SECONDARY MARKET INDICATORS

SECONDARY MARKET INDICATORS

The first edition of this book was published in 1995, and the second edition was published in 2001. I felt it was time for a third edition because we have continued to develop and apply the Point and Fig- ure theories and further the development of other indicators to en- hance our interpretations of the markets. These other indicators dovetail beautifully with the long-established Point and Figure indi- cators. With these new indicators, we still use the Bullish Percent concept. We simply apply this concept to the other aspects of a stock’s technical attributes that we find essential. I think about it like the dashboard of your car. You’d never be successful in reaching your journey if you didn’t keep your eyes focused on the road ahead, which for us are the NYSE and OTC Bullish Percents, but you do need to consult the gauges on your dashboard to make sure the car is performing the way it should be. You probably find that you most often glance at the speedometer, but periodically you glance at the temperature gauge to make sure the car isn’t running to hot sug- gesting something might be wrong with the engine internally. You keep checking the gas gauge and your RPMs. These gauges are akin to the secondary indicators we are going to discuss in this chapter.

All our indicators are kept on our web site (www.dorseywright .com) so you can refer to them in real time as you read this book. The Internet has truly revolutionized how we maintain and present our charting and portfolio system. It doesn’t seem that long ago we kept all these charts by hand. Each day before the advent of our computerized charting system with five analysts, we updated 2,500 charts by hand. Once we were able to computerize this process,

223

224 Learn the Point and Figure Methodology

getting our analysts to stop the hand charting was like pulling teeth. They loved seeing the stocks they updated. Every day each analyst rotated the book he or she updated to another analyst. This way in one week, each analyst saw firsthand 2,500 charts. We did this for a decade before the Internet became popular. Then we were limited to sheer people power with respect to the number of indica- tors we could develop, but today’s technology has allowed us to limit ourselves only to our imaginations with respect to the way these indicators can be applied to different markets.

While we have added a number of indicators to our repertoire, we are still very mindful of the fact that you have to keep it simple. Once a concept is developed and tested, it is then applied to each market, NYSE, ASE, Nasdaq, sectors, mutual funds, international markets, and even fixed income. But one thing you can be assured of: We never gravitate from the underlying principles of the methodology—supply and demand; they define our work. We have no need to search for any other concept. We are, however, always looking for other ways to apply this same concept. It’s like the hub of a wheel. This hub is the Point and Figure method of analysis with all the associated indicators. From this hub, we attempt to ex- tend as many spokes as we can without ever leaving the concepts that define our company. Many investors make the mistake of try- ing to follow too many indicators or jump from one to another when one doesn’t seem to work. Just about everywhere you turn there is another indicator that someone assures you will make you rich. Just go to the chat rooms on the Internet and you will be hit with a barrage of information and indicators that will both confuse and obfuscate the picture. The “real deal” is the irrefutable law of supply and demand. There is nothing else that causes price change.

In the previous chapter, we discussed our most important in- dicators—the NYSE and OTC Bullish Percent Indexes. Now that you understand the Bullish Percent concept, it can be applied to a multiplicity of different areas with differing time frames. The NYSE and OTC Bullish Percents are our long-term coaches, but within long-term trends it is important to identify underlying currents and shorter-term trends as well. First, we’ll start off with a look at some of the secondary Bullish Percent indicators, then our other equity indicators, and end with a review of apply- ing these indicators to the mutual fund markets.

Secondary Market Indicators 225

Other Equity Indicators

Bullish Percents

Recall the NYSE and OTC Bullish Percent concepts you just read about in Chapter 6. We can apply this Bullish Percent concept to other indices. Three other Bullish Percents that we review daily in our work are the Bullish Percent for the Optionable Stock Uni- verse (BPOPTI), the Bullish Percent for the S&P 500 (BPSPX) and the Bullish Percent for the Nasdaq Non-Financial (BPNDX). Let’s outline a couple of important tenets about these Bullish Percents. Some of this is a review from the previous chapter but it’s such important information that it doesn’t hurt to have another review.

All of these Bullish Percents are equally weighted meaning one stock, one vote. The charts measure the percent of stocks that are on a buy signal on their Point and Figure trend chart. Take the BPNDX, for example; there are 100 stocks in this uni- verse. Let’s say that 50 stocks are on buy signals. This would re- sult in a reading of 50 percent (50/100) on the BPNDX.

