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RULES
OF ENGAGEMENT
(for the long haul)
by Joseph Russo
ElliottWaveTechnology.com
April 2, 2007
In
this, our last article in the public series, we will focus our attention
on long-term broad market strategies for self-directed index investors.
The Traders’
Series
is in development, and will be available on our website soon.
In
addition to inviting index investors’ to realize the power and
convenience of Elliott Wave Technology’s Interim Monthly Forecast,
this article will present:
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The
premise and composition for three types of long-term investment
strategies
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Simple
guidelines to which one must adhere in effectively deploying each
-
Pitfalls
and risks if strategy disciplines are not implemented
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Long-Term
Charts of the Japanese Nikkei and the NASDAQ Composite Index from
1982 through present
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An
opening graphical summary of charts illustrating the results of
Elliott Wave Technology’s Pro-Active Long-Term Investment Strategy
for the NASDAQ 100 from 1994 to present
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The
easiest and most effective way for self-directed index investors to
monitor, and automatically track EWT’s ongoing Pro-Active
investment strategies
ELLIOTT
WAVE TECHNOLOGY’S, PRO-ACTIVE / LONG TERM INVESTMENT RESULTS:
This
series began with a Grand Strategy overview of the
NASDAQ 100, as such; we shall conclude with it. Although the NASDAQ 100
is not a large broad based market, it will serve as a prime example in
illustrating the profit capturing strategy of Elliott Wave
Technology’s long-haul investment discipline.
Below
is a performance summary illustrating the difference between practicing
a modest level of strategic control, a purely passive (always long)
strategy, and adhering to Elliott Wave Technology’s “easy
to follow”
Pro-Active Strategy.
In
the table above, the Modestly Controlled, or (mostly passive
strategy) has banked $212,771 dollars in realized profit, and
is positioned long the market with open profits of 7.14% from its last
90 share purchase, re-entering a full position back in September of
2006.
In
contrast, a Purely Passive (always long) Strategy
has booked zero in profits, and remains long the original 90
shares purchased at 397.90 back in August of 1994. The purely passive
strategy has unrealized open paper profits of $123,701 per the
market close on March 30, 2007 - $89,070 dollars less than the Modestly
Controlled Strategy has already taken to the bank!
Elliott
Wave Technology’s Pro-Active Strategy has banked $271,835
dollars in realized profit, and is positioned long the market with
open profits of 34.06% from its current 60-share exposure as of
September of 2006.
In
contrast, a Purely Passive (always long) Strategy
has booked zero in profits, and remains long the original 90
shares purchased at 397.90 back in August of 1994. The purely passive
strategy has unrealized open paper profits of $123,701 per the
market close on March 30, 2007 - $148,134 dollars less than the
Pro-Active Strategy has already taken to the bank!
In
further contrast, our Pro-Active Strategy has outperformed the Modestly
Controlled Strategy by $59,063 dollars or 27%, has less current market
exposure, and open profit of 34% vs 7% on shares held.
Below
are the charts that drive Elliott Wave Technology’s long-term
approach:
Typical
Broad Market / Long-Term Investment Analysis Included with EWT’s Interim Monthly Forecast
Chart
Highlights:
-
Here
we see all three strategies long the market in August of 1994
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Note
the long six-year span prior to any actionable signals
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We
also keep tabs on currency values, inflation, and the gold price in
the upper panel
-
The
indicators in the lower panel of our chart track early warning
signals and monitors the integrity of the Primary trend in force
-
We
define Wave Labels identifying the maturity of trend as price action
evolves
Typical
Broad Market / Long-Term Investment Analysis Included with EWT’s Interim Monthly Forecast
Chart
highlights:
-
Note
how our Pro-Active Strategy begins taking profits at higher price
levels
-
The
Modestly Controlled Strategy waits for a FULL EXIT ALERT to go to
cash
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After
more than six-years without a signal, how many investors maintained
the discipline, and patience in monitoring such events, and actually
went to a full cash position in November of 2000?
