|Here is where I learned it. It has been successful since 1998.. I run it in many 401 K plans and retirement plans flawlessly. Works well with Mutual Funds. |
Note: No charts inserted!
(beas98.doc – Don Beasley’s presentation, delivered on Oct. 14, 1998, at the Monitor Conference in Alexandria, Va. – edited by Chas Richards)
SELECTION & MANAGEMENT
POSITIVE & NEGATIVE
I think that there’s an awful lot of difference between mutual fund selection and management. If you use the same tools to select and then turn around and manage by those same tools, you get beat up. You just have a lot of frustration. So we try to determine selection and management by two different approaches in positive and negative environments.
Whipsaws vs. Drawdowns: I think you always have to seek a balance between whipsaws and drawdowns. Drawdowns, how many of you have ever prayed for 4 o’clock to get here? “If I can JUST get to 4 o’clock today.” Now that’s drawdown. Whipsaws kind of irritate you, like mosquitoes in south Georgia, or gnats. Drawdowns are agony.
It’s an eternal battle between fund selection and fund management. The truth is, you have to deal with whipsaws and drawdowns. And the balance we try to seek in there is what’s critical to us. Now, you guys with lots of money, plenty of guts, you say, “Aw, them drawdowns don’t bother me.” And I’m gonna tell you, it bothers me.
Our only tool: Stochastics + RSI: We only use one tool to measure our deal. Look at this chart, a 21-day Stochastic with a 13-day smoothing. Notice that most of the time, Stochastics are basically if it goes below 20 and goes back above, that’s supposed to be good. If it goes above 80 and back down, that’s supposed to be bad. It’s kind of slow, smooth and operates basically between 20 and 80. Doesn’t look like too much. It really isn’t.
Now, here’s a simple 14-day RSI. I would say that most of the time it’s used … if it’s above 50 it’s good, if it’s below 50 it’s bad. Looks a little nervous, though, doesn’t it. Well, look at them put together now: here’s old nervous 14-day RSI, and here’s old smoothie 21-day Stochastic with a 13-day smoothing. What we’ve done is combine these guys. Notice both the Stochastics and the RSI are zero to 100 indicators. It makes it pretty easy to combine these guys.
So, for a negative environment, we take our 21-day Stochastic with a 13-day smoothing, and divide it by two. Then we take the RSI and divide it by two. So ultimately, we have a measure here that is our measure in a negative environment. That’s all we use; we don’t use anything else. That’s all. I think honestly, the Stochastic and RSI, this is better than either one of them because it smoothes the RSI and the combination of the two end up making a better tool for measuring.
When we’re in a positive environment, we have a different approach. We make it even a little bit more smooth. We take a 34-day Stochastic with a 21-day smoothing. Same old 14-day RSI. Somebody asked me how we picked those numbers – 34/21 … and 21-13. I said, “Somebody told me about Fibonacci numbers one time.” Now doesn’t that sound good? I bet you there’s not three people in Georgia, Alabama, Louisiana and a few other southern states even know regular numbers, much less Fibonacci numbers.
Why did we pick a longer, smoother Stochastic? Because we’re in a positive environment. I want to have a tool that keeps me in the market. If we think we have a chance to make money, I don’t want to get whipsawed out. I don’t like to get whipsawed out. The relationship between the Stochastic and RSI is such that one of them, with half the input, just blinks and keeps you from getting out of the market when the other one dips below the 50 line. Then this one starts to go back up while the other one is kind of wobbling. So this is part of the marriage between the two.
Now, whether you’re in a positive environment using a 34-21 Stochastic or in a negative environment using a 21-13 Stochastic, the rules don’t change. The rules stay the same.
We have both the 34/21 Slow Stochastics and the 21/13 Fast Stochastics on the same page on our default chart. The 21/13 is a red line and the 34/21 is a green line. The red line is what we call our negative environment, a 21-day Stochastic, 13-day smoothing. And the green line is what we call our positive environment, the 34-day Stochastic. The red line is always going to act before the green line. Here’s an example of that, where it almost takes you out on the fast Stochastic, but look at the green line – it hardly takes you below 65.
This is the only thing we use – the ONLY thing we use. We look at this every day. We think it’s important to know what kind of environment you’re investing in so you can do that. But it’s not rocket science. You’ve got a fast buy and a slow sell, but you never have a slow buy. We always use the red line on buy signals.