No matter what Bullish Percent you are looking at (BPNYSE, BPOTC, BPSPX, etc.) they are all a measure of risk; it is not a measure of performance. That is, the BPSPX measures the risk in the S&P 500; the BPNDX measures the risk in the Nasdaq Non- Financial universe; and so on.

Similar to the BPNYSE, these two Bullish Percent charts are charted in the same manner in that the “field” extends from 0 to 100 percent, and the same lines of demarcation exist. The 70 per- cent level and above is considered the high-risk area, and the 30 percent level and lower is considered the low risk area. Each box is worth 2 percent, and the 3 box reversal rule still applies. There- fore, if we are in a column of X’s at say 60 percent, it would take a 6 percent change in the reading to reverse the chart back into O’s, which in this example would be a move to 54 percent.

If the Bullish Percent is in a column of X’s, this means that we have the ball and are on offense. If the Bullish Percent is in a column of O’s, this means we have turned the ball over to the opposing team (the market) and it is time to put the defensive team on the field. However, having the ball at the 30 percent level is much different than having the ball at the 70 percent level.

226 Learn the Point and Figure Methodology

The two most important considerations when using these Bullish Percent charts are field positions (whether the reading is 30 percent, 40 percent, 50 percent, etc.) and what column the chart is in (X’s or O’s). Risk is considered on the high side of the ledger above 50 percent and on the low side below 50 percent.

The Optionable Bullish Percent is a good intermediate term bullish percent that we follow closely. The reason we like this bullish percent is that it is made up of over 2,500 stocks that trade options. We don’t plot the option prices but rather we plot the Point and Figure charts of all stocks that have listed options on them. This is a nice cross section of stocks without one sector influencing too much of this Bullish Percent. For instance, financial-related stocks comprise about 20.6 percent of the stocks listed in our NYSE Bullish Percent calculation but only 11 percent of the Optionable Bullish Percent calcula- tion. The technology sector is also a great example. Technol- ogy-related stocks only account for about 3.3 percent of all stocks in our NYSE Bullish Percent and over 21 percent of all stocks in the OTC Bullish Percent but in the Optionable Bull- ish Percent, technology related stocks are 15.6 percent of the universe. Often changes in the Optionable Bullish Percent will precede changes in the NYSE Bullish Percent so we do take into consideration this Bullish Percent’s calculation in our assessment of the overall risk in the marketplace. The one time we did not find the Optionable Bullish Percent useful was in 2000. That was because the NYSE and OTC stocks were moving opposite one another and the Optionable Bullish Per- cent found itself gyrating around the 50 percent mark for most of the year.

Now let’s take a look at some of the nuisance of the smaller Bull- ish Percents. While the calculation of the Bullish Percent for the S&P 500 and the Nasdaq 100 is the same, these indexes have fewer stocks than our broader markets like the NYSE and OTC, so what you will find is that these charts do move much faster. Since 1998, the NYSE Bullish Percent has seen 38 column changes while the S&P 500 Bullish Percent has had 66 column changes. We also want to stress that these Bullish Percents are not designed to be used as trading or timing tools for the Exchange Traded Funds (ETFs) associ- ated with these indices. The primary reason is that the S&P Deposi- tory Receipts SPDR (SPY) and the Nasdaq 100 Shares (QQQQ) are

Secondary Market Indicators 227

both cap weighted, meaning that one stock can carry more than one vote while the Bullish Percents are a one stock one vote indicator.

Take the S&P 500 Capitalization-Weighted Index. The highest capitalization stocks in the index carry all the weight. Those stocks are in the top 40. Say for instance institutions sold out general stocks in their portfolios and moved to the largest capitalization stocks as a safe harbor in a market storm. This would put added buy- ing pressure in those top 40 stocks that in turn would pull the S&P 500 Capitalization-Weighted Index with it. So you end up with a bull market in capitalization-weighted indexes and a bear market in stocks in general. This happened in 1998 and in reverse in 2000. It’s incredibly interesting when you understand how the game is played. So, the Bullish Percent concept is a measure of risk in the market and not to be used as a trading signal generator. It is not a measure of absolute price movement. To evaluate the overall trend of an index ETF, always consult the ETF chart. Let’s look at an example.

