The Kirk Report

Q&A With Herb Greenberg

When I began this Q&A series five years ago, I sat down and made a list of people who I really wanted to interview someday. One of those people was Herb Greenberg.

Mr. Greenberg has worked as a financial journalist for more than 30 years. Most recently, he has served as co-president of Greenberg Meritz Research & Analytics and has returned to CNBC after a two-year absence. He is also the former weekend investor columnist for The Wall Street Journal and a former senior columnist for MartketWatch. Prior to that, Greenberg worked for a number of media outlets including TheStreet.com, San Francisco Chronicle, Fortune, Chicago Tribune, Crain's Chicago Business and the St. Paul Pioneer Press.

The main reason behind my interest to interview Mr. Greenberg is that through both his columns and media interviews, he consistently provided unique and helpful perspectives about the financial landscape. As many others would also attest, Mr. Greenberg has frequently helped investors cut through typical media hype and noise in order to focus on things that many market participants overlooked. By doing so he often highlighted issues and situations that made those who took time to read his columns (including me) vast sums of money.

After leaving journalism two years ago to start a research firm, Mr. Greenberg has recently decided to return to CNBC. In doing so, he agreed with my plea for this Q&A. As he will tell you, I've been working on this interview for many years so it is with true excitement that I'm finally able to share this with you today!

We hope you enjoy and find this Q&A helpful.

Q&A with Herb Greenberg

Kirk:  Hi Herb. First off, thank you so much for giving me the green light on this Q&A. It is nice to have you here!

Herb Greenberg:  My pleasure. I love your persistence, Charles.

Kirk:  Please tell us a bit about yourself.

Herb Greenberg:  Born and raised in Miami. Father sold furniture and later was an operations guy in a small department store. Mother was a social worker. I have two kids: One in college (aspiring fiction writer), one out (an aspiring kids' furniture designer.) I've been married for 30 years to a stay at home mom whose focus on the family allowed me to focus on my work. My brother is the publisher of the South Florida Sun Sentinel and the Orlando Sentinel. I have a sister living in NY. I have lived in Nashville, St. Paul, Minneapolis, Chicago, New York (twice), San Francisco and now live in San Diego, but moving to the East Coast (again!).

Kirk:  What do you like to do in your free time Herb?

Herb Greenberg:  In my spare time - my wife would say I work. Family is the top passion. Exercise and health are right below that. I don't golf or play tennis, which always made me wonder what I was doing in San Diego. Actually - I love San Diego. With or without golf or tennis I will miss it tremendously.

Kirk:  Prior to your career as a financial journalist, did you have any interest in the stock market and investing?

Herb Greenberg:  Zero interest or knowledge other than the Dow Chemical stock I inherited from my grandfather, who was a dentist.

Kirk:  How did those early experiences shape your own investment approach?

Herb Greenberg:  I don't have an investing approach, other than to be ridiculously too conservative and have way too much of my IRA in cash. (I talk my book!)

Kirk:  In the early days, what attracted you to financial journalism as a career?

Herb Greenberg:  Supply/demand. I was working at the Boca Raton News. The Sunday business-desk assignment was rotated every week. This was in the Woodward/Bernstein era. NOBODY wanted to do the business beat. I enjoyed it! The best business decision of my career.

Kirk:  What would you say was one of, if not the major highlights of your career?

Herb Greenberg:  Seeing the former CEO and CFO of Media Vision go to jail. (I had written extensively on the company while in San Francisco.)

Kirk:  What was a major low point and why?

Herb Greenberg:  I haven't really had one beyond the obvious: The downfall of traditional journalism as we knew it. Those were definitely the days. But I also think there are tremendous opportunities ahead, which is why I am shifting to CNBC.

Kirk:  For good or for ill, how do you see financial journalism evolving with the use of blogs and other social media?

Herb Greenberg:  The good: Leveling the playing field with an enormous amount of information. Bad: Zero accountability. Beyond traditional journalists, anybody can say anything under any name - real or assumed - and in the end those same people can disappear.

Kirk:  How do you use social media in your own research? Any tricks of the trade to share?

Herb Greenberg:  Every now and then I'll Twitter in an effort put out an all-points call to find sources in a specific industry. And I search Linkedin to find possible industry sources and ex-employees. Have had more luck with Linkedin than Twitter. I thought about using Facebook, as well, but I have decided (for the time being) to keep that private.

Kirk:  From your point of view, what are the primary strengths and weaknesses of social media?

Herb Greenberg:  Strength: Great way to connect, find sources. Weakness: No accountability.

Kirk:  Investors are seemingly now more informed than ever before yet when faced with real-time information 24/7 many are not seeing improvement in their overall returns. In fact, many have confessed to me privately that the more they pay attention to the financial media, the worst their performance becomes. What are your thoughts, if any, about this phenomenon?

Herb Greenberg:  Depends how you define and/or use media. Media, in general, should be A source of information for investors, not the only source. If they're using media for ideas, they should use it as a jumping off point to do additional research. The trick with the media is finding people who you believe are credible. If you are relying exclusively on media for your trading/investing ideas, perhaps you shouldn't be trading/investing.

Kirk:  It was apparent from reading your columns that you benefited tremendously by tips provided by others (often short-sellers) who would also most likely profit from your columns once you highlighted a major fundamental issue. When you received a tip, what steps would you take to verify its veracity?

