I’ve received more than a few questions like that based upon today’s 3% decline. Sorry, but I don’t give individual advice. I give general market observations based upon the analytical work I do. For the past several weeks, I have suggested that people pay attention,….. pay closer attention ……and I discussed the importance of getting centered. That’s as close as I can get.

A year ago as the market started to fall, I wrote a similar post called What Do I Do Now? Here’s a snippet that I think is still relevant for our current situation:

Now is the time for hindsight. It doesn’t need to be 20/20. It just needs to be less blind than it was a few weeks ago. Once you are done asking - “What do I do now?” - make sure to ask yourself and your advisor some better questions like “What should I have done weeks ago?”, “Why did I not do it?”, and “What can I learn from this to do better the next time?”

One day is one day. I don’t place much emphasis on daily movements. I need to see more evidence that the market has changed direction. As always, I’ll just have to wait until the weekend to do my analysis.

Thursday was tough and when you consider the move from the ridiculous open on Tuesday, this week has been brutal (about -4.6%.) Some commentators are suggesting we’ll get a bounce tomorrow. Something about Thursday being an overreaction or oversold or some other hopeful bullshit explanation that has no basis in reality.

Now what? Which way will the market go? I understand why people are asking those questions. Hopefully, some of you have been asking them a few weeks ago.

I “overdo” it sometimes with the signals. Sometimes I “underdo” it. One situation causes too much turnover, another causes too little, both usually cause a hit to performance.

Last week, I changed a lot of signals to DOWN while working on Getting Centered and this week, I changed more signals(209) to UP vs. DOWN(152). However, this ratio is misleading.

It is very very rare for me to change the signal on a stock in two consecutive weeks. This week, 45 of the “new” UP signals were “new” DOWN signals last week and 98 of the “new” UP signals were “new” DOWN signals two weeks ago. Of these 143 signals, 71 were losers averaging -5.8% and 72 were winners averaging 4.71%. Without these short term reversals, previous weeks would not have been so negative and this week would be more negative than it looks.

What to make of this? This market is very difficult, almost as tough as it was for me from November until mid-March. Under these circumstances, my normal portfolio management rules against changing signals on the same stock in consecutive weeks has to get thrown out. During these times, I work on my humility and find it much easier to admit when I am wrong and I have no problem “Undoing The Overdone.”

I apologize for anyone following the signals at HEDGEfolios. I hate turnover, especially when it gets excessive. This turnover is “excessive” and abnormal, but I expect it to continue until the sideways movements and volatility subside. I have no idea how long that is going to last. It has been going on for 3 weeks and the last time it persisted for about 4 months.

There is a very big battle going on right now to decide whether the market will retest lows or push higher. As a consequence, we get extreme volatility. I am never “neutral”, and the HEDGEfolios bias tells me to err on the side being Bullish. However, I much prefer to hang around the middle so I can adjust from week to week.

If you are running forward, the best posture is a forward lean. I’ve been leaning heavily in the bullish direction since mid-July and that has worked out quite well. However, if you expect to change direction in the near future or if you just fear that you are being too aggressive and might fall over on your face, it helps to do two things. The first is to slow down and the second is to get centered.

For the last 3 weeks, I have been working on those two strategies as I have gone from 80% UP signals to 63% (now). This week was more aggressive than last and I gave 429 new DOWNs vs. only 27 new UPs in the stocks I cover and 112 new DOWNs vs. only 1 (USO) in the ETFs. That may not sound like I am going slowly, but just consider this….I evaluated over 900 candidates for new DOWN signals this week and decided to avoid such an extreme move and did less than half that amount. To me, that is slowing things down. As for “getting centered”…. I am not quite at the 50/50 level and I may not get there exactly, but I am much more comfortable at 63% than I would be at 80%. Note that 80% felt like the right “lean” a few weeks ago. But that was when I was confident in the direction and pushing to optimize the ground I could cover.

Am I expecting a bearish reversal in the market? Yes.

I am just not convinced that the reversal is exactly right now. I am willing to forgo some bullish profits as I neutralize the portfolio a bit during this period. My analytical work on direction relies heavily on the ability to be as balanced as I can at the moments that are pivot points. So as I start to feel the shift, even if I am not convinced a change is imminent, I work really hard to find what I call the “portfolio center of gravity.” If you are a runner, sprinter or athlete of any type, you’ll know what I mean. If you are a physics geek, you’ll know what I mean.

