Black Jack Anyone?

By: Stock Barometer | Sun, Dec 2, 2007
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Bi-Weekly Stock Barometer No. 170
12/2/2007 10:03:29 AM

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Before I get into this weeks topic, just a heads up that as we approach the year end, we're beginning to do our research for our 2008 forecast. This is our most popular article and it only goes out to subscribers. So stay tuned.

Traders Can Learn a Lot from Professional Gamblers

Black Jack Anyone?

As a trading coach, I spend a lot of time sitting down with traders going through every aspect of their trading to identify areas to help them. The first part of my analysis is to get a back ground and determine where they are on the educational curve.

I have clients on both ends of the spectrum. And have found the following issues as roadblocks to their success.

  1. Trading too little money per position. Not allocating an appropriate amount of money means that your commissions will become a drag to your potential. It's difficult to be a short term swing trader and lose 5% on commissions alone, especially when you're targeting 10-15% short term returns.

  2. Not properly identifying the trade parameters. Trading is as basic as identifying an entry point, a reason for entering there, a stop price (incase you're wrong) and a profit target (in case you're right). This is a starting point. If you can't do this, I can't get you to the next level where we develop each of these components of the trade.

  3. Not analyzing your own trades enough. When you give me a list of your trades, the first thing I do is calculate the success rate and the amount of profit your making when you're right and the amount of losses you take when you're wrong (That's the P:L Ratio). It's important for me to know if you're at a 20% success rate. Then I have to figure out why. Actually, you can be successful at 20% as long as your P:L ratio is good - and that's the second component that I look at. The P:L ratio should ideally be 3:1. I've seen it go down to 2:1 for ETF traders - which works as you can trade ETFs with a higher success rate and put more money in ETFs to account for decrease in volatility.

  4. Trade to trade well, not to make money. All too often, client's main focus is making money. This, unfortunately, leads them away from what they should really focus on - learning how to trade well. Forget about the money. Just learn to trade. Learn everything you can about trading. Execute your trading plans accordingly. Trade well, and the money will follow. Trade to make money, and you're bound to fail.

Item # 3 brings me to the topic for today. Think of trade in terms of units. The units I'm talking here are profit units and stop loss units. I can not place enough emphasis on the 3:1 Profit/Loss ratio. It is the basis for establishing a successful trading plan, whether or not you're a swing trader, break out trader, candle trader, or any type of trader.

How do you utilize the 3:1 ratio? It's very simple. First, you have to identify an entry point. This depends on how you trade. Since there are so many different styles of trading, we won't talk about that here. The second, but actually more important component is the profit objective. Where do you think the stock is going to go? Subtract your target from your entry and you have the profit potential. Divide the profit potential by 3, and that's your Loss potential. You take that number, subtract it from your entry point and that's where your stop needs to be.

General rule of thumb in stock trading, you shouldn't give up much more than 9% as your stop when you're targeting 30% gains. Above that level, and you're going to make it difficult to recover - depending on the % winners you achieve.

Percentage Gain To Break Even After A Loss

Percentage
Loss

Gain Required
To Break Even

-10%

11%

-20%

25%

-33%

50%

-50%

100%

-75%

300%

-90%

900%

Traders can learn a lot from professional gamblers. Gamblers, the profitable professional ones that do it for a living, not the weekend warriors, employ a similar money management strategy. Go to the table with their 1x units and look to gain 2-3x units. Once they gain their 3x units, they walk away with the profits. Or adjust their stop - to protect their profits.

Think of it this way. If you go to a $10 black jack table, and bring $100 - then you'll have 10 units and the goal of making 30 units. It's like bringing 250 to a $25 dollar minimum table and looking to walk away with $750.

Gamblers, like traders, know losing is part of the game. They know there will be times when the cards work for them and against them. If you've ever gambled, you know the wins and losses come like a sine wave, where you'll catch a wave of winning and then go on a string of losses.

Thinking in units also allows the gambler to remove the emotional attachment to money, and will make it easier to move from a $10 table, to a $25 dollar minimum table. Think of the chips in terms of units and follow your strategy. And at the end of the day, if you're up 30 units, you simply go cash them in and collect your $300 or your $750. Losing the emotional attachment allows you to follow your system better.

Gamblers also employ a time stop. You can only gamble for so long, and if you haven't stopped out and haven't hit your target, you eventually have to leave the table. Traders should also consider the same thing. If your money is sitting in a position and it's not doing anything, then eventually, you have to consider exiting the position and put the money to better use elsewhere.

The stop units also have to be wide enough to allow for the normal number of losses you'll experience playing black jack. If you bring 4 chips to the table, you can easily lose your 4 chips in 4 to 6 hands in a normal cycle. Go to the table with 10 chips, and you have some room to go through a down cycle and recover.

Same thing applies with your stock trades. If you're trying to gain 30%, you can't put a stop 2% below your entry point. Otherwise, you're bound to get stopped out so frequently, that you will never realize your target gains.

