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.When Ilooked at the results, I was truly astounded.What I found was concrete evidence that market movements have statistically significant frequencydistributions, in terms of both extent and duration.In other words, market movements have a life expectancy, just likepeople.In a flash of insight, I realized that if insurance companies could make money by setting premium ratesaccording to statistical life expectancy profiles, I should be able to judge the odds of success in any given market tradeaccording to market extent and duration frequency profiles.There is, of course, one major difference between the kinds of numbers insurance companies use and thenumbers I derived.Insurance companies make money by having a large number of customers and betting,130as morbid as it sounds, that the vast majority of them will die within the statistically normal range.When you "bet" ona market movement, however, it is tantamount to insuring one person.Therefore, before setting your "premium" onthe market, so to speak, you must carefully consider the market's overall "health" using macrofundamental analysis,technical analysis, and so forth.What market life-expectancy profiles tell you is the essential age of the market.For example, at this writing(February 1992), stocks are in a bull market primary swing an intermediate-term (weeks-to-months) uptrend in a bullmarket.Instead of using just the Dow Industrials and Transports, as Rhea did, I characterize market movements byaveraging 18 major indexes.Currently, these indexes have appreciated an average of 18.6 percent over an averageperiod of 74.4 days.In terms of the Life expectancy distributions, 53.5 percent of all bull market primary swings havebeen greater in extent, and 67.3 percent have lasted longer.Stated another way, the market is approaching medianlevels both in terms of extent and duration.From a statistical standpoint alone, there is on average a 40 percent chancethat the market's "life" will end imminently.Therefore, if you used this as your sole criterion, you should be long nomore than 60 percent of portfolio maximums in stocks.Although this is not enough information on which to base such a cut-and-dried decision, it is enough toestablish a concrete frame of reference within which to analyze the risk of market involvement.Returning to the lifeinsurance analogy, being long right now, the market is roughly equivalent to the prospect of writing an insurance policyon a man in his early 60s.Naturally, before writing a policy and setting a premium rate, you would want to take a closelook at the health of a man in that age bracket.Similarly, you would want to examine the nature of the current marketmovement carefully before establishing if or to what degree you should be long.You can also use the statistics to examine the risk inherent in individual market segments in more detail.Forexample, although the current market has appreciated the average extent over the average duration stated earlier, theOTC market has skewed the average toward the upside, making it look "older." If you view the current move in theOTC industrials separately, for example, you would find it has appreciated 41.7 percent over a period of 215 days.Only 14.2 percent of all similar moves in history have been greater in extent, and only 26.5 percent have lasted131longer.If you are trading in the OTC industrials, therefore, you're not dealing with a man in his early 60s, but a man inhis 80s.Close examination of other current factors lead to the conclusion that not only are the OTCs an old man, butone who needs major surgery.Consequently, I am short selected OTC stocks, awaiting a correction in that market.On the other hand, if you filter out the OTC stocks, the likelihood that the rest of the market will continue itsuptrend is increased.The Dow Industrials, for example, have currently appreciated 14.4 percent over a period of 60days.In terms of history, 69.9 percent of all similar moves on the Dow have been greater in extent, and 77 percent havelasted longer.This indicates that in terms of age alone, there is a moderately low risk that the uptrend in the Dow willdie imminently.In fact, as I write, the Dow is making new highs while the NASDAQ Industrials are selling off.This measure of risk is far and away the most heavily weighted technical tool that I use.It is the underlyingfactor that has enabled me to limit my risk, minimize my losses, and maximize profits.It provides me an objective framework to help me concretely measure risk and reward, guiding me toward prudent weighting of my stock andindex portfolios.In the context of the current market, for example, I am short OTC stocks and long the deep cyclicals,largely because the statistics guided me to the best overall risk-reward approach in both arenas.With this in mind, let me explain in more detail how the life expectancy distributions are derived andimplemented.MARKET LIFE-EXPECTANCY PROFILESAs anyone can tell by looking at a year-to-year chart of the Dow Industrials, one way to make money is simplyto take a traditional buy-and-hold approach.Many investors and portfolio managers take this approach, whileattempting to further enhance returns through careful stock selection.Without a doubt, considered from a long-termperspective, this is an effective investment strategy.But money managers who consistently produce superior returnsfocus less on the long-term trend, and more on the intermediate-term trend.In a bull market, for example, they attemptto be 100 percent long in the early portion of a bull market intermediate uptrend, reduce exposure prior to a secondarycorrection, go short132or remain on the sidelines during the correction, and go fully long once again near the correction bottom.One of the greatest strengths of market life-expectancy distributions is the degree to which they enhance thetrader's ability to move in and out of the market with changes in the intermediate-term trend.Consider bull marketsecondary corrections as a case in point.First, a reminder on definitions.A correction (also known as a secondary reaction) is an importantintermediate-term price movement moving in the direction opposite to the major long-term trend; "intermediate term"means lasting weeks to months [ Pobierz całość w formacie PDF ]