Evaluate your portfolio. How far are you leaning in either direction? How fast are you moving? If you are uncomfortable with either or both of those factors, consider going slower and getting yourself centered. If the market reaccelerates in the bullish direction, you will be sufficiently balanced to rapidly position your portfolio to profit. If, on the other hand, the market heads lower, you will have a better chance to avoid losing your balance, and losing your gains.

There are a bunch of stocks that I obviously don’t get. Over time, approximately 68% of the 53,000+ signals at HEDGEfolios have been correct. However, there are a few stocks that I am chronically challenged by and when you take a look at the performance of past signals on any PROFILE page, you might run into one. For example, click on this link for Alcoa (AA). Inclusive of the current signal, I have been wrong on AA 13 out of 27 times since HEDGEfolios began (significantly below the 68%). That is not good and it is below what I expect of myself. But it is what it is and unfortunately, it is not the only one.

So why the confession? Portfolio management gurus will tell you the importance of identify and dealing with your trading weaknesses but don’t say much about how to actually do that. While I agree with that and as a general concept of going through life outside of trading, it is important to know your strengths and weaknesses. Nonetheless, I just don’t think it’s as easy as it sounds to identify a weakness and by definition, to learn how to overcome it. So I thought I’d share one of the ways I deal with this issue in the hope you might get something out of it.

If you’ve traded the same stock over the years, be objective and determine how many times you have been right. If it’s below your expectations, analyze what happened. Let’s say that you win 50% of the time, but your winners are significantly bigger than your losers. That wouldn’t concern me. However, if the situation is reversed or if your losers and winners cancel each other out, you should think about avoiding making trades in this stock.

For some reason, with the thousands of stocks that are available, too many investors get hung up on a small set that they trade over and over. If one of these stocks gets the better of your fundamental or technical analysis, make sure you recognize that if you decide to trade it again.

In my case at HEDGEfolios, I have committed to covering thousands of stocks and I don’t have the luxury of avoiding the ones that keep kicking my ass. So, I have a list of difficult stocks and when I am about to make a new signal in them, I try to evaluate whether I am making the same mistake.

In life, avoidance is not a way I advocate dealing with problems. However, in trading, as much as you’d like to believe you can identify a weakness and then modify your analytics to improve performance….I’d prefer avoidance. Learning from mistakes is great, but avoiding situations that encourage you to make the same mistake is greater. In trading, you will run into difficult stocks and it is not necessary to keep forcing the challenge.

Which makes you feel worse?

Having a gain on your portfolio that is worse than the gain on the index.

OR

Having a loss on your portfolio that is worse than the loss on the index.

Which makes you feel better?

Having a gain on your portfolio that is better than the gain on the index.

OR

Having a loss on your portfolio that is better than the loss on the index.

How does the joy of making 10% feel compared to the pain of losing 10%?

Asking questions like this and answering them with extreme honesty will help you identify some key elements of your portfolio management style, how you handle risk and how performance affects your desire to modify your portfolio.

Today was tough for anyone that had been betting that this rally would continue. I am one of those people - it was tough on me too. I went from being hugely hedged to the downside a week ago to making the biggest reversal to the long direction I have ever done.

Whenever something like this happens, I inevitably get some comments that either attempt to ridicule me for being a “moron” or ask me whether I regret what I did or wonder whether I still feel the way I did when I made the changes. As to whether I am a “moron”, I am comfortable with your assessment. The very short answers to those other questions are “No” and “Yes”. No, I do not regret making the changes (yet) and yes, I still feel more bullish than bearish in the short term. It was one day. I measure things in weeks, not days. If I spent my days like many people in this business getting in and out, I guess I’d feel like I got caught with my pants down by leaning in the wrong direction at the wrong time. As it is, I will wait until this weekend to evaluate things the way I do them.

I know it hurts to take a position that looks like it is solidly heading in one direction and then having that fall apart in the next 3 minutes after getting filled. It happens all the time. Sometimes, it takes longer than 3 minutes…maybe 3 hours…maybe 3 days. The emotions you go through are not much different regardless how long it takes to materialize. You start questioning yourself. And in my opinion (contrary to many trading psychology gurus) you should question yourself. You should always question yourself. And if in that process, you feel like a “moron”…you probably need to evaluate how you made your initial decision. What was it based upon that could possibly change so quickly? If you made a decision without adequate due diligence, you should not be surprised when you start questioning whether you did the right thing. And that realization will lead you to a desire to improve your investment decision process. The more you go through this exercise, your work becomes more disciplined, deeper, broader and more robust. As a result, your performance improves and the next time you question whether you got caught with your pants down, the less likely you are to shake your confidence.