So there you have it. You can learn a lot from other traders and other professions like gambling. Elements of the two professions can go hand in hand and if you're a trader, it would actually benefit you to learn a little about gambling and if you're a gambler, you may find yourself well suited for trading in the stock market.

Black Jack anyone?

On to the charts.

Message From The Markets

Market action is ruled by sentiment and by monitoring market internals and studying sentiment you can reasonably predict future market movements. The basis of the Stock Barometer system is overlaying extremes in sentiment with sound technical analysis to predict the likelihood of future price movement. Each indicator and chart measures the hope, fear and greed of investors and traders from different angles. Follow along with my charts and over time, you'll also learn to understand how to read the markets, which is essential prior to setting up each and every trade.

STOCK BAROMETER CHART

The Daily Stock Barometer is a proprietary measure of market energy. The direction of the stock barometer determines our short-term outlook on the market's direction. A BUY or SELL signal is triggered when the indicator clearly changes direction. If the line is moving up, we are in BUY MODE and if it's moving down, we are in SELL MODE. The black line is a 5-day moving average that we use to confirm changes in direction.

EQUITY PUT CALL RATIO CHART

The CBOE put/call ratio is comprised of two sets of data; equity options and index options. The index component contains items that are used as a hedge, thereby distorting the correlation and interpretation of the indicator. I use the equity put/call ratio. This is one of the most accurate read of investor's fear and complacency.

TRIN/ARMS CHART

Richard Arms developed the arms index. It is also referred to the Trading Index or TRIN for short. It is a measure of the ratio of up stocks and down stocks divided by the ratio of up volume and down volume. Our Spread Chart converts the arms index data into momentum Buy and Sell Signals.

TICK CHART

The tick index is represents the sum of all stocks ticking higher minus all stocks ticking lower (a stock is said to be trading on an up tick when it trades at a higher price than the last sale). It's utilized as a day trading tool as it gives you an up to the second read of the intensity of buying and selling.

BREADTH (ADVANCE - DECLINE) CHART

Each day several thousand stocks either advance, decline or remain unchanged. The number of advances and declines normally ranges from +2500 to -2500. A high number of advancing stocks normally marks a top just as a high number of declining stocks normally marks a bottom. Monitoring the 5 and 13-day moving averages of this allows us to better predict future prices.

VXO CHART

The VIX is a measure of volatility on options pricing. We use the old VIX, which is now called the VXO. The higher the volatility, the more likely the market is close to a bottom, as traders are willing to pay more premium for puts, which act as Insurance on their long positions.

Cycle Time

Monday will be day 13 in our UP cycle. I know it can be difficult to hold on during a period where the market is consolidating between highs and lows - but if you held out and remained in Buy Mode during this period - you should feel a little better now.

The Stock Barometer signals tend to follow a 5, 8 and 13 and sometimes 21 day Fibonacci cycle that balance with 'normal' market cycles. Knowing where you are in the current market cycle is important in deciding how long you expect to maintain a position.

Potential Cycle Reversal Dates

2007 Potential Reversal Dates: 1/10, 1/14, 1/27, 1/31, 2/3, 2/17, 3/10, 3/24, 4/21, 5/6, 6/15, 8/29, 10/19, 11/29, 12/13, 12/24. We publish these dates up to 2 months in advance.

We thought 10/19 would be a top - although it took a while to come in due to seasonal factors. In addition, Thursday was another key reversal date and given the +/- 2 day accuracy, it's difficult to ascertain anything significant from this. Our next date is 12/13 - 12/21 is the next options expiration. I still believe seasonality will trump here going into a typical mid January reversal.

My timing work is based on numerous cycles and has resulted in the above potential reversal dates. They're predictive and have nothing to do with the barometer cycle times. However, due to their accuracy in the past, I post the dates here.

2006 potential reversal dates: 1/16, 1/30, 2/25, 3/19, 4/8, 5/8, 5/19, 6/6(20), 7/24, 8/20, 8/29, 9/15, 10/11, 11/28.2005 Potential reversal dates based on 'other' cycle work were 12/27/04, 1/25/05, 2/16, 3/4, 3/14, 3/29, 4/5, 4/19, 5/2, 6/3, 6/10, 7/13, 7/28, 8/12, 8/30-31, 9/22, 10/4, 11/15, 11/20, 12/16.

Stock Barometer Buy And Sell Signals

QQQQ or SPY Chart: A chart is provided in every bi-weekly report and shows the barometer Buy and Sell Signals (which are provided in my morning updates) as well as showing the next highlighted 'reversal' window. The numbers adjacent to the buy and sell signals are the number of days between signal (cycle time).

Here's one years of our end-of-day buy and sell signals for the Stock Barometer over the past year. They're marked on the QQQQ chart with red and blue lines (or red and blue arrows). Note we recently changed bottom and top to read buy and sell.