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Note
how our Pro-Active Strategy begins fishing for a bottom in October
of 2002
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Properly
interpreting Elliott Wave structures, in combination with
directional and early alert indicators, sets our Pro-Active
long-term Investment Strategy far ahead of all other methods in
managing exposure to broad based market indices
Typical
Broad Market Long-Term Investment Analysis Included with EWT’s Interim Monthly Forecast
Chart
highlights:
-
Note
how wave structure evolution is governed by our Grand Strategy
view
of the market under study
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Of
added note is the increase in signal and caution frequency vs the
goldilocks runaway bull from 1994 -2000
-
Note
how our strategy stands pat amid the seven-month 16.5 % correction
from late 2003 through the summer of 2004.
Let’s
talk Strategy:
We
shall limit our strategy discussions to the three most common categories
of self-directed index investors.Three general types of long-term
investment strategies are:
-
Purely
Passive Strategy
-
Mostly
Passive Strategy
-
Pro-Active
Strategy
The
basic objective:
To
let profits run, and remain exposed to long-term cyclical trends amid a
diversified mix of broad market indices.
The
general exit strategy:
To
cash out when the invested funds are needed to serve a specific purpose
at a designated time in the future.
Purely
Passive strategy:
The
Purely Passive Investment Strategy is a rather simple one. Its
simplicity and brilliance is most compelling, and has broad universal
appeal.
This
strategy involves no effort at all. Its singular objective is to cash
out when the funds invested are required for their intended purpose at a
predetermined future date i.e. retirement, college, home purchase, etc.
Caveat:
In
order to adhere to this simple strategy, one must be totally immune from
emotional, or knee-jerk reaction to market crashes, recessions,
depressions, wars, hyperinflation, deflation, acts of terror, natural
disasters, currency crisis’, and all other imaginable market shaking
events.
The
Strategy:
Stay
fully invested under all market conditions. Dollar cost average, or
invest regular amounts of capital into the markets overtime, and one
should come out on top when one needs the funds for their intended
purpose.
The
only aspect of this strategy that needs management is to define ones’
timeline for exit.
The
premise of this strategy is that markets always rise over the long run.
The appeal lies in its simplicity and effectiveness amid long trending
bull markets.
Is
this a valid premise?
In
numerous instances, history has shown the answer is yes. Large Stock
Exchanges must “go up” to attract investment. That is precisely why
they exist.
Unbelievably,
this seemingly “asleep at the wheel” strategy has worked (in
nominal terms) for decades in select broad market indices. Unless
the current paradigm shifts, purely passive investment strategy should
selectively continue to perform.
Tactical
Considerations:
It
is essential that one diversify when employing a purely passive
investment strategy.
One
must ask and answer the following questions:
1.
Within
what specific time horizon does one generally expect to “cash out?”
2.
What
are the anticipated annual returns vs. risk-free alternatives?
3.
What
mix of broad markets will most likely achieve this objective?
General:
When
we refer to “nominal terms”, we are referring to the returns
calculated from the broad index itself. Nominal returns do not take into
account fluctuations in the underlying purchasing power of the currency
from which the broad market index is derived.
Another
way to describe the enduring success of purely passive investment is to
say that in select indices, paper claims on future corporate earnings
(stocks) have been a good hedge against the eroding purchasing power of
fiat currencies for quite some time.
A
large part of this strategy’s on going success hinges upon governments
continually increasing supplies of money, thus eroding the value of
currencies relative to their respective equity indices. Simply put, this
strategy relies heavily on continued inflation.
By
themselves, inflation, and deflation (a strengthening currency - less
money and credit in circulation) are relatively benign and quite
natural supply/demand responses to prevailing free market
conditions.
However,
the financial sphere is in large part, a tangent manifestation of the
political process. The natural ebb and flow of free markets are often
intervened upon by governments’ central control over the supply of
money and credit.