In Figure 7.1 we see a Bullish Percent chart for the S&P 500 with two areas highlighted, April 2002 and January 2005. In both of these instances the reversal down into O’s by the BPSPX suggested that risk was increasing in these stocks. I like to think about risk in the markets like I think about risk in driving my motorcycle. I used to have a group of financial-related professionals from all over the country ship their bikes out to the Southwest each year. We would then spend a week riding together, taking in the beautiful scenery, and in general have a great “City Slickers” experience. Having done this trip for a number of years, I’ve ridden through all types of weather. On a perfect day the sun is shining, it’s about 75 degrees, and it’s just our group out there on the open road. Those days I find myself a little more relaxed at the wheel. I can really take in the picturesque landscape. On a couple of these trips though, the weather was our enemy. One year we were riding in freezing temperatures, blowing snow, and visibility was next to nothing. This was no time to be relaxed at the wheel. I had to con- centrate intently, hold the handlebars with a tight grip, and slow down. All of these things I did to compensate for the fact that the conditions were not ideal. We still successfully made it from point A to point B, but the trip wasn’t as enjoyable, and the risk of an ac- cident was higher. The Bullish Percent concept is like our weather forecast. Can we expect the trip to be easy and pleasant, or is it

Figure 7.1 S&P 500 Bullish Percent.

228

Secondary Market Indicators 229

going to be a trip that is likely to encounter a number of potholes? Somehow we stopped doing this trip. Now I take my wife with me on a trip out west. I love it in New Mexico and Arizona. Maybe in the future I can get a group to start up the biking trips again.

By looking at Figure 7.1 we can see that in both April 2002 and January 2005 the S&P 500 Bullish Percent reversed down into O’s suggesting that risk was increasing. The next step in the process we take is to review our holdings to see which still have strong techni- cal pictures, as these are likely to be held in the portfolio. If any holdings have started to exhibit weak technical pictures like sell signals, violating Bullish Support Lines, or giving Relative Strength (RS) sell signals, these will be the first candidates for potential

Figure 7.2 S&P 500 Point and Figure chart: 2002.

230 Learn the Point and Figure Methodology

sales. Let’s assume for a minute that in both instances, April 2002 and January 2005, we owned the SPDR S&P 500 ETF (SPY) which replicates the movement of the S&P 500 Capitalization-Weighted Index (SPX). In Figure 7.2 from April 2002, we see that the S&P 500 Bullish Percent reversal down into O’s was accompanied by a chart

Figure 7.3 S&P 500 Point and Figure chart: 2005.

Secondary Market Indicators 231

pattern from the SPX that was also breaking down, making lower tops, and in general showing that supply was coming into control. The defensive action we take with a picture like this is much more stringent. By contrast, in Figure 7.3 we see that in January 2005 the trend chart of the S&P 500 remained above the Bullish Support Line and on a buy signal. The defensive action required here is less strin- gent. For instance, you might choose not to reduce your equity ex- posure as much as when the S&P 500 chart is negative.

Other Equity Indicators

The Percent of Stocks above Their Own 10-Week Moving Average Index

This index has one of our most important short-term market indi- cators. It should be used in conjunction with the High-Low Index. As its name implies, the Percent of 10 is simply made up of the percentage of stocks on any index you are evaluating that are trad- ing above their own 10-Week Moving Average (see Figure 7.4). We keep this indicator for both NYSE and OTC stocks and each sector as well. It is as important to keep abreast of the short-term trend of the overall market as it is to keep abreast of the long-term trend. We use the same grid with this index that we use with the Bullish Percent Index. The vertical axis has a value of 2 percent per box and runs from 0 to 100 percent. The best sell signals come when the index rises above the 70 percent level, then reverses down below that critical level. In cases like this, there is a very high probability that the broad averages have begun a short-term correction. This is significant because the short term often spills over into the long term. Conversely, the best buy signals come when the index declines below the 30 percent level then reverses back up. In the case of the buy signals below 30 percent, the index does not have to cross that level on the upside to be valid.

What about changes between 30 percent and 70 percent? For example, say the Percent of 10 reverses up from below 30 percent changing the prevailing risk level to a short-term buy signal. The index then rises to 58 percent where it encounters supply and re- verses into a column of O’s. In this case, we defer to the broad Bullish Percents. If the NYSE Bullish Percent were still in X’s in this case, we would conclude that demand is still in control of the

232 Learn the Point and Figure Methodology

Figure 7.4 NYSE Percent of Stocks above Their 10-Week Moving Average.

market, but a short pause that refreshes in the market could be expected. Overtime we have found that the most important sig- nals from this indicator tend to come from those changes in the Red and Green Zones, above 70 percent and below 30 percents, and particularly when the index gives a buy signal.