Herb Greenberg:  All business journalists talk to market participants. I had a stocks column. I talked to people who were short AND long stocks. I received more ideas than I could possibly handle. Most were based on publicly available data, which was easily verifiable. My question to anybody with an idea: "Where is it in the documents?" After receiving any idea, I had to do the work - not just to verify the information but determine whether it was a story. That's where instincts/experience come in. I'd like to think I had a very good knack at knowing a good story and being able to tell it in a short amount of space. That's the beauty of numbers/public documents: They're all subject to interpretation. That's what makes markets. More often than not I would put an idea from someone new on a pile, never spend a moment on it, and watch how it played out. That would always help create credibility and get me to pay closer attention next time. I expect to do that going forward, as well.

Kirk:  Clearly, not all of the tips provided to you were good or actionable. Do you think short-sellers are guilty of the same hype as those who attempt to push stocks higher?

Herb Greenberg:  Everybody talks their book, and there are creeps and crooks on both sides of the market. However, I spent a year working at an arbitrage firm and it taught me a valuable lesson: We knew more about the stocks we owned than the reporters writing about them. There was often a frustration when we would see them miss or ignore a story. When that happened, we would call them. It wasn't hyping, it was informing - or an effort to inform. I always looked for that frustration when I would hear a new idea. Often my best ideas came from a line I would toss in at the end of any phone call: "So, what else do you know?"

Kirk:  In your experience, do you think those with short-sell focus are the so-called "smart money?"

Herb Greenberg:  There is smart money on both sides. But because shorts generally go against the herd, I have found they often have to be that much smarter on the facts and fundamentals. But truth be told: They're often early!

Kirk:  Why do you think the financial media focuses so much on the bullish-long side versus uncovering fraud other shenanigans?

Herb Greenberg:  It's human nature to be bullish. When you talk "financial media" you need to distinguish between market participants who are commentators versus journalists. Most journalists I know tend to be born skeptics.

Kirk:  As an insider do you think the financial media is unfairly influenced by corporate interests as so many of us outsiders perceive?

Herb Greenberg:  No.

Kirk:  In your final column for the Wall Street Journal and MarketWatch, you boiled everything you learned as a financial columnist to five things. They are:

1. THE NUMBERS DON'T LIE. They can be stir-fried, oven-fried or convection baked, but in the end they always hold the keys to the kingdom.

2. QUALITY, NOT QUANTITY. Ignore the "beat the Street" headlines on earnings. It's what goes into the earnings that counts.

3. GAAP ISN'T THE SAME AS THE GOOD HOUSEKEEPING SEAL. Generally Accepted Accounting Principles, according to which all financial statements are supposed to be prepared, include plenty of gray areas that give management enough rope to hang itself.

4. DON'T CONFUSE STOCKS AND COMPANIES. They sometimes go in opposite directions. The numbers may not lie, but stocks sometimes do.

5. RISK ISN'T A FOUR-LETTER WORD. A good rule of thumb is that before you buy, instead of asking how much you can make, first ask how much you can lose. That is what the smart guys do.

This is a great list Herb. But, I have a few questions about them for further clarification. For example, let's talk about the first lesson - i.e. numbers don't lie. What are some things that you look for that indicate a fundamental problem at the company you are researching?

Herb Greenberg:  For me, it's what makes a good story. And that varies by company and situation. There is no one shoe fits all.

Kirk:  Are there any financial ratios that you specifically monitor more than others in your research?

Herb Greenberg:  Funny you ask that. In the research biz we use Cap IQ and I love their "ratios" page. Answer to your question: Again, no one size fits all.

Kirk:  What have you found to be the most significant fundamental signal that a company's stock price is at high risk?

Herb Greenberg:  I do NOT make valuation calls. I'm a journalist. From an observer's standpoint: I've seen more people steam rolled trying to bet based on valuation and traditionally normal metrics than anything.

Kirk:  I agree with that!

Is there any way to go about acertaining a company's earnings quality? Do you have a quick trick to share in this regard?

Herb Greenberg:  Hate to sound like a broken record: Varies by company and situation. My bias, however - and my business partner Debbie Meritz drilled this into me: Beware of anything that can be a discretionary lever to drive quarterly results. Reversals of reserves and a lowering of the allowance for doubtful accounts immediately comes to mind.

Kirk:  In the third lesson you say that there is a "lot of gray areas" that give management enough rope to hang themselves. What are some common gray areas you've found that tend to be more problematic than others?

Herb Greenberg:  GAAP is a big gray area. Virtually everything is subject to interpretation. I've learned that some managements are more conservative than others. Best thing is to compare the way companies and their peers in the same industries treat the same kind of accounts. Beware of companies that have no true public peers. They can account for anything any way they want and there was no way to tell whether they are being conservative or aggressive. And beware of companies that always seem to be changing the way they report certain metrics, especially if they have no apples-to-apples peers. Can't wait until International accounting standards take effect. They will make GAAP look stringent.

Kirk:  As you say in your fourth lesson, a good stock doesn't necessary make a good company. When looking for stocks that are on questionable fundamental footing and which still have rewarded shareholders handsomely, what are some early red flags you tend to notice in a stock that is vulnerable?

Herb Greenberg:  The point of that was that people often confuse a stock with a company (or the market with the economy.) As I said earlier: No one-size-fits-all.