For me, it’s largely about consistency. My analytical techniques are the result of a lot of practice and they are based upon a broad set of fundamental and technical factors. That consistency provides enough confidence to look at days like today as very small factors in the bigger scheme of things. For me to admit I was a moron, I have to convince myself that everything I used to make the decision was wrong. Because I look at factors that take a while to develop, it is only natural that it will take a while to fall apart. That rarely happens in one day, even if it is a day like today.

If investors make a decision based upon short term moves, then it is reasonable that they will second guess very quickly after something goes against them. If you are a day-trader that holds for a few hours on average, you should expect that you will question yourself and your trading methodology several times during those few hours. It’s a common and natural occurrence and nothing to be ashamed of. If you are a swing-trader, you should expect to question yourself a few times during the week or two you typically hold a position. It’s nothing to be ashamed of. And if you are embarrassed…get over it…use it to make yourself better. Each type of trader has their own emotional challenges that need to fit with their portfolio management. It’s just a part of the business. But if you plan to hold for a week and consistently find yourself stressing every few minutes or hours, you are not a match with the investment style you are practicing.

Feeling like you got caught with your pants down is not a problem if you are comfortable with what is underneath. Know who you are as a trader or investor. Know that things are going to go against you when they were going the right way just a few minutes, hours or days ago. If you can honestly say that your investing decision was wrong, then adjust accordingly. If the result of questioning yourself improves your confidence or your portfolio management, day’s like today will be kept in the right perspective.

It’s earnings season and once again, the new set of data allows us to evaluate the fundamentals. As I have written before, I used to love earnings season but I don’t anymore. I am sure it’s the media spin and the public reaction, but it really is sad for traditional investing. As far as I am concerned, earnings season and the way it is used is Fundamentally Flawed.

Yesterday was a perfect example. Here is the headline summary from Bloomberg U.S. Stocks Break Six-Week Slump as Citigroup Beats Estimates. Please read that and then take a look at what I wrote last earning’s season about the same stupid assumption.

From Analyzing Analysts on April 18, 2008

Let’s look at C back then….

What was the opening price per share of Citi on April 2nd, 2007? $51.31

• What was the Forward PE if you bought into Citi on April 2nd, 2007? 11.4 - Sounds cheap! Doesn’t it?
• What was the Expected Earnings Growth Rate? 9.6% - Wow, a PEG ratio of about 1.2. Sounds doubly cheap!
• What was the Dividend Yield? 4.2% - Fantastic and besides, they’d never cut that dividend. Right? Wrong!

So one year later on April 1st 2008, the price was $22.61 and the trailing 12 month PE was 33.6. OOPS! That’s quite a bit off from the 11.4 projected last year. But don’t fear, today’s Forward PE based upon the analyst estimates is only about 8. Sounds cheap! Doesn’t it?

So as a followup, I am going to pick on Citi’s earnings loss reported this quarter. It was a loss, not a profit. Revenues were down significantly from the year ago quarter. And if you can seriously buy into this notion that they beat estimates, please take another look.

• 90 days ago, average analyst estimates for Citi’s quarter just ended 6/30/08 was +$0.57 per share. Not a loss of 57 cents but a profit of 57 cents.
• 60 days ago, the average estimate for C was 36 cents per share and 30 days ago it was for a profit of 31 cents.
• 7 days before the report, suddenly analysts are down to a loss of 59 cents per share.

Is that impressive to you? Did Citi really beat estimates as per the media’s claim? It depends which estimates you believe. And if you believe the estimates for next quarter, just for the record, it’s a 34 cent per share profit. 90 days ago, the same estimate was for 68 cents per share profit. I look forward to checking back on this 90 days from now. Oh and by the way, the forward PE is 8. Magically, that’s the same “cheap” ratio that we had last quarter based upon the same group of incorrect estimates. Doesn’t it bug anyone that C has maintained positive 12-month forward earnings expectations each quarter since this whole thing began? Those are the fundamentals we were supposed to believe in? Excuse me but they have lost more than a few billion the past 4 quarters. So despite those quarters being losses and analysts had expected that the worst was over a long time ago….we now are supposed to buy into the current fundamentals being better than analyst expectations and future earnings that are going to be good. Okay, I got the message….the worst is supposedly behind the financials.

