent, and never forget that it is naturally harder to consistently realize higher rates of return. So you are going to need to work for, and that it is going to take time and real personal growth to achieve the higher rates of return that can beat the broader market averages. Understand that it can be done, lots of people have developed this skill and you can too; but it requires an understanding of (and trust in) this strategy (or your own effective CPT strategy), lots of capital (personal savings), the self-discipline to work the strategy and develop the skill needed to earn the desired proceeds. There is no Santa Claus and there are no easy fortunes made on Wall Street.

Have you ever wondered, "What is doing better?" "Is money flowing to riskier assets or to safer assets?" "Are we in a "Risk-On" or "Risk-Off" environment?" The next two charts address these questions. They use StockCharts.com's Relative Strength Comparison option to setup a useful ratio (e.g., Ticker A over Ticker B or A divided by B or A/B, via "A:B" ticker notation), which allows a ticker to be compared against its benchmark index to see if a ticker in a group of tickers is leading, lagging or just tracking its broader index, a form of relative strength comparison (don't confuse this with RSI). It can also be used to compare the relative performance of two competitive tickers and that is what we're doing in these two charts. The first looks at Small-Caps vs. Large-Cap Stocks (ETFs). Small-Caps are generally start-ups and riskier issues that can grow faster in a better economic environments and Large-Caps are the safer Blue-Chips that almost always do okay in both good times and bad. So, is money flowing into Large-Caps or Small-Caps? The first chart answers that question. In the top panel, we see a line chart of the Total U.S. Stock market, which was grinding higher at that time. In the lower panel, we see a ratio of Small-Caps (IWM = The Russel 2000 Index ETF) vs. Large-Caps (SPY = S&P 500 ETF) or Riskier investments Vs. Safer Investments, with a 20-day MA to smooth out normal trading noise. When these lines go up, money is flowing into Small-Caps (Riskier Investments) and out of Large-Caps, a Risk-On environment. The current chart is generally down, a Risk-Off environment, after initially going up, a Risk-On environment. Money is lately flowing into Large-Caps and out of Small-Caps. I know from other charts at the time, money was flowing to Apple, Microsoft and Amazon, the three largest of the Large-Caps (about 16% of that large-cap index) while most other stocks are going down or sideways and that is why the Stock Index looks bullish but is actually "Not So Much." However, in a week or so, Warning Season will come to an end and prices should rally into the next Earnings Season, and that is why I was buying the dips at that time. This is an example of how I read The Tape (the charts, etc.), a historic record of all the news and trades hitting Wall Street. The next chart looks at the bond market. In the top panel, we see ticker BND, the ETF for the Total U.S. Bond Market Index, which is in an uptrend after putting in a near-term bottom. In the lower panel we see a ratio between HYG the "High-Yield Index ETF" and TLT the "U.S. Treasury Index ETF" or "Risk-On" Vs. "Risk-Off" (or Profit Seeking Vs The Safety Trade), which was signaling a Risk-Off environment. Money was flowing into U.S. Treasuries and out of Riskier Bonds.

