Posts tagged with: Foundations

Market orders, limit orders, stop-on-quote orders … what does it all mean?  In this episode, I start with the basics of order flow and execution: what happens behind the scenes when you buy or sell stocks and ETFs.  Then I go through the various order types, from simple to complex, to help you understand your choices.  You’ll get examples of situations where you might use one order type over another.


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Section 1: How Securities are Traded

Bid and ask prices

Market depth

Exchanges and other trading platforms

Order routing

National Best Bid and Offer (NBBO)

Price improvement

Brokers often get paid for order flow – is that fair or are we getting ripped off?

Section 2: Basic Orders and Conditions

Market orders

Limit orders

Conditions: All-or-nothing (AON), Fill or Kill, good ’till canceled (GTC), good ’till date (GTD), day orders, market on close (MOC), limit on close (LOC)

Stop orders


Trailing stops

Section 3: Complex Orders

One Cancels Other (OCO)

One Cancels All (OCA)

Conditional orders

Pegged orders



Scottrade: Anatomy of an Order (PDF)

TD Ameritrade: Order Execution FAQ

SEC Investor Publication – Trade Execution

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(Wrap-up of ten-part series on Financial Truths)

In this episode, I tie together all the concepts I’ve introduced throughout this 10-part series on financial truths.  I illustrate a few different asset allocation ranges that will position you for profits and preserve your capital so you can trade for many years ahead.

Pick one of these asset allocation ranges that best suits your goals and risk tolerance, then just make sure your portfolio stays within the ranges at all times.

This process works for long-term investors in a 401(k) or IRA, as well as those with short-term trading accounts.


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Important disclaimers to review

Asset Allocation Workbook in Microsoft Excel – Download Here



(CC image from Joe on Flickr)

Section 1: Financial Truths for Traders & Investors

  • Review of the series (find prior episodes here)
  • Why I chose the topics I did
  • How it’s different than what many others teach

Section 2: Take Action

  • A flexible asset allocation framework
  • Start today with the attached spreadsheet
  • Find the row that best suits you:
    • Choose one of the four categories based on how active you want to be
    • Move to the right side of the table.  Look at the annual loss section, with the 1-in-20-year, 1-in-10-year, and 1-in-5 year loss amounts: which row matches most closely with your personal risk tolerance?
    • Go to the right side of the worksheet and select that row from the drop-down box.  Those will be your asset allocation targets.

Section 3: Not Quite Right?  Here’s How to Adjust

  • Found the closest fit, but want to reduce the risk?  I explain how.
  • Found the closest fit, but want to take on more risk?  I explain how.

Section 4: The Next Level

Section 5: Make Sure You Stay on Track

  • Calculate and monitor your asset allocation
  • Calculate “asset exposure” for each investment or trading position you own
  • Add up the asset exposure by asset class (simple investment universe) or subclass (detailed investment universe)
  • Note: If you are using a highly leveraged strategy, use total assets in the denominator instead of asset exposure


My personal long-term target asset allocation baseline as of Feb 2017:

I’m currently short equities and much more heavily weighted towards cash equivalents (“Currency” category) like CDs and money market funds, based on intermediate-term trends.  This is the long-term baseline.


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The Right Way to Read a Chart

(Part 7 of ten-part series on Financial Truths)


Section 1: What is Technical Analysis?

Section 2: Identifying the Higher-Level Trend

Section 3: Pattern

Section 4: Price

Section 5: Momentum

Section 6: Time

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Section 1: What is Technical Analysis?

Section 2: Identifying the Higher-Level Trend

  • Uptrend: Series of rising lows
  • Downtrend: Series of falling highs
  • Diagnosing trend during choppy periods

Section 3: Pattern

  • Trends (same direction as the higher-level trend): typically consist of 5 waves (3 trend waves and 2 corrective waves)
  • Corrections (opposite direction as the higher-level trend): typically consist of 3 waves (2 trend waves and 1 corrective wave)
  • Basic patterns
  • Advanced patterns: Harmonic (e.g. Bat, Butterfly, Gartley)

Section 4: Price

  • Identify high-probability price targets and zones for trade entry/exit
  • Depth of past trends & corrections
  • Fibonacci retracements and projections
  • Pattern completion targets

Section 5: Momentum

  • Stochastics, MACD, or RSI
  • Examine multiple timeframes

Section 6: Time

  • Less precise than the other dimensions, but don’t ignore it
  • Correction periods should be shorter than trend periods
  • Length of past trends & corrections (e.g. 180 months for long-term cycles, 10 months for intermediate-term cycles)
  • Cycle compression/decompression
  • Fibonacci ratios can work on time as well as price
  • Pattern symmetry


Real-Life Examples:

Chart 1: Technical Framework in Action

Chart 2: Profitable Harmonic Pattern Set-Up


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“Intermediate-term” market cycles – which I define as 6 to 14 months in length in most cases, with an average of 10 months – are the “sweet spot” of trading.  I make the most money trading these cycles, and you can too.

Shorter-term trends and cycles are more prone to unpredictable random noise.  Longer-term ones can be accurately forecasted, but because long-term cycles average around 8 years in length, it takes a long time to extract profits from them.  Good for a long-term investor, but not enough if you are serious about trading and you want to make a living from it or generate enough trading profits to meaningfully supplement your annual income.  Active traders must be aware of the long-term trends but will place trades according to the intermediate-term trends instead, even when those intermediate-term trends oppose a slower-moving long-term trend, because active traders have a shorter time horizon for holding positions.


Don’t Trade Without an Intermediate-Term Forecast

In my earliest foundational post, I introduced a framework for building wealth entitled “The Five Components of Successful Investing”.

The five components are the blue boxes in this flowchart, taken from that post (with the blue circle added to mark today’s focus):

In the earlier post, I briefly touched on how I make my intermediate-term forecasts.  Again, when I refer to the “intermediate-term”, I mean cycles that generally last between 6 and 14 months, with an average of 10 months.  In another post, entitled “Want to Conquer the Investment Universe? First, Make a Map!”, I listed the asset classes and subclasses I forecast.  They include: the US dollar, major commodities, bonds, and each of the ten stock sectors.  Now, I’ll explain my forecasting methodology in more detail.


Start with Your Long-Term Forecast

Always consult a long-term chart (30+ years of data, if possible) before placing an intermediate-term trade.  In my post titled “Fearless Forecasting for Long-Term Investors”, I introduced my methodology for making long-term forecasts.  Here’s a high-level summary:

  1. Begin with a baseline trend, which you expect to observe over several long-term cycles.
  2. Establish a range around the baseline trend, based on the depth and length of prior long-term cycles.
  3. Determine the current long-term trend direction by looking for a series of higher lows (an uptrend) or a series of lower highs (a downtrend).  Also, determine whether this trend is strong or weak.  If there isn’t any clearly discernable trend, look at the prior trend direction.  Most likely, what is occurring is a flat correction and we would expect the prior trend to resume once the correction is over.
  4. Forecast the long-term trend direction and strength based on: The current long-term trend direction and strength, momentum, intermarket analysis, and fundamental factors.  Look for more details on this in future posts, podcasts, and videos.
  5. Take the actual and forecasted long-term trends from steps 3 and 4 and translate them into a single percentage between -100% and +100%.  This percentage determines where your long-term forecast will fall within the range of possible forecasts we defined in step 2.