Earnings season is a volatile time. Crap earnings are sensationalized as beats just because the analysts pump them up 90 days ago and then wipe them out before they are announced. And the media buys into it. And apparently, based upon the market reaction…so do investors relying on “fundamentally flawed” information. Fundamentals are being overrun by media hype and a belief in estimates that are chronically wrong. Then… when the historical data comes out, we are told that bad stuff is good and that the future stuff is more important anyway.

Now, in the last 3 days, we hear how Wells Fargo, JP Morgan and Citi have pushed the market higher based upon their “better than expected” reports. First, as I keep saying…”better than expected” is a pretty flawed concept and second, those are historical earnings. AHEM! I thought past earnings are not so important for all the fundamentalists who love to fantasize about discounting future earnings. And what about those future earnings or the health of the financial system is encouraging? Other than a bunch of analysts and media and executives putting a spin on the future - what fundamental info are you relying upon?

For the last several earnings seasons, we have repeatedly been told how great earnings are when you exclude financials. Suddenly ex-financial reports like GOOG and MSFT are not good and miss estimates and the market heads higher. Okay, I got it. Apparently, ex-financials are now not so important.

And suddenly financial losses and reduced revenues are looked at as a good thing. That is fundamentally flawed.

I was asked whether I could increase the frequency of my signals in the database recently. The short answer is “NO.” I thought I could just send my reply with a blunt (often confused with “rude”) one word answer and a link to a previous post because I was certain I had written on this topic before. After reading through a lot of my old posts, It turns out that I’ve not really addressed the frequency of my signals except for brief and vague comments. So thanks to Alan, I’ll finally spend some time on this very important topic.

The answer to why I do my signals weekly has two primary components. The first is practicality and the second is portfolio management.

Practicality - I am one person. I probably cover more stocks than any other single person. As I have previously mentioned on this blog, my analytical work is not an algorithm or black box program like many quants. I actually look at each stock at least once every week. I use my own experience, judgment and human intuition and I use my own techniques of both fundamental and technical analysis. All of this takes a lot of hours as you might imagine. From Friday’s weekly close until the following Monday’s open when the market is stopped, I have sufficient time to do everything I do for this site and still have time left over for a regular life to enjoy the company of others, perform my responsibilities as an adult, spend time appreciating nature, and do all the things that most people like to do on weekends. During the week, when the markets are moving I just don’t have the time to do any more than the site administration work to update the signals (that usually takes me from Monday until Tuesday) and then general research during Wednesday through Friday.

In 2001 and early 2002 when I started testing out some of my theories with HEDGEfolios, I toyed around with daily signals. Doing this was a great benefit because it forced me to become very efficient and the challenges I experienced contributed greatly to modifying my portfolio management and the techniques I use. However, the daily signals were so consuming that even at my best, I could only do 500 stocks per day and I had no life balance - it was pretty close to 18 hours per day, every day and I knew that would not be healthy or sustainable. Just doing the research to make signal changes used up all my time but doing the administrative site work to update the data is also time-consuming. Doing that every night regardless of the number of signal changes would take me about as long as it does now for weekly updates and I don’t have 28 hours in a day. I had a crazy goal of covering approximately 4000 stocks and I just couldn’t do it with anything more than weekly frequency. As a practical matter, doing signals more often is not physically or emotionally possible for me.

I believe one of the biggest reasons HEDGEfolios has consistently outperformed while still covering between 3,000 and 4,000 equities is that I do not overreact to something on Tuesday that gets reversed by Friday. By not responding to every sensationalized story in market coverage, I am able to reduce (not eliminate) unnecessary trades. More importantly, I don’t drive myself crazy. I have a discipline that says no changing of signals during the week and consequently, I don’t get sucked in to the panic moments. There is a downside and I cannot deny it - it is painful to watch one of my signals be correct on Monday, a little incorrect on Wednesday and a big loser by Friday. This inaction would be unacceptable in my opinion for someone else that has a different personality. The day-trader would be devastated and yet, a long-term investor would likely be okay with it and look at it as an opportunity to average-down. I am in between and due to some of my other portfolio management theories, the tradeoffs make my forced inaction on blowups tolerable for me.

