• Whether the market is undervalued or overvalued? No!
• Whether interest rates will go up or down? No!
• Whether a particular company is undervalued or overvalued? No!
• Whether you should buy ABC or XYZ? No!
• Whether Joe Bloggs, the famous analyst, says it is a great buy? No!

All these questions are useless! There are whole office buildings full of people pumping out answers to these questions. They are not trying to mislead you. They are just trying to supply answers to these questions because people keep asking them and are willing to pay large amounts of money for the answers.

Even if they could be answered, the answers will not help you reach your financial goals. Why? Because they are the wrong questions.

Focussing on these questions will give you the illusion that you are a serious investor. Long hours reading all the articles and books, perhaps even poring over charts and financial reports, will only keep you locked in the system of struggle and mediocre success.

For others, the questions will give you an illusion of confidence and comfort because you are acting on the advice of the latest Wall Street hotshot.

But illusions hold you in bondage. As Morpheus in the film The Matrix explains, “Like everyone else, you were born into bondage. Born into a prison that you cannot taste or smell or touch. A prison … for your mind.”

Chasing answers to these questions will keep you in this prison. At best you may from time to time do better than the S&P500 or some other index. At worst you will see your money slipping away with poor returns and excessive fees.

Consider the case of trying to determine whether a company is undervalued or overvalued. It may turn out to be undervalued using some academic model. And there are hundreds of books describing such models. But if it stays undervalued for the next 10 years it is not going to be much of an investment.

Even the whole notion of what is value is flawed. Suppose you go into a jewellery store and decide to buy an emerald ring for $2,000. The jeweller assures you that it is really worth a lot more and even arranges to get an insurance certificate for $4,000. Great! You are now congratulating yourself for buying something that is valued at 100% more than you paid for it.

What if you split up with the person you were going to give the ring to. No worries, you are thinking. “I’ll just sell it back to the store.” But when you go back in you are told that they will only pay $1,000 to buy it back. What you thought you were getting for 50% of its true value turns out to be overvalued by 100%.

All the other questions asked above can be dealt with in a similar manner. For example, Warren Buffett said that he has no idea what the market is going to do and whether it is undervalued or overvalued, whatever that may mean. What is more, he is not interested in knowing.

The same applies to interest rates. Buffett once said, “If the Federal Reserve Chairman Alan Greenspan were to whisper to me what his monetary policy was going to be over the next two years, it wouldn’t change one thing I do.”

There is only one question. Underneath it all, there is only one desire. What is my profit rate or percentage return?

The core activity of an investor is to estimate with confidence the percentage return over a specified holding period when buying stock in a company. And you want to be able to do this based on numbers that you can see and adjust such as the growth rate of earnings.

When you can do this with a range of companies you have a rational basis to decide when to buy stock in a particular company, when to hold, and when to sell. You can decide between companies. You can even decide between investing in a particular company or in bonds.

You are in control. The market is now working for you instead of against you. Because you know the expected return on a range of quality companies, you can wait until Mr. Market offers to sell you stock in one of these companies that will give you the return that you want.

You can do this and more in a few minutes with the Valuesoft Investment System.

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Now it is up to you. As Morpheus said in The Matrix, “I can only show you the door–you are the one that has to walk through it.”

http://www.sherlockinvesting.com/articles/thequestion.htm

Dedicated to Warren Buffett, the Sherlock Holmes of the stock market, on his 70th birthday

What has Sherlock Holmes got to do with investing? Most people, including myself up to a few years ago, would probably answer nothing. But something happened in 1997 that made me change my mind.

At the time I was mulling over a talk I was to give at a conference on the mathematics of options. My mind went from thinking of the pricing of options as paradoxical to thinking of them as mysterious. From there I went to Sherlock Holmes who was created by Sir Arthur Conan Doyle as the world’s greatest detective, the pre-eminent person to solve any mysteries.

This led to two outcomes. The first was that I prepared a talk entitled the “The Case of the Missing Ten Pounds.” It described the arcana of the theory of pricing futures and options in the setting of a Sherlock Holmes mystery. This talk became an article that you can read on my website.

The second outcome was that I reread all the Sherlock Holmes books and articles on the lookout for quotations that could be interpreted as sound advice for long-term strategies for the stock market. All right, we all do weird things from time to time. The important thing is that I came across a lot of pithy comments that can be directly applied to the stock market.

As this is the occasion of the second anniversary of writing the Price on Value articles, I thought that I would give you some of the quotes. Most of the quotes are from conversations that Holmes has with his friend and biographer, Dr. John Watson. Just let your imagination go and think of Holmes as expounding on principles of long-term investing in quality companies.

Methods

You know my methods in such cases, Watson: I put myself in the man’s place, and having first gauged the man’s intelligence, I try to imagine how I should myself have proceeded under the same circumstances. (The Musgrave Ritual)

You’ll get results, Inspector, by always putting yourself in the other fellow’s place, and thinking what you would do yourself. It takes some imagination, but it pays. (The Adventures of the Retired Colourman)

These quotes reminds me of Warren Buffett’s many comments stating that he tries to think as an owner of any company that he might invest in. “I always picture myself as owning the whole place,” he once said.

Ask your self questions such as, “What could go wrong?” and “Who are the competitors?”

Relevance

It is of the highest importance in the art of detection to be able to recognize out of a number of facts which are incidental and which are vital. Otherwise your energy and attention must be dissipated instead of being concentrated. (The Reigate Squires.)