Kirk:  The fifth lesson is probably the most important in my view - i.e. first ask how much you can lose. As you've heard by know, the market and stocks for that matter can remain irrational longer than you can remain solvent. Speaking of this, when you find a company that has problematic fundamentals but a strong stock, at what point do you know when the right time is to short or sell the stock? Although I know you don't trade your own research, in this business, timing is everything, so how what have you learned about the actually timing of your research ideas? Is there anything you like to watch for that verifies that your research is correct and actionable?

Herb Greenberg:  Actionable is in the eye of the beholder. One person's short is another person's reason to do more research on something they already own - or another person's value stock. And one person's value stock is another person's activist stock. In my former businesses, we didn't issue buys and sells. Our research was often a jumping off point for our subscribers, if they found the idea worthwhile.

Kirk:  As you know, after spotting a company that appears to be a good short-sell, timing is always the difficult part. Although I know you don't trade or invest on your own, do you think this is where technical analysis could be helpful? Why or why not?

Herb Greenberg:  So many people use technical analysis today that, in my opinion, it would be foolhardy to discount it as another tool in trying to pick direction. But remember, technical analysts tend to know symbols, not companies. In the end, it's about the companies.

Kirk:  You don't have to answer this if you don't want to but I'm sure people would be interested to know why you ditched your very successful financial journalism career to start your own research firm and then a couple of years return back again.

Herb Greenberg:  The convergence of a variety of factors, including changes in journalism, just made the timing seemed right. Debbie Meritz, my partner, had mentioned the idea several times over the years. This time I thought, "Why not?" You do, after all, only live once.

Kirk:  Did you learn anything of importance while working at your research firm that will make you an even better journalist now?

Herb Greenberg:  A ton, but don't ask me to be specific. I never stop learning.

Kirk:  In the FAQ page of your firm's research website, you say that "In general, our ideas come from our own proprietary financial screens." Without giving away your secrets, what are some general things your stock screens tend to look for?

Herb Greenberg:  It's an art and Debbie was the artist of our outfit.

Kirk:  You also say that you pay special attention to the business model. Can you explain what you mean by this? For example, what would be a faulty or problematic business model in your view?

Herb Greenberg:  Across the lot. Rollups that can no longer rollup are one example. Companies that have relied on legacy products whose markets have matured are another.

Kirk:  It is generally well-known that there is a historical tendency between the rise of questionable accounting practices and a difficult economy. In other words, when times get tough, companies get more "creative" to keep their shareholders happy and their jobs and bonuses secure. So, have you seen a rise in questionable accounting practices?

Herb Greenberg:  Not yet, but I firmly believe that human nature is human nature and as it becomes harder to beat the numbers, especially with stock prices and expectations so high, human nature will once again rear its head. Speaking of which, I can't BELIEVE people still play the beat-the-street game. That's SO pre-market crash.

Kirk:  A number of sophisticated investors have shared their concerns over how difficult it is to evaluate companies in the financial industry. Has this been your experience as well? Why or why not?

Herb Greenberg:  So easy to hide things because it is way too complicated for all but those who really know where to look. It's a true specialty. I mean - look at all of the geniuses who didn't really know what was really going on in the world of collateralized finance. How many people really dig into the financial documents of each collateralized security, even though most are filed publicly? (Hint: Few. Reason: Too damn complicated.) For that reason we avoided it at the research firm.

Kirk:  Are there sectors of the market that you have found to be more problem-ridden and difficult to research than others?

Herb Greenberg:  Keeping in mind that there are exceptions to every rule, I'd say Biotech, which is another area we tended to avoid. I've seen too many smart people fooled by biotech since the first biotech bonanza in the early 1990s. Too much can happen between concept and Phase 3. We'll leave that to biotech specialists.

Kirk:  In all of the research you've done, what are the names of some of the companies you think are managed well and you also think deserve shareholder praise?

Herb Greenberg:  Good question. Apple is an obvious. So is Starbucks, despite its problems. But there are plenty. You know who I really like? The guys who run P.F. Chang's. For years, when I would write critical commentary, they would take my calls and answer my questions. They never took it personally. They were very non-promotional. They understood that the restaurant business is the restaurant business, which means success is not guaranteed. Regardless of the stock price, Dick Federico and Bert Vivian are great operators.

Kirk:  Likewise, are there any companies out there you don't like for one reason or the other?

Herb Greenberg:  Any company that attacks its critics.

Kirk:  As someone who always keeps their ears close to the ground, are there any investment themes that you think have the potential to captivate the interest of the markets later this year?

Herb Greenberg:  You're giving me too much credit. Answer: No other than the reality that not every company will grow into its valuation. Not every company was well-managed going into this mess and not every company will be well-managed coming out. Just don't ask me which ones!

Kirk:  What is your thought regarding financial reform right now? Do you think anything has changed for the better?

Herb Greenberg:  Wall Street is and always will be Wall Street. Beyond that, if I've learned nothing else from my years in media: Avoid getting political.

Kirk:  Is it realistic to suggest that individual investors have what it takes to do the type of homework you and other professionals do?

Herb Greenberg:  Some do, some don't.

Kirk:  What do you think individual investors must do in order to profit from the market as much as the professionals?

Herb Greenberg:  Know what they're buying and why they're buying it.

Kirk:  Overall, is it your view that most investors would benefit from being an active investor or would a passive low-cost index-focused approach be better?