Each investor or trader must understand the frequency that works for them and know how to be disciplined about it. Do not follow or adopt my frequency unless it happens to be your own. There are many reasons why people should ignore my work and the mismatch between their trade frequency and mine is just one of them. If I have an UP signal that gets whacked by Wednesday, make your own decision on what to do on Wednesday - don’t wait to see what I do almost a week later when my next signals are updated.

Portfolio Management - Trading frequency is one of the most personal subjects for any investor and trader. It depends on many factors such as your non-market obligations and personality characteristics that determine how you handle various trading stresses. Warren Buffett is calm as a long term investor - how calm do you think he would be if he was forced to trade something at least once per hour? Conversely, how would a day-trader feel if you told him he had to sit and watch 5-minute trading bars but could only make a trade once per month? Every person’s portfolio management preferences are a result of many factors and for me, trading frequency has a large impact. It’s important to know who you are and what kind of life you want before you figure out the right trading frequency. If I only covered 20 stocks like most analysts, I could certainly do daily signals, probably even twice-a-day signals. But I wouldn’t be able to enjoy my life as I do now and since my portfolio management theories have been based on covering between 3000 and 4000 stocks, weekly fits my personality and needs very well.

We all know the importance of reducing transaction costs and hence, turnover. The turnover stats on my signals with daily analysis was slightly above 1200% per year! That is not only ridiculously high but it will ruin performance. During 2004 and 2005, weekly analysis resulted in total (long and short) turnover around 200-300%. With all the market volatility in the past two years, it was approximately 375% in 2006 and 430% in 2007. Worse yet, 2008 is on track to exceed 520%. My technical analysis formulas are modified to reduce sensitivity to reduce the temptation of more frequent trading and despite all that focus, I am still putting out turnover ratios that make me sick. Certainly, if I was to measure all my portfolio management goals - the area where I would give myself the worst grade would be reducing trade frequency. If I didn’t mind massive turnover, I’d have less of a problem with higher frequency signals. As it is, my portfolio management theories have a goal of longer duration trades, not shorter.

There is a balance that you must maintain between trading frequency and performance. I don’t advocate day trading for myself or for others. I also don’t advocate buy-and-hold or deciding to dollar-cost-average once per month. In fact, I have tested out my technical and fundamental analysis techniques using monthly data to see whether it might be better than the daily or weekly options. I was not happy with the results and emotionally, I felt out of sync and I didn’t enjoy doing what I do. When I evaluated the three trading frequencies I found that daily signals had unacceptably high turnover and lower performance statistics and monthly had much better turnover data but subpar performance as well. The best fit for my style is weekly. Look at my performance statistics and their consistency over the 4 years this site has been online for all to see. Doing weekly signals is a big part of the results at HEDGEfolios and it is so integral to many of my portfolio management theories that I suspect a change would not be advantageous to my performance or how much I love doing what I do.

There are many “statements of the obvious” that have almost no value although we all know they are true. In the trading business, you’ll often run across a list of rules that will lead you to success. Usually, I find these things to be useless and boring and frequently, I just happen to disagree with many of the ideas the guru gives. Readers of this blog know that I prefer to write only about my own ideas rather than repeat the thoughts of others in their entirety.

I am making an exception for Chris Perruna’s recent post because it is an exception to the useless advice of “experts.” I respect Perruna’s work more than most of the people that try to convince you they are an expert.

Finish reading his stuff and then I have something to say at the end of the post.

Here’s a link to Perruna’s 10 Steps to Profitable Trading and the full text which follows:

Last week’s negative headlines and 1.85% decline in the S&P would lead most people to expect that my negative positioning of 72% DOWN signals would be proper. And then I did my analytical work!

One of the reasons that HEDGEfolios has been able to consistently outperform the benchmark is that I ANALYZE FIRST and then make an assessment.

Too many investors allow their bias to overlook what is happening…either with the market as a whole or individual stocks. That goes for negative and positive impacts.

Regardless of how the market responds to the US government bailout of the GSE’s - Fannie and Freddie, I saw a lot of stocks that had significant improvement in their technicals and I will not ignore it.