We approached the case, you remember, with an absolutely blank mind, which is always an advantage. We had formed no theories. We were simply there to observe and to draw inferences from our observations. (The Cardboard Box.)

The difficulty is to detach the framework of fact-of absolute, undeniable fact-from the embellishments of theorists and reporters. (Silver Blaze.)

It has long been an axiom of mine that the little things are infinitely the most important. (A Case of Identity.)

When analyzing a company, focus on what is important and don’t get stuck in side issues. Buffett started his career in New York but moved back to Omaha, Nebraska, where he found it “much easier to think.” On Wall Street everyone has an opinion, a hot tip, but ultimate success depends on separating the facts from, as Holmes said, “the embellishments of theorists and reporters.” Here we might add, “and stock analysts.”

Secrecy

You know a conjurer gets no credit when once he has explained his trick; and if I show you too much of my method of working, you will come to the conclusion that I am a very ordinary individual after all. (A Study in Scarlet)

One of Sherlock Holmes’ defects-if, indeed, one may call it a defect-was that he was exceedingly loath to communicate his full plans to any person until the instant of their fulfillment. Partly it came, no doubt from his own masterful nature, which loved to dominate and surprise those who were around him. Partly also from his professional caution, which urged him never to take any chances. (The Hound of the Baskervilles.)

We know just how secretive Buffett is regarding his investment decisions. He once said that he is lucky to have one good idea each year. “Good investment ideas are rare, valuable and subject to competitive appropriation just as good product or business acquisition ideas are,” he wrote in the Berkshire Hathaway Owner’s Manual. By keeping ideas a secret and at the same time acting on them with sizeable investments, Buffett ensures that Berkshire Hathaway profit the most every time his mental light bulb lights up.

Present Value

To determine its exact meaning I have been obliged to work out the present prices of the investments with which it is concerned. (The Adventure of the Speckled Band.)

Here we have it. Perhaps the first statement anywhere that the important calculation when valuing an investment is to determine the present or discounted value of its financial rewards. As Buffett has said, intrinsic value is “the discounted value of the cash that can be taken out of a business during its remaining life.”

Putting it together

When Watson said that he thought that Holmes had seen more in the rooms than was visible to him, Holmes replied, “No, but I fancy that I may have deduced a little more. I imagine that you saw all that I did.”(The Adventure of the Speckled Band.)

A similar idea is expressed in “A Case of Identity” in which Watson remarked that Holmes had seen things that were invisible to him to which Holmes replied, “Not invisible, but unnoticed, Watson.”

Another time Watson complains that he cannot see anything unusual about what Holmes was showing him. Holmes responds, “On the contrary, Watson, you can see everything. You fail, however, to reason from what you see. You are too timid in drawing your inferences.” (The Adventure of the Blue Carbuncle.)

I see no more than you, but I have trained myself to notice what I see. (The Adventure of the Blanched Soldier.)

Isn’t this the secret core of investing? The ability to see what everyone else sees, the company reports, the products, the competitors, and so on, but to see it in a new way so that you can tell whether it is a superior investment or just another ho-hum stock. Buffett, for example, said that when he made his major purchase of Coca Cola stock that he only used the same information and material that was available to everyone else. The difference was that he deduced more than everyone else to arrive at the conclusion in 1988 that this was an excellent investment. He was right; the stock quadrupled in value over the next four years.

Stay with the facts

It is a capital mistake to theorize in advance of the facts. (The Adventure of the Second Stain.)

No, no: I never guess. It is a shocking habit¾destructive to the logical faculty. What seems strange to you is only so because you do not follow my rain of thought or observe the small facts upon which large inferences may depend. (The Sign of Four)

The temptation to form premature theories upon insufficient data is the bane of our profession. (The Valley of Fear)

In 1934, Benjamin Graham wrote in Security Analysis that the intrinsic value of a stock is that value which is justified by the facts, e.g., the assets, earnings, dividends, definite prospects, as distinct, let us say, from market quotations established by artificial manipulation or distorted by psychological excesses.”

Doyle/Holmes in 1890 and Graham in 1934 could have been referring to the wild speculations that are put out by market commentators and analysts regarding dot com companies and that are dressed up as reasoned reports.

Knowledge and experience

He possesses two out of the three qualities necessary for the ideal detective. He has the power of observation and that of deduction. He is only wanting in knowledge, and that may come in time. (The Sign of Four)

It is better to learn wisdom late, than never to learn it at all. (The Man with the Twisted Lip.)

Learn from your mistakes

If it should ever strike you that I am getting a little over-confident in my powers, or giving less pains to a case than it deserves, kindly whisper ‘Norbury’ in my ear, and I shall be infinitely obliged to you. (The Yellow Face.)

Norbury was one of the rare cases when Holmes was not at his best. He asked Watson to use this as a reminder to make sure that he did not become over-confident in the future.

This reminds me of Buffett after his investment in USAir in 1989. Within a few years the airline was in such difficulty that Buffett wrote down the investment by 75 percent while trying to sell the shares at 50 cents on the dollar. Fortunately for stockholders in Berkshire Hathaway, Buffett was unsuccessful in finding a buyer for within a year or two USAir returned to profitability. In the end, Buffett’s action brought a healthy profit to Berkshire Hathaway.

On a personal level, Buffett admitted that the purchase was a result of sloppy analysis that may have been caused by hubris. To guard against a similar lapse in the future, he once joked, “So now I have this 800 number, and if I ever have the urge to buy an airline stock, I dial this number and I say my name is Warren Buffett and I’m an airoholic. Then this guy talks me down on the other end.”