Mike Burke, of Mirat, I talked to him about this last year out in Arizona, and we’ve been flopping around with it some, and used it as our tool, so he took it back and improved on it. He and Charley Hooper have added another component, that not only do you have to go above 50 and below 50, you have to cross the moving average. Notice what this would have saved you on this chart. We actually got a little negative environment buy, but we didn’t cross the moving average. And I’ve got quite a few examples of that. Here, we crossed below here, but we didn’t violate our moving average, and again we didn’t violate our moving average, and we finally got out of it over here.
If you use a trend-following mechanism with the Stochastic/RSI indicator, you’ll have better returns, fewer trades. And ultimately, that’s better. Here’s some examples of where the little measure up top here was OK, but you didn’t meet the moving average. At certain times, the moving average will violate as you move along, and the little Stochastic/RSI bug at the top will keep you out. So, that’s another little vehicle that Mike has improved upon.
Now, look at this chart of Fidelity Select Electronics. Here’s a way to double your money, from 25 to 50 (September 1997 through September 1998). If you were in a negative environment – see, we had a couple of trades here, got beaten up a little bit, but look if we’re in a very constructive positive environment. Do you realize this is six or seven months in the market. Notice that you get a little bit of whipsaw here, yet if we’re in a positive environment we can stay in it the whole time.
Notice up here, we basically could not have traded. We could have gotten some queasiness, but our rule says if it’s above 65, you can’t sell it. If you own a fund that’s above 65, we’re in that zone. Go fishing. Go work in the garden. Go shopping, lady. Because I’m telling you, you’re going to have more money next week than you did last week. It works basically over periods of time. It works pretty well. But it also says if you’re below 50, it’s prudent not to have too much of your money in the market.
Here’s a good example. Let’s assume we’re rocking along here in 1997 in a positive environment. Interest rates are OK, relative strength is OK, price oscillator is OK, and look at this: we go from May all the way into March, almost a year’s time that we’ve been in the market – because of the environment. Notice the difference though. If we were in a negative environment, we would have had a few of those whipsaws. Whipsaw here, whipsaw here, whipsaw here. Now, over here, when the slow Stochastic/RSI finally crossed below 50, I was kind of glad when we got to 4 o’clock. All my lines were down. So we avoided some of the agony.
Now, I don’t want to come across as suggesting that our way is perfect. It’s not, and there are whipsaws. So nothing is perfect. Our way is not. This is just our way of measuring things.
Now, notice this. Looking at a chart of the Wilshire 5000, in 1994, it got beat up. But everybody got beat up a bit in 1994. But once we got into a fairly constructive period of time, the environment got better. We moved into our mode and look what happened. We stayed up here in never-never land for a long period of time, got outselves out of it and got back in.
With this, you can capture and avoid large segments of the market. Notice that portion that you’re sitting out of the market; that’s two or three months. But you should be pretty glad, see, because of what goes on during that two or three months. That’s a pretty tough environment. Then you turn around and capture four or five or six months out here, and you want to get all the money you got and put it in the market. Now’s the time to borrow what you can from your mother-in-law and put IT in the market. Boy, we’re having some fun.
So it allows you to adjust as you go along. It allows you to capture large portions of the market.
The “65” No-Sell Zone: At the top of all our charts, you’ll notice we have this little line here called the “65 Line.” When the Stochastics value and the RSI value are added, and you divide that by two, if you’re above 65 percent, you can’t sell. When you’re above 65, you can really, really carry some long moves in the market.
The Below-50 Sell Zone: And below 50, we call the sell zone. So, if you’re in a fund, and the value is above 65, you can’t sell. If it’s below 50, there’s no decision – you’re not in the market. So, the only time we have to make decisions is when it’s here – above 50 but less than 65. We call that the “Decision Zone.”
Are we entering the buy parameters here? Are we leaving a position that we might could trade up? If we go below 65, it becomes fair game at that time that we can leave the party and go to the next one. OK?
If you look at a 6/24 AccuTrak – I didn’t realize this until a few months ago – it has a lot of the same characteristics. Now, I would say to you this is actually faster buys in most cases because we’ve still got the slow Stocastics down here grunting and moaning. But it has a lot of the same characteristics.
