Maintaining Objectivity

Whether trading or investing, it is important to develop good methods and stick with them.  Keeping focused on a winning approach can be difficult when there is a lot of emotion, be it fear or greed.

A good test is to continually ask, if you are bullish, what could happen to change that stance.  Bears should, of course, ask the opposite question.  Last week Steve Birenberg raised this point on Street Insight.  Steve, whose sharp analysis has made money for his readers in Apple and entertainment stocks, asked fellow commentator Doug Kass what would make him bullish.  To be fair, Steve revealed what would change his own bullish stance.  (I have not yet seen Doug’s promised reply, but my vacation schedule has kept me busy, so I might have missed it.)

At "A Dash" we test our objectivity every day with some key questions.  The answers depend upon our investment time frame, our method, and the goals of our customers.

For individual investors, we rely mostly upon fundamental analysis of individual stocks and the market as a whole.  We use technical analysis and market feel to determine the exact timing of position changes based on the fundamentals.  Our bullish stance — and we remain enthusiastically bullish — reflects our valuation of the overall market and our confidence in the economy.  We particularly like economically sensitive stocks like CAT, some transports, major financials, and upstream energy stocks like RIG and GSF.  We also like several of the major technology names.

Long-term investors should not be concerned by moves like those of the past week.  It is too difficult to get in and out to catch a small change.  It is more important to be on the right side of the major moves. Rich Karlgaard answered the question about what would make him bearish.  Citing Brian Westbury, he said that stocks were cheap.  He would change his view if the relative valuation of stocks became worse, either through higher interest rates or reduced earnings projections.  He does not see that coming and neither do we.  Earnings projections are solid and we expect them to remain so.  We’ll introduce a series analyzing earnings forecasts next week.

For traders, the objectivity question can be trickier.  In the funds we manage, we follow our technical indicators and methods, even when these conflict with our fundamental thinking.  Just as an astute trader like Doug Kass takes long positions on a short-term basis, we take significant short positions when our models give that signal.

The current market is a good example of how we react.  Charles Kirk did a great job of posing the objectivity question for technical analysts with this chart, also cited by Barry Ritholtz on the Big Picture.  (We used to test our technical analysts with fake charts like this twenty years ago.)  Our methods did respond to the technical breakdown.  Vince Castelli (the brilliant scientist behind our modeling) uses a timing method that gave us a bearish signal eight days ago.  We hedged heavily with ultra-short ETF’s and futures in trading accounts that follow Vince’s timing method.  (We reported our position change last Thursday on the Ticker Sense Blogger Sentiment poll.  As of today, the model was still on a bearish signal.)

To summarize, we use technical methods for trading accounts and fundamental methods for long-term accounts.  We follow the methods, not emotions.  This discipline is crucial to success.

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