Let’s use the technology sector as our example for this post.  My long-term forecast for tech stocks is +1.4%.  Here’s how I got there:

The range of possible long-term forecasts is -15.3% to +18.0% with a baseline of +7.0%.  Technical note: The positive skew exists so we have symmetry across up and down cycles.  (1+.180) * (1-.153) = 1.000.  The percentage I apply to this range is -25%, which reflects that the current long-term trend is “Up” and the forecasted downtrend is “Down (?)”.  In other words, there is a strong uptrend now, but I expect a weak downtrend to emerge so I select a long-term forecast that is below the midpoint of my forecast range by 25%.  Calculation: 1.4% = 7.0% + (-25%) * (7.0% – (-15.3%)).


Study Prior Intermediate-Term Cycles

Using a daily or weekly chart with at least 10 years of history, identify past uptrends and downtrends.  Let the price be your guide – don’t assume that every single cycle will follow the same length of time.  It rarely works out that way.  But, although the duration of any two cycles may vary, their average duration is usually stable over time.  The half-cycles will average approximately 10.5 months from low-to-high or high-to-low.  Thus, the full cycles will average approximately 21 months (10.5 * 2) from low-to-low or high-t0-high.

Here’s how it shakes out for the tech sector (as tracked by the XLK exchange-traded fund):

Lots of variation in cycle length, indeed – but averaging 23 months apiece when examining the last 10 years of history.  Pretty close to our 21-month expectation.  It’s very helpful to know that the cycle lengths tend to revert to a mean over the long-term.  This knowledge helped us anticipate a couple quick turns in late 2015 and early 2016 following the extremely long uptrend that ran from August 2011 to July 2015.

The fourth column in the chart above shows the lag between the tech sector and the S&P 500.  This is part of the intermarket analysis framework I’ll mention later in the post.

Identifying the past trends is pretty simple and is done in just the same way as the long-term trends.  Look for a series of higher lows (an uptrend) or a series of lower highs (a downtrend), in alternating fashion.  If the price action looks choppy or flat, look at the prior trend direction.  Most likely, what is occurring is a flat correction and we would expect the prior trend to resume once the correction is over.

There are other nuances that make this both an art and a science.  Sometimes I select a cycle low or high that is not the precise low or high that was reached.  For example, the XLK hit 11.44 on 11/20/08, which is below the low of 11.53 I marked on 3/9/09.  But, I chose 3/9/09 instead because it coincided with the overall low in the S&P 500 and because the points immediately before and after the 3/9/09 extreme were lower, indicating the 11/20/08 low may have been a fluke.

A note on trading being both an art and a science: I’m always skeptical of trading schemes that claim to be purely quantitative, or algorithm-based.  There is simply no way to get around the fact that anytime you develop a trading system, whether it explicitly allows for the use of educated judgment or not, you ARE using judgment.  All mathematical models rely upon some sort of assumptions, such as: market returns following a given distribution, a random process being stationary, or the model having an error structure that follows a normal probability distribution with a mean of zero.  By using a mathematical model to make trading decisions, you’re making the judgment that those assumptions are valid.

Why do we record and study the prior cycle highs and lows?  Because, we need the following info for our forecast:

  • The depth of a typical low-to-high or high-to-low cycle: the percentage gain or loss that usually occurs.  This is one piece of evidence we use to determine whether the current trend is nearly exhausted or has more room to run.  First, select a depth of a low-to-high cycle, expressed as an annual return.  For the tech sector, I chose +40.0% as the annual return during an upward cycle after examining the data.  This seems like a very high return, but remember that it’s the return from the exact day of a cycle low to the exact day of a cycle high, with hindsight.  It’s not meant to be a real-life return.  For a downward cycle, I solved for -26.5% because this is the annual return that produces an annual return of +1.4% across an upward cycle and a downward cycle.  Recall that +1.4% is our long-term forecast for tech stocks from the section above.
  • How long the typical cycles are: do they average close to 21 months between highs and between lows?  Have recent cycles slowed, suggesting the current and next cycles will accelerate?  Or vice versa?
  • Is there another sector, market, or asset class that typically lags or leads this one?  In our example, the tech sector usually turns within a month or less of the S&P 500, so we’d look at any divergence between the two with great skepticism.  This is intermarket analysis – drawing connections between different sectors, markets, or asset classes.  The S&P 500 highs and lows should themselves be determined by considering highs and lows in bonds, for example.  Most traders fail to consider this big-picture view, focusing on narrow indicators or chart patterns instead.  Many of the best opportunities to rake in serious profits are found in scenarios where the asset you’re trading is out-of-line with similar stocks, sectors, or asset classes.  If you learn to spot these situations, you’ll start to capture those profits and avoid traps.

We will choose an actual trend (direction and strength) and a forecasted trend (direction and strength) for the intermediate-term, as we did for the long-term.  We’ll choose from one of the five options below:

  • “Up” – representing a clear upward trend
  • “Up (?)” – representing a weak upward trend
  • “Down” – representing a clear downward trend
  • “Down (?)” – representing a weak downward trend
  • “??” – representing a situation where the trend cannot be determined

Now that we’ve recorded and studied past cycles, the actual trend for tech falls right out of that analysis.  The last low was 2/11/16, so an uptrend is in place and it’s a clear one, as the below chart shows.  So we pick “Up” as the actual trend.

As far as the forecasted trend goes, we’ve already gathered some info that will help us make a prediction.  Yet there’s more we can and must consider.


Forecast the Intermediate-Term Trend

So far we’ve looked at the depth and the duration of the current cycle and we’ve seen how it compares with past cycles.  We’ve also brought in intermarket analysis as part of this process.

Next, let’s join this insight with some more technical analysis to select a trend forecast and to pinpoint entry and exit points for a potential short-term trading position.

I’ve organized this into categories of: Pattern, Price, Momentum, and Time in homage to Robert Miner’s outstanding book High Probability Trading Strategies: Entry to Exit Tactics for the Forex, Futures, and Stock Markets, which I selected as one of my ten most essential books for traders and investors.  Each of these categories deserves its own follow-up posts, so stay tuned for those.  I’ll simply introduce each for now.


In general, a “trend” usually consists of five distinct sections or “waves”.  During a trend, as “trend” is defined here, the market is reaching successively higher or lower extremes.  A “correction”, during which the price moves in the opposite direction from the trend, usually consists of three distinct sections or “waves”.  The corrective waves will also usually be shorter in time than the trend waves.  These principles come from Elliott Wave theory.  Many well-known traders have integrated these principles into successful trading strategies.

How does this fit in with the framework we’ve defined?  I’ve called every cycle a “trend”, and haven’t used the term “correction.”  It’s simple!  Since we’re talking about the intermediate-term timeframe here, the trend (5-wave) direction is the direction of the long-term trend.  The corrective (3-wave) direction is the opposite of the long-term trend.