 

12/20

Projected SELL Signal (21 days from last signal)

 

11/13

BUY (4 days)

 

11/07

SELL (7 days )

 

10/29

BUY (13 days)

 

10/10

SELL (3 days)

 

10/5

BUY (2 days)

 

10/3

SELL (2 days)

 

10/1

BUY (1 days)

 

9/28

SELL (12 days)

 

9/12

BUY (4 days)

 

9/06

SELL (3 days)

 

8/31

BUY (3 days)

 

8/29

SELL (7 days)

 

8/17

BUY (3 days)

 

8/14

SELL (4 days)

 

8/8

BUY (16 days)

 

7/17

SELL (3 days)

 

7/12

BUY (15 days)

 

6/20

SELL (4 days)

 

6/14

BUY (20 days)

 

5/15

SELL (27 days)

 

4/5

BUY (7 days)

 

3/27

SELL (13 Days)

 

3/8

BUY (34 days)

 

1/18

SELL (4 Days)

 

1/11

BUY (17 Days)

 

12/22

SELL (6 Days)

  (historical reversal dates and performance figures are published at the Performance Page on the home page and updated at least annually)

The following work is based on my spread/momentum indicators for the QQQQ, GLD, USD, USO and TLT. They are tuned to deliver signals in line with the Stock Barometer and we use them only in determining our overall outlook for the market and for pinpointing market reversals. The level, direction, and position to the zero line are keys in these indicators. For example, direction determines mode and a buy signal 'above zero' is more bullish than a buy signal 'below zero'.

Gold Spread Indicator (AMEX:GLD)

To trade Gold, utilize the Gold ETF AMEX:GLD. This gives us a general gage to the overall health of the US Economy and the markets, as well as to assists us in the entry of positions in our stock trading service.

US Dollar Index Spread Indicator (INDEX:DXY)

To trade the US Dollar, I'd utilize the Power Shares AMEX:UUP: US Dollar Index Bullish Fund and AMEX:UDN: US Dollar Index Bearish Fund.

Bonds Spread Indicator (AMEX:TLT)

To trade Bonds, I recommend Lehman's 20 year ETF AMEX:TLT. Note that the direction of bonds can have an impact on the stock market. Normally, as bonds go down, stocks will go up and as bonds go up, stocks will go down.

OIL Spread Indicator (AMEX:USO) *NEW*

To trade OIL, utilize AMEX:USO, the OIL ETF. We look at the price of oil as its level and direction can have an impact on the stock market.

Summary & Outlook

The barometer remains in Buy Mode and we continue to expect the markets to remain resilient here - even with the high oil and gold prices.

I also want to remind readers that you can save almost $50 - or 20% by subscribing for a year for only $239 (click here). Then email Carl at customer support and let us know you want to change over your subscription to an annual - and they'll make sure you're monthly subscription is turned off. customersupport@stockbarometer.com

Friday's action was somewhat bearish in that it left us with a slew of bearish candlestick patterns - or the initiation of a potential bearish candlestick patterns. We feature some of those patterns on our Free Reports page - here's a link: http://www.stockbarometer.com/freereports.aspx

To follow our daily signals and trades and learn more about our system, click here and sign up for a free trial. Sign up for our free weekly newsletter to get up to date advice from our Pro Traders.

As always, if you have any questions or comments, feel free to email me here at jay@stockbarometer.com.

Regards,

 


 

Stock Barometer

Author: Stock Barometer

www.stockbarometer.com

Stock Barometer is completely independent. We have never and will not ever accept compensation from any company whose stock we recommend.

Our goal is to make you money. We offer you the tools and information to do so and leave it to you, the individual investor, to apply them in the best way possible.

Important Disclosure: Futures, Options, Mutual Fund, ETF and Equity trading have large potential rewards, but also large potential risk. You must be aware of the risks and be willing to accept them in order to invest in these markets. Don't trade with money you can't afford to lose. This is neither a solicitation nor an offer to buy/sell Futures, Options, Mutual Funds or Equities. No representation is being made that any account will or is likely to achieve profits or losses similar to those discussed on this Web site. The past performance of any trading system or methodology is not necessarily indicative of future results.

Performance results are hypothetical. Hypothetical or simulated performance results have certain inherent limitations. Unlike an actual performance record, simulated results do not represent actual trading. Also, since the trades have not actually been executed, the results may have under- or over-compensated for the impact, if any, of certain market factors, such as a lack of liquidity. Simulated trading programs in general are also subject to the fact that they are designed with the benefit of hindsight. No representation is being made that any account will or is likely to achieve profits or losses similar to those shown.

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Investment Research Group (IRG), as a publisher of a financial newsletter of general and regular circulation, cannot tender individual investment advice. Only a registered broker or investment adviser may advise you individually on the suitability and performance of your portfolio or specific investments.

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