In a conversation with the master jazz musician and Pulitzer Prize-winning composer Wynton Marsalis, he told me, “You need to have some restrictions in jazz. Anyone can improvise with no restrictions, but that’s not jazz. Jazz always has some restrictions. Otherwise it might sound like noise.” The ability to improvise, he said, comes from fundamental knowledge, and this knowledge “limits the choices you can make and will make. Knowledge is always important where there’s a choice.” – The Art of Choosing, Sheena Iyengar

We have all been taught to “play by the rules” since the very beginning of our lives. Our parents did the best they could to teach us rules of proper behavior. That list of rules continued to grow longer the older we got, governing our day to day interactions with others. However, each of us has learned that in many instances rules can and should be changed. It just takes an overwhelming amount of effort to do so, and leaves those attempting to enact that change open to bullying by the status quo.

Investment advisors, since 1940, have been subject to the legal rules established in the Investment Advisors Act, which spells out the fiduciary duties they have to their clients. Since then, the basis for these underlying fiduciary rules has not changed much. However, due to the rapid development of statistical analysis based on more powerful computer capabilities, academic finance has greatly changed what is today considered “correct and reliable” investment portfolio management rules. As a long time practitioner I have learned enough to know there are no reliable universal rules, and those willing to put complete faith in such rules will end up losing at some point.

One academic I have followed over the years is Dr. Andrew W. Lo, the Charles E. and Susan T. Harris Professor at MIT Sloan School of Management. Most of his academic work in the world of finance is not something an average investor would enjoy, let alone comprehend, but for those who want to take on the challenge, I would recommend it. For the rest of us, his book Adaptive Markets is full of stories with purpose and meaning that are easily understood by both professionals and non-professionals.

Though I recommend the book, that does not mean I am in full agreement with his Adaptive Markets Hypothesis. However I do take pleasure in knowing that there is someone of stature who is pushing for change in the status quo. I want to highlight the principles Lo discusses in Chapter 8 of his book. First, I’ll share his “Core Beliefs and Principles of the Traditional Investment Paradigm Spawned by the Efficient Markets Hypothesis.” Lo says “These are the convictions held not just by finance professors, but also by investment managers, brokers, and financial advisers.” I agree that these are guiding rules for most in the investment world, though I hold myself out as an exception.

Core Beliefs and Principles of the Traditional Investment Paradigm

Principle 1: The Risk/Reward Trade-Off. There’s a positive association between risk and reward among all financial investments. Assets with higher reward also have higher risk.

Principle 2: Alpha, Beta, and the CAPM. The expected return of an investment is linearly related to its risk (in other words, plotting risk versus expected return on a graph should show a straight line), and is governed by an economic model known as the Capital Asset Pricing Model, or CAPM.

Principle 3: Portfolio Optimization and Passive Investing. Using statistical estimates derived from Principle 2 and the CAPM, portfolio managers can construct diversified long-only portfolios of financial assets that offer investors attractive risk-adjusted rates of return at low cost.

Principle 4: Asset Allocation. Choosing how much to invest in broad asset classes is more important than picking individual securities, so that asset allocation decision is sufficient for managing risk of an investor’s savings.

Principle 5: Stocks for the Long Run. Investors should hold mostly equities for the long run.

The almost universal acceptance of these principles may actually have the opposite effect: lessening returns over time. Take Principle 4, which emphasizes asset classes over individual securities. This completely removes the investor’s connection of her investment to the very real operating business she owns, or the actual entity she is lending money to. By default, this could encourage speculation based more on fear and greed than on the fundamental relationship between price and value.

Dr. Lo’s Adaptive Market Hypothesis attempts to address behavior. Here is his “adaptive” approach to the above five principles.

The Five Principles of the Traditional Investment Paradigm from the Perspective of Adaptive Markets

Principle 1A: The Risk/Reward Trade-Off. During normal market conditions, there’s a positive association between risk and reward among all financial investments. However, when the population of investors is dominated by individuals facing extreme financial threats, they can act in concert and irrationally, in which case risk will be punished. These periods can last for months or, in extreme cases, for decades.

Principle 2A: Alpha, Beta, and the CAPM. The CAPM and related linear factor models are useful inputs for portfolio management, but they rely on several key economic and statistical assumptions that may be poor approximations in certain market environments. Knowing the environment and population dynamics of market participants may be more important than any single factor model.