For the tech sector, the actual trend we’ve chosen is “Up” in both timeframes.  Therefore, we expect upward intermediate-term cycles like the one we’re currently in to have 5 waves.  We expect downward intermediate-term cycles to have only 3 waves, and to be shorter in time than the upward cycles.  This will hold until the long-term trend changes direction.

In the tech uptrend that began 2/11/16, there is a 5-wave pattern:


Consider also checking for other, more complex patterns.  I recently began incorporating harmonic patterns, as found in Scott Carney’s book Harmonic Trading, Volume One: Profiting from the Natural Order of the Financial Markets, into my technical analysis framework.  Simpler patterns like a head-and-shoulders top, double bottom, or wedge/triangle formations are also useful.


The introduction of a wave structure also allows for the projection of price target points using Fibonacci principles.  This is a deep subject that I’ll tackle in a later series of posts.  Here, the most likely endpoints of Wave 5 are between 51.72 and 52.51, so we should expect a little further rally before this upward cycle ends.


Many traders use momentum oscillators like the MACD, Stochastics, or RSI to measure how rapidly price is changing.  This is what momentum oscillators do well, but most new traders go too far with them.  They trade using very simple rules like MACD crossovers, and they aren’t successful.  Never, ever, trade based on one indicator or one simple rule in isolation!  A crossover, in which a more responsive momentum indicator crosses over a smoothed momentum indicator, may indeed signal an important reversal in momentum and may be a sign of an important trend change.  But, you need to look at all the other market conditions first before executing a trade based on this single factor.

I recommend looking at momentum across multiple time frames, as Miner teaches in his book.  As a general rule, you want to trade in the direction of the longer-timeframe momentum and execute your trades when the shorter-timeframe momentum reverses in the direction of the longer-timeframe momentum.  For instance, when momentum on a weekly chart is rising but not yet in the overbought area, you would want to look for an entry point to buy when the momentum on a daily chart makes a bullish crossover.  Again, don’t execute the trade unless you’ve first studied the overall market conditions.

In our tech example, the momentum on a monthly chart is positive but very overbought and starting to decline.  This reinforces my view that the high between 51.72 and 52.51 will represent a long-term high in tech stocks.  The momentum on a daily chart, shown in the screen capture above below the price chart, has risen into the overbought zone but has not yet reversed.  This reinforces the view that there is just a little more room to run in this intermediate-term cycle.

Volume (the number of shares traded) can also be a useful indicator of momentum, but has become far less reliable than it was in the past because many trades take place off the major market exchanges so they are not part of volume statistics.  Many of these are large block trades between institutions.


The only thing I’ll add on time, besides what I already mentioned in the context of intermediate-term cycles, is that you can layer time projections onto a 3-wave or 5-wave price structure to identify dates where a wave is more likely to end.  Like Fibonacci price projections, it’s a deep topic that I’ll save for future posts.


I added fundamental analysis as another crucial element to consider, although some traders will consider it anathema.  Fundamental analysis is a broad term for factors that aren’t viewable on a price chart.  It includes: political trends, demographics, social patterns, economic indices, and other factors that may impact a single sector or all financial markets over a very long period of time.

Many technical analysts believe all information is reflected in the market price, so they’d say it’s merely a distraction to look at fundamentals.  I agree that much of the “market news and commentary” out there is distraction, but I strongly disagree that you can ignore the fundamentals.  They can provide clues that you’ll never find on a price chart.

I believe fundamental analysis is most valuable for spotting major extremes in price or bubbles.  In 2000, 19 online startups bought very expensive Super Bowl advertisements.  Certainly, this would add some evidence in favor of the dot-com bubble being about to burst, which it did shortly after.

The Verdict

Considering all the above info, I’ve chosen an intermediate-term trend of “Up (?)”, signifying that the uptrend is still in place but has weakened and is almost done.


Translate the Trend Into A Fearless Forecast

Like we did with the long-term trend, next we take the actual and forecasted long-term trends (“Up” and “Up (?)”, respectively) and translate them into a single percentage between -100% and +100%.  I have a grid I use to define the percentage for every possible combination of actual and forecasted trend (5 x 5 = 25 combinations in total).  Here, the percentage is +20%.  This indicates that although we still want to hold tech stocks (the percentage is positive), we are only slightly positive on the sector and we certainly don’t want to buy more of it.

When the XLK gets above $52, or breaks down from its current levels, I’ll mark the forecasted trend “Down”, the percentage will go negative to -50%, and I’ll be going short the tech sector.

We want to go long the sectors, markets, and asset classes that have the highest percentages (closest to 100%) and go short the ones that have the lowest percentages (closest to -100%).

If you have a baseline asset allocation, you’ll want to adjust it up or down based on the percentages in each asset class, but staying within a minimum and maximum for each asset class.  This is what I do to ensure that while I act on opportunities, I don’t get too carried away with a single asset class.  More on this in future posts.

Also, look forward to many more examples of this framework in action throughout future live streams, videos, and of course our free trading podcast.

I know this approach takes more time than the easy single-indicator “strategies” (advertised as such, but really a total fraud!).  But it works.  This is a winning approach for managing a large portfolio of assets or for swing trading a smaller account.  It is a comprehensive, time-tested, and successful strategic framework when it is used in conjunction with good risk management and a sound mental approach to trading.

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Some say that long-term trends in the financial markets are impossible to predict.  Not so!  Markets follow cycles that, while not precisely predictable to the exact date, time, or price point, can be reasonably well-anticipated in advance.

If you’re a day-trader with a time horizon of minutes or hours, long-term trends won’t have any impact on your results at all.  But if your investing time horizon is multiple days, weeks or months as we recommend, then a good understanding of the long-term trend will enhance profits and reduce drawdowns.

If you have a long-term time horizon and you don’t like to make trades more than a few times a year, these long-term trends will be the single most crucial factor in deciding where to invest your money.


Don’t Invest Without a Long-Term Forecast

In my earliest foundational post, I introduced a framework for building wealth entitled “The Five Components of Successful Investing”.

The five components are the blue boxes in this flowchart, taken from that post (with the blue circle added to mark today’s focus):


For a longer-term investor, someone who can’t or does not want to make trades every week or every month, this simpler framework applies:

In the earlier post, I touched on how I make my long-term forecasts.  When I refer to the “long-term”, I mean cycles that generally last between 4 and 12 years, with an average of 8 years.  In another post, entitled “Want to Conquer the Investment Universe? First, Make a Map!”, I listed the asset classes and subclasses I forecast.  Now, I’ll explain my forecasting methodology in more detail.