Right
or wrong, by decree, governments or quasi agents thereof, have control
of managing sovereign fiscal affairs and imposing a desired rate of
inflation or deflation to accommodate the prevailing mandate of the
times.
Risk
imbalances and the potential for dislocations escalate when inflation or
deflation approach extreme, unsustainable levels for prolonged periods.
Risk also surfaces in the short term, should there be a rapid,
unanticipated rate of change in the prevailing inflation or deflation
expectation.
The
deep-rooted paradigm, is that a steady and controlled inflation will
persist indefinitely into the future without interruption or
consequence. This paradigm provides a powerful incentive, fostering
confidence in forever-rising stock prices, real estate prices, and
therefore the general cost of living.
Until
this long-standing paradigm shifts, purely passive investment strategies
will no doubt remain viable in select indices.
Risk:
Given
ones’ broad market selection, level of diversification, and time
horizon for “cashing out,” a purely passive strategy may not always
work out as planned.
Do
the broad markets always “come back?” The short answer is generally
yes; larger broad markets do eventually bounce back, and maintain an
inherent upward bias over time.
However,
one must recognize that there can be unusually long periods of extended
flat, volatile, or downward regress in markets as well.
The
possibility of one’s long-term time horizon coinciding with an
extended flat, volatile, or down cycle, presents the greatest risk
to this strategy achieving its intended objective.
The
Japanese Nikkei Index is a clear and recent illustration of such timing
risk. Had one adhered to a purely passive investment strategy in
the Nikkei over the past 20-years, one would more or less be right where
one started.
The
longer a market continues advancing in an unchecked parabolic fashion,
the higher the odds of reaching an inevitable and lasting crest.
Such
extremes can lead to longer-term sideways or potentially devastating
bear markets, similar to that which the Japanese market struggles with
today, 18 years from its peak.
After
a 13-year bear market slaughter from 1989 -2002, it has taken the Nikkei
5-years to reclaim only 30% of all the gains lost since 1989.
Tokyo’s
Nikkei Stock Market: 1982 - 2007
Typical
Broad Market / Long-Term Investment Analysis Included with EWT’s Interim Monthly Forecast
Chart
Notes:
·
From
a larger perspective, it is clear that from 1982, that Japans fiscal
posture has engendered a long-term deflationary environment
·
Real
Inflation, as measured by the Yens value relative to that of Gold, has
been on the rise since 1999, and continues to accelerate sharply in the
2005-2007 period
The
Nasdaq 100 experienced a
similar massacre; however, the 80% loss in the NASDAQ took place over a
2-year period. It is interesting to note that similar to the Nikkei, the
NASDAQ is also in the midst of struggle to reclaim 30% of its losses,
5-years after bottoming.
The
NASDAQ Stock Market: 1982 - 2007
Typical Broad Market / Long-Term Investment Analysis Included with
EWT’s Interim Monthly Forecast
Chart
Notes:
-
From
a much larger perspective, it is abundantly clear that since the
inception of the Federal Reserve System in 1913, that the United
States fiscal posture has fostered a long-term inflationary
environment
-
Real
Inflation, as measured by the Dollars value relative to that of
Gold, has been in perpetual rise from the turn of our last century,
and continues to accelerate sharply from the 2001-2007 period
Those
who elect to embrace the purely passive investment strategy should do so
knowing that the odds of a sustained long-term down, flat, or volatile
sideways market will increase with each passing year amid a maturing
secular, or runaway bull market.
Mostly-Passive
(modestly controlled) strategy:
This
strategy may fair better, or worse than the purely passive
approach.
Depending
on reactions to various market conditions, such investors may be scared
out of the markets right near the bottom of a deep correction, or become
overly exuberant when markets are in their latter stages of a topping
process.
To
acquire just a modest level of control, one must adhere to a
disciplined strategic approach.