There were no 800 numbers in the late nineteenth century so Holmes had to rely on Watson to “talk him down.”

Check and double check

I have forged and tested every link of my chain, Professor Coram, and I am sure that it is sound. (The Adventure of the Golden Pince-Nez.)

These are just a small sampling of quotes from Sherlock Holmes that have an investing flavor. In fact, some of them seem to have been written as if their main purpose was to provide sound principles of investment, rather than as methods of criminal investigation. But perhaps we should not be surprised at this. After all, patience, tenacity, clarity of mind, a willingness to sift though the facts, resistance to unnecessary or premature speculation are surely traits of the best detectives as they are of the best investors.

_____________________

I sent a copy of this article to Warren Buffett and he replied:

http://www.sherlockinvesting.com/articles/sherlock.htm

Dear John:
      I enjoyed the Sherlock Holmes piece. Thanks for the dedication; I’m flattered.
                    Sincerely
                     (signed) Warren E. Buffett

Dr. John Price

It is rare for someone to react neutrally to the idea of wealth. Envy, anger, anxiety, scorn, superiority, inferiority are all in the spectrum of reactions. Resignation is another, perhaps the saddest. For many of us it seems that there is never quite enough money as we struggle to stretch our pay cheque from one week to the next.

Fortunately there is brighter side to our money tussles and trials—generosity and philanthropy. During 1998 each Australian donated on average $78 to the nation’s non-profit organizations, up from $46 per person in 1988.

You can do an experiment for your self to see how seriously most people view money. Watch the change in people’s speech and behaviour when they enter a bank. Better still, observe how you change. As soon as most people cross the threshold from the street to the bank, they become more reserved and respectful, particularly when they can see large amounts of cash. Researchers at Columbia University discovered that nowhere else, not even in church, did people behave more soberly.

Things get even more complicated and confused when we broaden the idea of wealth from the narrow boundaries of money and financial wealth. We can have spiritual wealth and emotional wealth. Also wealth in terms of health and environment. Another area is time. You could measure this one by a feeling of having all the time you wanted to do whatever took your fancy. There is such time poverty in modern society that the longest conversation between some husbands and wives is on a mobile telephone when one of them is in the supermarket checkout line.

There is such time poverty in modern society that some husbands and wives rarely get more than a few minutes at a time to talk to each other. Resorting to mobile phones, their communication proceeds by snatching a few moments here and there in supermarket checkout lines, ticket queues and traffic jams.

Fixed amount of wealth?

Why does wealth seem to elude some of us and not others? One reason is that most of us act as if we are allotted a fixed amount of wealth. If we have it in one area of our lives, then we cannot have it in another area. If we have it in money, we don’t have it in terms of time or perhaps family relationships.

Or if we have it in creativity-a wealth of ideas-then we don’t expect to have it in terms of money. Some of us, writers in particular, seem to get a high from our lack of money. It is a badge of honour that makes us feel martyred and self-righteous. Repelled by the consumerism of modern society, we are equally trapped by our own obsessive judgements.

And here is the big one: if we have spiritual wealth, then we certainly cannot have financial wealth. The primary focus of spirituality, we are told, is on the area of the soul, the area of life with such depth and universality that it transcends all relative values. When on this path we are encouraged to turn up our noses at the superficial trappings of our materialistic society.

Religions, recognising the ease with which we can become caught by a love of money, support this one-or-t’other view. In the Bible we read of “filthy lucre” (Timothy i.3) or “It is easier for a camel to go through the eye of a needle, than for a rich man to enter the kingdom of God” (Matthew xix, 24).

No matter which side of the coin we are on-rich or poor, wealthy or living hand-to-mouth-most of us have an addiction to money. We spend a great part of our lives thinking about money, talking and reading about money, and performing actions that we do not enjoy for money. Putting it bluntly, money is seductive.

In short-term trading in the stock market much is made of the importance of having the right mental attitude towards money and success. Without this, it is said, it will always be a struggle and only a matter of time before you will loose all that you started with.

In the introduction to Market Wizards, Jack Schwager writes that on two occasions he was able to multiply $8,000 by more than tenfold but was not able to go much past that. It was his desire to understand the reasons for this that led him to write his book consisting of interviews with the top USA traders. He wanted to understand the keys to continued market success and he thought that the best way to do this was to talk to the top people in the field.

Even though his interviewees represented a large variation in strategies and approaches, one discussion stands out. “Win or lose,” Ed Seykota said, “everybody gets what they want out of the market.”

He continued, “I know one trader who seems to get in near the start of every substantial bull [upward] move and works his ten thousand dollars up to about a quarter of a million in a couple on months. Then he changes his personality and loses it all back again. This process repeats like clockwork.”

Of course, for most of us, the idea of trading is as foreign as the far side of the moon. Even more so is the idea of starting with ten thousand dollars and converting it to a quarter of a million. Yet I see similar personality changes over and over again in the conservative world of secure, long-term investing.

Levels of wealthFor the past few years I have been giving workshops on the investing principles of Warren Buffett. In 1940 he started with $140,000 and now, through conservative, long-term investing, he is worth $35 billion. Buffett started with a partnership which he terminated in 1969. He then took control of Berkshire Hathaway as a vehicle for his investing. Amazingly, $10,000 invested in Buffett Partnership Ltd in 1956 and reinvested in the stock of Berkshire Hathaway at the partnership’s termination would today be worth well over $200 million-after all taxes, fees and expenses.