This index is of great benefit when you are planning your trade. Investors, however, should never use the Percent of Stocks above Their Own 10-Week Moving Average Index as their sole indicator in making new stock commitments. Rather, it is used to help us with play selection. The NYSE Bullish Percent tells us which team is on the field, offense or defense, and then depending on the posi- tion of the short term indicators, the Percent of Stocks above Their Own 10-Week Moving Average, and the High-Low Index discussed next, we can get a better idea of which plays to run. For instance, let’s say the NYSE Bullish Percent is in X’s but the Percent of 10 has reversed into O’s and fallen below the 70 percent level. This would tell us that the risk in the market is now a little higher, so perhaps buying 300 out of your 500 share position would compen-

Secondary Market Indicators 233

sate for that increased risk. Or maybe buying an ETF instead of an individual stock would work better for you. In both plays we are still maintaining long exposure, just the manner in which we do it adjusts for the fact the short-term indicator is in a column of O’s.

The High-Low Index

This index is another short-term indicator that we use in conjunc- tion with the Percent of 10. Again, just as with the Percent of Stocks above Their 10-Week Moving Average, we keep a High-Low Index on both the NYSE and OTC stocks. If you wish, you can cal- culate this indicator yourself. Just take the daily NYSE (or OTC) highs divided by the daily NYSE (or OTC) new highs plus the new lows. Then take a 10-day moving average of this number and plot that figure on a grid exactly like the Percent of 10 (see Figure 7.5). The vertical axes will extend from 0 to 100. We evaluate it the same way as the Percent of 10. The two critical levels are 30 per- cent and 70 percent. Buy signals come from reversals up from below 30 percent. Sell signals come from reversals from above to below 70 percent. Buy and sell signals can also come by exceeding a previous top or bottom, respectively. Reversals from above 70 percent suggest that there is a trend change from more stocks making new highs to more stocks making new lows. Conversely, when the index reverses up from below 30 percent, it tells us the number of stocks making new lows is drying up considerably.

There are a couple of other things we want to point out about this indicator. First, to get a good feel for the risk in the short term, we place the greatest emphasis on the signals when the two short- term indicators are moving in tandem. Second, the High-Low can go above 70 percent and remain above that level for some time, even months at a time. Second, this indicator can really move to ex- tremes, hitting 90 percent or higher and also falling to 10 percent or even lower. Third, when the NYSE High-Low Index goes below the 10 percent level, it is a sign of a very washed-out market. Think about it for a second. To get to 0 percent we would have to see 10 consecutive days of no stocks hitting new highs. Reversals up from 10 percent are usually good buying opportunities. Figure 7.6 shows the times the NYSE High-Low Index has been below 10 percent.

234 Learn the Point and Figure Methodology

Figure 7.5 NYSE High-Low Index. The Percent of Stocks Above Their

30-Week Moving Average Index

The NYSE Percent of Stocks above Their 30-Week (150 Day) Mov- ing Average is a longer-term indicator for the NYSE universe of stocks. As its name suggests, this indicator measures the percent of stocks that are trading above their 30-Week Moving Average. Let’s say that the 30-Week Moving Average of a stock is 50. If the stock’s price is above 50 we say that it is above the 30-Week Moving Aver-

Secondary Market Indicators 235

Figure 7.6 NYSE High-Low Index times below 10 percent.

age. Once we do this for all the stocks in the NYSE (we also do it for the Nasdaq market), we plot the percent of stocks above their 30-Week Moving Average on a grid from 0 percent to 100 percent. Like the other indicator charts that we follow, there are two lines of demarcation on the chart, the 70 percent level and the 30 per- cent level. The 70 percent level and above is the red zone or high- risk area. The 30 percent level and below is the green zone or low risk area. Like the NYSE Bullish Percent, the 30-Week does not get to either of these extreme levels very often, much less to very over- bought or oversold conditions of 80 percent or 20 percent. The NYSE 30 has reached the 80 percent level 14 times since 1970. Typically, the 80 percent level has only been seen in very strong markets in which almost all stocks rally.