The
Strategy:
This
strategy is very similar to the purely passive approach, but contains
two essential differences.
1.
In
addition to setting a specific time horizon for exit, this strategy also
involves monthly trailing exit stops in order to maintain engagement.
2.
The
strategy also incorporates a monthly trailing re-entry provision in the
event an exit level breaches.
Key
points:
-
Secure a competitive
advantage to provide regular checks and balances
-
Have discipline
to monitor monthly closing price levels
-
Maintain
consistency in adhering to all aspects of management and execution
-
Keep plans as
simple as is needed to accomplish each task
-
Maintain
confidence even in the face of setbacks
Tactical
Considerations:
Defining
ones’ exit and re-entry triggers should be simple, and maintain
adequate alignment with ones’ long-term objectives.
A
monthly moving average that has held numerous closes at key pivotal lows
over an extended period is a good indicator with which to monitor the
health and integrity of longer-term uptrends.
This
strategy will NOT get one out near major tops, nor get them back in near
major bottoms.
The
strategy’s Long-term exit triggers intend to protect the lion’s
share of amassed profit, and move one out of harms way and into a full
cash position.
Likewise,
re-entry triggers intend to assure the longer-term trend has returned to
a more favorable climate, fostering confident redeployment of funds.
Risk:
In
a word, “whipsaw.” Whipsaw is a term describing a choppy or volatile
non-trending market that is stuck in a narrow or wide trading range for
an extended period. Such conditions may trigger a succession of exit,
and re-entries of no apparent value.
Key
Point:z
·
Consider a
flexible strategy so one can adapt to changing conditions
elliott
wave technology’s pro-Active strategy:
The
Pro-Active Investor segment is subject to the same pitfalls as the
previous. Perhaps more so, in that active investors may be inclined to
try to time, or side-step markets more frequently.
To
take such a level of proactive control, one must adhere to a much higher
level of both patience and discipline.
The
Strategy:
This
strategy is very similar to the last, but contains two additional
parameters.
In
addition to dynamic monthly exit and re-entry stops, this strategy
intends to:
1.
Begin
reducing exposure near critical market highs
2.
Begin
adding back exposure near critical market lows
Key
points:
-
Secure competitive
advantage for checks and balances
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Discipline to
monitor price chart indicators on a regular basis
-
Maintain
consistency in adhering to all aspects of management and execution
-
Keep plans as
simple as is needed to accomplish each task
-
Maintain
confidence even in the face of setbacks
Tactical
Considerations:
In
monitoring a combination of wave structures and indicators, this
strategy intends to reduce exposure by 1/3, taking high-level profits
when early warning indicators and maturing wave structures warn in
confluence.
Should
the market continue down, and breach a full exit warning, this strategy
will either disengage and go to a full cash position, or further reduce
exposure, maintaining a 1/3 long exposure, contingent upon the cycle
maturity of the Elliott Wave structures.
Should
the market continue to fall hard for an extended period, this strategy
will monitor indicators and wave structure for signs of a lasting
bottom. When such elements are in confluence, the strategy intends to
begin building back in a 1/3 position size near market lows.
Risk:
“Whipsaw,”
once again Whipsaw is a term describing a choppy or volatile
non-trending market that is stuck in a narrow or wide trading range for
an extended period. Such conditions may trigger a succession of exit,
and re-entries of no apparent value.
Key
Point:
To
summarize, one must identify what type of investor one is, or wishes to
become. Once decided, one must then be accountable, and disciplined
enough in managing the responsibilities associated with their
objectives.
Any
strategies more complex than these would fall under the classification
of trading vs long-term investing.
Until
next time…
Trade
Better/Invest Smarter,
Joseph
Russo
© 2007
Joseph Russo
Editorial
Archive
CONTACT
INFORMATION
Joseph
Russo
Chief Editor & Technical Analyst
Mission Viejo, CA USA
www.elliottwavetechnology.com
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