The market for tradable securities can be, at times, a bit maddening; offering an amazing range of prices, some prices will be ridiculously low and at other times unbelievably high. Without a time-tested strategy (a plan) that we understand, trust, and that puts the odds in our favor, we can easily find ourselves buying when prices are high (when a security is popular) and selling when prices are low (out of favor). It's hard to predict future prices, and any strategy that requires that to be successful is doomed to failure, unless you are truly able to effectively play the Winner's Game. But it's not too hard to recognize the broader market (economic) trend as it goes through boom-and-bust cycles. Short-term traders will naturally push the current trend forward until it becomes overdone, to a level where current prices are an unrealistic reflection of likely future outcomes, to discount and premium levels that attract large savvy value investors (big fund managers) that create support and resistance levels that force trend reversals back towards the mean away from the extremes. We can take advantage of this behavior by trading with the broader market trend and against deviations away from that trend, exploiting a natural reversion to the mean — Trading our Timeframe's Support and Resistance Channel. If a security can survive volatile markets and will pay us to hold, earning an acceptable total return is just a matter of time, and thus giving us a real hold option (we can choose to ignore most minor correction related stop-loss requirements, the curse of trading), which avoids locking in avoidable losses. Money lost or squandered away on worthless products and services or popular counterproductive tactics cannot grow to support our retirement needs. However, when the broader economic trend turns on us or signals that it is likely to turn, we simply must close or greatly reduce the size of those positions that are likely to be significantly diminished by a turn in the business cycle. We need to build a small list of survivable (preferably un- or at least loosely-correlated) issues that will pay a market rate of return to hold, thus allowing us to profit from natural market rotations and surprises. Getting to know this list of tickers well (becoming a specialist in each of them) gives us a real trading advantage and puts the odds in our favor. This knowledge, with a little planning (use a spreadsheet and maybe a notebook to plan, track, and analyze results), and lots of patience are the keys to success in this business. Having a strategy that puts the odds in our favor, planning and the self-discipline to work that plan are the attributes that differentiate the professional from the wannabes. All we have to do is plan (target) our entry and exit prices, and then wait for the market to come to us; and once in a position, manage our cost-basis, the position's break-even (average) price. When market prices turn on our position (giving us a drawdown), we can work to keep that average price (our cost-basis) as close to the current market price as possible, thus allowing any upswing to be an opportunity to harvest an acceptable rate of return. Scale (average) in at discount prices (make each subsequent buy interval or size larger, thus more effectively pulling down the position's average price) and scale back out at premium prices (using Last In First Out or LIFO accounting to minimize the tax burden and to maximize the rate of return on each transaction, more on this in the next paragraph). We are thus more likely to earn our targeted rate of return (via capital appreciation, income or a combination). This is how the big professional fund managers do it, and we can do it too.

The Fast Money (best professional day-traders) focus on trends with positive relative strength (issues that lead an index higher or lower). They stick with the current trend until that trend runs into major support or resistance and reverses. They then take a quick stop-loss trade and reverse their prior trade until prices reach the other end of the current trading range. Thus, defining and refining the size of the current trading range. The best way I know how to lose money quickly and persistently is to trade like this, thinking I only need to be better than average. The average fast money trader is a professional with a track record of success. They specialize in this trading technique, and they generally specialize on a relatively small list of securities. They are the best traders in the world, and everyone else is, What? Not them! It is very unlikely that most will every become professional fast money traders. But we don't have to become one of them to make money in the markets.

The Smart Money (best professional investors) focus on mean reversion; and kept their operations in-synch with the broader economic trend. They are the smart money because they know how this game is played. They know that market prices spend most of the time within the broader trading range, cycling around the broader trading range average. A range that reflects the market collective view of likely future value. Plus, they know how to do the fundamental analysis required (or can pay to get it) to build profitable investment models for the securities they specialize in. They do their buying at relative discounts and their selling at relative premiums (i.e., they scale-in in the lower half of the current and broader trading range, and they scale back out in the upper half of the current and broader trading range). Their increasing size creates the major support and resistance that cause the fast money trends to reverse over-and-over again. There is a natural symbiotic relations ship between these two groups of professionals. The best way I know how to make money slowly and persistently in the market is to learn how to see (in longer-term charts) how the smart money play their game, and then learn how to trade with them. Thus, becoming a CPT and allowing compounding to do the heavy lifting that can create amazing wealth in the market over longer periods of time.