There is another interesting phenomenon about the NYSE 30- Week that we want to bring to your attention. Dan Sullivan of the Chartist found that when the Percent of 30 goes above 80 percent and then falls below 60 percent it will see 40 percent before it sees 80 percent again. This has happened 14 times and on each time

236 Learn the Point and Figure Methodology

the 80-60-40 percent rule has worked. When this phenomenon has happened, it has occurred before important, often severe, correc- tions in the market. For instance, in October 1982, the Percent of 30 went above 80 percent and then fell below 60 percent in August 1983, which was the beginning of a year-long decline in the mar- ket, carrying the NYSE Bullish Percent below 30 percent before another lift off in the market in 1984. The Percent of 30 also saw this action, above 80 percent, below 60 percent, in April 1987 be- fore the Crash of 1987. It was also a very early warning of the 1998 crash. Figure 7.7a is a list of each time the NYSE 30-Week has seen the 80-60-40 phenomenon occur as well as the corresponding Point and Figure chart in Figure 7.7b. For the last two times this indicator saw the 80-60-40 phenomenon.

The Advance-Decline Line

The Advance-Decline Line is a nonprice measure of the trend of the market. It is based on the number of issues advancing and declining

Figure 7.7a NYSE 30-Week Moving Average 80-60-40 Rule.

Secondary Market Indicators 237

Figure 7.7b NYSE 30-Week Moving Average 80-60-40 Rule.

and not on the price of these issues. Every day, the difference be- tween the issues advancing and the issues declining is calculated. If more issues advanced than declined, the difference is added to the preceding day’s total; if more issues declined than advanced, the dif- ference is subtracted from the previous day’s total. We keep Ad- vance-Decline Lines for the NYSE, ASE, and Nasdaq markets. We look at the Advance-Decline indicators in two ways. First, we look to see if the level is above that of 10 days ago. If it is, then we say that market’s Advance-Decline Line is positive on a short-term basis. Second, we look at a Point and Figure chart of the Advance-

238 Learn the Point and Figure Methodology

Decline Line. If the chart is on a buy signal, we say the Advance-De- cline for that market is positive longer term. If the chart is on a sell signal, we say the Advance-Decline for that market is negative longer term. In addition to looking for Double Tops and Double Bottoms on the chart, we also take into account High Pole and Low Pole Warnings. We like to look at Advance-Decline Lines because they, like the Bullish Percent, give each stock one vote. While the Dow Jones or Nasdaq Composite may be going down what are most of the stocks doing? The Advance-Decline Lines give us insight into the “true market” and not just an index of 30 stocks or so.

Average Weekly Distribution

Regression to mean—it’s a natural progression that we all go through in our lives. Just the other day I was on my way to Wash- ington, DC, from Richmond, Virginia. The two-hour drive north was going quite smoothly. There was relatively no traffic, no po- lice running radar, and the weather was sunny. The conditions were right to make good time, so I pushed the envelope and ended up speeding. I get just outside of Washington, DC, and don’t you know it, an accident. Darn, foiled again. I had just been regressed to mean. Have you ever gotten too big for your britches? Come on, be truthful. We all at times become too full of ourselves and all of a sudden we get figuratively slapped down. We get regressed to mean. Something happens to make us aware we are getting a little out of control and we settle back to normal.

It’s life’s way of keeping nature in the center of the curve. In a particular field there might be a certain number of rabbits. As they begin to reproduce, their numbers grow geometrically. The more rabbits in one particular field mean the available food sup- ply decreases as a percentage for each rabbit. The rabbits repro- duce until starvation kills some off. This is life’s way of regressing the rabbits back to normal for this field. Then, the over abundance of rabbits in the field attracts more wolves to the area. The wolves in the area cause the population to regress past the mean to the endangered side of the equation. The wolves leave be- cause their food supply is gone, and the cycle begins again. This is how the stock market works.