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.When Ilooked at the results, I was truly astounded.What I found was concrete evidence that market movements have statistically significant frequencydistributions, in terms of both extent and duration.In other words, market movements have a life expectancy, just likepeople.In a flash of insight, I realized that if insurance companies could make money by setting premium ratesaccording to statistical life expectancy profiles, I should be able to judge the odds of success in any given market tradeaccording to market extent and duration frequency profiles.There is, of course, one major difference between the kinds of numbers insurance companies use and thenumbers I derived.Insurance companies make money by having a large number of customers and betting,130as morbid as it sounds, that the vast majority of them will die within the statistically normal range.When you "bet" ona market movement, however, it is tantamount to insuring one person.Therefore, before setting your "premium" onthe market, so to speak, you must carefully consider the market's overall "health" using macrofundamental analysis,technical analysis, and so forth.What market life-expectancy profiles tell you is the essential age of the market.For example, at this writing(February 1992), stocks are in a bull market primary swing an intermediate-term (weeks-to-months) uptrend in a bullmarket.Instead of using just the Dow Industrials and Transports, as Rhea did, I characterize market movements byaveraging 18 major indexes.Currently, these indexes have appreciated an average of 18.6 percent over an averageperiod of 74.4 days.In terms of the Life expectancy distributions, 53.5 percent of all bull market primary swings havebeen greater in extent, and 67.3 percent have lasted longer.Stated another way, the market is approaching medianlevels both in terms of extent and duration.From a statistical standpoint alone, there is on average a 40 percent chancethat the market's "life" will end imminently.Therefore, if you used this as your sole criterion, you should be long nomore than 60 percent of portfolio maximums in stocks.Although this is not enough information on which to base such a cut-and-dried decision, it is enough toestablish a concrete frame of reference within which to analyze the risk of market involvement.Returning to the lifeinsurance analogy, being long right now, the market is roughly equivalent to the prospect of writing an insurance policyon a man in his early 60s.Naturally, before writing a policy and setting a premium rate, you would want to take a closelook at the health of a man in that age bracket.Similarly, you would want to examine the nature of the current marketmovement carefully before establishing if or to what degree you should be long.You can also use the statistics to examine the risk inherent in individual market segments in more detail.Forexample, although the current market has appreciated the average extent over the average duration stated earlier, theOTC market has skewed the average toward the upside, making it look "older." If you view the current move in theOTC industrials separately, for example, you would find it has appreciated 41.7 percent over a period of 215 days.Only 14.2 percent of all similar moves in history have been greater in extent, and only 26.5 percent have lasted131longer.If you are trading in the OTC industrials, therefore, you're not dealing with a man in his early 60s, but a man inhis 80s.Close examination of other current factors lead to the conclusion that not only are the OTCs an old man, butone who needs major surgery.Consequently, I am short selected OTC stocks, awaiting a correction in that market.On the other hand, if you filter out the OTC stocks, the likelihood that the rest of the market will continue itsuptrend is increased.The Dow Industrials, for example, have currently appreciated 14.4 percent over a period of 60days.In terms of history, 69.9 percent of all similar moves on the Dow have been greater in extent, and 77 percent havelasted longer.This indicates that in terms of age alone, there is a moderately low risk that the uptrend in the Dow willdie imminently.In fact, as I write, the Dow is making new highs while the NASDAQ Industrials are selling off.This measure of risk is far and away the most heavily weighted technical tool that I use.It is the underlyingfactor that has enabled me to limit my risk, minimize my losses, and maximize profits.It provides me an objective framework to help me concretely measure risk and reward, guiding me toward prudent weighting of my stock andindex portfolios.In the context of the current market, for example, I am short OTC stocks and long the deep cyclicals,largely because the statistics guided me to the best overall risk-reward approach in both arenas.With this in mind, let me explain in more detail how the life expectancy distributions are derived andimplemented.MARKET LIFE-EXPECTANCY PROFILESAs anyone can tell by looking at a year-to-year chart of the Dow Industrials, one way to make money is simplyto take a traditional buy-and-hold approach.Many investors and portfolio managers take this approach, whileattempting to further enhance returns through careful stock selection.Without a doubt, considered from a long-termperspective, this is an effective investment strategy.But money managers who consistently produce superior returnsfocus less on the long-term trend, and more on the intermediate-term trend.In a bull market, for example, they attemptto be 100 percent long in the early portion of a bull market intermediate uptrend, reduce exposure prior to a secondarycorrection, go short132or remain on the sidelines during the correction, and go fully long once again near the correction bottom.One of the greatest strengths of market life-expectancy distributions is the degree to which they enhance thetrader's ability to move in and out of the market with changes in the intermediate-term trend.Consider bull marketsecondary corrections as a case in point.First, a reminder on definitions.A correction (also known as a secondary reaction) is an importantintermediate-term price movement moving in the direction opposite to the major long-term trend; "intermediate term"means lasting weeks to months [ Pobierz całość w formacie PDF ]