Follow the Yellow Brick Road 11/30/11

Develop a good process/system.

Verify and validate the process.

Then follow the process.

For it will lead to good results over the long haul.

This is the mantra I must remember.

Being human, my first reaction to the DJ30 +485 point up day today was to be euphoric about the money made today. Instead, I wish I could be more Zen like about this when making money. I have to remind myself that what I should be happy about is that I am able to execute my systems to a “T” and what I control is my ability to follow the process, despite fear of losses. I will certainly have losses at times but following my systems, I will gain more while losing less.

Control and manage the Process. And let the Process deliver positive Results.

Focus on what I can control. Let my execution be flawless…

I am still long biased based on the partial entry signal in my 401K system last month. I have been hedged against the loss and that limited my losses in the last two weeks; but it was still painful. I sold part of my hedge after I felt we had gone down too deep; but with the rise will add some more back.  

My next monthly 401K analysis can be done during this weekend to see if there are any changes. My market signals are still down on DIA and SPY.

Buying into a Falling Knife 11/27/11

It is tempting to buy dips. Even when those dips are in the context of a bearish drop. This is Dollar Cost Averaging and it goes against the grain of what I would do. Why? Because losses can get larger and larger as the stock or fund drops. Months later or perhaps years later it may rise and get you out of trouble. In the case of some stocks, that might never happen. Some people have that patience and consider that long term investing.

Why not invest and go long when the market tells you people are buying and the fund is going up instead? Is that so hard to do if you use good technicals? I don’t think so.

Case in point is the India Fund IIF. I recall my friends buying into IIF when it was in the 20s and had a bearish signal. The response at the time was it had dropped 15-20% over 3-4 weeks and it seemed like a good time to buy since no one can tell when there is a bottom. No. I think it is better to buy when there is a technical Buy signal supporting the decision. Sometimes those buy signals can be short lived in which case it is better to get out on a sell or exit signal. IIF is now at 14.85. It has been dropping continuously for the last few weeks. Time to buy? Sure for contrarian investors. It might be a good oversold period and a bounce is likely but that is too risky for me. I work too hard to grow my money. I would rather buy when I get a Buy signal. A contrarian I am not. And if I did buy now, I would do it with options to keep my risks limited.

A Down Signal on DIA 11/23/11

The Dow Jones 30 fired off a down signal after the close today. Not good. The chart structure resembles another period of time back in 5/23/08 eerily. It is identical to the down signal on 5/23/08 after which the market dropped and DIA went from 126 to 80 over a few months. I don’t think the market will repeat itself. That would make it too easy, too simple. Nothing about the market’s moves is simple. But the global fundamentals are looking more ominous than the collapse of the housing and real estate markets. Our borrowing along with the borrowing in Europe is setting the stage for a bigger collapse. The top hedge fund soothsayer says we will see it by end of 2012. So what do I do? Jump for shelter?

I think the trading down band is stretched and I have no choice but to wait for a small bounce to start taking the down moves. At this rate my 401K system will kick me out of equity funds by the first week of next month. I will patiently wait the 30 days Fidelity wants me to wait. I hate that about Fidelity. It is that holier than thou behavior. I will never get an independent Fidelity account. All right. I am stuck with them on my 401K but in case they wanted to know how I really feel….

My SPY puts have gained value and will reduce the losses from my partial long positions from my 401K system, triggered early this month. The only thing that saved me was my ICE system on SPY that still told me exit on long. I know it is quirky but I trust it because of that. The markets are quirky also. Those nice simple systems don’t cut it on the major indexes. I wish I had taken some of the down signals that came along on individual stocks earlier this week and last week and wish I had purchased put options. Perhaps I can take it on the small bounce that I expect to see soon.

