Wednesday, February 3, 2010


I want to start off today and talk about something that…I wouldn’t say bothers me, maybe puzzles me is a better way to put it. Of all the different tools we as investors and traders can use to give ourselves an edge almost without exception, when asked, any individual will almost always have one he trusts or relies upon when making his investment decisions.

For some it’s big picture fundamentals. Smart money investors tend to choose this path. People like Jim Rogers, Warren Buffett, George Soros, etc. These are people with lots of money and patience. When they see a fundamental shift in the market they get on board and just hold on till the secular move has run its course. Needless to say there is a reason these people are rich. Riding a secular wave is the easiest way to amass a fortune. But unless you have the patience of a Buffett or Rogers it’s hard to do. Most people tend to get knocked out during the corrections… and there are always some doozies in any secular bull.

There are others who follow sentiment. They attempt to time the markets based on extreme sentiment levels, taking the opposite side of the trend as a contrarian play when sentiment levels get stretched too far in one direction. is an excellent source for monitoring sentiment levels.

Some watch market cycles. Because human emotions move through periods of ups and downs, and let’s face it the markets are really just a reflection of human emotions, cycles are often a pretty decent tool for timing market moves as they tend to occur with fairly predictable regularity.

Others follow the smart money, i.e. the COT reports and WSJ money flows. Knowing that big money players are probably privy to information that the rest of us don’t have, it makes sense to watch what these players are doing. Since this group controls most of the money in the market it's probably safer to follow behind the train instead of standing in front of it.

And then there are the multitudes that base their investment decisions on technical indicators. These are people who believe the future can be discounted by looking at lines, patterns or indicators on a chart.

Whatever tool one uses, the point I want to make is that almost without fail investors will fall into one of those categories. What I’m puzzled about is why? Why do most investors limit themselves to only one or two tools? Is it because of some misguided search for the holy grail of investment? When we find something that works for a while do we then make the mistake of assuming that it’s always going to work?

Every single one of those tools I outlined above (fundamentals, sentiment, cycles, smart money, and technicals) are useful in achieving an edge in the market. Why would one throw out any of those in favor of only one?

My one real talent for most of my life, other than a moderate ability to hang on to the side of a cliff and, when I was a younger man, the skill to lift fairly heavy weights over my head, has been to see the big picture. To see how all the parts fit together. So I have to ask why not use all of the tools at our disposal? That is of course what I attempt to do. Sometimes with pretty good success, and sometimes... not so much ;-)

To start off I think everyone simply must be able to see the big fundamental picture. If you can’t or won’t do that then how are you going to know when a major shift in the market has occurred. When it does it could affect every other tool in your arsenal. In my opinion the big picture fundamentals for the market changed in 2000. At that time we entered a long term bear market for paper assets and a long term secular bull market for commodities. As long as this fundamental underpinning remains I don’t really want to buy stocks and I do want to buy commodities.

After the big picture fundamentals I would say it’s a toss up between cycles and sentiment as my next most useful tool. Both are excellent tools for the most part but both have their limitations if a fundamental shift occurs. As an example, during the crash last year extreme sentiment levels had no bearing on market behavior. The underlying fundamental driver of the market was so strong that it really made no difference that sentiment had reached extreme bearish levels, the market just kept on falling. The same can be said to some extent for the rally out of the March bottom. There was so much liquidity in the system that extreme bullish sentiment really had no bearing on market direction other than occasional short term corrections.

The same could be said for cycles. As the market rallied out of the March lows the unimaginable amount of liquidity accomplished something that’s never been done before. It aborted the path of a left translated 4 year cycle. I’m completely guilty of missing that this summer. At the time I knew the Fed had pumped trillions of dollars into the markets but I just didn’t believe it would be able to alter the path of a 4 year cycle. I put too much trust in one single tool at the expense of ignoring a major major fundamental change.

Following the smart money is another useful tool. Except just like everything else it too fails from time to time. The COT reports used to be one of my most trusted tools. Except in 07 when they basically stopped working as a timing tool for the stock market. Watching money flows in the WSJ has also been a pretty dependable tool for spotting trend changes except sometimes the signals come too early. During the crash in `08 we saw several days of heavy buying on weakness but none of those led to anything other than a brief bounce. The recent sell signal was first given in Nov. yet we had to wait till the middle of January before anything became of it.

I think we all know the limitations on purely technical signals. For one they can be easily overridden by any of the other tools, (fundamentals, smart money, sentiment or cycles). Secondly, it’s pretty easy for big money players to run trend lines and support/resistance levels in order to get the typical retail technical trader to do what they want. Those stuck using purely technical signals are always going to be at the mercy of the big boys pulling their chains.

All in all every tool we use has its limitations and from time to time market conditions pop up that will completely negate some or all of our tools. But in my opinion the least likely way to succeed is to pick only one tool and trust it to give you an edge in every market environment.

I think a much higher success rate can be achieved if one uses all the tools at our disposal, especially when most of those tools are telling the same story.