Buffett’s methods are founded in everyday commonsense. Find companies that have an economic moat around them, wait until they are selling at low prices as determined by the cash the company can generate over its life, and buy a substantial parcel with the intention of holding them for the long-term. “Forever,” Buffett replies when asked for his favourite holding period.

To apply his methods requires a full understanding of each of the steps. The part that makes it easy, or should do so, is that each of the steps can be carefully described and laid out. Even so, it is curiously difficult for many people to follow them consistently.

In my workshops I detail Buffett’s investing principles which people may prudently follow for years. Suddenly they blink and invest in some fly-by-night venture. In a few seconds all their careful analyses are thrown out of the window.

The reason for this is that to be truly wealthy we need wealth on all levels: financial, emotional and spiritual. Financial wealth without emotional wealth leaves us open to the seduction of money. It is too easy to be seduced into schemes that are on the edge of commonsense, let alone the edge of morality and legality, and then to slip over.

Emotional wealth without spiritual wealth is even more dangerous. People with this combination are just as open to the seduction of money, but now they have powerful emotional tools to make sure they get it. Understanding their own weaknesses, they have deep insights into the weaknesses of others which they can exploit in their relentless pursuit of money.

Without the balance of emotional and spiritual wealth, even if financial wealth is attained, it is a hollow victory since the hunger for more and more is not satisfied. It is no accident that drug addicts talk about drugs in terms of deals. While the addict is injecting one deal, he or she is anxiously considering all the ways to get the next one. Similarly, the money addict is not able to enjoy the success of a deal without fretting about how to set up one that is even bigger and better.

Fred J. is a business consultant who was never satisfied with any of his business successes. “Even as I signed up a consulting project, I immediately dismissed it as luck and would be searching for the next one,” he said. “There was never any pleasure in the actual project from the initial consultation to the cheque at the end.” Fred was suffering from the curse that was placed on Narcissus: “May he fall in love and not have what he loves.” In Fred’s case it was the love of the big deal, the one that was going to set him up for life financially.

In the wealth workshops taught by Sandy, my wife, and myself we describe thirty principles of wealth. In some cases the same principle applies on all levels even though the outer appearance may be quite different. This is like the principle of gravity-it is universally valid but appears to be quite different when applied to a satellite rather than the path of a cricket ball. In other cases, the principles only apply to a particular level.

In the remainder of the article I give a taste of some of the principles.

Universal principles of wealth

An example of a universal principle is that wealth is not a destination. It is a transformational journey through levels of spiritual, emotional and financial abundance. “It is the nature of life to grow, to be more and to do more,” said Maharishi Mahesh Yogi. Life is safe when there is growth.

Another example of a universal principle is the importance of honouring the source recognising that in doing this you are providing the nourishment for further creativity and abundance. A tree growing from a seed honours its source by creating a carpet of seeds. From within these new seeds more trees emerge. This fundamental dynamic of honouring the source along with its creative outcome is expressed by Lord Krishna in the Bhagavad Gita, “Curving back on myself, I create again and again” (ix.8).

Self-referral action is also a theme that runs through the books Conversations With God by Neale Walsch. One example in Book 1 is: “My divine purpose in dividing Me was to create sufficient parts of Me so that I could know Myself experientially.” (p.25) Another is: “My purpose in creating you, My spiritual offspring, was for Me to know Myself as God.” (p. 26) In these books we are more than being invited to participate in the curving back process, we are being told that we are essential for the actual fulfilment of the process.

How does this theme apply to the three levels of spiritual abundance, emotional abundance and financial abundance? Starting with the last level, we first see it applied in the act of donating money to support the social and physical environment in which we live: charitable and philanthropic gifts. Apart from the emotional satisfaction of making these gifts, there is often a financial reward. Many people report that, when they give money to causes that they believe in, even more money flows into their lives.

Paying taxes can be considered as a way of honouring the source of our financial well-being. When we pay taxes we can use it as a means of acknowledging the support obtained from the government and its various structures. In 1993 Berkshire Hathaway, the company run by Warren Buffett, paid US federal taxes of around $500 million. Commenting on this in the 1993 Berkshire annual report, Buffett said, “I have absolutely no complaint about these taxes. We work in a market-based economy that rewards our efforts far more bountifully than it does the efforts of others whose output is of equal or greater benefit to society. Taxation should, and does, partially redress this inequity. But we remain extraordinarily well treated.” Last year Berkshire Hathaway taxes were well over $1 billion.

Turning to the emotional level, self-referral means spending time nourishing the emotional side of your life. Make sure you allow doing time on activities that you enjoy. Ask yourself what gives you pure joy. What makes your heart sing? So often we are scared to ask this simple question in case it leads to impossible dreams and ideas. We have struggled to find some equanimity in our lives so why risk disturbing it with pie-in-the-sky whims and daydreams?

When you put aside your fears and dare to ask this simple question, you may be pleasantly surprised. Often the outcome is a desire to do earthy things such as sit under a Morton Bay fig tree or walk barefoot in the froth at the edge of the ocean. Or perhaps splurge on a banana split. For others it may mean restarting the singing lessons that they had to give up when they started a family. Or paying regular visits to art galleries.

Nourishing the emotional component of your life also means acknowledging the gifts that you already have in terms of happiness, satisfaction and health.

