December 11th, 2012

Our Discipline: A Case Study in MED

As I’ve written here often, I believe the best approach for the typical individual investor is to manage their portfolios employing the following three steps: 1) a well-founded, unemotional approach to market timing, 2) the notion of industry group rotation and 3) diversification that spreads risk among a fairly large number of individual stocks (i.e., investing approximately equal amounts among stocks in the portfolio).

Put another way, the portfolio management effort down to answering the following questions: How much money should be put at risk in the stock market at any particular moment and, if new money is to be put to work, which stocks should be added to the portfolio? 

I solved the first question for myself several years ago.  I collected data back to 1963 on the daily S&P 500 Index and, by asking a series of “what-if” questions determined when it would have been better to have invested money in the market making an average return than having it sit idle on the sidelines.  Or, stated in the reverse, when would having money sit on the sidelines been better for long-term returns than had it been invested earning an average market return?  The analysis resulted in my Market Momentum Meter, an unemotional barometer of market sentiment, that allows me to shut my ears to all the media noise and hype about what they claim is “Breaking News” and focus instead on the truth about conditions conducive to momentum-driven markets over the past 50 years.  Following the Meter’s signals over the long run, investors could have avoided market crashes while still taking advantage of the bull market runs.  I can attest to the fact it helped me avoid the worst of the 2007-09 Financial Crisis Crash.

Once the Meter signals that it’s relatively “safe” to put new money to work in the market,  I use a two-step approach for finding the stocks best for carrying that risk.  I scan all stocks to find those that meet one of four different sets of criteria and, once having narrowed down the population of publicly-traded stocks, I look at their charts to find those that might have a good chance of crossing above levels that stymied their past advances (in other words, those that look like they could soon breakout across significant, long-term resistance trendlines). The first stocks to breakout are first in line as investment candidates.  The discipline requires me to sometimes be fairly active and at other times to do nothing but unemotionally watch the Portfolio run with the market or sit idle safely protected in cash.

The debate/negotiations in Washington has brought us again to a crucial market pivot point.  The Meter indicates that when market conditions look as they do today it might have been best for us to have money invested.  I have begun running those scans to begin finding those stocks that look like they’re ready to trigger Buy Points in their charts by crossing above key resistance levels.

While 75% of the stocks currently in the Portfolio show gains and 69% have outperformed the S&P 500 since their purchase, few have delivered the sort of results as has MED since its purchase last March.  I had never heard of Medifast when it dropped through one of the Scans and presented a compelling chart.  When I purchased the stock, I wrote in the Instant Alert to Members that the stock is “a product of yesterday’s Stocks-on-the-Move scan.  It has formed an inverted head-and-shoulders reversal pattern at what I hope will be the bottom of a multi-year descending wedge pattern.”  Since then, the stock has advanced 95%:

As the usual disclaimer says, “Past performance is no guarantee of future performance”.  But, I believe in the discipline and am using it today to find the next batch of stocks some of which, with some patience and luck, will hopefully deliver what turns out to be the outstanding performers over the next nine months or a year.

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