Herb Greenberg:  Depends on the person's tolerance and knowledge.

Kirk:  How do you think stocks should fit into a person's overall wealth plan?

Herb Greenberg:  I'm not an adviser or planner but, again: Depends on tolerance and knowledge.

Kirk:  Are there any books or other resources (websites, etc.) you'd recommend for those who wish to learn more about how to undertake forensic financial analysis and investing in general?

Herb Greenberg:  Anything by Charles Mulford, the Georgia Tech accounting prof. Ted O'Glove's classic, "Quality of Earnings." And keep an eye out for Howard Schilit's latest revision of his "Financial Shenanigans" book. I've reviewed it; it's very good.

Kirk:  Can you share one or two things that you believe have made the biggest difference in developing your own skills?

Herb Greenberg:  Each mistake is a learning experience. And just when you think you've got it figured out, you get blind sided. It's a continuous process.

Kirk:  In your opinion, what is the single most important lesson you've learned so far?

Herb Greenberg:  Learn to trust your instincts.

Kirk:  Who are the people in this business that you admire the most and why?

Herb Greenberg:  The authors of the above three books -- for starters. There are simply SO many smart people in and around Wall Street and corporate America that it's hard to name them all.

Kirk:  What do you think may be the key ingredient to their success?

Herb Greenberg:  Passion.

Kirk:  Finally, if you had one piece of advice to share with all investors what would it be?

Herb Greenberg:  Old cliche but it has never been more relevant: Don't confuse brains with a bull market - and vice-versa.

Kirk:  Thank you so much for the interview Herb. We wish you continued success in all that you do!

Herb Greenberg:  Same to you.

Your Trading Edge

Earlier this year I was profiled by Your Trading Edge magazine. Although I don't do many interviews, it was an enjoyable opportunity:

Most of what I say in the interview will not be new or shocking to members, but if you are new to the website, you may find it interesting and perhaps helpful in some respects. Enjoy!

Money Mailbag

Time for another mailbag. Here are the topics I’ll cover this fine Friday afternoon:

• Lazy Portfolio Performance Stats

• Using The Guppy MMA

• Potential For 200 Day Whipsaw

• Risk Management & Position Allocation

• Everyday Is A Battle Toward Success

• Should We Go To A 24/7 Market?

• Outperforming Commodities

• Time Frames For Technical Analysis

• Searching For Topics At The Kirk Report

• Pros & Cons Of Disclosing Trades

* This is a members' only post. To read, please login.

Posted by Kirk at 2:26 PM in Questions | Bookmark | Feeds | Link |

Thursday, November 06, 2008

10 Questions With David Fry

It's difficult to believe that it has been well over three years since our last Q&A with David Fry of The ETF Digest! So, we're long overdue for at least a quick update.

If you didn't read the previous Q&A, many of you know Dave from his Daily ETF blog in which he shares annotated charts of many popular ETFs along with his market musings. If you haven't visited his website, I highly recommend you do so!

10 Questions With David Fry

Kirk:  Since our last Q&A, what are some key developments in your area of expertise - i.e. exchange trade funds and their use in portfolio management?

David Fry:  It’s been awhile since we did the last one and a lot has changed. Other than what is probably the tremendous growth of issues available and assets under management there have been some great new developments that we’re thrilled about.

First is the arrival of many Alternative Investment, Inverse and Leveraged issues.

As some investors know, adding true uncorrelated assets to a conventional investment portfolio can reduce risk and increase overall returns. Therefore, having commodity and currency issues have been a major breakthrough. Previous to having commodity and currency ETFs, the only way for conventional investors to deal with them was either directly through trading expensive and highly leveraged futures contracts or in commodity limited partnerships.

As a former CTA [Commodity Trading Advisor] and CPO [Commodity Pool Operator] these pools traditionally involved high leverage, high minimum investments, expensive double digit fees, illiquidity and other negatives that turned-off mainstream investors.

ETFs have changed that considerably. Most of the previous negatives have been eliminated with ETFs linked to Commodity Tracking Indexes, gold, currencies, agricultural products, base metals, energy and so forth. If you want to use some leverage you can add a modest amount with some issues, liquidity is high and costs are comparatively much lower than previous vehicles.

Further, commodity markets are driven primarily by supply/demand issues. It’s as likely to be long a commodity as short. And, in 2007 and 2008 we’ve benefited in both directions.

Currency investing has always been intriguing for most investors but was equally as difficult to participate in as commodity markets. Now, ETFs can be utilized for most major currency markets either for speculation or hedging without having to use the futures market or employ complex options strategies.

Inverse and leveraged issues covering US sectors, major market indexes, overseas sectors, and commodity and currency issues have been a great addition to the ETF Digest portfolio menu giving investors the opportunity to create some basic hedge fund like strategies.

Kirk:  Following what we've seen transpire especially over the past few months, what are some key things you're looking for as we finish up the year?

David Fry:  Given the lethal nature of market conditions taking positions is difficult given the wide intraweek and even intraday trading ranges we’re witnessing. You expand your stops to very wide levels, invest with great conviction and courage or just stand aside in cash.

For us, the key to preserving wealth is risk management.

As they say, the first rule of investing is not to lose money. And, if you’re down 40% or so, you’ll need to make perhaps twice that amount just to get even.