The only saving grace would be if the US consumer saved the day by purchasing their way out of this mess. A friend of mine asked me the other day, what are we good at in the US? My first thought was “consumption”. Yes, I think we can do a massive Thanksgiving buy that shows the world and the Corporations that feed us that we the US consumers are not done. If that happens we can get another whipsaw and the markets move back up. The longer the market goes down, the less likely we would say is the chance of us just having a higher low and the whole market moving up. I think there is a decent chance that this market gets ugly; but what good is such a prediction? Zero. Better to say I don’t know and that I will trust my chart signals.

Below is a chart on DIA showing the down signal now and another DIA chart showing the down signal in 5/22/08. Quite a resemblance…mulling that over.  Got to protect my capital first.

Current state of affairs - 11/19/11

I am now partially invested long in my 401K based on my monthly system, probably to the tune of 35% of my 401K portfolio. All my investments in R/IRAs are cash so this does not represent 35% of my total portfolio, much less. Due to the Exit long signal on my SPY chart, I am hedged on even this exposure with put options on SPY. During last week the markets dropped 3% and while my 401K funds dropped in value, my put options increased in value and kept my losses contained. I would normally remove the hedge once I see long signals on SPY. Meanwhile the chart on DIA still shows long, although the indicators are certainly showing a weakening and wilting of the index.

Last week I also placed stops on my long position on GLD and AMD to protect the modest profits I had in each. I was stopped out on both and was glad to lock in some profits as both have turned negative to my point of entry. I hate giving up gains on positions and have to cash out with a loss. Stops do have its usefulness at times and this was one fo them.

I see emerging markets and my IIF India fund charts all showing down signals. I don’t like that as those are the regions I hope to see lead with gains and right now they are leading with losses. At this time the bond funds like TLT are holding up as well as the US Dollar, UUP. The focus is on Europe and we are waiting to see if they can extract themselves from the contagion they are in. Can the leaders lead themselves out of trouble or will the countries financially self-destruct from getting goodies that they cannot give up… and within a couple of years, the US will have to face up to its own debt situation…

The markets are ripe for a rinsing but that is just my brain thinking. Much better to stop that and follow the signals.

Book Review on Covered Calls: “Show me the Money” – Ron Groenke 11/19/11

I just finished reading the book “Show me the Money” by Ron Groenke. It is about placing covered calls and naked puts for a monthly cash income.  I give the author a rating of “A” for the book. It is an easy read despite his including tables and charts on trades that might scare off some readers. I think it reads like a simple story book with a happy ending – showing you how you can make 25% return per year or more on your investments. Sounds too good to be true? Read the book. His website is:  http://www.rongroenke.com/index.php

What are covered calls? A covered call is when you buy the stock and sell call options against it, collecting the call premium. By doing covered calls on a portfolio of stocks that are either going sideways or moving up, it is possible to generate an average of 25% returns on your portfolio. Ron also shows how one can sell naked puts that are out-of-money (OTM) to rack up additional premium; but only do it in stocks you intend to buy for covered calls. If the stock crosses the strike price at expiration, then you land up owning the stock or the stock gets “put” to you so to speak. Ron would immediately turn around and do a covered call on the stock that he purchased at a discount, as he collected premiums on the put options sold.

The obvious weakness to this method is that there is no downside protection other than the offset the call premiums provide. If the market changes and is in a freefall, there would be significant losses. And I dislike losses. Ron points out this risk; but still presents the method as an almost sure thing. That is only true if the stocks are going sideways or going up. If we can combine Covered calls with market timing, it can be a powerful tool and one can truly generate significant money of your portfolio, making it in fact  a money tree.

In order to follow this technique, it would be wise to learn about options first. I learned options through Optionetics. That gave me a good grounding – but I must say it was rather expensive classes. Still, it gave me an added tool I wanted to use for protecting my portfolio, and just reading books was a hard way to learn options.

Ron also offers software that you can lease at about $220/year for the whole package that enables you to select the right stocks to do covered calls on, and time it, and find the best options to sell against these stocks. There is a free walk through software demo that is not too bad. Like any software, it would take some getting used to. Overall, it would be possible to generate $120K income against a portfolio of $360K.