Secondary Market Indicators 239

One of the best ways to graphically represent this movement back and forth to mean is with the 10-week trading band. We all re- member the bell curve concept from our college Stats 101 class. Given a set of data, we can construct a range, which is depicted as a bell curve. There are six standard deviations to the bell curve (Figure 7.8). Three standard deviations to the left are considered 100 percent oversold. Three standard deviations to the right are considered 100 percent overbought. The middle of the curve is nor- mal and most of the time stocks reside within one standard devia- tion of normal. For each stock and index, we can take 10 weeks worth of data and create a bell curve. When a stock gets to the overbought side of the curve, it will typically move back to the middle. There are two ways a stock or index can get back to the middle of the curve. First, the stock can fall in price and move back to the middle of the curve. Second, as time passes, the stock can stay relatively the same in price and the curve shifts. Conversely, when a stock or index gets oversold, you will typically see it move back to the middle in one of those two ways. As a general rule, you will see strong RS stocks trade between the middle and the top of their trading bands. Most of the time you will see weak RS stocks trade between the bottom and the middle of their trading bands.

Since every stock in the DWA universe is plotted on its 10- week trading band or bell curve, we can obtain a calculation of where the average stock lies on that bell curve. This chart is called the Weekly Distribution (WD) chart. What the WD chart does is take a simple average of where all the stocks are on their

Figure 7.8 Bell Curve—Normal Distribution.

240 Learn the Point and Figure Methodology

10-week trading band. For instance, if there were two stocks in our universe, one at −100 percent (100 percent oversold) and one at 100 percent (100 percent overbought), then the average would be 0 percent. Using the symbol WDALL you can access this chart at any time on the DWA system.

If a stock were three standard deviations above normal, it would be considered 100 percent overbought. Conversely, if a stock were three standard deviations below normal, it would be considered 100 percent oversold. The middle of the curve or nor- mal is considered 0. These three areas depict the range of the 10- week trading band where the top is 100 percent overbought, the bottom is 100 percent oversold, and the middle is the 0 percent point, or the middle of the statistical bell curve. So, if we were to see a reading on the Average WD chart of 0 percent, this would mean that if you were to flip through individual stock charts by hand, what you will find is that the average stock is going to reside at the middle of its trading band. A reading of 0 percent means that the average stock is neither overbought nor oversold as nature has regressed the stock back to mean. A reading of 50 percent, for in- stance, would mean that the average stock is 50 percent of the way between the middle of the trading and the top of the trading band.

Looking at the Weekly Distribution for All Stocks, see Figure 7.9, especially over a period of years, we can get a feel for when the average stock, and thus the overall markets, are a little high and due for a pullback or a little low and due for a bounce. We have found that this chart tends to reside between the 50 percent (overbought) and −40 percent (oversold) levels. When the average stock is up in the 30 to 50 percent overbought territory, we tend to see near-term pullbacks in the market as stocks have rallied in a condition like this. Conversely, we have seen market bottoms come when the in- dicator is approaching the −40 percent level. As a sidebar, to get to levels of −70 percent or more the drop in the market must be ex- treme, swift, and severe like July 2002 and September 2001, for in- stance. The Weekly Distribution for All Stocks chart is a secondary indicator to the Bullish Percents, the Percent of Stocks Above Their 10- and 30-Week charts, and the High-Low Indices, but we find this chart especially helpful in gaining an overall perspective of the mar- ket on a near term basis. We should also note that the WD chart is available for sectors as well. The format for this chart is WD, and

241

Figure 7.9 Weekly Distribution Reading for All Stocks.

242 Learn the Point and Figure Methodology
the first four letters of the DWA sector. For instance, WDBIOM

would be the WD chart for the Biomedics/Genetics sector.

Summary of the Indicators

Now let’s stop for a second and allow this discussion to seep in, because I know that we have covered a lot. We have talked about several different concepts and indicators that can be applied to the NYSE and Nasdaq markets as well as to sectors. Each week to keep this information straight in my mind, I sit down and fill out the Market Indicator Summary form shown in Figure 7.10. We do the same type of exercise on our web site, but I still find that writing something by hand is especially helpful. It just makes what is going on in the market more real when you write it down instead of just looking at it on the computer screen.

Once I have the Market Indicator Summary form filled out, I evaluate it. You would be surprised that there are very few changes. Making changes in the overall bias of the indicators we have outlined here is like moving an aircraft carrier, not a jet ski. But when those changes occur, it is important to heed them and take action where necessary. If you become very comfortable with these indicators and the types of strategies you want to em- ploy when changes do occur, you won’t have the “deer in the headlights syndrome.” You will intuitively understand what used to baffle you. Someone once said, “lack of decisiveness has caused more failures than lack of intelligence or ability.” I think this is so true of investing and in life.