The principle of self-referral on the spiritual level means closing the loop of experience at the deepest level of our existence. Prayers of gratitude are one way, keeping a journal in which you write letters of appreciation to God, or to Nature, or the Universe is another. Try meditation. There are now many organizations teaching wonderful forms of meditation that allow you to expand your consciousness while experiencing its source. Ask your heart to guide you to the one that is best for you. If you are still unsure, based on almost forty years personal experience and hundreds of independent research studies, I can report that I am very happy with the Transcendental Meditation technique.

Specific principles of wealth

As well as the universal principles of wealth, there are those principles that apply just to a single level. The most important principle that applies specifically to the financial level is to start a regular program of saving and investing. Calculations show that for every five or six years you delay in establishing an investing routine you have to double the amount you invest each year to reach the same financial goal at retirement. For example, $226 per year for 40 years at 10 percent annual interest results in $100,000. But to reach this same goal with five years of investing requires $16,380 per year, a figure that is beyond the reach of most people. You can see more examples in the following chart.

The chart shows the annual contribution at 10 percent per year that is
necessary to achieve a goal of $100,000 over each investment period.

On the emotional level a central principle is to locate and dissolve the mixed messages we have regarding wealth. On one hand we might say we want a higher income. On the other we sabotage ourselves with thoughts such as “rich people are mean” or “if I am rich, I won’t know who are my true friends-do they like me for myself or my money?”

We see the ambivalence we have about money in many of our expressions. “Filthy rich” is one; it implies that money is dirty and unclean and so, by extension, poverty is pure and clean. Another expression “lousy with money” identifies having money with being covered in lice.

Sometimes in my investment workshops I talk about a wealth angel whose role is to give each person all the wealth he or she desires. The only requirement is that there must be no other personal beliefs or desires that contradict the desire. Because of our ambiguous attitudes towards money, few of us would have more than a fleeting visit from this angel. Within a few moments she would be well aware that although we might say we want the money for a new car, we push it away by complaining about the cost of insurance.

On the spiritual level of wealth, a central principle is to have regular meetings, preferably daily, with your Personal Financial Advisor or PFA. “Whoa,” you are probably thinking. “I don’t have any financial advisor. And if I did, I would not be able to afford daily meetings.”

Fortunately, consultations with your PFA will not cost you a cent. By your PFA, I mean your soul, or your heart, or that quiet voice on the subtlest level of feeling. Whatever words you use to describe that gentle level of knowingness that is patiently waiting to give you precious advice.

No question is too small for your PFA and no problem is too big. Don’t know how you are going to find the money to pay the telephone bill? Just ask. Can’t decide between two multi-million dollar investments? Again, just ask.

It may take a little time to learn to hear your PFA. And still more time to learn to listen with trust and openness. But your patience will be rewarded over and over. As you progress, start to ask deeper questions. “Why do I always have difficulties finding money to pay the telephone bill?” Or, “What projects can I start that will do the maximum amount of good for myself and for my community?”

When you become familiar with your PFA and recognize its priceless gifts, then wealth can blossom in your life in all its varieties and on all levels: spiritual, emotional and financial.

Universal journey

The binding power of money has been recognized by religious and secular leaders from the time of Pythagoras who declared that luxury should be avoided adding that we all should accustom ourselves to living simply. Yet, the act of eschewing money can be just as binding as a committed search for more and more wealth. Frightened of falling prey to the power of money, we give it even more power over our decisions.

When we recognize our money addictions and conflicts, then we have taken a bold step to a level of preferences regarding money where we act upon it, rather than it acts upon us. Or, even better, we act in harmony with it recognizing that money, just like a person, responds to the way we think about it. “Nurture it, treat it well, and it will grow and flourish,” writes Suze Orman in The Courage to be Rich. “Treat it carelessly, or with disrespect, and it will dwindle away to nothing.”

By implementing the principles of wealth described above, we can move to a level where we have all the financial, emotional and spiritual wealth that we choose. At the same time, it is a level where we welcome the opportunity to use our wealth in the most evolutionary and positive way for our own good and the good of humanity. At this stage the journey of wealth is experienced as an expression of the universal journey that we are all on whether consciously or unconsciously, openly or secretly, and this is the journey of coming home. It is the journey of recognition that the quality of our lives does not depend upon how much we earn or accumulate, but on knowing who and what we are.

References

Orman, S. The Courage to be Rich, Riverhead, New York, 1999.
Schwager, J., Market Wizards: Interviews With Top Traders, Harper, New York, 1993.
Walsch, N., Conversations With God, Book 1, Putnam, New York, 1996.

This article appeared in Wellbeing, October, 2000.

http://www.sherlockinvesting.com/articles/wealth.htm

The Dow Jones Industrial Average is up 46% since March 9, when the world itself seemed to be coming to an end. In the entire 113-year history of the Dow, only six rebounds have been bigger and faster. But the swiftness and magnitude of this bounce-back aren’t reasons to be cheerful; they are reasons to be cautious.

In March, stocks traded as low as 11.7 times their average earnings over the previous 10 years, adjusted for inflation, according to finance professor Robert Shiller of Yale University. That put the market at its lowest valuation since January 1986. Today, however, stocks are selling at 18.4 times Prof. Shiller’s measure of earnings. That isn’t only up hugely from March but is above the long-term average of 16.3 times earnings.
Heath Hinegardner
 Robert Rodriguez, chief executive of First Pacific Advisors in Los Angeles, says that in March, investors feared getting crushed in a further decline. Now all they seem afraid of is missing an even greater rally.