Another reason I like the Stochastics/RSI tool over the 6/24 comparison is I’m pretty big on ranking things. I like to run a rank every day or every week, and I’ve found that the little Stochastic/RSI doesn’t allow your funds to be going from first to 300 on a bad three or four days, an event driven thing – bad earnings news. You see these tremendous vacillations, and the little Stochastic input sometimes keeps it from running way up and down.
Trading Rules: I use them only for U.S. and international equity funds and only for the appropriate environment. I think you can use this with sector funds. If we have money at Invesco, an appropriate list, what the heck do we care what Fidelity’s doing, what Founders is doing, what Janus is doing? We’ve got Invesco money. So, if you’ve got money at Jack White, or Schwaab, take your Schwaab list and run it on it. Don’t worry about everything else.
Now, maybe you have a great market timing signal. Everybody’s got their favorite, and all this means, really, is that we have a positive expectancy to make a few pennies. That’s all it means. So, when we get our great signal, we now turn and say, “We must buy a fund that’s ranked in the top 10 percent of funds being evaluated, Column A, I want to show you that.
Column A must have a value of greater than plus 50. We just saw a picture of that. It has to meet our minimum criteria. And then, the fund must have in Column B a value that’s positive. Column B, for us, is a six-day rate of change of Column A. That’s all it is. The fund must have a greater relative strength than the dominant index. If the dominant index is the OTC-C or the NYC-I, our fund must be doing better than that.
Now, again, once you’ve selected your fund or funds, you sell if the Stochastic/RSI bug drops below 50. You cannot sell when it gets above 65. And I’m telling you, if it’s above 65, don’t let your ego get in front of it. If you own Dividend Growth and it’s plodding along, believe me, you’re going to have more money this week than you had last week. And that’s a pretty good feeling. It’s when the value is in between those two that you have the leeway to trade up to another fund. Two criteria have to be met to trade up: (1) when a fund falls out of the top one-third of the funds evaluated OR the fund’s relative strength against the dominant market turns negative.
And whatever you want to do, DO it. Don’t sit around and say, “Oh, gosh, the futures are down 9 points today.” Forget about the futures. I’m telling you something – have a life. The world’s not going to come to an end. If it goes below 65, you might need to consider if there’s a better place for your assets.
Now, let’s look at what happens when you get a general market timing sell signal: Sell if the fund falls below 50 in Column A, or the fund reverses by 3 percent from its highest price. Our market timing approach does not have lockouts. You know you get locked out of the market for periods of time. You know, where somebody says “We can’t get another buy until such and such happens”? Hey, I want that sucker to sell, I’m selling. Or if I want it to buy, I want it to buy. I don’t mind getting whipsawed, but I hate losing money worse than anything. So those are our simple rules of operation with our funds.
OK, say you’ve been forced out of the market, and a new buy signal is initiated.
Buy the funds that got bombed the most after a corrective action of more than 10 percent. If you’re trying to decide which fund to buy, and the two funds at the top of the list are Safeco Small Company and Morgan Stanley Gold. They’re both in their 90s, but look in the column on the far right, the annual percentage return. Here we have one fund that gained 37 percent and another fund that lost 49 percent. Which would you rather own? Now, be careful, before you answer. Most people might be saying, “Boy, I’d love to have some of that Safeco.” But let me tell you, it just depends. It depends on your objectives and what you’re trying to accomplish. Safeco might be extended too far.
Here’s another example: Prudent Bear Fund (BEARX). It’s got great momentum, but look over here: it doesn’t even qualify. RSI/Stochastics is 17, not even close to 50. Even though it’s got momentum. Once you get down so low, you can have momentum. But momentum from where? So this other one is the better fund. And quite clearly it shows over here in the annual return column.
We have another formula called 50m20. It’s the relationship between the price and its 50-day moving average over the last 20 days. They can both be up 10 percent, but the one that has the greatest relationship, or the greatest spread between the two, is the best to own.
Here’s an interesting chart: it’s Select Energy, Select Energy Services and Select Health. They’re ranked 55, 52 and 51. Now this is the zone I really like to buy in.
Now, here’s a chart actually of funds we have owned. We have assets at variable annuities, Invesco, 401K’s, Fidelity. We’ve got money just jumbled all around. So we own 15 or 20 funds at any given time. So, we rank and look at this. We’re in a positive environment and we already own these things. Notice that Janus High Yield, Invesco Hi-Yield, Alger Growth, Janus Flexible I, Invesco Growth, Janus Growth, I can look at that right there and say, “I’m not even going to worry about those guys.” Why? They’re greater than 65. Take a hike.