I have just recently taken up golf and am absolutely enthralled with the game and trying to improve. Those of you who play golf have probably read some of Robert J. Rotella’s works. He was the di- rector of sports psychology at the University of Virginia and is a con- sultant to many professional golfers; he also writes extensively about golf. One of Dr. Rotella’s tips that stayed with me was, “It is more important to be decisive than to be correct when preparing to play any golf shot, particularly a putt.” Life on Wall Street means that you will not be correct every time. However, you must not let that keep you from sticking to your game plan, and you must not allow yourself to second-guess your tactical moves. One of the prob- lems with pursuing perfection is hunting for the perfect method.

Secondary Market Indicators 243

Figure 7.10 Indicator Summary table.

Trying a new system each week will not get you to your goal. It re- quires remaining focused on one method and maintaining consis- tency and discipline. You may find that Fibonacci numbers, Gann angles, or astrology work for you, and that is fine. But once you find the method that you are comfortable with, you must stick with it. We find the Point and Figure method works the best for us, because it is firmly cemented in something we can easily understand and

244 Learn the Point and Figure Methodology

know is true—the irrefutable law of supply and demand. If you begin to second-guess your play book, you are doomed to lose the game. Take those principles you have practiced and implement them when the time comes. Remain true to yourself, win, lose, or draw. Nothing is right every single time but the objective is to be more right than wrong and to stack as many odds in your favor as possible.

When you are evaluating the form in Figure 7.10 each week, think about some of the scenarios that might occur. If there are more indicators in X’s and rising for each market, then I know I have the football and can run plays. If the indicators are in X’s but all near the 70 percent level, then I know the risk is high and I need to make sure the defensive players are well rested and ready to come on the field at a moment’s notice. If the majority of the indicators are in O’s and falling, that tells me we have a weak mar- ket and I should continue to employ wealth preservation strate- gies. If the indicators are in O’s but all below 30 percent, then I need to begin formulating shopping lists of ideas to begin buying once the indicators reverse up. What you will find is that some in- dicators move faster than others, and when major changes in the market occur, it is like a puzzle coming together. When you dump out a puzzle on a table, it is a hodgepodge of pieces. Once you get those corner pieces in place and the border set, however, the pic- ture becomes much clearer. That’s the way the indicators work.

Mutual Fund Indicators

As we pointed out at the beginning of this chapter, you can apply the Bullish Percent to any grouping of stocks; you can do the same thing to a universe of mutual funds. If you recall from Chap- ter 2, when plotting a mutual fund chart, we use three different scales for varying levels of sensitivity. Because of this fact, mu- tual fund Bullish Percents are maintained using three different sensitivity levels for each group. The short-term Bullish Percent reads the short-term charts for each fund using relatively small box sizes to pick up more net asset value (NAV) action and can be used by anyone who needs to take advantage of that short-term reading. The intermediate version is less sensitive and each fund is measured using its intermediate chart, which uses larger box sizes to filter out more NAV action, and this indicator can be used

Secondary Market Indicators 245

by all investors as the to bullish or bearish nature of the fund market. The long-term Bullish Percent uses very large box sizes to filter out even more action and presents the long-term investor with something to give guidance as to the major long-term areas of support and resistance for the fund. Figure 7.11 is a picture of the Intermediate Term All Equity Mutual Fund Bullish Percent.

The longer term the Bullish Percent is, the less activity. All three Bullish Percents can still be useful in your analysis though. I like to think about the varying nature of these Bullish Percents like a weather forecast. You can look at tomorrow’s forecast, the seven-day forecast, or you can take a look at the entire season’s projection for say rainfall. You will notice all of the same princi- ples about Bullish Percents you have already learned to apply— X’s mean offense and O’s mean defense and field position analysis is important. Something else you’ll notice about mutual fund Bullish Percents is that they tend to move to greater extremes, often hitting 10 percent and 90 percent, especially the shorter term Bullish Percents. Once you learn the application of the Bull- ish Percent concept, you can apply it to any universe—the S&P 500, mutual funds, or even foreign markets.

