Market School Comments 11-11-11

[Mike]

Some people have asked me private questions about the workings of the market model. I would prefer to answer these in public so I don't need to repeat. Here are a few comments about the model to clear up some of the confusions.

In general I am blown away and greatful that IBD came out in public with their model that they use to run a lot of money. I suspect in the region of $2 billion dollars invested using canslim and this market exposure model. I pay attention to people who run money and these people definitely qualify. Bill may be the best trader of all time and he is willing to share how he does it. One probably can't run that much money in a single account using canslim rules. Canslim rules suggest that you do not hold more than 7 positions. That large of a portfolio would cause each position to be more than $250M or $500M when on margin. So the portfolio is split up amongst some number of portfolio managers who independently trade their portion. I have met most of the portfolio managers, I am unsure of the number, maybe or 8 including Bill.

The market exposure model is simplicity in what it is trying to do. The rules themselves can be difficult to interpret because they are very exacting statements. In general the market exposure model very directly analyzes the market to determine if the market is actually rallying and whether it is proceeding in a way like other rallies have unfolded. The more evidence that the rally is actually occuring the more money that can be commited from the portfolio. I with a team of individuals are writing an automated model which is maybe 75% complete. For probably the next year or so I am suscribing to the IBD Leaderboard product. IBD publishes the current market model results at the end of each day with an annotated chart if you have attended Market School training. Without the training the market model does not appear. When I am absolutely certain the automated model is working properly I may or may not continue with that service. I do however recommend people make the effort to attend the Market School. It is probably the single most important seminar I have taken from the IBD organization. It is taught by Bill's head portfolio manager and his second most experienced portfolio manager. I know that there is a grass roots effort underway asking IBD to have another Market School in the Los Ageles region next January. People did not want to wait until April in Florida for the next scheduled Market School.

Someone asked why a particular day was not a B3 signal (intraday lows above the 21-day). B3,4,5,6 signals can only occur on an up day. The day in question was a down day with lows above the 21-day.

Two people asked me what I meant by "forced 5" in a post. The exposure count normally has a maximum of 5 count. If additional buy signals occur the count is not increased because it is maxed out at +5. So in this sense it is forced.

There are a couple of switches that I may not have mentioned. The Power Trend switch is turned on if the 21-day ema remains above the 50-day for 25 days in a row and no S9 signal (break below the 50-day) has occured during that 25 day period. With the Power Trend switch on a floor of +1 is established on the exposure count. The exposure count maximum is also allowed to go to +7. The larger count does not mean you increase your esposure more than 100% but the larger count and the floor are designed to keep you in the market with the inevitable tough periods or pull backs that can occur when the market moves this far so fast. We make most of money in Power Trends and this switch is desinged to maximize your ability to withstand the volatile nature of the market when the money making possibilities are the greatest.

The other switch is the Restraint switch. This switch goes on on the day of a FTD. When on the exposure count is limited to +2. It is designed to keep you from getting too exposed too soon in a flegling rally. When the market index closes 1.25% above the close of the FTD close the restraint switch goes off. This switch saves your bacon on the many rallies that struggle and quickly fail.

There is an interlock on signals B3,B4,B5. Once you get one of these signals you can not have another one unless they are reset by an intervening S5 signal. After an S5 (break below the 21-day) you can now have another one of these signals.

There is a similar interlock on signals S5,6,7,8. These are reset by a subsequent B3 signal.

The current market model exposure count sits at +4. The bad breakdown we experienced on 11/9 produced an S5 signal (break below the 21-day). During the course of the day it became very apparent that the sell signal would be produced dropping the exposure count to +4 or 90% invested. I had to sell something to meet this rule. I chose to sell DLTR as it was my most laggard position and it had not reported earnings yet. One effect of this ebb and flow of the exposure count is that it causes you to prune your garden and get rid of laggard positions.

Yesterday morning at the open I saw the brisk selling on AAPL. I decided to short AAPL on that action.

Even though the exposure model says to be long 90% I am cognizant that the market is at a very major cross road. Most bear markets produce a rally like we are in right now and the bear market rally rallies up to the 200-day moving average and subsequently fails. We are right there and the market needs to make a decision. It will take the high road or the low road eventually. AAPL failing may be a leading indicator. However since we have seen an S5 signal, today could end up being a new B3 signal (lows above the 21-day) which would increase the exposure count to +5. If this is the situation late in the day I may get more long...

[nickola.pazderic]

Mike,

This is a very rich contribution.

Many thanks,

[mnoel]

Thank you very much Mike. Very valuable information. Very interesting material.

Martin

[eschroeter]

I took the IBD Market School class in Las Vegas a few weeks ago. I then learned (and have since joined) the EV site. Have you looked at how the Market School signals "reconcile" with the EV 20 DMF market signals? How do you use both schools of thought together?

Thanks

Emanuel Schroeter

[Mike]

I took the IBD Market School class in Las Vegas a few weeks ago. I then learned (and have since joined) the EV site. Have you looked at how the Market School signals "reconcile" with the EV 20 DMF market signals? How do you use both schools of thought together?

Thanks

Emanuel Schroeter

Emanuel,
I am glad to have another MS trained person in our midst. Have you taken Level 4 also? I am in the middle of assembling a Market School Market Exposure Model and will have a tool to look at questions like this when complete. The model is not an easy undertaking but without it it would be difficult to conduct studies of how other indicators such as Money Flow would help or hinder. I also want to explore some market internal data for signals that would help or hinder.

I found the Market School Model beutifully simple and very O'Neilian. O'Neil always says to look at what the market is actually doing and forget opinions on what it ought to be doing. That is the focus of their model. Right now the market is rallying and leadership is acting well enough. What other information does one need? In fact I have not seen it easier to operate a CANSLIM portfolio in a long time. The indices may be choppy but the leading stocks are much steadier.

I have done some research on offensive sell signals such as the one that occured October 31,2007 when the NASDAQ went up higher (percent) than it had above the 50-day moving average in more than three years. It was a blow off top. The Market School Model had two buy signals that day. In reality I was 200% invested that day and decided it was a sell signal and sold part of my portfolio that day and began an orderly exit.

I think Money Flow could produce significant input to the model.