Begin with a Baseline Trend (The “Very Long-Term”)

First, I make an assumption for what the trend will be across the next few long-term cycles.  This is the baseline trend that would best fit the long-term cycles, if we could knew them in advance.  To develop the baseline trends, I consider several factors:

  • Historical returns, in the form of risk premiums over the risk-free rate (the difference between the annual return and the risk-free interest rate).  This paper, by Aswath Damodaran of the Stern School of Business, explains the concept of equity risk premium in detail.  The author estimates the average annual risk premium for stocks as having been 4.10% (using geometric averages and the long-term risk-free rate) over the period from 1928 to 2010, albeit with a declining trend across that time period.  This means it is ok to make a choice that is slightly different than the longest average, because the risk premium may vary over the course of decades or a century.  Assuming that today’s 10-year US Treasury rate of 2.58% will be representative of the next few decades, the long-term baseline return for US stocks I’d derive from this approach would be 2.58% + 4.10% = 6.68%.
  • Inflation expectations.  In my post titled Inflation, Deflation, and Your Portfolio, I explain what inflation really means, as well as how essential it is to have a good forecast of inflation before making any long-term forecasts.  I expect deflationary pressures to continue to rule the day, up until the point where the massive amounts of unrepayable worldwide debt are either defaulted upon or renegotiated, as explained in my inflation forecast for 2016 and beyond.  Deflation depresses returns across all asset classes, but inflation tends to increase returns as long as there are not sudden shocks.  Because I expect deflation followed by an inflationary shock, it is hard to estimate what the overall impact of the two together will be, but it has to be considered.
  • Fundamental analysis, including political trends, demographics, social patterns, economic indices, and other factors that may impact a single sector or all financial markets over a very long period of time.

Here are the baseline long-term trends I am using as of today:

I also establish a range around each baseline trend value.  I do this by defining and measuring the depth of previous long-term cycles that have occurred in each asset subclass.  For example, the range of possible long-term annual returns I’ve established for gold mining stocks (“PM Stocks”) is -25.9% to +35.0%, but for consumer staples stocks it is only -11.1% to +12.5%.  [Technical note: The positive skew exists so we have symmetry across up and down cycles.  (1+.125) * (1-.111) = 1.000].  I use these ranges later in the process.


Determine Trend, Using a Long-Term Chart

Next, I look at a weekly or monthly chart to determine the direction and strength of the current long-term trend.  You can see countless examples of how I gauge trend direction and strength on my YouTube channel.  Recall that the definition of an uptrend is a series of higher lows, and the definition of a downtrend is a series of lower highs.  If there is not a clearly discernable trend, look at the prior trend direction.  Most likely, what is occurring is a flat correction and we would expect the prior trend to resume once the correction is complete.  For example, in the chart below, I have marked the rising yield cycle from 2003 to 2006 which appears as a flat correction when looking at the 30-year yield.

Long-term chart of US Treasury Bond yields, with long-term cycles marked by the blue lines.


This example also illustrates how price outweighs time when evaluating long-term cycles.  Often, cycles don’t follow regular lengths, so it is very dangerous to assume that major highs or lows will occur X months from now merely because that happened the last couple times around.  I’ll go more in-depth on this subject in later posts on intermediate-term cycles, another component of my framework for successful investing.

Besides examining the price action in a long-term chart, I also consider the following factors when forecasting the future trend direction:

  • Momentum: The rate at which prices are increasing or decreasing.  Technical indicators that measure momentum include the Stochastic Oscillator, RSI, % rate of change, and deviation from a long-term average.  If prices make a new long-term low or high, but momentum is weaker than another low or high that recently occurred, the odds favor a change in the long-term trend direction.
  • Intermarket analysis: The performance of other asset classes that tend to move in the same direction as, or opposite direction from, the asset class we’re examining.  For instance, the US dollar index and the price of gold (in dollars) tend to move in opposite directions.  When the typical relationship doesn’t hold, it is a warning sign that the trend may be changing.  John Murphy has written several excellent books on the subject, one of which is on my list of essential books for trading and investing.
  • Fundamental factors: shifts in political trends, demographics, social patterns, economic indices, or other factors that may impact a single sector or all financial markets.

Based on the long-term chart, I select an “Actual Long-Term Trend” and a “Forecasted Long-Term Trend” from one of the five choices below:

  • “Up” – representing a clear upward trend
  • “Up (?)” – representing a weak upward trend
  • “Down” – representing a clear downward trend
  • “Down (?)” – representing a weak downward trend
  • “??” – representing a situation where the trend cannot be determined


Translate the Trend into a Fearless Forecast

So far, we’ve selected a baseline long-term trend, defined a range within which the long-term forecast can fall, and assessed the current long-term market situation.  Now that we have assembled all the info we need, we can proceed to make our long-term forecasts.

I take the actual and forecasted long-term trends from the prior step and translate them into a percentage between -100% and +100%.  This percentage determines how much my long-term forecast will vary from the baseline trend.  A percentage of -100% represents the most bearish, or negative, stance on from a long-term standpoint, and would produce a long-term forecast at the absolute bottom of the range.  Conversely, a percentage of +100% represents the most bullish, or positive, stance on from a long-term standpoint, and would produce a long-term forecast at the absolute top of the range.  Anything in between will fall within the range, with higher percentages giving higher forecasts and lower ones giving lower forecasts.  A percentage of 0% puts us right in the center of the range.

I have a grid I use to define the percentage for every possible combination of actual and forecasted trend (5 x 5 = 25 combinations in total).  The grid is the same for all asset classes.  The forecasted trend carries much more weight than the actual trend, because the future trend will determine our profit or loss, not the past trend.  As legendary hockey player Wayne Gretzky famously said, “skate to where the puck is going, not to where it has been.”

When I am confident in the forecasted trend, and differs from the actual trend (e.g. actual trend is Down, forecasted trend is Up), the percentage will be positive but not too strongly positive.  We want to start getting on-board the new trend, but not too heavily in case the current trend extends longer.  As the new trend begins to emerge, we become more confident in the forecasted trend so the percentage goes up.  At an actual trend of “Up (?)” and a forecasted trend of “Up”, I am at a percentage of +100% which means I am as bullish on that asset class as I can be, and I’m putting a higher percentage of my assets into it.  In this case, I see the actual trend beginning to turn up, in line with my forecast, so I have more confidence that my forecast is indeed correct.

As another example, let’s continue the earlier case of gold mining stocks.  As of today, my assessment of the actual long-term trend is “Down (?)” and I have chosen “Down (?)” for the forecasted long-term trend.  This is a weak situation, and negative for the gold miners.  However, because both forecasts have low confidence, the percentage is -40% and not any lower.  Applying this percentage to the range we established, -25.9% to +35.0%, and the baseline trend of +6.5%, we get a long-term forecast of -6.5%.  Calculation: -6.5% = 6.5% + (-40%) * (6.5% – (-25.9%)).

This forecast applies to the stage of the long-term cycle that we are in.  For example, if a few months from now the downtrend seems to be exhausting, causing us to change our forecasted trend to “Up (?)”, the percentage would go to +35% (as defined for that combination of actual trend “Down (?)” and forecasted trend “Up (?)”) and the long-term forecast would increase to +16.5%.  This is a big move, but I don’t change my long-term forecasts very often, only when conditions warrant.

To see this in action, including loads of real-life examples, check out our live stream, YouTube channel, and free trading podcast.

Armed with a fearless long-term forecast, we can now take action.