Principle 3A: Portfolio Optimization and Passive Investing. Portfolio optimization tools are only useful if the assumptions of stationarity and rationality are good approximations to reality. The notion of passive investing is changing due to technological advances, and risk management should be a higher priority, even for passive index funds.

Principle 4A: Asset Allocation. The boundaries between asset classes are becoming blurred, as macro factors and new financial institutions create links and contagion across previously unrelated assets. Managing risk through asset allocation is no longer as effective today as it was during the Great Modulation.

Principle 5A: Stocks for the Long Run. Equities do offer attractive returns over the very long run, but few investors can afford to wait it out. Over more realistic investment horizons, the chances of loss are significantly greater, so investors need to be more proactive about managing their risk.

As you read these Principles, I believe you will find merit in Dr. Lo’s adaptation. I know I do, and I hope other academics will take up the cause and expand this research. Principle 1A is one to take note of, as I believe it has particular merit today, although in opposite of what most of us would think. We know that investors will act in concert irrationally during times of extreme financial threats; just think back to 2008 and early 2009. Not only did individuals act irrationally, but a very large portion of institutions did the very same, joining the largest club of investors in the world, the Buy High Sell Low Club.

Today I believe the next membership drive is about to start. To be a member of this club you must begin with buying high. Dr. Lo’s Principal 1A states investors will act irrationally due to financial threats, but the threat today is not a fear of losing money. In fact, it’s just the opposite; fear of not making any money when all your friends and peers are. Wall Street affectionately calls this FOMO, or the “Fear of Missing Out.”

I have experienced this in previous bull markets. We just hope this time it is not as disappointing as the last FOMO market in common stocks from 1998 to 2000. The results were disappointing to those who jumped on the bandwagon late in the game. In the ten years beginning on January 1, 2000 and ending on December 31st 2010, the S&P 500’s annualized return, including the reinvestment of dividends, was just 0.36%. We may have just seen the beginning of the next round of a FOMO market, or maybe it is just a false start. Time will tell.

Until next time,

Kendall

Anderson Griggs & Company, Inc., doing business as Anderson Griggs Investments, is a registered investment adviser. Anderson Griggs only conducts business in states and locations where it is properly registered or meets state requirement for advisors. This commentary is for informational purposes only and is not an offer of investment advice. We will only render advice after we deliver our Form ADV Part 2 to a client in an authorized jurisdiction and receive a properly executed Investment Supervisory Services Agreement. Any reference to performance is historical in nature and no assumption about future performance should be made based on the past performance of any Anderson Griggs’ Investment Objectives, individual account, individual security or index. Upon request, Anderson Griggs Investments will provide to you a list of all trade recommendations made by us for the immediately preceding 12 months. The authors of publications are expressing general opinions and commentary. They are not attempting to provide legal, accounting, or specific advice to any individual concerning their personal situation. Anderson Griggs Investments’ office is located at 113 E. Main St., Suite 310, Rock Hill, SC 29730. The local phone number is 803-324-5044 and nationally can be reached via its toll-free number 800-254-0874.

In this week’s issue:

• Stockscores’ Market Minutes Video – Don’t Chase the Wave
• Stockscores Trader Training – 3 Ways to Improve Your Trading Profits
• Stock Features of the Week – Abnormal Breaks

Stockscores Free Webinars

Stockscores Market Minutes – Don’t Chase the Wave

Most traders react to what has happened rather than think about what is going to happen next. This week’s Market Minutes looks at the importance of not chasing the wave when trading, but anticipating it. Plus, my regular weekly market analysis and the trade of the week on NKE.

Click here to watch on the Stockscores Youtube Channel

To get instant updates when I upload a new video, subscribe to the  Stockscores YouTube Channel

Trader Training – 3 Ways to Improve Your Trading Profits

Traders are faced with a lot of information and one of the great challenges is knowing what techniques and skills are most important for trading success. This week, I share with you 3 things that I think every trader must do to maximize their trading profits.

Focus on Abnormality

Almost every stock that outperforms the market starts is upward trend with abnormal price and volume behavior. The Stockscores Market Scan tool has been built around this fact, offering specialized filters to find the stocks behaving abnormally.

However, not all stocks trading abnormally make market beating upward trends in the future. It is important to know how to qualify what are the best trading opportunities. Don’t consider stocks that are rallying in to resistance because they will usually get stuck at that resistance level. Be cautious with stocks making abnormal moves on low volume because the market activity is less trustworthy when there are fewer people trading the stock.