Kirk:  Over the past couple of years we've seen our fair share of significant sector booms and busts. Where are you looking for the next boom to occur and which sectors do you think we'll see as leadership groups over the coming year or so?

David Fry:  The first task is to create portfolios with market sectors that are uncorrelated. Once those allocations have been made, I select a set of ETFs that exhibit the best trending characteristics and that work well historically with our systems.

But, we don’t make forecasts. We only follow our systems which hopefully will lead us to the right trends within those allocated sectors.

Kirk:  A lot of investors have been burned by investing in overseas markets. Looking ahead are there any international ETFs that you think investors should continue to have on the radar screen? If so, why?

David Fry:  We were very overweight overseas sectors whether through BRICs [Brazil, Russia, India and China] or the regional issues like EEM [Emerging Market ETF], ILF [Latin American ETF] and EFA [EAFE ETF].

There was a lot of “talk” that these markets would decouple from US markets but that never happened. The only thing that did happen was the overseas markets rose and fell more in percentage terms than their US counterparts. The old expression, “when the US catches a cold the rest of the world catches the flu” was still operative.

Again, these markets exhibited good trends but did so in both directions. Therefore we were able to make good returns on the way up and the way down through the inverse issues that were available. I remember when we shorted Brazil in the summer through EWZ and that was thought heretical since the bullish theme was so ubiquitous.

I still like these themes but like the trending characteristics of them even better. I expect that to continue into the future no matter the direction.

Even though many investors are uncomfortable shorting, if our exit or shorting signals are sound, then just being on the sidelines is a smart and effective strategy.

Kirk:  Average spreads on ETFs have widened substantially over the past year. Do you consider this to be a problem, and if so, what recommendations do you have for investors?

David Fry:  Spreads were a serious problem when large market makers like Bear Stearns and Lehman Bros disappeared from the scene. Then risk aversion was extreme among remaining firms which led to poor market making and arbitrage for firms. Their credit lines were squeezed and things became inefficient. Further, hedge funds and mutual funds were awash in redemption and margin call issues which created fast market conditions.

When the SEC imposed restrictions on shorting, a large portion of important stocks hurt market making and caused further problems. Many restricted financial stocks crossed-over to major market indexes and that exacerbated inefficiencies.

Kirk:  You've said that "it's more important in a changing global economy to internationalize a portfolio and add uncorrelated assets." The latter - uncorrelated assets - has become quite a challenge. For someone who has a typical exposure to the market using both stocks and bonds, what suggestions would you recommend for those seeking to add uncorrelated assets to their portfolio?

David Fry:  Correlations are extremely important. On occasion you may see an important index generating a sell signal not supported by some of the lesser but highly correlated indexes or subsectors. It can often be important to trade off that one clue versus waiting for all the dominoes to fall in place.

Uncorrelated assets fall into the Alternative Investment category which includes commodity and currency issues. In most market environments and in this one in particular, you are doing yourself a great disservice by not being involved.

With the advent of ETFs whether leveraged or not, the opportunity finally exists for typical investors to get involved with these powerful effective sectors without destroying their portfolio with high leverage, fees and personal stress.

Kirk:  Tell us more about your "aggressive growth portfolio." Why do you think this represents a good model for investors and how has its performance been holding up this year?

David Fry:  You can see how allocations crossed into international and alternative investments with those sectors having heavier weightings [70%] than is typical. But, it’s important to remember that we’re now in November and next month the allocations will be changed again. It’s too early to say how this will be done, but it will happen and we’re working on it.

The Aggressive Growth ETF Hedge Fund Portfolio is up over +6% through the end of October and naturally has done well when compared to its peers. The portfolio went to cash over a month ago.

More exciting for us has been the evolution of Dave’s Special Portfolio [DSP] which pursues a “Multi-Strategy Hedge Fund” approach. The allocations there are 15% Leveraged International ETFs, 10% International Special Situations, 25% US Special Situations, 25% US sectors leveraged long/short, and 25% Alternative Investments [Commodities and Currencies]. The DSP is up over +9% through October 31st and is also primarily in cash.

There’s a favorable aspect of using leveraged issues that suit our style. Since we utilize primarily “weekly” charts to enter fresh positions given our trend-following style we can be late to new positions. Whether long or short, the leveraged issues allow us to make-up ground fast. And, if we’ve identified the trend correctly, these will allow us to beat the indexes ultimately.

Our oldest ETF covered is QQQQ which goes back to the beginning of 2001 when the newsletter began. We covered that alone for the first few years before adding new issues one or two at a time and ultimately portfolios in 2004. So, it’s helpful for investors to analyze our track record for QQQQ.

From inception, the QQQQs using ETF Digest signals returned +19.95% annualized from 2001-2007 versus a buy and hold approach for the same period of -11.69%. But, what investors will notice is that most of the gains were made in the first few years. Since that period, we’ve underperformed the index. Nevertheless, the growth of a dollar over this 7-year period went from $1 to $2.45 versus buy and hold which declined from $1 to roughly $.48.

There are two points to make:

First, it’s always better to restart into trends from a high level than trying to make-up ground from major declines. This is the case with our record since we started back on the long side of the market from a high dollar level.

Secondly, as I stated previously, with the advent of leveraged issues we can make-up ground fast and ultimately beat the index even if we’re late, assuming our trend identification is correct.

Leveraged issues aren’t for everyone. But here’s a strategy tip: If you’re not interested in being leveraged but still wish to hedge yourself or short modestly, use a half position and you’ll still be able to achieve your goal without the leverage.