Big moves in the market happen when the pros are surprised by unexpected news. This forces both the fast money and smart money to trade to avoid big loses. When fast money suddenly finds themselves on the wrong side of the broader market trend, they take a stop-loss to exit and then re-enter on the right size. Thus, both fast money trades push the current trend forward. Professional fund managers (the smart money) are constantly being compared to their benchmark index. They can keep their million dollar salary jobs by just keeping up with their benchmark. It's okey to underperform a little. Everyone knows that 80 to 90% of all fund managers underperform their benchmark by a little because their benchmark is a mathematical construct that does not have to deal with real trading costs. All fund managers must deal with normal market inefficiencies, a simple fact of investment life. But they will lose their job if they significantly underperform that benchmark. So, when the smart money finds themselves holding too much cash and not enough of the surprising move, they start to pyramid in, that too pushes the new primary trend forward. The move continues until all the trading power is spend, which is also about the time when current prices no longer reflect the likely future value of the security or index in motion, which is also about when prices reach the edge of the broadest trading range. The best way I know how to profit from this is to just own survivable investments, that'll pay you to hold, like a total stock market index fund or some of the big blue-chip issues in that index that have positive relative strength. These are tickers that can fill a monthly chart because they have been trading for decades. Just scale in (be a buyer) when prices are in the lower half that broader trading range and scale back out (be a seller, book profits, and raise cash to re-invest) when prices are in the upper half of that trading range.