Turn Forecasts into Profit

With forecasts on all areas of our investment universe, we are ready to face the market.

Long-term investors can stop here, allocating their wealth to the asset subclasses with the highest projected forecasts.  It’s still important to monitor the risk level of the portfolio to avoid overconcentration.  More about risk levels in Episode 2 and Episode 10 of my investing podcast.

Intermediate-term traders, or swing traders, will want to layer intermediate-term forecasts onto the long-term ones.  Here’s a link to another post with more details, as I continue my series on the Five Components of Successful Investing.

So get started today on your fearless forecasts, and be prepared for the volatile times that lie ahead for financial markets.

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(CC Image by Samantha Marx on Flickr)

(CC Image by Samantha Marx on Flickr)


In today’s world, opening up a book may seem like an old-fashioned way to learn.  However, despite the popularity of virtual webinars and other online learning tools (like our free trading podcast, live stream, and YouTube channel), books remain a critical resource for professional traders and investors.  You’d be hard-pressed to find one pro that couldn’t name at least a couple books they read that taught him or her fundamental skills or inspired a new strategy.

For me, books were the first place I turned when I started my investing journey over a decade ago.  Over the years, my collection has expanded through regular purchases as well as inheriting a collection of classic trading books from my uncle.

In the spirit of the holiday shopping season, I’d like to share my list of the ten most essential books for anyone who wants to become a better trader or investor.  Every book on this list is one I personally endorse because it influenced my growth and development as a trader.

These are foundational books that will give you a strong base of knowledge that you’ll be able to apply right away, without overwhelming you with technical mumbo-jumbo.  Many of these books have a practical focus with plenty of examples to illustrate the concepts shown.  That said, I couldn’t resist including one textbook (Derivatives Markets) on the list so those who are mathematically inclined like myself will have something to sink their teeth into.

Without further ado…

Technical Analysis Explained, Fifth Edition: The Successful Investor’s Guide to Spotting Investment Trends and Turning Points, by Martin J. Pring

Pring introduces all the commonly-used technical analysis concepts and indicators in this book.  It’s a great reference book to have on hand and a solid introduction to technical analysis.

The Layman’s Guide to Trading Stocks, by Dave Landry

This accessible and slightly irreverent book is a fun place to start for the beginning trader.  Landry covers several basic yet fundamentally important trading strategies here, along with good coverage of the mental aspects of trading.

Intermarket Analysis: Profiting from Global Market Relationships, by John J. Murphy

John Murphy has written several books on intermarket analysis, all of which are classics that continue to stand the test of time.  Murphy’s excellent analysis of the connections between global stock, bond, currency, and commodity markets had a tremendous influence on the technical strategies I’ve developed.

Tragedy & Hope, by Carroll Quigley

What, a history book?  Yes – a 1300+ page history book, no less.  And I honestly believe it may the most valuable book on this list for investors.  Quigley’s magnum opus, first published in 1966, is an unparalleled study of 20th century history.  Social and political trends have been a major influence on the financial markets since markets were invented, and they always will be.  Reading this book will help you ensure your investments are aligned with these trends.  The book is freely available in PDF form here, although you’ll be missing out on the pride you’d have if this beast was on your bookshelf for all to admire.

Derivatives Markets, by Robert L. McDonald

This comprehensive textbook teaches important theoretical concepts related to the pricing of futures, forwards, swaps, and options.  This textbook is part of the syllabus for the Society of Actuaries’ MFE Exam.  When I took the actuarial exams I learned from a similar book, Financial Economics by Harry H. Panjer.  The Panjer text, published in 1998, is out of print but used copies are still available.

The Volatility Edge in Options Trading: New Technical Strategies for Investing in Unstable Markets, by Jeff Augen

Every trader must understand the concept of volatility, because trading is all about managing risk.  Augen does a great job of explaining volatility in this book in a way that is understandable for newer investors.  He also introduces strategies to take advantage of mean reversion and other concepts related to volatility.

Harmonic Trading, Volume One: Profiting from the Natural Order of the Financial Markets, by Scott M. Carney

Carney introduces several harmonic patterns which are composed of four price waves each, with all the waves related to each other by Fibonacci ratios.  These patterns don’t appear tremendously often, but they are reliable when they occur.  You’ll want to have harmonic pattern analysis as part of your technical toolbox.

High Probability Trading Strategies: Entry to Exit Tactics for the Forex, Futures, and Stock Markets, by Robert Miner

Miner provides a thorough yet accessible framework for successfully trading all markets and all timeframes.  One of the biggest mistakes I see traders making is having too narrow of a focus.  Miner covers all the bases with his four-part framework consisting of price, pattern, momentum and time.  His writing style can be a little abrasive at times, but it’s clear he knows what he is talking about.

Forecasting Financial Markets: Technical Analysis and the Dynamics of Price, by Tony Plummer

This little-known gem is now out of print, but used copies can still be found.  Plummer’s writing style can be hard to decipher, hence the mixed reviews, but patience is rewarded here.  I have read it several times and unlocked new secrets each time through.  Fibonacci ratios are at the core of Plummer’s ideas.  The 2010 book, linked above, shares the emphasis on theory over practice.   It’s not the place to start for a new trader, but it contains quality insights I’ve yet to find anywhere else.

The Education of a Speculator, by Vic Niederhoffer

This is the most enjoyable book I’ve read about trading, hands-down.  Vic experienced more than his share of ups and downs in the markets, and his writing provides a lot of insight into how he managed through those experiences.  You won’t get charts or trading strategies in this one, just an entertaining glimpse into how the trader’s mind works.


I’ve tried to include a mix of easy and challenging books here, with a variety of subject matter, so traders of all experience levels will find something to enjoy.  Now get started!

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(CC image by Hubble ESA on Flickr)


Think back to your most successful trades – the ones that made you jump out of your chair and run around the room, high-five your friend, enjoy a celebratory drink, or all of the above.  As traders, we all want more of this kind of trade.  In these moments, we feel like masters of the investment universe!

It takes lots of dedication and practice to achieve mastery, but it is not difficult to get started on the path towards success.  One of the critical first steps is defining what your investment universe will be.  After all, we can’t master something unless we first know what it is we want to master!

I call this mapping your investment universe.  It’s the process of deciding which markets you will follow and analyze, along with making a list of the securities you will trade.


Every Winning Plan Includes a Map of the Universe

In my earliest foundational post, I introduced a framework for building wealth entitled “The Five Components of Successful Investing”.

The five components are the blue boxes in this flowchart, taken from that post (with the blue circle added to mark today’s focus):


While the Universe of Securities box sits to the right of the other blue boxes, because it doesn’t need to be updated as often as the other components of successful investing, all the others depend on it.  We can’t make forecasts unless we have first chosen what types of investments (e.g. stocks, commodities, bonds) we want to forecast!  Also, most of us will use technical analysis of chart patterns to inform our trading decisions, which first requires us to select which charts we want to look at.