My next steps will be to read the book over again. There are many useful nuggets of information. I am probably more comfortable selecting stocks using TC2007 software from Worden Bros from the S&P500, using some of the fundamental criteria that Ron mentioned. Then I would generate technicals off Metastock to give me Buy and Sell signals that are relatively slow. I would like to use this method on five stocks that have good fundamentals and have a buy signal against them. Run the covered calls on a portion of my portfolio and see how it does. No hurry to jump in immediately. I will do my homework over the next month and start in 2012. Using covered calls to generate income of your portfolio such as Rollover IRA accounts is certainly a good idea but it is best to have a plan and then trade the plan. Still need to know when to enter, when to hold it and when to fold it…

DIA Up and the Money tree 11/13/11

Attaching a chart on DIA. This is an ETF on the Dow Jones 30 stock. The signal is up on this since 10/11/11, more than a month ago. Meanwhile my more elaborate system on SPY still shows an exit on long, which holds me back a little. And my 1/month 401K system has had me dipping my foot back into stock funds like Vanguard Explorer Admiral and Artisan Mid-Cap value. I did buy some SPY put options in one of my R/IRA accounts as protection on my 401K long positions and will leave them on till I get a positive up signal on SPY.

Other than that, I have been thinking about a money tree. I went to the local chapter AAII meeting this weekend and picked up a book for reading. It is called “Show me the Money”, Covered Calls & naked Puts for a monthly cash income by Ronald Groenke. The money tree method so to speak. Plant a tree at the back that grows dollar bills that you can keep taking, as long as your underlying stock doesn’t get decimated..

I have rarely practiced using covered calls as I consider them risky with no downside protection. Yet I have met at least a couple of people who have practiced this strategy quite successfully. I think it might be worth considering when combined with tactical asset allocation (market timing) based on slow signals that don’t get you in and out frequently.

The author starts of with an example where he shows a 21.44% return per year over 28 months. Buy the stock and sell the call options and collect premium. This method certainly has downside risk but I will keep my opinions bottled and take a look at what the author has to say. It will take me a little while to digest the strategies he promotes and then I can combine it with some of my own ideas. What is wrong with buying a chunk of high grade stocks like WMT, PFE and KO and selling options on it over and over again as additional income? I think there are nuances I will want to add and do the what if scenarios so that I am prepared with the proper reaction if the stock goes down. But even if one did this in a mindless manner through downturns, would we not come out ahead in the long term? Capital preservation is still important to me so I probably won’t participate when we get major downturns. Still, this might be a good method for sideways and up markets. I like a slow upward moving equity curve on my portfolio and this might add to it. More on this later.

401K transitional times 11/6/11

It is that time of the month when I take a look at my 401K choices and run my Metastock software through its monthly algorithm and decide whether to keep the same choices or make changes. This month I see that the results are mixed; suggesting a transition taking place.

I have two 401K plans to look through. One is the current company and the other belongs to a previous company. Both are with Fidelity. In the first one it is a tussle between Bond funds and Vanguard Explorer Admiral and Artisan Mid-Cap Value. The other is between Fidelity Govt Income and a Mid-cap fund and Spartan 500. That means I will turn my cash funds into equity based on about 40% of my 401K. I am going less than 50% as my slower weekly technical charts on each of the equity funds are still showing down signals. The only up signals are still from Fidelity Govt income and bond funds. Although I see that the daily chart on Fidelity Govt Income has turned in a down signal.

Therein lays the problem with technical analysis. If you look hard enough, you will always find a reason to do nothing – and with all the analysis, stay frozen - analysis paralysis. When the signals are all tuned together, it is usually too late. It is best to weigh the trading systems but have a trading plan to follow consistently without muddying the waters with additional analysis. There is plenty of uncertainty out there but I feel it is appropriate for me to dip my feet into the 401K equity funds now.

This is a change from previously being in money market, cash and Fidelity Govt Income funds only and no equity funds. I am also modestly into GLD (gold ETF) in my R/IRA fund based on my last week’s post.