I believe these issues to be far superior for mainstream investors than the use of options and I say this as a former Options Principal. After all, there aren’t any complex strategies or other considerations like: time premiums, strike prices, expiration considerations, deltas, collars, ratio writing, strips, straps, straddles and so forth.

But, using leveraged issues still requires you to be disciplined and systematic. There are too many investors who think a certain sector is going to make a move and they just throw an order in and lose money.

Kirk:  In the charts you provide at your blog, typically you provide two indicators - the RSI and the MACD and both the 50 day and 200 day moving averages. Why are all of these so important in your analysis? I've also noticed more weekly charts at your blog. Do you think weekly charts should take priority over daily charts in this environment?

David Fry:  Basically I have two presentations, one for the public and one for members. This isn’t duplicitous since the audience is different as are the objectives.

With the public blog, I use StockCharts default presentations which happens to include the indicators you mentioned. The indicator I value on those charts is the “weekly” Relative Strength Indicator [RSI]. I then try to annotate the charts with pithy comments and lines of support and resistance. Needless to say, I like to have fun with the blog as well. I do this to give public readers what I see as market possibilities and little else. Based on feedback, most folks seem to like the both the humor and the analysis.

For members, I utilize much more in the way of detailed technical indicators which I value and from which signals are indicated. For example we’ve integrated complex DeMark Indicators to our system and these seem effective since implementation.

Kirk:  I know from reading you these many years that you practice and encourage strong risk management. When using ETFs, do you have any suggestions or recommendations on how to set stops and generally manage portfolio risk?

David Fry:  It’s not unusual for us to carry a lot of cash. That in itself reduces risk. For example we’re nearly 100% in cash and have been the past few weeks.

Remember, we don’t have a requirement (and most individual investors don’t either) to be fully invested 100% of the time. We’re not running a large mutual fund which often has such a requirement or approach. For them, when money comes in, they just chuck it in there as any portfolio manager with a large cash position might be fired. While that seems harsh it happens to be a fact of life since mutual fund management believes investors are making a conscious choice to be “invested” in that fund strategy.

As indicated previously when using leveraged issues I have a much different approach to our trading. With basic ETF positions we utilize straightforward stop management techniques but we don’t publish stops for many reasons. The most important reason is that they’re changing everyday. So changing them frequently is quite a task beyond blogging and analyzing over 150 different markets. I definitely don’t like to use resting stops in this type of market which can especially lead to a lot of unproductive trading.

As one insight, I’m more interested in what linked indexes are doing rather than ETFs and generally base my stops on that versus the security.

Kirk:  Beyond your own website, what online tools/website do you find particularly helpful to research and monitor the hundreds of ETFs now available to investors?

David Fry:  Reading the Kirk Report gives me good links to topical stories of the day and you’ve done a great job of sorting through all the noise to pick out meaningful stories.

One good thing about the bear market is that it’s slowed new ETF issuance down although some of the commodity, currency and leveraged folks have a lot in registration waiting to come to market. But the SEC, with all its problems, has slowed things down in that as well. Nevertheless, a person in my position must stay abreast of new issue developments by staying in contact with ETF sponsor companies and with that it’s important to have good communications with individuals within these organizations. Therefore we visit them and do podcast interviews with these market veterans. Also, my weekly podcast of the market conditions with co-host Greg Newton is made available to the public on Sundays.

Index Universe does a good job at research and keeping everyone abreast of new issues coming to market.

The Emerging Markets Monitor in London has been a great source for us to stay abreast of developments in important global markets. We do a quarterly podcast interview with the principals and they’ve been very good with fundamental research and market forecasts as any.

I do pay attention to conversation in various bear chat rooms since occasionally they offer links to good articles describing current conditions.

Don Coxe with BMO group has a very good podcast regarding commodity markets.

Greg Newton’s Naked Shorts blog is always interesting and a fun read since he offers articles and comments from an experienced insiders view regarding hedge funds and many other investment issues.

You’ll find many research links to other sites at ETF Digest.

Thank you David. We appreciate the update and wish you well in your market adventures!

Posted by Kirk at 10:40 AM in Questions | Bookmark | Feeds | Link |

Wednesday, June 11, 2008

So, What Do You Do For A Living?

For this week's mailbag I received an interesting question from a fellow member:

"I have recently begun trading full time. On a recent stint in a part-time, temporary job I was asked who I was currently working for. This question came up very frequently both in the social world and the professional world. Although being a trader is a fantastic way to make a living, it does not translate so well into terms that most people would understand. I loathe to label myself "a day trader," and yet that is the closest description of what I do that most people understand. I have also tried "self-employed" but that seems too close to "unemployed" for comfort. How do you describe what you do in a simple sentence?"

As my wife would be the first to testify, I've long struggled answering the same exact question. Truthfully, my answer varies depending on the person who asks. For example, if I'm on vacation and I'd rather not be asked for stock tips by strangers and/or spend my vacation time talking about the market (my usual preference), I'll often say I'm retired. In previous years, I'd get some odd looks due to my age (I'm only 37), but strangely I'm finding that when I say that to people now they don't give me the same weird looks as before. :)

In other contexts where I feel somewhat obligated to actually tell people who don't know me what I do for a living, I usually just say that "I trade stocks for a living." The typical response I receive is about the same as when I tell people I'm retired (i.e. I get some strange looks and odd questions in response). For example, a couple of weeks ago my friend and I were playing golf with two guys we hadn't met before and when I told them that I trade for a living they responded by asking me me the typical question - "You can make a living doing that?" I usually smile and say, "At least so far, but you never know."