— In Summary —

• It takes money, a lot of it, to play on Wall Street. The best investments are naturally expensive. The more capital we have to invest, the easier is becomes to make even more while also reducing overall risk. So, start early and save as much as possible.
• The Market will pay us to play, but rarely when we need the cash. It's often feast or famine, and we'll need to smooth out those lumps. However, if we learn how to play this Loser's Game, are paying attention, and take action when the market is issuing paychecks, we can earn a very attractive salary working the market. But let's not forget to save some of that paycheck for leaner times, that will surely come, and go.
• Successful trading and investing requires self-discipline, a capital base (our savings in a brokerage account), preparation, methodical persistence, and lots of patience.
• Ultimately, our current rate of return is very likely to be function of the skills we bring to the effort, the amount of effort and time we're willing to apply, and of course what the market is doing. Much of our skill depends on our ability to have an investing strategy that has favorable odds and on our understanding of the market's nature. Much of our effort will depend on our willingness to keep up with current events (to analyze the market action), to plan-out our investments, and to trade that plan, and leaning from the results improves our skill. A slow-moving market is not likely to yield much in terms of capital improvements and forces us to rely on being paid to hold; however, a more volatile market can yield greater opportunities for capital improvements when appropriate skill and effort is applied.
• All securities trading on Wall Street are issued by either a company or government and the price of each security is supported by two factors. Over shorter timeframes, the first factor is supply and demand for that security; and over longer timeframes the second factor is the ability of the issuer to survive and generate or gather wealth and deliver it to the owners of that security.
• The economy naturally goes though boom-and-bust business cycles; and so do market prices, in a noisy, erratic, quasi-fractal pattern of cycles leading cycles and cycles within cycles. It's not that hard to learn how to spot and track these cyclical data patterns when that data is plotted on histograms (charts) over various timeframes; and as a result, we can learn to profit from these cyclical (predictable) data patterns.
• Market prices over shorter periods of time will lead (attempt to anticipate) changes in the economy's boom-and-bust cycles; but ironically over longer periods of time, prices will actually track (follow, thanks to price corrections) the real growth and contraction in the profitability of businesses that issue and back securities that traders and investors can buy, sell and hold in a brokerage account.
• Short-term trend traders will naturally push the current price trend forward toward support and resistance levels created by bigger value-based investors that force trend reversals, thus creating a trading range (a semi-cyclical support and resistance channel) that reflects the market's collect view of fair-value over the timeframe being analyzed.
• Chasing Hot Story investments and trying to pick tops and bottoms is a fool's errand, and the classic signature of a Newbie (the Dumb Money). Prices can always go higher or lower. We can only know that we've seen a near-term top or bottom after the fact on a chart. The best we can do is take advantage of available favorable prices when we see them (i.e., prices that are good enough or very likely to yield our target rate of return).
• Amateurs also tend to focus on the near-term price trend; and tend to assume the near-term future will be like the near-term past, which is not always the case. Past data can show us what is possible, the nature of the data, and the historic odds of various events in the past, which can all be a useful guide for the future; but we should never assume the future will be like the past. It's true that what has happened in the past tends to happen again in the future, but never forget that every moment in the future is unique and anything can happen.
• Professionals tend to focus on a much broader set of market data and setup their trades based on well considered plans given likely future news and commentary, the broader market (economic) trend, and likely future price ranges; they play the odds, and only trade when the odds favor portfolio growth.
• The Smart Money likes to buy low and sell high (be a buyer at relatively higher yields and a seller at lower yields); and if possible, earns income while waiting. The Smart Money knows that low (discount) prices only exist when a security is out of a favor, is suffering from bad news, and is trading at the lower-end of the current S/R Channel; and high (premium) prices exist when there's good news, the security is popular, and trading at the higher-end of this range. Like the Smart Money, we need to be buyers at discount prices (at relatively higher yields or just above support on a chart and preferably longer-term support found near the bottom of longer-term charts) and sellers at premium prices (at relatively lower yields or just below resistance on a chart and preferably longer-term resistance) when we have attractive profits to harvest (when the market is issuing paychecks; and don't worry if your paycheck is not the biggest, it simply needs to be big enough to justify the risks taken).
• Pros know that prices can always to higher or lower, and can turn at any time, and that is why they scale in and out. They understand that they cannot control prices, but they can work to improve their cost basis and rate of return. Optimizing these two averages can greatly improve their results over time (e.g., improve the average price per share on the whole or on the various parts of a specific investment, and improve the average rate of return on the whole or on the various parts of that investment by locking-in above average returns when the market offers them). Working to optimize these averages is the professional approach, and we can do that too.
• Always think and trade like a big Value Investor. It's best to specialize in boring, predictable, above average investments that allow us to scale in and out over time and at better prices, thus allowing us to manage and optimize our averages. Only make a trade when that trade is very likely to improve the portfolio's averages. Basically, we want to be a buyer at below-average prices of above-average investments, and a seller when we see above-average prices or when we have an above-average rate of return to lock-in or when the health of the broader market (economic) trend (the boom-bust cycle) is clearly ready to turn.
• It's best to focus the bulk of our time and capital on just a few securities that are very likely to survive volatile market cycles and that will pay us a market rate of return to hold — think large, mature CEFs and ETFs, and Blue-Chip issues. By limiting ourselves to just a few issues initially, we're more likely to do a better job on each. In time as our skills improve and the size of our capital-base increases, then it's okay to gradually add to our list of securities that we specialize in.
• It's best to keep our operation in-sync with the health of the broader market (economic) trend. That is the trend that's likely to come to pass given the health of the economy looking forward. The really big money is made and kept riding (being in) the big cyclical moves. It's okay to book a little profit when things get a little over done on the upside and to buy back in when the correction is over done on the downside; but don't feel like we must time every little turn. We want to develop an ability to see when the big turns are likely, adjust our asset allocation appropriately, while learning to ignore all the noise associated with shorter-term trading.
• It's best to maintain an appropriate (uncorrelated) asset allocation that is slightly biased toward sectors that are likely to do better in the upcoming phase of the boom-and-bust cycle.
• It's also best to Maintain a Watch-List, and an associated analytical and trading methodology. Having a small list of ticker symbols to focus on and a simple iterative process to find and exploit favorable trading opportunities is another professional technique. Note that the easiest way to attain and maintain CPT status is only take on trades that are very, very likely to yield an acceptable profit sooner or later, and to avoid all trades that require good luck or skills that we've not yet clearly mastered.
• Be a Consistently Profitable Trader (CPT). Our primary goal should be to learn how to be a Consistently Profitable Trader (CPT). Be someone who can grow the size of their brokerage account over their operational timeframe. Operate in our Optimally Effective Timeframe (OET). Our secondary goal is to reduce our operational timeframe while maintaining CPT. It's best (easiest) to start with the biggest timeframe (e.g., economy's boom-bust cycle) and then ratchet down the size of your operational timeframe as we generate the skill and capital base to retain CPT status over shorter (quicker) timeframes. Of course, the ultimate goal is to have the skill and capital to be a True Market Professional — someone who can make their living in the market.

Click here to see a summarize of My Market Insights and how I apply the information above to earn a living, here to see a detailed example of how I plan out and manage a CEF (and ETF) position based on the information above, click here to learn more about my Trading and Investing Rules for retirement, and here to review my old Prop. Trading Notebook.

Stan Benson