So, what should your investment universe be?  The answer is: it depends!  It depends on what YOU like to learn about, follow, and trade.  Some traders prefer to follow one industry, such as tech stocks or retailers, and get to know it in great depth.  These type of traders might define their universe as all the stocks in that sector, including small-cap stocks that they feel comfortable trading given their specialized knowledge.  Their universe might also include options or warrants on these stocks, depending on risk tolerance and other factors.

My approach to trading and investing is more broad than this.  It can be best categorized as “macro investing”.  Macro investing is all about trading a wide variety of assets and investment vehicles with the goal of capitalizing on large-scale trends and cycles.  I might buy a small-cap security if I think there is an opportunity there which aligns with a larger trend, but generally I am trading larger ETFs (exchange-traded funds) that hold a basket of securities in any given area.

I believe that macro investing is the optimal approach for most investors.  Here is why:

  • If your universe includes ALL the major asset classes, you’ll be able to take advantage of the best opportunities to bet alongside or against every area when it is becoming underpriced or overpriced, respectively.
  • Having a larger universe requires you to stay current on all the important trends, which makes you a better-informed trader.
  • Using ETFs as your primary investment vehicle, as opposed to individual stocks, provides better diversification within an asset class.

The exception to this would be if you have the time and desire to do lots of research on individual stocks, above and beyond the larger market trends.  In that case, you’d want to select stocks yourself for better returns and lower risk.  The vast majority of traders simply don’t have the kind of time needed in order to select stocks across many different sectors.

In the remainder of this post, I’ll explain how I map out my universe of securities.  This will serve as an example that you can adapt for your own situation.


Select Asset Classes

As I mentioned above, I try to include all categories of tradable assets in my investment universe.

First, I group them into major asset classes:

  • Currencies;
  • Precious Metals;
  • Commodities;
  • Bonds;
  • Equities (Stocks); and
  • Pure Derivatives.

Next, I further define “subclasses” within many of the asset classes.  For example, beneath Equities (Stocks) I have the ten market sectors (e.g. energy, utilities, financial services) along with mining stocks.  Beneath Commodities, I have: Soft Commodities, Base Metals, Oil, and Natural Gas.

Now that I’ve defined the scope of my universe, I can choose which securities I’ll trade.


Select Securities

To keep it simple, I choose only one preferred investment vehicle within each subclass.  Typically, this will be an ETF that tracks all major components of that subclass.  In some cases, there will be multiple “go-to” choices, as in the Currency Derivatives category where we can use UUP to trade the U.S. dollar, FXE to trade the euro, or FXY to trade the Japanese yen.

My list changes periodically as funds change and new choices become available.  Here is the list as of today:


My investment universe

These are the criteria I use to form the list, in order from highest to lowest priority:

  • Coverage (i.e. low tracking error);
  • High trading volume (i.e. low bid/ask spreads);
  • Low expense ratio;
  • Availability of options;
  • Trading volume in options.

I recommend you use some combination of the above criteria to form your own list, since your priorities might differ from mine.  For example, if you are a very frequent trader of options, the amount of trading volume in options could be your top priority.  In that event, you’d want to entirely remove the ETFs that don’t have high trading volume in options (e.g. DBA, DBB).


Follow Your Map, Unless You Are Absolutely Sure Where You’re Going!

Over 75% of my trading activity is in the ticker symbols found in my list.  I only deviate from the list when at least one of the following conditions hold:

  • I am trying to get more exposure outside the United States markets (e.g. I’m bearish on the dollar or U.S. markets have become overbought).  In this case, I’ll choose a fund with more foreign-listed stocks (like RWX instead of VNQ).  I keep a list of favorites.
  • Or, I’m trading a niche that is only a small piece of a subclass.  For instance, while uranium stocks are part of the energy sector they trade quite differently from the rest of the sector, which is dominated by oil and gas companies.
  • Or, I’ve thoroughly researched a company and am confident enough in my view of that firm that I’m willing to take on company-specific risk by trading it.

In the past, when I’ve strayed from my list by trading in different securities without one of these valid reasons, my results have been mediocre to poor.

I learned this lesson in the FactorShares 2x Gold Bull S&P 500 Bear ETF (FSG), an ETF that, mercifully, no longer exists.  From mid-2011 to mid-2012, this fund extracted over $9k from my account before the pain stopped.  I’d been buying it on the thesis that the ratio of the S&P 500 to gold would decrease.  As we see below ….


… it was a faceplant.  Ouch.  But although the ratio rose instead of falling as I’d expected, I suffered a bigger loss than necessary.  FSG wasn’t in my universe of securities, and I didn’t trade it for any of the three reasons listed above.  I used it because it looked on the surface like it tracked the ratio I wanted to trade.  I’d have been better off creating a synthetic long-short position with GLD and SPY instead of using this ill-contrived fund.

What I discovered later was that FSG was managed terribly.  Factor Capital Management, the managing owner of FSG and 4 similar ETFs, shut down its operations in 2013 and liquidated its funds, but not before:

  • Charging excess expenses above its stated 0.75% fee (already too high) which weren’t clearly disclosed in the fund’s prospectus;
  • Failing to provide required tax forms to investors before March 15 as required by law (I had to amend my taxes in 2012 because of them – what a pain!);
  • Failing to adequately promote its funds, which kept volume low and hurt the fund’s liquidity.

I shared this example because I don’t want to see you fall into the same trap.  Stick to your list of preferred funds only, and don’t deviate unless one of the three conditions in my list is true.

Macro investing can seem like too much to handle.  It can look like the universe is far too vast to navigate.  But make a map, stick to it, and you won’t get lost!  You’ll be ready to pounce on opportunities anywhere they appear, and you’ll be on the path towards mastering your investment universe.

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Currency - (CC image by Taki Steve on Flickr)

(CC image by Taki Steve on Flickr)


“Inflation” and “deflation”: These are two of the most commonly used terms in the world of investing, but what do they really mean?

And, why is it so crucial to understand these concepts before making any long-term forecasts?


Why Inflation Matters

In an earlier post, I introduced a framework for building wealth entitled “The Five Components of Successful Investing”.

The five components are the blue boxes in this flowchart, taken from that post:


Long-term forecasts, the second component of the plan, are the most impacted by inflationary or deflationary forces in the economy.  The stronger and more persistent the inflation, the higher will be the expected returns across most asset classes.  Of course, the cost of living will rise at the same time, limiting the purchasing power of those investment gains.

The rate at which we expect inflation to expand or moderate in the future will also have a major impact on our preferences for certain asset classes over others.  Assets with a fixed stream of cash flows, like bonds, will be badly hurt by rising inflation, whereas gold will shine.  In mild deflation, when prices are gently falling or nearly constant, cash is king.  In that scenario, a wise investor will maintain a large cash reserve and consider writing options or shorting stocks to generate returns.

For these reasons, all long-term forecasting must start with an assessment of whether we expect inflationary or deflationary forces to be operating, and to what extent.

Before I go further down that path, it’s important to define what “inflation” really means.

What is Inflation?

Most people define inflation as the rate at which prices are increasing in an economy.  This is a good definition, but let’s dig deeper into it to avoid some important pitfalls.