Other unique indicators in the mutual fund arena include addi- tional moving average indicators. The 40-Week Bullish Percent is just like a 10-Week or 30-Week Bullish Percent but this indicator measures the percent of funds in a group that has its NAV trading above its 40-Week Moving Average, which is another way to say the 200-day moving average. Many technicians look at the 200-day moving average of the markets and individual equities so it is a fairly important measurement of the health of price movement over time. It is helpful to know where this average is especially if the fund’s trend line is too far away to be of immediate importance. The moving average is an invisible trend line, if you will, that is al- ways relevant and you can use it to make trending evaluations.

Another longer term moving average indicator for mutual funds is the 1040 Bullish Percent. This measures the percent of funds that have their 10-Week Moving Average above their 40- Week Moving Average. Another way to look at this is whether the fund has its 50-Day Moving Average above its 200-Day Moving Average. If so, that would be considered a “buy signal” in the Bullish Percent calculation. Funds that have this characteristic are considered to be positively trending and vice versa.

Figure 7.11 Intermediate Term Bullish Percent for All Equity Mutual Funds. 246

Secondary Market Indicators 247

Figure 7.12 Mutual Fund Indicator Summary Table.

At our web site (www.dorseywright.com), you can find the most extensive technical research available on mutual funds in the world. Above is a recap of the absolute mutual fund indicators followed on our web site. Figure 7.12 is categorized by an in- vestor’s time frame. Those investors sensitive to the short-term fluctuations of the markets need to pay attention to the short- term indicators. Investors that have more of a buy and hold objec- tive can use the long-term indicators to evaluate their funds and more tactically manage their portfolios. We tend to find the inter- mediate indicators to be the area of emphasis for us.

POINTS AND FIGURES BY DORSEY, WRIGHT MONEY MANAGEMENT

Save more money. Everyone wants to know the answer to the question “How to get Rich?” but no one wants to believe that the answer may be as simple as saving more. Perhaps Americans are simply averse to saving and therefore living beneath their means. In fact, judging from the data on con- sumer debt, many Americans are busy living beyond their means.

Putnam’s new study, mentioned in October 2005’s Wall Street Journal, suggests that savings may be the key to building assets. Putnam studied the retirement savings plan of “Joe,” the prototypical 401(k) investor, over a 15-year period. Joe started off earning $40,000 in 1990, received 3 per- cent annual pay increases, and finished off 2004 earning $60,500 annu- ally. Joe put 2 percent of his salary in his 401(k) each year.

248 Learn the Point and Figure Methodology

Scenario 1 has Joe invested with a conservative asset allocation which never changes, and somehow (probably much like most investors) Joe manages to pick out bottom-tier mutual funds. He ends up with $39,700 after 15 years.

Scenario 2 gives Joe a crystal ball. He has the same conservative asset allocation, but this time Joe buys all of the best-performing funds. In this scenario, he ends up with $42,000 after 15 years. In other words, after 15 years of saving, he’s $2,300 ahead because of better investment performance.

Scenario 3 makes Joe double his salary deferral to 4 percent a year, but still sticks him in the crummy funds. In this case, Joe ends up with $79,500 after 15 years. Doubling his savings has doubled his wealth.

There’s no doubt that Putnam spun the story to encourage larger 401(k) contributions, some of which would undoubtedly end up in some of their funds. The truth is that savings counts for a lot more early in the game, when the absolute size of the pool of funds is small. Joe’s 401(k) contribution of $1,210 for 2005 (2 percent of $60,500) is relatively a lot bigger when his capital base is $4,000 than when it is $100,000. As the capital grows, the investment performance does become more critical. With a $100,000 account, a 10 percent year in investment performance has the ability to add a lot more value than Joe boosting his contribution rate to 4 percent.

Savings, it seems, is particularly important when you are starting out. When the asset base is small, incremental savings can make a big differ- ence in how fast it grows. Joe’s case is a good example of that, as were the Beardstown Ladies. For a young or new investor, it’s most important to get them motivated to save and build some capital. Worrying about which fund to buy or the return of one fund versus another really isn’t the point.

Once the pool of capital becomes larger, the focus should shift to in- vestment management. It’s not that savings isn’t still important—it’s just that a good return on the portfolio can add more value than additional sav- ings. I’ve never seen a rule of thumb mentioned, but just from looking at Putnam’s example, something like the greater of $100,000 or 10× the an- nual contribution rate might be a reasonable threshold at which to start paying more attention to investment performance.