Keep it simple. If a stock starts to attract a crowd of traders, do your homework to find out what is going on and analyze the chart to see what the reward for risk trade off is.

Limit the Size of Your Losses

No matter how good your analysis, you will be wrong and lose money on some of your trades. With good risk management, you can be very profitable even if you are wrong more often than you are right. The key is to not suffer from big, portfolio crushing losses.

You can limit your losses by using a stop loss order with your broker or manually execute an exit when the stock falls to threshold that  you determine to be the signal that the trade is not working.

I recommend only using a stop loss order when trading very liquid stocks in the very short term. I only use them when I am day trading.

Otherwise, I establish where support is and plan to exit if the stock closes below that threshold. This requires checking my holdings daily to see if there is a sell signal on any of them.

To determine the ideal stop loss point, I collect a lot of data from trades I have found and do what if analysis to find the ideal stop loss point. The method tends to be different for each of my strategies. For example, my Worm day trading strategy has been most profitable using a wide stop of -5 Reward for Risk element. A reward for risk element is based on the height of the entry signal candle, typically the difference between the closing price and low of that candle.

For a longer term strategy based on the daily charts, the ideal stop may be at -1.3 or -2 RR. I use large data sets to find the ideal but also constantly collect and check the data to see what is working the best. There is nothing wrong with changing your approach when the data tells you to.

Add to Your Winners (and NEVER add to your Losers)

Finally, I add to my winners, using the profits from an earlier position to mitigate the risk of a later one.

This is called scaling in and, simplified, this is how it works.

Suppose I buy a stock at $10 with a stop at $9. Later, the stock moves up and gives another buy signal at $12 with new support at $11. I can buy more at the point because my new stop loss point at $11 actually makes my first position profitable since I bought it at $10.

As the stock continues to move higher, I continue to add every time there is a new buy signal that has a stop loss point that is higher than my previous entry.

These 3 concepts are simple but take some time to learn. For more in depth discussion of them, consider one of the Stockscores trader training options found here.

This week, I ran the Abnormal Breaks Market Scans on Monday after the close and found a couple of stocks worth checking out.

1. LTRX
LTRX made an abnormal price move today on strong volume, breaking it up and through some short-term resistance. Still has to fight through some resistance as it tries to surpass last year’s highs around $4. 7/10

2. NVCN
NVCN (T.NVCN) is another abnormal mover today, breaking it steep downward trend line. Has strong support at $0.50 that should limit downside. 7/10.

If you wish to unsubscribe from the Stockscores Foundation newsletter or change the format of email you are receiving please login to your Stockscores account. Copyright Stockscores Analytics Corp.

References

• Get the Stockscore on any of over 20,000 North American stocks.
• Background on the theories used by Stockscores.
• Strategies that can help you find new opportunities.
• Scan the market using extensive filter criteria.
• Build a portfolio of stocks and view a slide show of their charts.
• See which sectors are leading the market, and their components.

Disclaimer
This is not an investment advisory, and should not be used to make investment decisions. Information in Stockscores Foundation is often opinionated and should be considered for information purposes only. No stock exchange anywhere has approved or disapproved of the information contained herein. There is no express or implied solicitation to buy or sell securities. The writers and editors of this newsletter may have positions in the stocks discussed above and may trade in the stocks mentioned. Don’t consider buying or selling any stock without conducting your own due diligence.

As investors’ bullish sentiment moves up to euphoric levels, the markets are reaching extreme leverage.  This is terrible news because a lot of people are going to lose one heck of a lot of money.  According to CNN Money’s Fear & Greed Index, the market is now at the “extreme greed” level and if we go by Yardeni Research on “Investor Intelligence Bull-Bear Ratio,” it’s also at the highest ratio in 30 years.

But, of course… this time is different.  Or is it?  I continue to receive emails and comments on my blog that the Fed will continue to prop up the markets forever.  Unfortunately, there is only so much the Fed can do to rig the markets.  Furthermore, the Fed can’t do much to mitigate investor insanity in record NYSE margin debt or the massive $2 trillion in the global short volatility trade.

The $600 billion in NYSE margin debt suggests traders have racked up a record amount of margin debt (33% more since 2007) and the largest short volatility trade in history.  By shorting volatility, investors are betting that the VIX Index (Volatility Index) will continue to move lower.  A falling volatility index suggests more calm and complacency in the markets.

So, the market will likely continue higher and higher, until it finally POPS.  And when it does, watch out.