Mr. Rodriguez is convinced that the consensus — economic recovery by early next year at the latest — is wrong. “People are talking about whether the shape of the recovery will be a ‘V’ or a ‘W’ or even a ’square root,’ ” he says, “but I think we are in what I call a ‘caterpillar economy.’ It will be up and then down, up and then down. We will be far from normal for a very long period of time. People deploying capital will end up destroying capital.”

I am not as worried as Mr. Rodriguez, but it is at times like these, when a rising market sweeps our spirits up with it, that investors need to evaluate their emotions and consider whether their beliefs and actions are justified.

In August, corporate insiders — officers and directors of public companies — sold nearly 31 times as much stock as they bought. From last September through this past March, in the depths of the bear market, that ratio was just 2 to 1, according to TrimTabs Investment Research of Sausalito, Calif. The long-term average is about 7 to 1.

The people who run companies don’t know exactly what the future holds, but they do know more about their own firms than outsiders do. If they are furiously selling, how eagerly should the rest of us be buying?

It is well-known that investors chase past performance, buying whatever has just made the most money for other people. What isn’t commonly understood is that investors also chase their own past performance, buying more of whatever they themselves have made the most money on.

Research by economist David Laibson of Harvard University shows that 401(k) participants tend to add significantly to whichever funds they already own that have gone up the most. “Investors expect,” Prof. Laibson says, “that assets on which they personally experienced past rewards will be rewarding in the future, regardless of whether such a belief is logically justified.”

That is exactly what seems to be happening now: In June, according to Hewitt Associates, 401(k) participants put 41.0% of their new contributions into stocks. In July, as the Dow shot up 725 points, they pushed that rate up to 42.3%. Participants also cut their contributions to “lifestyle” funds that keep a portion of their assets in bonds and cash.

The market’s latest hot streak makes the future feel predictable, but it isn’t. The Dow had an uncannily similar 46.5% gain in the 117 days that ended April 9, 1930; it lost almost 51% over the next year. Another 47% upswing in 1971 led to a long, choppy decline of more than 37%. The market also could go nowhere, as it did for months after a similar-size gain in 1975. Or it could hit new heights, as it did in 2004 after rising 47% from the lows of 2002.

In his classic book “The Intelligent Investor,” the great money manager Benjamin Graham wrote that “the investor with a portfolio of sound stocks should expect their prices to fluctuate and should neither be concerned by sizable declines nor become excited by sizable advances.” If you can’t exercise that kind of emotional control, then by Graham’s definition you aren’t an investor at all.

I see nothing wrong with dollar-cost-averaging into this market, purchasing a fixed amount every month — especially in a low-cost stock index fund. But to buy more of what has gone up, precisely because it has gone up, is to fall for the belief that stocks become safer as their prices rise. That is the same fallacy that led investors straight into disaster in 1929, 1972, 1999, 2007 and every other market bubble in history.

The market’s light has turned yellow. Don’t try to run it.
by
THE INTELLIGENT INVESTOR SEPTEMBER 2, 2009
Why Investors Need to See the Light and Slow Down
By JASON ZWEIG

http://online.wsj.com/article/SB125149410400267863.html#printMode

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http://www.markfiore.com/wall_street_executive_air_0

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Engulfing: This is my all time favorite candlestick pattern. This pattern consists of two candles. The first day is a narrow range candle that closes down for the day. The sellers are still in control of the stock but because it is a narrow range candle and volatility is low, the sellers are not very aggressive. The second day is a wide range candle that “engulfs” the body of the first candle and closes near the top of the range. The buyers have overwhelmed the sellers (demand is greater than supply). Buyers are ready to take control of this stock!
Hammer: As discussed on the previous page, the stock opened, then at some point the sellers took control of the stock and pushed it lower. By the end of the day, the buyers won and had enough strength to close the stock at the top of the range. Hammers can develop after a cluster of stop loss orders are hit. That’s when professional traders come in to grab shares at a lower price.
Harami: When you see this pattern the first thing that comes to mind is that the momentum preceding it has stopped. On the first day you see a wide range candle that closes near the bottom of the range. The sellers are still in control of this stock. Then on the second day, there is only a narrow range candle that closes up for the day. Note: Do not confuse this pattern with the engulfing pattern. The candles are opposite!
Piercing: This is also a two-candle reversal pattern where on the first day you see a wide range candle that closes near the bottom of the range. The sellers are in control. On the second day you see a wide range candle that has to close at least halfway into the prior candle. Those that shorted the stock on first day are now sitting at a loss on the rally that happens on the second day. This can set up a powerful reversal.
Doji: The doji is probably the most popular candlestick pattern. The stock opens up and goes nowhere throughout the day and closes right at or near the opening price. Quite simply, it represents indecision and causes traders to question the current trend. This can often trigger reversals in the opposite direction.
Bearish Candlestick Patterns

 
You’ll notice that all of these bearish patterns are the opposite of the bullish patterns. These patterns come after a rally and signify a possible reversal just like the bullish patterns.
Ok, now it’s your turn! I’ll let you figure out what is happening in each of the patterns above to cause these to be considered bearish. Look at each candle and try to get into the minds of the traders involved in the candle.
Kickers
There is one more pattern worthy of mention. A “kicker” is sometimes referred to as the most powerful candlestick pattern of all.