Inflation is controlled by three factors, broadly speaking:

  • The supply and demand for goods and services in an economy;
  • The amount of liquid assets circulating in the economy, and;
  • How rapidly money circulates in the economy.

I’ll refer back to these towards the end of this post.

Goods and services are anything that is produced and available for sale to consumers.  This includes physical products, digital goods, and all kinds of services.  It even includes the underground economy or “black market”.  For simplicity, we’ll assume a closed economy, like a country that does not trade with other nations, so we can ignore the impact of cross-border flows of goods, services, and currency.

The second factor includes money, defined as any item that is serves as both a store of value and a medium of exchange.  Today, the vast majority of money in circulation is in the form of bank notes issued by central banks (paper currency, notes, and digital entries), but this category also includes gold, silver, and digital currencies like bitcoin.  A follower of the Austrian school of economics would simply define inflation as the rate of growth of the money supply, but this ignores all forms of credit and other liquid assets besides money.  It also ignores the rate at which money circulates in the economy.  Thus, the money supply by itself is useless for measuring inflation.

By “liquid assets”, I mean anything that can be converted to money in a reasonably efficient and fast way.  This includes far more than the supply of money and credit in the economy, and rightfully so.  For instance, let’s say you are considering the purchase of a new car for $30,000.  If you have $30,000 in your checking account, clearly this is money.  But if you instead have $30,000 of stocks in your online trading account, and all you have to do to get that money into your checking account is to: (1) click “Sell” and (2) request a check from your broker, how is this any different than money?

I’ve also included credit in my definition of “liquid assets”.  There are many types of credit.  As a simple illustration, let’s stay with the car-buying scenario.  Instead of using any money at all for the car, you could get a zero-down loan from your local bank.  That bank will then create the money out of “thin air” and use it to purchase the car on your behalf.  This puts new money into circulation, which will be taken out of circulation as you repay your loan.

The third factor, often forgotten, is arguably the most critical one when trying to predict future inflation rates.  It is the velocity of money – the rate at which all that money, credit, and liquid assets are circulating.  It generally follows a well-defined trend over long periods of time:

Prior to the start of this graph, money velocity also exhibited stable trends (down 1900-1932, up 1932-1960), when removing the impact of the two world wars.

Prior to the start of this graph, money velocity also exhibited stable trends (down 1900-1932, up 1932-1960), when removing the impact of the two world wars.


In the extreme case, the Treasury could print warehouses full of cash and drop it by helicopter, but if everyone stuffs it under their mattresses then it will have no impact on prices today.  Yet we can be certain that as soon as velocity begins to rise again, pent-up inflation will be released.   It is just a matter of time until it occurs.  We’re seeing this same phenomenon today in all the world’s leading economies, just not to such a dramatic level.  Central banks continue to stimulate growth by pumping money into the banking system, but its effect remains limited because it is not being deployed into the broader economy.

Now that we’ve defined inflation, let’s consider the factors that cause the inflation rate to go up or down (all other factors held equal).

Inflation increases when:

  • The supply of goods contracts (e.g. production quotas or natural disasters);
  • The supply of liquid assets increases (e.g. growth in money supply, financial asset values);
  • Liquid assets begin to circulate more rapidly.  For instance, when people expect rapid inflation, they spend their money more quickly.

Inflation decreases when:

  • The supply of goods expands;
  • The supply of liquid assets decreases (e.g. banks pull back on lending);
  • Liquid assets begin to circulate more slowly.  For instance, when people worry about the economy, they tend to hold onto their money longer.

(Which scenario fits today’s economy?  More the second scenario than the first, I’d say!  We see this in the inability of inflation to hit the Federal Reserve’s 2% target level, despite massive money-printing.)

If the rate of inflation is negative, i.e. price levels are dropping, we say that “deflation” is happening.


How is Inflation Measured?

It’s easy to measure inflation if you’re only interested in past or present values of the inflation rate.  Government agencies regularly publish inflation data, often labeled as a Consumer Price Index (CPI).  These series measure the rate at which prices are increasing for consumers in the economy.  Price levels at the producer level, like commodities and raw materials used by manufacturers to produce consumer goods, are measured by a Producer Price Index (PPI).  A more obscure measure of price levels, yet one that is arguably more valuable for investors, is the GDP (Gross Domestic Product) deflator.  The GDP deflator is the inflation series used to convert the GDP of a nation (a measure of its annual production of goods and services) into today’s prices.  I prefer to use the GDP deflator when running analyses because it aggregates all transactions in the economy, including those at the consumer and producer levels.

PriceStats and State Street have collaborated to develop their own inflation series, giving an alternate view that in many ways is more comprehensive than official series.

The tougher task is determining how much inflation to expect in the future.  The prices of gold and silver offer some insight into how much inflation investors are expecting, but these markets are small and subject to many forces beyond just inflation expectations.  Tracking gold and silver prices isn’t enough.

Without a good forecast of inflation, all our long-term forecasts will be too high or too low, and we won’t be adequately protected against distastrous outcomes.


Forecasting Inflation

It’s a whole lot easier to predict future inflation once you break it down into the three factors that I listed earlier.  Here is each one, with a list of questions to ask yourself when assessing each:

Supply vs. demand of goods & services

  1. How rapidly will technology advance?
  2. Will energy become more abundant, or more scarce?
  3. How rapidly will governments increase their spending?  Will some pull back?
  4. Will the population expand rapidly, or level off?

Amount of liquid assets circulating in the economy

  1. Will central banks follow loose (expansionary) or tight (contractionary) policies?
  2. Will government policies cause banks to hold on to reserves, or incentivize them to lend to the public?
  3. How will investors preferences change between non-liquid assets, like privately owned businesses, and liquid ones, like publicly traded companies?

The velocity of money

  1. Which will be stronger, fear or greed?
  2. How likely is it that a major war will break out, pulling money off the sidelines into the war effort?
  3. Has velocity been trending downward or upward, and for how long?  Is it due for a reversal?


After reflecting on these questions, you’ll be able to make more confident long-term forecasts.

Think of a swimmer going along with the current, or fighting against it – this is the difference between a forecast that starts with a good understanding of inflation, and one that does not.  Whether you’re a long-term investor or a frequent trader, you’ll want the current on your side.



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(CC image by Jim Linwood on Flickr)

(CC image by Jim Linwood on Flickr)


Have you ever been to one of the world’s financial centers – London, New York, Hong Kong, Chicago, to name a few – and seen the huge glass-walled towers full of luxury offices?

When you hear about the massive salaries and bonuses being paid to the high-ranking people inside those offices, which house companies like Goldman Sachs, JP Morgan, Morgan Stanley, Lehman Brothers (rest in peace), Bear Stearns (another RIP, maybe they’re not so smart after all?), PIMCO, Wellington, Edward Jones, and so many more – how does it make you feel?

Certainly, these firms perform many useful functions for large institutional investors, who must maintain portfolios full of thousands of individual securities and file tons of paperwork.

But what about the office down the street in your town?  The branch office that handles the accounts of high net-worth individuals, corporate middle managers, hard-working entrepreneurs and diligent savers from all walks of life.  They work in the brand-new building, drive around luxury cars, and advertise constantly on TV.  They must be doing something really hard to earn all that money, right?