I’ve put together some charts showing the extreme amount of leverage in the markets.  While this leverage may increase for a while, at some point the insanity will end in one hell of a market correction-crash.

The Commercial Banks Are Betting On Much Lower Oil Prices

As I mentioned in previous articles and my Youtube video, Coming Big Oil Price Drop & Market Crash, the Commercial banks have the highest net short positions in the oil market in over 20 years.  In the video, I explained how the Commercial net short position in oil increased from 648,000 to 678,000 contracts in just one week.  Well, according to the most recent COT Report (Commitment of Traders), the Commercials outdid themselves this week by adding an even larger amount of short contracts.

The Commercial net short position in the oil increased by a stunning 58,0000 contracts to another record high of 732,000:

If we look at the “Commercial” long and short positions at the bottom of the chart, we can see that the total short contracts increased to 1,486,922 while their longs fell to 755,208.  So, the Commercials added a 46,000 more shorts and reduced their longs by roughly 12,000 contracts.  Furthermore, the Commercials are only 34% Bullish about the current oil price while the Large Speculators are 85% Bullish.

When the Commercials hold a very large net short position in commodity, metal or asset, that normally indicates a correction will shortly take place.  Especially, when the Commercials hold the largest short position in oil, going back for more than 20 years:

The BLACK line represents the oil price, and the BLUE line is the Commercial net short positions.  Right before the oil price fell from $105 in mid-2014 to a low of $30 at the beginning of 2016, the Commercials held nearly 500,000 net short positions.  However, as the oil price increased from $42 at the end of September to $64 currently, the Commercials net short position increased from 350,000 to a massive 732,000 contracts:

In my video linked above, I mentioned that the technical analysis indicator of a shooting star suggested that the oil price may have peaked.  Well, it looks as if this may be true, but time will tell.  However, we can clearly see that the Commercials record net short positions provide us with evidence of extreme leverage against the oil price.  I would not be surprised to see a $20+ decline in the oil price as the Commercials liquidate their short positions back toward more normal levels.

A $40 oil price is not good for the U.S. Shale Oil Industry.  I will be publishing a new video shortly on the ongoing U.S. Shale Energy Ponzi Scheme and the financial disaster taking place in the U.S. shale oil and gas industry.

Regardless, if the leverage in the oil market is reaching record levels, you should see what is taking place in some of the Dow Jones Industrial stocks.

WARNING: EXTREME MARKET LEVERAGE, Dow Jones Stocks Are Well Beyond Bubble Territory

I get a laugh when I receive emails from individuals who write me stating, “This time is different” in the stock market.  They let me know that my calls for a bubble market and a crash have been overblown, severely overdue or simply, not true.  While I am quite surprised at the longevity of this present bull market, my warning remains the same… THE HIGHER IT GOES, THE BIGGER THE CRASH.

Let’s take a look at some of the Dow Jones Industrial stocks and their price changes in just the past two weeks.  As the overall market increased significantly since the beginning of the year, Caterpillar’s stock price increased from $161 to $170:

And if we remember my chart on Caterpillar from my first video, Stock Market Bubble vs. Gold & Silver, Caterpillar’s price was $137 on Nov 5th.  So, in just two and a half months, Caterpillar’s stock price is up a staggering 24%:

You will notice that Caterpillar’s stock price experienced several short-term peaks, but nothing quite like what is taking place now.  Another impressive mover in the Dow Jones Index is Home Depot.  While Home Depot’s stock price chart isn’t as remarkable as Caterpillar, it is also moving beyond bubble territory:

From 2000 to 2012, Home Depot’s share price averaged approximately $25 a share.  However, on Jan 5th it was trading nearly eight times higher at $192.  But, if we look at its current price, it is NOW trading more than eight times higher at $201:

Now, could have Home Depot’s revenues and profits increased tremendously since 2012 to suggest a price of $201?  According to Home Depot’s financial reports, their revenues grew from $70 billion in 2012 to over $100 billion in 2017.  Furthermore, Home Depot’s net income has increased from $3.8 billion in 2012 to $6.8 billion in the first three quarters of 2017.  But does a $30 billion increase in revenues and $6 billion increase in profits translate to a 700% increase in Home Depot’s stock price over the past five years?