 
You can see in the above graphic why this pattern is so explosive. Like most candle patterns there is a bullish and bearish version. In the bullish version, the stock is moving down and the last red candle closes at the bottom of the range.
Then, on the next day, the stock gaps open above the previous days high and close. This “shock event” forces short sellers to cover and brings in new traders on the long side.
This is reversed in the bearish version.
Confirmation?
Most traders are taught to “wait for confirmation” with candlestick patterns. This means that they are supposed to wait until the following day to see if the stock reverses afterward. This is absolutely ridiculous!
I ain’t waitin’ for no stinkin’ confirmation!
How’s that for good grammar! Seriously, think about it for a second. If a stock pulls back to an area of demand (support) and I have a candlestick pattern that is telling me that buyers are taking control of the stock, then that is all the confirmation I need.
As a swing trader I have to get in before the crowd piles in, not when they get in! In other words, I want to be one of the traders that make up the pattern itself! That is the low risk, high odds play.
Just the way I like it.

http://www.swing-trade-stocks.com/candlestick-patterns.html

Say, for example, that a stock jumps 5% in one trading day after being in a long downtrend. Is this a sign of a trend reversal? This is where volume helps traders. If volume is high during the day relative to the average daily volume, it is a sign that the reversal is probably for real. On the other hand, if the volume is below average, there may not be enough conviction to support a true trend reversal. (To read more, check out Trading Volume - Crowd Psychology.)

Volume should move with the trend. If prices are moving in an upward trend, volume should increase (and vice versa). If the previous relationship between volume and price movements starts to deteriorate, it is usually a sign of weakness in the trend. For example, if the stock is in an uptrend but the up trading days are marked with lower volume, it is a sign that the trend is starting to lose its legs and may soon end.

When volume tells a different story, it is a case of divergence, which refers to a contradiction between two different indicators. The simplest example of divergence is a clear upward trend on declining volume. (For additional insight, read Divergences, Momentum And Rate Of Change.)

Volume and Chart Patterns
The other use of volume is to confirm chart patterns. Patterns such as head and shoulders, triangles, flags and other price patterns can be confirmed with volume, a process which we’ll describe in more detail later in this tutorial. In most chart patterns, there are several pivotal points that are vital to what the chart is able to convey to chartists. Basically, if the volume is not there to confirm the pivotal moments of a chart pattern, the quality of the signal formed by the pattern is weakened.

Volume Precedes Price
Another important idea in technical analysis is that price is preceded by volume. Volume is closely monitored by technicians and chartists to form ideas on upcoming trend reversals. If volume is starting to decrease in an uptrend, it is usually a sign that the upward run is about to end.

Now that we have a better understanding of some of the important factors of technical analysis, we can move on to charts, which help to identify trading opportunities in prices movements.

http://www.investopedia.com/university/technical/techanalysis5.asp

Yet as I have tried to demonstrate, swing traders overlook volume at their peril. Volume should be an indispensable part of the analysis of every price pattern. Astute swing traders should pay particularly strong attention to volume on breakouts, climactic bottoms, and spikes after sustained uptrends. Volume divergence, when price is rising but volume is trending down, is a strong warning that price itself will likely soon fall.

Joseph Granville, creator of the On Balance Volume indicator, shares this same insistence on the importance of volume analysis. He exclaims that volume precedes price, and he even goes so far as to argue that volume is cause and price is effect.

The indicator he designed to track the flow of volume in and out of a stock or index is called “On Balance Volume,” or OBV. OBV is a running total of volume. Designed in the early 1960s, before computers were used in stock analysis, its calculation is simple. An arbitrary number (usually a very large one) is used to begin an OBV line. On days when price closes higher, all the volume of that day is added to this line. On days when price closes lower, the volume is subtracted from the line.

For example, let’s say that XYZ went from $20 to $21 in a day and traded 100,000 shares. The next day it retreated exactly to $20, but traded only 50,000 shares. Even though price stayed the same for the period, the OBV line would have increased by 50,000 — the difference in trading volume between day #1 and day #2. If this same pattern were to repeat itself for several days in a row, then the security’s price would remain constant, yet it would have a rising OBV line. Granville would argue that this situation is highly bullish. The On Balance Volume Line is rising even though price is staying the same. Eventually, he would argue, this hidden demand will surface and will force prices higher.

An OBV line typically takes the form of a zig-zag. It can trend up (a bullish sign), down (a bearish sign) or sideways (in which case the OBV trend is doubtful).

When analyzed in conjunction with the price chart, the OBV line can do one of three things. First, it can confirm the price movement, trending upward as prices rise. Second, it can diverge bullishly or bearishly from price. A bearish divergence would occur when prices hit a new high, but the OBV line makes a lower high. A bullish divergence occurs when prices hit a new low, but the OBV line makes a higher low. Finally, the OBV line can act as a leading indicator. If OBV breaks out to a new high, but price is below the previous high, then the probability is that prices will follow it to higher ground. Swing traders can analyze OBV by examining trendlines and moving averages.

The three-month chart of grocery chain Albertson’s (ABS) shown below illustrates the importance of OBV analysis. In the period marked “1,” ABS began an uptrend that took the shares from $19 to $23. The OBV line mimicked the price trend and rose steadily to a peak along with price in early September.

In early September ABS moved about $1.50 — a huge amount for this stock — on a volume spike. (For more on volume spikes, please visit our issue archives.) For two more days prices rose. Look carefully, however, at the OBV pattern that is circled and is marked “2.” Note that there was bearish divergence as price hit a new high, but the OBV line was slightly lower. Note also that a trendline drawn on OBV broke before the trendline on price.

As Albertson’s shares declined into mid-September, the OBV indicator also trended lower. In the period marked “3,” note, however, that there was bullish divergence. Prices trended lower, but the OBV indicator went higher, implying that the stock would reverse in price.