Now these, where Stochastics / RSI is less than 65), I get to the point where we look at their momentum and if it's not so good … in most cases, would we continue to own these funds? Probably. But we would never let it go below 50. Never. This is just an example of monitoring. Once we own something, I’m not interested in trading up unless I have to. We have a reason for doing it.
Here’s a 6/24 AccuTrak comparison. Here’s the Select family, notice that the rankings in my little system here, you see that as these 6/24 numbers get negative, you’re almost always looking at values that are less than 50. So there are parallels in a lot of way.
The only advantage I like of this one vs. 6/24 is you don’t have one of them be at 300 and then gold has a hiccup and it’s down to 32 in four days. The Stochastics input keeps it from allowing to whiz through those rankings.
OK, some key points:
From a new buy position: volatility is good. The funds that got killed the worst are absolutely going to be the best performers on the way out of the decline.
From a trade-up situation: We’ve been going along here and all of a sudden my fund goes down below 65, goes down below 50, and I look up and here comes Safeco or Founders or Janus coming on, it’s getting better – I think I want one that is safe. Buying tops in an ongoing market, always buying the No. 1-ranked fund, is not necessarily best in an ongoing buy signal. When you trade up, look for stability.
Number of Funds: How many funds do you own? I wouldn’t own but one if I could get away with it. The fewer funds you can own, the better off you are. The more likely your returns are going to be better than average. Just like herding goats. It’s easier to herd 3 or 4 goats than it is 20, or 40.
The Final Cut: OK, we have got it narrowed down. We have some money. We need to get some money in the market. What do we do when we get it narrowed down to a few candidates? We run Brian Stocks’ tools, and what do we do when we get it narrowed down to the final four, five, six, eight, ten funds? Here’s what we do.
1. Size. All things being equal, the smaller the fund, the better probability that you’ll make money out of it. Because money’s pouring into that fund. Fidelity Contrafund has to own 400 stocks, while this guy has $150 million in his fund, and he owns 15 stocks. He can make it do. That’s the single biggest advantage that the individual investor has over the larger dudes.
2. One to three day settlement: We deal with that probably more than the individual investor does.
3. More important when trading up is, how the selection handled the last two corrections of the dominant index greater than 4 percent. All things being equal, go back and look. Say you’ve got it down between Fidelity Growth and Income and Fidelity LargeCap. How did those funds handle the last two corrections of greater than 4 percent. In today’s market, that could have been the last two days. This is critical to us, and can be the separator of whether we pick one fund vs. another. And I really think that helps you. All you’re saying is, “If I’m wrong, I’d rather be in the one that handled it better.”
4. Recent momentum over the last six days.
To me, those are the four things that decide do you pick this fund or that fund. Not just the fact that it’s ranked No. 1. Buying the top-ranked fund can cause disappointment.
The Psychology of Admitting a Fund Selection Mistake
OK, I have a question: how many of you like to admit that you made a mistake in fund selection. You say, “I’ve got a loss in the fund …” and tell me what the next part of it is. “I can’t sell it now.” Have you ever said that to yourself. Or, “It’s a core position in my fund!” I’m telling you … they are losing their ass. Or, “I’m in it for the long haul!” And lately, the haul has been getting longer. Last, and best, “The fund manager has a good long-term track record.” I’m telling you, it’s a lot easier to have you a line of 50 and sell that sucker when it goes through, or it goes through the moving average.
Here are some random thoughts:
• I prefer to select funds that are going up between 50 and before we get to 65. That means we’re getting that upward momentum before it’s already there. It allows you to catch things moving out of there into there.
• Mike Burke’s MIRAT goes on a buy. What are my chances of going out and picking four great funds that one day? Slim. If I picked two, and waited a week, and picked another one, and waited a few days, and picked another one, my chances are a lot better because of all four funds they’ve probably on the same kind of information, they all were built around the same thing, so put yourself in the position of not all of a sudden have this buy signal, and bam, go 100 percent into this. You don’t have to trade as much.
• Pick funds that have a relative strength greater than the dominant index. Or your personal benchmark. You might not want to beat the dominant index. You might want to beat the money market. Whatever it is, have some benchmark that you rank your funds against.