Okay, let’s look at Boeing Airlines.  What’s going on with Boeing’s share price?  On Jan 5th, Boeing was trading at $308… nearly three times higher than what it was trading at $112 at the beginning of 2016:

As we can see, Boeing’s share price is up 9,200+% over the past 34 years.  If we go by Boeing’s 2007 peak of $80, it’s up nearly four times.  However, if we check the trading activity over the past two weeks, Boeing’s stock price is moving well beyond bubble territory to a new record high of $337:

Gosh, Boeing’s severely pointy price chart resembles the antenna on the Empire State Building in New York City.  Good heavens, Boeing’s stock has gone up 10% in just two weeks.  If investors don’t see anything wrong with this chart, you probably have been hanging around too many “Cryptocurrency Aficionados.”   People, if you think the only direction is UP with stocks or cryptocurrencies, you need to get your head examined.

Here’s another chart worthy to compete with the tremendous gains in Bitcoin, Ethereum, and Ripple.  However, this is one those industries that should NOT BEHAVE like a high-flying tech stock or cryptocurrency.  Why, because it’s a healthcare stock.  United HealthCare’s stock has surged from $53 in 2012 to $223 on Jan 5th:

If you were clever and started buying United HealthCare’s stock in 1990, you would be enjoying cryptocurrency type gains of nearly 43,000%.  But that is all history now.  United HealthCare’s price is up another 6% to $243 in just the past two weeks.  If you look at the chart below carefully, you will see that its current two-week trend is virtually a STRAIGHT LINE higher:

United HealthCare and Boeing’s stocks represent a market that has gone completely insane.  Unfortunately, the leverage in the market will likely increase from the current extreme levels to “outrageously” extreme… if there is such a term… LOL.

Investors need to understand that the Fed and Central Banks realize by rigging the market higher, it can only go in that direction.  Ever since the 2008 U.S. Housing and Banking Market collapse, the world has been living on borrowed time, money and a massive amount of debt.  By increasing the value of Stocks, Bonds, and Real Estate, the Fed and Central Banks not only give investors the impression that they are wealthier, so they spend more, it also allows governments to collect more taxes.

While inflated asset values allow governments to collect more taxes, they still aren’t enough to keep the economic and financial systems from collapsing.  Yes, I know I am a broken record, but the FUNDAMENTALS DON’T LIE…. only humans do.  So, a lie or a Ponzi Scheme can continue for quite a while.  A perfect example is the Bernie Madoff 20-year Ponzi Scheme that defrauded investors by $65 billion.

If the Fed and Central Banks lose control over the markets (Yes, they will), then the ensuing collapse will make 1930’s Depression and the 2008 economic meltdown look quite tame indeed.  As I have mentioned in several interviews, when the markets were crashing in 2008, the U.S. Oil Industry was still in relatively good shape.  However, today the shale energy industry has debt up to its eyeballs and two-thirds to three-quarters of the shale energy companies are losing money:

The chart above by energy analyst, Art Berman, shows that the majority of U.S. shale energy companies lost money in the first three quarters of 2017.  While Chevron, ConocoPhillips, and Statoil made money, they are not heavily invested in shale oil or gas as are the companies are shown in the RED.

Lastly, the oil price is getting ready to experience one hell of a correction-crash as the Commercials hold the largest number of net short positions in history.  Furthermore, the NYSE margin debt and the Volatility Index are at extreme levels.  This has allowed the stock prices of many companies to surge to completely insane prices.

While the leverage in the market will move from extreme to outrageously extreme before it crashes, the timing of this event is not years or decades away as some more WISHFULL thinking investors have deluded themselves into believing.  Huge market corrections are normal, and stock market crashes have occurred many times in the past.

However, the present leverage in the market is now beyond bubble territory.  When the markets finally crack, if you own some physical gold and silver, you will be one of the few 1% that will have protected your wealth as most individuals watch their investment bubbles pop.

Check back for new articles and updates at the SRSrocco Report.

Economic guru Peter Schiff warns savvy investors that the current Trump bull-run stock market actually is flashing many obvious danger signals if one would only ignore the dazzle and examine the details.

“The stock market is rising despite the fact that there are very, very negative factors that are building, that are hiding in plain sight, that everybody is ignoring,” 

Schiff cited various danger signals, including rising inflation, as evidenced by the surging price of oil, the tanking dollar, and warning signs in the bond market with reports China plans to quit buying US Treasuries. Bloomberg News recently reported that Chinese officials reviewing the country’s vast foreign exchange holdings have recommended slowing or halting purchases of U.S. Treasury bonds amid a less attractive market for them and rising U.S.-China trade tensions.

….read more of the video synopsis HERE