So, the question of the day for those of who you trade for a living, what do you tell others in a social & professional context what you do for a living?

Take This Survey

I'd like to collect your responses and share them in a future post to help all of us who struggle with responding to this question. For the five most creative suggestions I receive, I'll even send out a small gift in appreciation to those who send them in. So, put on your thinking cap and come up with some creative responses to this question that those of us who trade for a living must frequently answer. I can't wait to see what you come up with!

10 Questions For Brian Shannon

When Brian Shannon contacted me awhile back to read and provide a review of his new book "Technical Analysis Using Multiple Timeframes," I couldn't have been more excited. Brian has been blogging about stocks for a long time and his video chart presentations are a unique offering that many find useful. His intense passion for the market and deep love of the game itself is evident in everything Brian does and shares with his readers.

Brian's book is an excellent resource because he is such a great instructor. Unlike many books on trading written by traders who frankly have a difficult time explaining their methods, Brian shows his skills by breaking down relatively complex ideas in a straightforward manner. Ultimately this makes his book particularly good for traders who are just starting out on the learning curve and those who've found other trading books too complex or difficult to implement in the real world.

After reading his book, I sent Brian 10 questions so that you can at least get some idea of what is covered there and whether you think it may be something worthwhile to check out on your own.

10 Questions For Brian Shannon

Kirk:  What was your main goal from writing the book? In the book you say admit to being reluctant to write it because "you are still learning and honing your methods" something I can also identify with.

Shannon:   My main goal was to help the reader better understand how and why prices change so they can find a strategy which fits their individual objectives. I wanted to provide a resource for traders which allowed them to better understand market structure and then use that as a starting point to identify and manage low risk/ high profit potential trades. The idea for the book came about as a result of the many questions I receive from readers of my blog. Even with 16 years of full time trading experience, the reluctance to write the book comes from readers expectations which may be too high. No one truly masters the market, there is always a way to do better. I know that you are a golfer and am sure that you have yet to attain the "perfect round", Tiger Woods might even say he is still seeking it.

Kirk:  Why do you think trend following is the "lowest-stress way" to profit from the markets consistently?

Shannon:  I am a big believer in the phrase that "a trend, once established, is more likely to continue than it is to reverse." Trends tend to persist much longer than most people expect. It seems that anytime an uptrend or a downtrend pauses there is someone calling it a top or a bottom, occasionally they get it right, but most of the time the market will continue along the path of least resistance.

Kirk:  According to you, "Technical analysis is not about memorizing patterns - it is rather about understanding the motivations of participants so you can anticipate their next moves." Where do traders frequently go wrong in their analysis?

Shannon:  I think they tend to take technical analysis too literally. Just as you cannot expect to profit from buying stocks with a single fundamental valuation tool (such as buying stocks with a P/E of 15, or any other number), you cannot expect a technical pattern to work all the time. There is a definite cyclical flow of capital through markets, sectors and stocks, recognizing those flows with technical analysis is a starting point for a trader to identify potential trade scenarios. There are many technical traders who spend an inordinate amount of time seeking out the perfect pattern or indicator, but in the end there has to be flexibility and an openness to admitting your analysis may be flawed. Technical analysis is referred to as "an art, not a science" and just as no two people see a masterpiece of artwork exactly the same, the interpretation of price action will be influenced by subjective biases. In the end it is only price which pays us and our final buy and sell decisions should be weighted towards price action first.

Kirk:  You've said the goal is to "time the trade so that your account is exposed to minimum financial downside and the greatest potential profit." How do traders learn how to do this?

Shannon:  By obsessively managing risk and being selective about what you trade and when you trade. To me it is about understanding who is in control (buyers or sellers) and then objectively assessing the potential for risk versus reward. The very definition of an uptrend (higher highs and higher lows) assures us that the sum of rallies will be greater than the sum of declines in an uptrending stock and the opposite is true for a stock in a downtrend, so the simple math tells us that trend trading provides greater odds of profits. Of course, you have to enter the trends at the correct time (which multiple timeframes allow us to do with better accuracy) and be willing to exit with a small loss if the market does not agree with your analysis.

Kirk:  The book focuses some time on the four stages - accumulation, markup, distribution, & decline - a stock (or market) can be classified. Why is it so important for us to know?

Shannon:  Because it breaks the market down into simple logical structure. Stock can be trending higher or lower or they will be range bound. By identifying which stage the vehicle we are trading is in we can start with the odds in our favor and avoid tying our money up in stagnant positions.

Kirk:  Ultimately you think that price action is the most important indicator above all else? Why is this?

Shannon:  Because price is the only true representation of value. Many people claim that "XYZ is under/over valued." The only value which matters is price, if you need to liquidate, that is the value, period. Your models may tell you that it should be worth something else, but what if your model is flawed? In the end the only thing that pays us is price so that is where I focus the majority of my attention.

Kirk:  In the book you recommend that investors, swing traders, and daytraders utilize a minimum of three time frames before you commit capital to a trade. Why is using at least three time frames so important and, more importantly, which one ultimately takes priority over the others when push comes to shove?