• When trading up, don’t pick the fund with the greatest momentum: consider risk. How many of us, we sell a fund and we go right to the top of the list, and there’s Electronics sitting there. And four days later you curse. Why? Because you just had a 6 percent drawdown. Why? Because it’s so overextended, why can’t you go back in there and pick one that’s got good momentum and coming up. I like to go down the list and find something that’s coming on, instead of already there.
Develop a Personal Sell Discipline
Here’s a key to selection and management. Develop a personal sell discipline. Any number of tools can tell you when to buy, but I’m telling you something, you’ve got to have your own personal sales discipline, and it should be different for every person. We’re all different ages, different objectives and things like that. Find some reason before you put money in the market to create a personal sell discipline. Some of us got bigger willage than others. Some of us, “Aw that doesn’t bother me to have a 6 percent drawdown, an 8 percent drawdown, a 14 percent drawdown.” Well, it bothers me! It bothers me. So you have to develop that. I’m telling you, that’s a critical thing that we need to do.
Why is it so difficulty for people to make money in the market? There are three factors: No. 1, they don’t have a positive expectancy system. They listen to CNBC. They listen to their broker. They listen to newsletters. ‘I heard …” … “Did you hear? … “ No. 2, money management. They’re risky with their losses and conservative with their wins. No. 3, individual psychology. I just touched on it. You let yourself get in front of it.
Here’s the No. 1 problem: traders don’t understand what a positive expectancy is. People would rather be right than make money. You think about it. How many people have you heard, “This is a wave 3 but it might be a countertrend rally. We think it’s going to bottom next Tuesday at at about 11:45 a.m.” That’s bullshit. I’m telling you something. You would rather be right. You would rather be right. You would rather pick up the phone and say (in hushed tones), “Dexter, did you know that I called it. It was actually, it was a 38 percent retracement.” Hey, you’re trying to be right. But this group’s always got an answer for it: “Reoptimize it! Rationalize it! Or put another filter on it!” And I’m being a little funny here. If I step on some toes, that’s all right. Don’t worry about it.
But I’m telling you something. The No. 1 problem is they don’t have a positive expectancy. They want to be right. The need to be right is compelling beyond what you can imagine.
Which would you rather have: a sure loss of $900, or a 95 percent chance of a $1,000 loss plus a 5 percent chance of no loss at all?
Which would you prefer: a sure gain of $900, or a 95 percent chance of a $1,000 gain plus a 5 percent chance of no gain at all?
Now this goes back to my positive expectancy. Most people might be on the wrong side of this. If you take a sure gain, you’re being conservative with your profits. Hey, 95 percent chance? Where can you get a 95 percent chance to get an additional 10 percent gain.
The Golden Rule of Investing: Cut your profits short, and let your profits run. OK, that’s what we’ve got to do.
The seeds are being sown in a bull market. How? CNBC. Hey, if you turn on the sound on that thing, you’re setting yourself up to failure. Because when you’re talking about bullshit to the fourth power, they’ve got it. They’ve got it! Here’s this guy, comes in and he’s got that suit, he’s got that tie, he’s got that hair back hair, and he’s selling you something you don’t need. I’m telling you something. Do your own work.
We always follow our trading rules, because we never know which it will be – a nice profit or a small loss. And that is the only outcome that’s acceptable. A good trade to me is the fact that I followed my rules. Having a 2 percent loss or a 3 percent loss and following your rules, I promise you that’s the right thing to do. Because the next one is going to be all right.
Too often, we shoot arrows at the wall, paint a circle around it and yell, “Bullseye!” How many of you have seen these damn wonders that come up. “I optimized the last three months, and I had 14 straight winning trades.” That’s a setup for failure.
Do your homework, do it right and do it for yourself. Everyone’s intelligent, everybody’s talented, everybody’s creative, but … not everybody has discipline. I’m not so sure that this person’s discipline is better than mine, or that mine is better than this other person’s, and it doesn’t really matter to me what it is. I honestly don’t think that this trick is better than that trick. It’s the fact that you don’t have a core belief in what you do. Hey, have discipline. You can’t just put it on one day. You’ve either got it or you don’t.
If you have discipline, sometimes you’re wrong, but you are never undecided. If it goes below 50, sell it. If it goes above 50, you can buy it.