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Greetings, Pro-fundity team members -
07-04-03

At the bottom of the Guidepost, a full listing of this weeks picks are shown, in addition to the Charts via the Pick-link.

As a benefit of membership, you have access to all Guideposts (including Archived GP's) and Picks. If you miss a week or two for whatever reason, you will be able to go into the Historical Guidepost link to catch up with both the weekly guidepost and the 30 picks made for the week.

Greetings, fellow Pro-fundity team members

1. Last week we posed the question, is there any value in this trading effort, is there a reason to spend the time required to give it a fair shake? Lets consider the question by going back to the basics. Why invest?

2. Is investing simply another form of gambling? The age-old myth that says everything (life, crossing the street, getting on a plane, etc.) is a gamble misses the point. How about life, is life a gamble? The certainty is none of us will get out alive. Where’s the gamble? The odds are that I will never get hit crossing the street in my entire life. That’s held for the first half, 60+ years. But there is a reason for these odds. I take precautions before crossing a street. That’s not rocket science. It does not mean its impossible for such an event to occur, just highly unlikely. Going down in an airplane? Possible, but very unlikely. Now, what are my odds in the Casino? We know the tables, the games, the slots are tilted towards the house. That is how they survive, how they pay for the lights, entertainment, salaries for all the help and a handsome profit for the owners. It has to be that way. My odds of winning in a casino are less than even. Over the long-run I can expect to lose. Now that’s a gamble.

3. What is a surebet? A bet we can’t lose. If there were such a thing, it wouldn’t be a bet, would it? The idea of a “bet” suggests a wager on the outcome of some event, over which we have no control. We can have opinions about the outcome based on previous experience which may improve the odds of winning, but the idea of a bet suggests winning or losing, including some element of chance. Lets consider what the term “odds” means.
   If I roll a fair die, it can come up 1, 2, 3, 4, 5 or 6 with equal likelihood. That means the odds of rolling a one is 1/6, or 0.1667 (the chance of success divided by all possible outcomes… as a percentage, 16.67%). If I want to roll an even number, there are three possibles out of the six total, so the odds now are 3/6, or 0.5 (50%). If the odds of an outcome are say 0.8 (80%), the outcome will occur 8 out of 10 times, on average. Notice, we’ve created a probability scale from 0 to 1 (0% to 100%) where a 0 (0%) is impossible and a 1 (100%) is certain. All events in life lie somewhere along this scale. What is certain? Death & taxes… Point: Six rolls of a single die will not produce each of the six numbers. It is a bias, a tendency, a likelihood. If we roll the die 60 times, we will get around 10 for each number. 600 times and it will be even closer to 100 for each number. That is why we used the expression “on average” earlier. You can take that to the bank. We will return to this idea of “odds” many times during our discussions. Consider it well.

4. What is important here is the difference between the likelihood (chance) of success and failure. The odds of crossing the street safely and a winning weekend at the casino are not even remotely close. This applies, most importantly, to the concept of risk as well. Risk suggests danger, or the magnitude of harm that may result. If I’m hit by a car crossing the street, it could mean my life. A loss at the casino may be an inconvenience. Sound judgments in life and in the market must be made considering the risks involved (both magnitude and likelihood). If we only considered the magnitude, we’d never leave the house. If we only considered the odds, a 10-cent bet would mean the same to us as a $10,000 bet. Our example using the six-sided die to find the odds, used numbers. This is a critical step for us to understand the dynamics of the market. Using numbers, we can quantify the risks involved. If we bet only on sure things (odds = 0.9), we’ll succeed more than those who bet on unlikely outcomes (odds = 0.1) over some period of time. The numbers, 0.1 and 0.9, are how we quantify the risk. Without numbers, risk is simply a matter of gut.

5. Now look at the table-odds if we invest in the stock market. The chart below shows a historical record of the value of the Dow Jones Industrial Average from 1920 to the present.
   The Dow is the most popular index of the market and the one most often reported during the market day. It is considered THE measure of market activity. It is not strictly an “average” market indicator, being made up of 30 industrial giants, all leaders in their fields. It is an index designed to express the health of the companies represented.

6. Had we invested $1,000 in the market in August of 1920, it would be worth $113,000 today (adjusted for inflation that would look more like $12,000). That is a fact, a matter of public record. Given that record, what do you suppose your odds are of winning (increasing your personal wealth) in the market over the past 80 years? Two commonly used chart types for market activity are shown below. The first chart is linear, meaning the vertical scale has equal divisions bottom to top. Notice the distance between any two vertical grid lines equals 976 points.

   
   

   

   Fig. 1 DJI Price Chart on a Linear Scale

7. The previous linear-scale chart tends to distort relative market activity. For example, back in the mid 20’s the Dow was around 95 points, then increasing to 381 before the crash in 1929, nearly a 300% increase. That dramatic increase is hidden well on this chart, barely a blip near the “30” marker. As well, looking at the severe drop in the Dow since 2000, we might think all the good market action is behind us and stay out. A different vertical scale is shown in the next graphic which gives a better look at market activity over this same time period. This uses a Log scale where the difference between grid lines is now 60%, giving equal graphic value to the changes over this time period.
   Pictures are always worth more than words. Charts are the pictures we use to view market activity. Different type charts help us see different things as shown in this example.

   
   

   

   Fig. 2 DJI Price Chart on a Log Scale

8. We’ve drawn six trend-lines to heighten our awareness of market action on the previous chart. Notice, the recent decline since 2000 (line 6) is not as severe a drop as the crash of 1929 (line 2). Look carefully at the six trend-lines. What can we conclude from this picture? The market goes up and the market goes down. However, the market has shown a positive bias throughout this period. Marty Allen once observed, “A study of economics usually reveals that the best time to buy anything is last year.” Figure 2 confirms that observation, with some noted exceptions. Look at the chart below which covers the period of Trend-line 4:

   
   

   

   Fig. 3 DJI Price Chart Showing Sideways action, 1966 to 1980

9. During the period covered by trend 3 in Fig. 2, the DJIA moved between 570 and 1022, an 80% swing. Gainful opportunities can be found in all time segments, understanding how to adjust as the market moves from one trend to another. This is important for a fundamental reason: Over 70% of any stock price movement is tied to the total market. That is why life is so great during a bull market (line 3 or line 5 in Fig. 2) when everything seems to be right. On the other hand, if the market is going sideways or down, adjustments must be made.

10. Investing in the stock market involves measures of risk, with the chance of loss right along side the chance of gain. The profound difference between investing and gambling, however, lies in the measure of risk. Numerically, classic casino gambling has a risk of less than 0.5. That means in the long-run there is no way to win. Whereas, investing in the stock market puts us into a game with the house-odds on our side. That does not mean we cannot lose. With an average positive bias of over 13% per year for 80 years, it means there are many ways to win. Enjoy.
    07-04-03 Pick Selection:

    Main Picks:
    AMTD,FGP,IDXC,MCRS,MDCC,NWRE,RADS,RSCR,SRX,STMP
    Breakouts:
    AMSC,ATYT,IGI,IIJI,MTEX,SGMS,SKYW,SMSC,VIXL,WDC
    QuickPicks:
    ACTI,AGU,AOC,AVX,CREE,DPMI,MVK,NENG,PUMA,VAST

    For detail and followup on Pro-fundity Tradescape,
    find the link on "Advanced Trading Tools" on the home page.

    Be Diligent
    Take Action!

    

    
    
    
    
    

    
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