Based on the experience with our recent trades we wanted to send an educational piece on our investment thesis. We feel it is an important piece because it details the pure psychology of the markets and our strategy. This is something you won’t see from the majority of advisors. However, psychology truly is the backbone of what moves the markets and why we use technical analysis (i.e. stock chart reading) in our approach.

Yes, our approach is based with a large weighting on a company’s fundamentals (i.e. earnings growth, sales growth, etc), however price and volume action is a guiding principle as it shows what the market is doing - not what the news, commentators, etc are reporting. The majority of individuals don’t truly understand why technical analysis works so well in the market. These people don’t realize that the markets are just one exchange of human emotion; thus susceptible to repeatable movements. Here are a couple great points:

• “…there is nothing new in Wall Street. There can’t be, because speculation is as old as the hills. Whatever happens in the stock market today has happened before and will happen again.”Reminiscences of a Stock Operator, 1923
• All through time, people have basically acted and reacted the same way in the market as a result of: greed, fear, ignorance, and hope. That is why the numerical (technical) formations and patterns recur on a constant basis. Price movement patterns are repeated and appear over and over with slight variations. This is because humans drive the stocks, and human nature never changes. Jesse Livermore

We aren’t going to tell our clients how they should feel – that would be wrong. However, we highly value our clients’ relationships; thus we want our clients to be educated in such a way that they understand the markets or at least understand the way we will manage their money. The difference between what we do and mainstream investment styles is that our strategy is difficult to implement, as it goes against conventional thinking (i.e. human nature). In Gerald Loeb’s classic, The Battle for Investment Survival, he writes, “accepting losses is the most important single investment device to insure safety of capital. It is also the action people know the least about and that which they are least liable to execute.” Though this statement should resonate with all investors, it has a special meaning for us. We tend to be more aware of the relationship between losses and gains than other types of investors. We realize that a large loss affects investment gains over the lifetime of a portfolio.

According to Ed Seykota, elements of good trading include, “(1) cutting losses, (2) cutting losses and (3) cutting losses. If you can follow these three rules, you may have a chance.” Does this make taking a loss easier? Yes and no. Yes, we know we can’t predict the future, that there are statistical opportunities for those who know how to exploit them, that we must respond to every opportunity, and that we must preserve capital to continue investing. And no, we are human and hate to part with something of value. The need for the adage “cut your losses, let your profits run,” is much like the need for the Ten Commandments. We do not have to be told what is in our nature. I once read (but lost the reference) “by going against our nature, instinct and a lifetime of cultural conditioning, trend followers really earn their money”.

The point here is that our strategy will incur losing trades – many of them. Some of these trades will probably sputter and roll over for a minimal loss, while others move for a relatively small gain (the reality of cutting losses and cutting lackluster performers). However, some will advance for tremendous gains. The importance is to always focus on the big picture and not on a trade by trade analysis. This analysis is scrutinized in our personal trading journals. The strategy will prove itself over a 6 -12 months period. Again, using one of the greatest of alltime Jesse Livermore, we see how his principles coincided with this thought process:

• Money is not made in day trading on price fluctuations. Livermore emphasized the importance of focusing on markets as a whole, rather than on individual stocks. He noted that greater success comes from determining the direction of the overall market than attempting to pick the direction of an individual stock without concern for market direction. Investors who focus on the short term eventually lose their capital.

The strategic world of investing is a systemic process that provides a vehicle for individual dreams to become reality; if executed properly. We have spent our careers (many more years ahead) studying and executing the concepts to minimize risk while simultaneously achieving outsized returns. Our concepts, use as a foundation, the William O’Neil CAN SLIM growth strategy.

Recently, an 11-year independent study by the American Association of Individual Investors found the CAN SLIM Investment System gained +1,351.3% while the S&P 500 dropped - 6.9% (1998 through 2008). A concrete strategy demonstrates superior results in an investment advisory practice. An example from developing and leveraging an effective strategy is the availability to control emotions; which an investment advisor must realize these emotions are found in him or herself and that of the client. That is why we don’t get married to fundamentally strong companies. We identify the strongest fundamental companies and then employ our technical analysis methods to assist us in holding/adding to winners or determining our sell levels. We continue to guide ourselves by following key principles that were established to sideline the one factor that clouds judgment and damages ultimate success – emotions.

Those key principles are:

• How you think is everything, so have a system based on sound time-tested rules
• Focus on the big picture; don’t get tied down by the now
• Always follow the trend of the markets not outside ”noise“
• Establish an exit strategy
• Manage client behavior

The most important point here is that a well formulated and executed strategy can combat the volatile future facing the markets.

Sincerely,
Clinton & David
The Friesen Group