Shannon:  I like to use a longer timeframe to identify the primary trend, intermediate term timeframe to plan the trade and short term timeframe for entry and management of the open position. Looking at price action on multiple timeframes allows us to be more precise in our entries and exits which ultimately leads to greater profitability. The timeframe which takes priority for me is the shorter term timeframes. The longer term trends are nothing more than the sum of the shorter term trends, therefore the short term trends lead the longer term trends. With commissions as cheap as they are, I can always get back into a trade if I reconsider my actions.

Kirk:  One of my favorite quotes from your book is the following: "Our job as traders is to objectively observe the supply and demand imbalances in the issues we are trading while we take advantage of the trends that are created by these imbalances. Leave the reasons for the journalists and academics to debate while we go about our business of harvesting profits from the markets. Listen to the market!" As you know, it is a natural instinct for all of us to look for explanations to market and stock behavior and quite a few investors think that the market should be rational at all times when it seldom really is. How did you learn how to stop looking for neat rational explanations as a trader?

Shannon:  Early in my career I realized that the market doesn't care about my opinions and that stocks don't always do what it appears they should do. As we know, the market is a discounting mechanism which looks forward, a lot of times the "reasons" for a move are revealed after the fact. I have always liked the phrase that "news and surprises follow the direction of the trend."

Kirk:  Can you provide a quick explanation to your 1:3 risk/reward ratio analysis?

Shannon:  Sure. First, its not "mine." The concept is that when you identify a trade situation you want to make sure that the potential for reward appears to be at least three times greater than your perceived risk, that way even if you have only 50% win/loss ratio you will still come out ahead. The key words there are "potential" and "perceived". Again, as technical analysis is more art than science, there is a great deal of subjectivity when it comes to measuring the potential in a trade. In essence, a risk/reward ratio is "garbage in, garbage out" meaning that it will only be as good as our analysis and then how disciplined we are in implementing our plans. The risk/reward should be based on actual trading levels where the stock has previously shown support or resistance, not on random percentages or other methods. Risk management is actually one of the longer chapters in the book.

Kirk:  The final chapter of your book "putting it all together" was my favorite because it basically provides readers with nice overview of how you manage your work. Thinking back, how has your routine changed and improved over the years?

Shannon:  I am a lot more methodical in everything I do in the markets. I have become more anticipatory but always wait for price confirmation before I will take action. Early on in my career I would react to what has already moved and find that I was consistently late to a trade. Planning for all potential outcomes in advance will never eliminate losses, but it does reduce the chance that emotions be allowed to influence my thinking and emotional decisions are usually costly.

As you can see, Brian's a smart trader and his book and blog are valuable resources to use and explore further when you have time.

Questions From Members

As always, thank you for sending in your questions to my mailbag! I had a lot of good questions to choose from and there were many I did not have time to answer but will keep them for the next time.

Here are topics I'll cover today:

• Understanding poor market breadth

• Tax loss carry forward for financials

• Dealing with overbought breakouts

• Why timing market tops is more difficult

• Using my screens as a gauge for sector rotation

• How I choose long-term investments

• Perspectives on my timing indicator

• How relevant candlesticks are to my trading

• The one sentiment indicator you really need to watch

• Problems with inflexible trading rules

• Stocks that go up when oil prices go down

• What types of stocks that have rallied the most recently

• A performance update for my Fantastic Four Filter portfolio

• Why you don't see me on CNBC

• Music I listen to before the market opens

To view this feature, you must be member.

Choosing The Right Broker

One of the more popular questions I receive is simply which broker I recommend. Even though over the years I've tried out most of the well-known brokers, I use Tradestation for my trading account and Scottrade for my retirement portfolios.

That being said, I wouldn't simply recommend either of these brokers just because I use them. What is "right" for me and my situation, may not be "right" for you. In fact, my standard response when asked about this is to highly recommend that those who are thinking about switching brokers or opening up an online brokerage account for the first time is to pick three brokers which your research indicates are the best fit for you, your type of trading, and most importantly - your pocketbook. After one year, then choose one broker and stay with it. In fact, that's the process I used to make this decision several years ago and it didn't lead me wrong.

The problem, of course, is that which three brokers do you choose from the wide array that is available? Fortunately, I think Barron's provides a great starting point. I know when I was researching my choices, I found their research very useful. And, if you've been with a broker for a long time now and want to make the switch, I would advise against doing so just out of routine boredom or broker feature envy. In my experience, there is a great deal of benefit from sticking with a platform you know, even if it has shortcomings that annoy you. The last thing you need is to be unfamiliar or uncomfortable with any broker you choose. And, no matter what broker you choose, I've yet to see any correlation between investing/trading success with the type of broker. In fact, if I had to place a bet on it, I think the brokers who offer more advanced options generally experience lower net returns for their customers, even though I have no evidence to back up this assertion.

I-Watch

A common question I receive is how I watch what the elephants (i.e. institutions) are buying and selling on an intraday basis. There are quite a few tools I use to accomplish that, but one of the better free tools available is Thomson's I-Watch.

Here is a graphical representation of today's trading environment:

Syndicate

I know from reviewing my website statistics, that most of you read this website through your regular Internet browser. But, there are other ways to keep on top of what I post.

               

          

If you want to explore these later, just remember you can access these options anytime through the syndicate link on the left-side menu.