As the chart ends in the period marked “4″, ABS is well below its early September high. The OBV line is testing is previous high. A breakout into new high ground by OBV implies that prices should trend higher. For this reason, as well as several others, I flagged Albertson’s as a “Stock to Watch” in today’s newsletter.

Many technical analysis tools (such as moving averages) are referred to as “lagging indicators” because they describe changes in pattern after the fact. OBV is one of the few tools that can serve as a leading indicator. When it diverges from the underlying price action, its message should be taken very seriously.

http://web.streetauthority.com/terms/onbalancevolume.asp

On daily price charts consolidation patterns can last several days, several weeks or several months.  They are most often rectangular in shape but the geometry is immaterial.  The fact is that consolidation patterns are direct results of investor indecision and they are almost always followed by large price explosions.

Consider this example for Dell Computer (DELL).  There was a time when Dell Computer was a must own stock for growth oriented money managers but all of this changed in the winter of 2000 when some investors began to doubt that computer markers could turn-in good profits in the face of slowing demand and rising competition from handheld and other devices.

In November of 2000 Dell Computer began a decline that would see the stock ultimately almost cut in half over the course of just seven weeks.  The stock peaked at $33 and sank to a mere $16.75 in late December.  At the time very few investors probably understood that the stock would remain mired in this trading range for most of the next year.  In fact, Dell Computer became entangled in a triangular trading range (wedge) that saw prices narrow and trading volume collapse as investors tried to make sense of the outlook for computer hardware in a slowing economy and the aftermath of the technology bubble. By the middle of April 2001 Dell Computer had rallied to $31 only to falter once again to $22.60 in the middle of June. During this entire consolidation period trading volume slowed progressively.

Price consolidation is a necessary stage for all stocks. The period that follows consolidation is breakout and this can be the most exciting phase for any stock. Let’s examine volume during this phase.

http://www.1source4stocks.com/technicalanalysis/volume_consolidations.asp

The latest book I am reading, Fortunes Formula: The Untold Story of the Scientific Betting System That Beat the Casinos and Wall Street by William Poundstone is a fascinating account of how some of the smartest scientific minds in America along with some of the most unsavory characters in organized crime managed to create a perfect betting formula that provided just the right balance of risk and reward in order to generate massive profits for those bettors who enjoyed an edge in the game.

The key to success however, lay in the ability of the bettor to garner an edge. Without it, the Kelly criterion as the formula is known cannot help you, despite its very clever math. The underlying thesis behind the Kelly criterion is to bet only a portion of your stake, ratcheting up the amount as you hit a winning streak and decreasing the bet size as you start to lose. By betting a smaller and smaller amount each time you lose, you avoid what’s known as gambler’s ruin - where you eventually run out of money.

The Kelly criterion is a brilliant piece of mathematical work, created by scientists responsible for the intellectual foundation for all of modern electronic technology. Literally every device we use to communicate with each other from the computer, to the cell phone, to the satellite is a direct result of these men’s inventions. The story of how the Kelley criterion came into being and generated millions of dollars for some of the earliest quant funds on Wall Street is fascinating tale of the intersection between Mafia, MIT  and Bell labs and is worth reading just for its dramatic impact alone.

However, this week I’d like to focus on just one aspect the Kelly formula - the idea of an edge.  As traders we are constantly taught to seek out trading opportunities with a positive edge.  Books are littered with advice to always look for trades with at least 2:1 reward to risk ratios (This way you only need to be correct just half of the time and you’ll make money! They cheerfully inform you). Some of the professional currency strategists I’ve encountered even boast that they never trade anything with less that 4:1 r/r ratio.

We have all heard the statement that 20% of your employees generate 80% of your output, 20% of your customers provide 80% of your revenue and so on and so on.  In general this is true in markets as well. The Pareto distribution, as it is known scientifically is present in many types of observable physical and social phenomena including the financial markets. In theory, under the Pareto distribution a few good trades will make up the losses of many bad trades.

There is only one problem - human psychology.  Suppose I gave you a choice. You can take 10 trades 9 of which would lose you $10,000 each or $90,000 in total and the tenth would make you $120,000 for a net profit of $30,000.  Or you can take 10 trades where 7 would make you $20,000 each and 3 would lose you $40,000 each for a net profit of $20,000.  On the surface the first strategy appears to make you more money but I can almost guarantee you that 99% of traders will wind up losers under that method. Why?  Human beings hate to lose. Furthermore they hate to lose consistently. If you deconstruct the first strategy you basically have only 1 out 10 chances to make a winning trade. These are lottery like odds for an average trader. Here is what’s most likely to happen. You will quit after the third trade and never catch the winning trade in the sequence.  You will cut your winning trade short because you are so desperate to recoup some - any - part of your money that the end result will still end up negative. Or worst of all you will miss the one winning trade and will simply generate 9 losers in your account.

Flip the scenarios. In strategy number two you have 7 out of 10 chances to win. That fact alone is likely to keep you on track and help you adhere to your trading strategy. Furthermore, if you are lucky you may even miss one of the large losers and improve your performance even more.  That’s the paradox of negative edge. At BK we trade with a negative edge not because we think it is mathematically superior - we know that it is not. We trade with negative edge because we know that it is psychologically more palatable and trading at its core is always more psychological that it is logical. Academics never factor in human frailty as a variable and yet it is perhaps the most important element in achieving  long term trading success.  

 BKForex Advisor