What if I told you that they’re not doing a single thing you can’t do, if you have only:

  • A computer or tablet,
  • The ability to listen to podcasts (a shameless plug for our podcast!) at some point during your week, like during your commute,
  • A minimum of 1-2 hours per week to review your investments (or only per quarter, if you prefer a more “hands-off” approach).

The more time and dedication you’re willing to put in to building these skills, the better your results will be, of course.  But even with just the basics, you can do most of what the “professional” advisors down the block are doing, and you can do it for a much cheaper price.

Even if your portfolio is as high as $10 million, this is within your reach.  You can learn it, and you don’t need to be a math whiz to do so.

Let me illustrate.


The Five Components of Successful Investing

This is the approach I developed to manage my own assets, which I accumulated across 10+ years of working in the corporate world.  Although I’ve developed advanced analytical tools to perform  each one of these steps, this is the overall process I follow.  You can do it too.



Each step will be the foundation for lots and lots of future podcasts and posts.  For now, I’ll introduce the topic by giving just a brief outline of each step.


1. Determine why you’re investing.

Is your goal to have a secure retirement?  To save for your kids’ college?  To leave a legacy for future generations?  To become filthy rich and own 5 Lamborghinis?  No matter how ordinary or ambitious the goals, you need to know what they are.

Your goals impact your risk tolerance as well.  I like to distill the concept of risk tolerance to one sentence to make it easier to think about.  “If my net worth went down by [X%] in a short period of time, I would get very worried about my investments.”  Fill in the [X%] for yourself, it is a personal choice.  Yours might be as low as 2%, or as high as 100%!

Lastly, figure out your liquidity reserve.  That is, how much money you must keep safe and secure because you might need it in the not-too-distant future.  This is an emergency fund for job loss or, if you’re self-employed, a downturn in your business.  Three months, six months, or a year of expenses are common amounts.  Add on any big expenses you know are coming up soon, like a car purchase or down payment on a house.  The total is your liquidity reserve, or how much you absolutely must keep away from potential risk.

2. Develop long-term forecasts.

When it comes to forecasting, you can do all of the work yourself, rely on outside resources like Torpedo Trading, or fall somewhere in between the two extremes.  If you want to develop your own forecasts, you could mimic my comprehensive approach.  I developed my forecasts using: historical returns adjusted for long-term cycles, volatility assumptions, and correlation matrices.  If not, it’s much simpler to tune in to the podcast and follow the blog since you will find the results of all this hard work there, for free!  Alternatively, you could make your own forecasts based on independent research, talking with other investors, your favorite advisory services, astronomical cycles, or whatever you heard on CNBC yesterday.  (OK, not the last two examples.)

I re-evaluate my forecasts about once per quarter, sometimes sooner if there is a major shift in market conditions for a particular asset class.  Trends I define as long-term usually last 10 years or more, so they will not change much.

I chose about 25 asset classes in total, including: the 11 stock sectors, gold, oil, corporate bonds, Treasury bonds, and others.  You could use as few as 6 to 8 and get decent coverage of the investing spectrum.

Once you have a forecasted return and volatility level for each asset class, just put all your money into the one with the highest forecasted return.

JUST KIDDING!  That’s NEVER a good idea because of something called correlation.  Quite simply, correlation is the tendency for two asset classes to move up or down at the same time.  Even if you think bonds will have a lower return than stocks, you still want to include some bonds because they offer you diversification.  During a year in which stocks drop 25%, bonds may lose only 5% or even go up in value.  You might not have sufficient risk tolerance to take a 25% loss, but could absorb a smaller loss.

If you don’t want to be checking your portfolio or trading weekly or monthly, stop here!  Your plan looks like this instead, a shortened version of the one from earlier in this post:


Simply keeping your asset allocation in line with the long-term targets will put you in good position for long-term gains.  Once you’re confident in steps 1 and 2, it’s also enough to feel comfortable putting your advisor out of a job!

On the other hand, if you like to trade and you want the best plan, read on!


3. Develop intermediate-term forecasts.

By intermediate-term, I mean around 6 to 14 months.  I find that to be the typical trend length in most markets.

Intermediate-term cycles operate within longer-term trends, which last from several years to decades.  Aligning yourself with intermediate-term cycles takes more work and involves more risk than simply tracking the slow-moving long-term trends, but offers tremendously higher rewards.

I use a form of intermarket analysis that I developed with inspiration from an acclaimed book by John Murphy.  I also use a few other advanced technical tools to identify likely turning points.  More info on my approach can be found in this blog post.

You’ll use these intermediate-term forecasts to flex your asset allocations up or down from their long-term targets.  For example, you might have set a long-term allocation target of 50% for stocks, but your risk tolerance and goals permit you to vary that percentage in a range between 30% and 70%.  If you’re forecasting an intermediate-term rise in stocks, you would increase your stock holdings towards 70%.  When your forecast changes, anticipating a drop in stocks, you would begin selling stocks down to 30% of your total portfolio.


My current intermediate-term targets. I'm not bullish on stocks or bonds right now.

My current intermediate-term targets (some asset classes have been grouped together here, like all the stock sectors). I’m not bullish on stocks or bonds right now.


4. Be aware of short-term market moves.

Notice I don’t say “develop short-term forecasts” or “watch charts every single day” here.  This would be a full time job by itself.  We’ve all got a life to live!

I’m not opposed to day trading, but it’s foolish to be playing tiny moves in an hourly or shorter chart unless you’ve already got extremely sound intermediate-term and long-term forecasts.  Those moves will always dwarf the short-term oscillations.

If you’re under- or over-weighted in an asset class based on the intermediate term forecast, you’ll be trying to increase or reduce your position in that asset class.  Simply be aware of whether the last few days have trended down or up so you’re buying on a dip or selling on a pop.

I use my live stream and YouTube channel, both of which are free to watch, to keep viewers up-to-date on the latest developments in the financial markets.  Please consider subscribing to be updated when I release new content on those platforms.


5. Choose what you’ll buy and sell from each asset class.

I call this step “mapping your investment universe”.  Learn how it works and see an example here.

I usually recommend the major ETFs because they’re liquid and cost-effective.

It’s certainly appropriate to pick individual securities instead of ETFs here, wherever you feel comfortable doing so.  For example, maybe you work in the health care sector so you keep up on the trends in that area.  Or perhaps you love the latest tech products, and you’ve got a good lead on what will be hot and what won’t.

As part of this step, you’ll also want to consider whether options (calls or puts) are appropriate for you or not.

At Torpedo Trading, we maintain a list of preferred ETFs for each asset class.  The list changes from time to time as the fund companies make changes or add new funds.  This list will be provided to members once our membership program goes live.


More to Come

Stay tuned for future podcasts and posts that will dive much deeper into each of the steps above.  I hope this post will serve as a helpful reference for the overall process and how it works.

I’m here to help you take control of your investments, and avoid being gouged by expensive advisors.  This framework will set you on the path towards success.

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